OECD Economic Outlook, Volume 2019 Issue 1

Hungary

The economic expansion is projected to slow, but GDP will still grow at 3.9% in 2019 and 3% in 2020. Private consumption will be underpinned by income gains from strong real wage and employment growth. Investment will be supported by the business sector’s need to expand capacity, government housing support and disbursements of EU structural funds. A tight labour market is pushing up inflation and increasingly tight capacity constraints are reducing GDP growth, with expanding demand being increasingly satisfied via higher imports.

Fiscal policy remains expansionary as further cuts in social security contributions are combined with higher spending, particularly on public sector wages. Tighter fiscal policies are required to counter signs of economic overheating. Higher monetary policy rates are needed to limit rises in inflation expectations and contain inflation within the central bank’s 3+/-1% inflation target band. Measures to expand labour resources, including faster reduction of public work schemes and greater supply of early childhood care, would prolong the recovery.

Domestic demand is driving strong growth

Strong private consumption is driven by rising real incomes, high consumer confidence, and supportive macroeconomic policies. Buoyant investment growth reflects disbursements of EU structural funds, generous housing support schemes and the need to expand production capacity, including foreign direct investment in the export-oriented automotive industry. Solid export growth dipped in the second half of 2018 in line with external demand. Rising imports are lowering the current account surplus.

Labour capacities, and inflation: Hungary

1. Percentage of manufacturing firms pointing to labour shortages as a factor limiting production.

2. Core inflation excludes food products and fuels.

Source: Eurostat Industry database; and OECD Main Economic Indicators database.

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Hungary: Demand, output and prices

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A historically low unemployment rate of 3.6% has been achieved, and firms are reporting a severe lack of qualified workers. The tight labour market, strong public sector wage growth and a third consecutive yearly hike in minimum wages have maintained double-digit wage growth into 2019. The pressures on total labour costs have been offset to some extent by the lowering of employer social security contributions. However, the pressures are likely to continue as industrial action in the important automotive industry in early 2019 led to wage increases of nearly 20% in the sector. Higher prices of services, food, alcohol and tobacco – the latter two linked to excise tax hikes -- induced an increase in core and headline inflation from end‑2018 onwards, with the latter approaching 4 per cent in early 2019.

Tighter macroeconomic policies are required to prevent overheating

Stimulatory macroeconomic policies are increasing the risk of overheating and should gradually be reversed. In early 2019, the central bank increased the overnight deposit rate by 10 basis points to -0.05%. This normalisation should be continued, as higher rates are needed to contain inflation expectations. Expansionary fiscal measures in 2019 include lower social security contributions for businesses, higher public sector wages and subsidies for house purchases, leading to an unchanged public deficit despite the strong economy.

The strong recovery is an opportunity to introduce measures to improve fiscal sustainability, reduce old‑age poverty and address access challenges in the pension and health system. Also, the expansion of employment opportunities in the primary labour market allows for an acceleration of the ongoing reduction in public work schemes. This should be combined with investing in childcare, at least at the announced pace, to allow parents with young children to combine work with family life. Bolstering domestic SMEs should focus on improving business regulation, facilitating their integration into regional and national supply chains, and upgrading skills.

Growth is projected to slow amidst rising inflationary tensions

Economic growth is projected to slow, but will remain robust. Private consumption will benefit from continued strong growth in real incomes, while business investment will expand in reaction to increasing capacity pressures. Exports are supported by the installation of new export-oriented industrial capacity, although rising unit labour costs will reduce market-share gains amidst slowly expanding export markets. Imports will remain vibrant, reflecting increasing production capacity constraints. Downside risks include higher-than-expected wage increases that could de-anchor inflation expectations, requiring an abrupt monetary policy reaction. This may also be necessary in the event of negative spillovers from renewed financial turmoil in emerging market economies. In contrast, a faster reduction in public work schemes could ease wage pressures, sustaining the recovery for longer. Likewise, larger‑than‑projected reductions in import price growth would mitigate domestic price developments.