OECD Economic Outlook, Volume 2021 Issue 2

Hungary

GDP is projected to expand by 6.9% in 2021, before growth slows to 5% in 2022 and 3% in 2023. The recovery will be driven mainly by domestic demand. Private consumption will continue to benefit from higher real incomes. Investment will rebound on the back of increasing industrial capacity constraints and inflows of EU funds. Headline inflation will remain high, reflecting supply-side constraints and a tight labour market. A significant risk is that stronger wage growth and prolonged supply shortages could intensify inflation pressures.

Fiscal policy will remain expansionary in 2022, before gradually consolidating in 2023. In contrast, the central bank began a tightening cycle in early summer, which has seen the policy base rate increase by 1½ percentage points to 2.1%. A better-balanced policy mix would help to contain inflation expectations. Moreover, structural reforms should focus on raising potential growth. Labour taxes should be further lowered to help address labour shortages, financed by lower spending and increased consumption, property and environmental taxation.

Economic activity has now surpassed its pre-pandemic level

The initially fast vaccination rollout has slowed and as of November 2021, only about 60% of the population was fully vaccinated. Nonetheless, fewer restrictions and stronger international demand have allowed economic activity to surpass its pre-pandemic level in the second quarter of 2021. Since then, domestic demand has become the main driver of growth, as reflected in the strong expansion of retail sales and domestic orders over the summer, sustaining economic growth of 0.7% in the third quarter. By contrast, external demand is weighed down by supply chain disruptions. Industrial production contracted for the fourth consecutive month in September 2021, while exports and new export orders remain volatile. The resurgence of COVID cases and hospitalisations led the government to introduce new restrictions in mid‑November, including the mandatory use of masks in-door, although no new lockdown measures were announced.

Hungary: Labour market, inflation and new orders indicators

Source: OECD Labour database; OECD Main Economic Indicators database; Hungarian Central Statistical Office; and OECD calculations.

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Hungary: Demand, output and prices

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By mid-2021, the labour market had returned to its favourable pre-pandemic situation, with a fall in the unemployment rate by 0.4 percentage points to 4%, while the employment rate rose by 1.1 percentage points to a historic high of 73.9%. Gross earnings of full-time employees in the private sector continued to register strong growth of around 8% in early summer. Core inflation has been rising due to service price increases, as the services and tourism sectors re-opened, followed by industrial goods price increases driven by imported raw material prices. High energy prices and supply side constraints are further feeding into headline inflation, with the annual rate reaching 6.6% in October and remaining consistently above the central bank’s upper tolerance band of 4% since February 2021. The yield curve has become steeper since spring, pointing to higher inflation expectations.

Fiscal policy will remain expansionary next year

Fiscal policy remains expansionary while monetary policy has entered a tightening cycle. The central bank has raised its base policy rate by 1½ percentage points to 2.1% since June, and has announced further policy tightening via monthly base rate increases as long as the headline inflation forecast remains above the central bank’s target of 3%. Fiscal policy will become more expansionary with another four-percentage point reduction in employers’ social security contributions in 2022, which will compensate employers for the 20% rise in the minimum wage and help preserve their external competitiveness. There will be further temporary tax reductions for small local businesses. In addition, families with dependent children will get a personal income tax refund up to the average wage in early 2022. The announced fiscal measures will contribute to an expected budget deficit of 5.8% of GDP in 2022. The budget deficit will fall to 3.9% of GDP in 2023, reflecting the strong economy and the removal of one-off measures. Despite the large deficit, gross public debt will be reduced by using government reserves. Additional EU subsidies from the Recovery and Resilience Facility will finance investment in health, infrastructure as well as the green and digitalisation transformation, boosting total EU funds to 3½ per cent of GDP annually between 2021 and 2026.

Domestic demand will be the main growth driver

Economic activity is projected to remain strong, bringing economic output to levels above its potential in 2022. Domestic demand will continue to be the main driver of growth. Private consumption will benefit from further increases in real incomes on the back of a tightening labour market. Private and public investment will rebound strongly, reflecting ongoing capacity constraints and stronger inflows of EU funds. Unemployment will decline to pre-pandemic levels in 2022. Higher energy prices are expected to feed into headline inflation until mid-2022. High inflation will persist also due to strong wage growth. The 20% increase in minimum wages in January 2022, affecting about a fifth of all employees, is likely to have strong spillover effects on other wages. However, the impact on overall wage costs, and indirectly on price inflation, will be dampened by the reduction of employers’ social security contributions. Downside risks include prolonged supply chain problems, which together with stronger wage growth could fuel rising inflation expectations. Also, the resurgence of the virus could potentially lead to new lockdown measures and lower domestic spending. On the upside, a faster resolution of supply chain problems and a stronger recovery of major European trading partners would benefit growth.

Policy needs to contain inflation expectations

A faster fiscal consolidation would help contain inflation expectations and secure long-term fiscal sustainability. Structural reforms should focus on raising potential growth. Labour taxes should be further lowered to help address labour shortages, financed by lower spending on mortgage and loan subsidies, and an increased reliance on consumption, property and environmental taxation, while addressing adverse distributional impacts. Productivity growth would benefit from more effective competition regulation as well as enhanced anti-corruption efforts.