Resilient growth and gradual unwinding of imbalances

Hungary is a modest performer among emerging economies and its high dependence on exports, in particular on automotive shipments, causes above-average cyclical fluctuations in growth. Real GDP expanded by an average +2.1% over the past 20 years though the performance was better over the last five years prior to the Covid-19 pandemic (+4.1% on average, on par with the average of the Central and Eastern European EU member states). While the global Covid-19 crisis affected the Hungarian economy markedly in 2020 (-4.5% contraction), it rebounded strongly with a +7.1% output increase in 2021. However, Hungary’s economic prospects have considerably worsened since war broke out in Ukraine. This is mainly due to the country’s heavy (pre-war) energy-import dependence on Russia and the impact of EU sanctions against Russia on the domestic economy. In 2022, economic growth in Hungary still held up better than initially expected (+4.6%) thanks to robust consumer and public spending as well as external demand. However, the impact of surging inflation, rising interest rates, sluggish external demand and deteriorating business confidence took full effect in 2023. Real GDP contracted by -0.9%, largely driven by plunging consumer spending and investment activity. The recovery in the first half of 2024 was subdued owing to continued weak external demand, coming in at +0.6% for the full year. Looking ahead, GDP is forecast to expand to +2.1% in 2025 and +2.6% in 2026, mainly thanks to improving investment and consumer spending on the back of falling interest rates and recovering real income growth. But a weak Germany with strong interlinkages particularly in the automotive sector are gnawing at the growth prospects.

Inflationary pressures have declined but will remain on the cards in 2024-2025. Consumer price inflation rose to a peak of 25.7% y/y in January 2023, the highest rate seen in the EU, driven by surging energy and food prices combined with a weakening forint (HUF, the local currency) in 2022 that pushed up import costs. The Magyar Nemzeti Bank (MNB, the central bank) began monetary tightening earlier than peers in the region (in June 2021) and eventually also more decisively – it hiked its key policy rate from 0.6% in May 2021 to 13.0% in September 2022 and the overnight lending rate to 25.0%. Meanwhile, inflation has fallen back to the upper half of the +3% ± 1pp target range of the MNB and is projected to remain there for most of the period until end-2025. The MNB was one of the first central banks in Europe to embark on a monetary easing cycle in October 2023 and has since cut its key policy rate to 6.5% in December 2024. Further gradual easing is likely in 2025 with inflation hoovering around target.

The Hungarian business environment is just above average. Increased state interference in the economy through frequent and arbitrary policy changes (for example sectoral taxes, pension nationalization, mortgage pre-payment schemes, utility tariff cuts and the weakening of institutions (diminished roles of the Fiscal Council and the Constitutional Court)) have hurt the investment climate in recent years. This is also reflected in the World Bank’s annual “Worldwide Governance Indicators” surveys, according to which Hungary has steadily deteriorated with regard to regulatory quality, rule of law and perceptions of corruption over the past decade. In our proprietary “Environmental Sustainability Index”, Hungary is ranked 141st out of 210 economies, reflecting poor scores for renewable energy, water stress and recycling rate.

Systemic political risk remains somewhat elevated since the government has engaged in unconven­tional economic and institutional measures over the past decade. As a result, international relations have suffered, especially with the IMF and the EU. Currently, the EU is withholding some funding for Hungary under the “Recovery and Resilience Facility”. This probably explains why Hungary’s economy is one of a few in the EU which experienced a huge drop in investment activity in 2023. In the longer term, persistent tensions with the EU may have a damaging effect on investor confidence.