Hungary

High inflation drags on growth

Consequences of weak economic activity that materialised with the recession and which started in the second half of 2022 and continued into 2023, will spill over into 2024. The prolonged period of high inflation has eroded disposable income and is a contributing factor to declining household consumption. Hungary’s inflation rate soared to the highest level in the European Union and exceeded 25% in the first quarter of 2023. Despite preceding months which brought a gradual disinflation process, consumer prices were still 20% higher in June 2023 than a year before. The reasons for price acceleration are similar to other countries – the increased costs of imported energy and other economic consequences of war in Ukraine. Also similar, relatively lower commodities prices have had a diminutive impact on inflation, with the latter experiencing overall price increases that spread to other parts of economy, as confirmed by high levels of core inflation that still exceeded 20% in June 2023. Nevertheless, Hungary’s inflation also includes specifics: the relaxation of energy price caps made it accelerate strongly while those still in place on selected food products resulted in companies being compensated with price increases for products not covered by caps. Furthermore, weak harvests in Hungary in 2022 decreased supply and fuelled agricultural product prices. Last, a loose fiscal and monetary policy that started in the pandemic year 2020 and continued to include increased public spending ahead of 2022 elections added to inflation pressure amid a strong labour market through double-digit wage growth. Furthermore, the weakened forint contributed to higher imported goods prices.

Investments will remain muted for as long as the economy benefits only from growing net exports. Lower imports will contribute to the latter amid moderate-low key domestic demand, and improving external demand expected in 2024. The slowdown in Hungary's main EU trading partners has had a major impact on local industry, especially automotive, electronics and machinery, which are highly integrated in Western European supply chains, particularly as Europe could again suffer from potential challenges in energy markets in the winter of 2023-2024. Hungary's economic recovery could remain tepid and only revive during the second half of 2024 given the limited improvement of trade partner activity.

Despite currency exchange volatility, the National Bank of Hungary (MNB) is expected to continue normalising its monetary policy. Since prices started to accelerate in the second half of 2021 a series of hikes were performed elevating the base interest rate to 13% (the highest level among Central and Eastern European countries) in September 2022. Since then, the base rate has remained on that level. However, the central bank has already started to decrease its deposit tender rate. Nevertheless, the MNB is expected to be cautious with monetary easing due to durably high inflation and possible forint depreciation despite the currency’s partial recovery from weak levels recorded in the last quarter of 2022.

Budget deficit moderating but still high

After the high fiscal deficit recorded in recent years, including during 2022 due to the energy crisis and post-pandemic expansionist policies, fiscal consolidation has been supported by windfall profit taxes in the energy, banking, insurance, retail, telecommunications and aviation sectors as well as increased revenues in the environment of high inflation. Nevertheless, the deficit level, although moderating, will remain relatively high in 2023 due to persistently significant public debt servicing and huge government subsidies that are required to attract large FDI projects. Compensation paid to utility companies to cover their losses due to subsidised regulated energy prices has abated in line with falling gas prices.

Economic recovery and less pressure from energy prices should further support fiscal consolidation in 2024. However, the latter is not expected to return to pre-pandemic levels, especially since debt servicing costs will continue to be high while revenues will suffer from the expiration of temporary taxes. Clashes with the European Commission are limiting EU financial transfers to Hungary; however, funds from the previous Multiannual Financial Framework (2014-2020) are still in place, as well as the EU’s direct payments to farmers. Conversely, negative developments in terms of further access to EU funds, resulting in investors' negative sentiment in relation to Hungary, and sovereign downgrades by rating agencies could hinder Hungary’s access to domestic and international debt markets.

Fidesz secures a further term in office

Prime Minister Viktor Orbán and his conservative Fidesz-Hungarian Civic Union (Fidesz) party were re-elected to a fourth four-year term in the April 2022 elections. They secured another supermajority in Parliament, after similar electoral victories in 2010, 2014 and 2018. Fidesz continues to benefit from its ability to govern unilaterally. Despite a challenging economic environment and extremely high food inflation, the government’s popularity has remained relatively unscathed as government-owned or dominated media put the blame for elevated prices on the war in Ukraine and EU sanctions.

Relations with the European Commission remain tense. In 2020, the European Council adopted the “conditionality mechanism” to wield an effective instrument that subjects disbursement to the rule of law in the respective country. Later, the European Court of Justice (ECJ) ruled in 2022 that the Commission could withhold funds to sanction states deemed to be flouting the rule of law. Both Hungary and Poland have been under EU investigations for undermining the independence of courts, media and non-governmental organisations, thereby putting them at risk of losing tens of billions in EU funds. Hungary subsequently introduced only minor changes that did not satisfy the European Commission. The dispute with the EU over the release of funds is set to continue for the foreseeable future.

Fidesz is expected to remain in power until at least the end of its current term, i.e., in early 2026. Local elections are scheduled to take place in October 2024.

Last updated: September 2023