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Thursday, September 27, 2007

World Bank Report on Labour Shortages in the EU10

The European Union's 10 eastern members must take concerted action to increase employment participation levels to avoid a serious short-term slowdown in economic growth and important supply-side structural problems in the longer term according to a report published today by the World Bank.

"Addressing the emerging skills shortages is particularly important, because failure to do so will constrain job creation and future economic growth"

You can find the report summarized here, or you can download direct here.

Claus and I will prepare a full summary and review over the weekend, but for now here are some revealing extracts.

The report in fact says the following:

In this atmosphere of short term turbulence it is important not to lose sight of the longer term trends and the fundamental challenges the EU8+2 continue to face. With the exception of Hungary, growth remains high throughout the EU8+2 and in the case of Latvia represents serious overheating. This growth is sustained largely by consumption and investment. With tightening labor markets, large increases in real wages and employment and very rapid credit expansion, a moderate slowdown in growth may in fact be desirable in the countries showing signs of overheating.

They also have this to say, which is IMHO very important, and to the point:

Unemployment has fallen substantially in virtually all EU8+2 countries since 2004 due to strong growth in labor demand. This has given rise to skill shortages and associated wage pressures, often amplified by out-migration of EU8+2 workers. However, employment/working age population ratios remain relatively low.

Really this is the very point that Claus and I have been making. They then continue:

In contrast to the earlier period of weak labor demand it is now the supply side of the labor market that constrains new job creation. Many persons of working age are economically inactive in EU8+2 either because they lack skills demanded by employers, or because of labor supply disincentives, such as early retirement benefits, generous disability schemes, high payroll taxes, and limited opportunities for flexible work arrangements. These effects are concentrated among the younger and older workers, while the participation rates for middle aged workers are similar to those of the EU15. Hence the main challenge facing now EU8+2 is to mobilize labor supply to meet the demand. Addressing the emerging skills shortages is particularly important, because failure to do so will constrain job creation and future economic growth. To increase the effective labor supply EU8+2 countries need to: (a) improve labor supply incentives through reforming the social security systems, (b) improve worker skills through reforming the educational systems and improving domestic mobility; and (c) import labor with skills that are in short supply by opening labor markets to foreign workers. The weights assigned to each policy depend on the nature of the most binding constraint to labor supply, which vary across countries.

also this is very important, even if I am nowhere near as optimistic as the World Bank is about the possibilities of Eastern Europe staying out of the firing line, especially as the eurozone itself is slowing fast.

The effects of deepening financial turbulence would potentially be more serious for the EU8+2, but are more difficult to predict. The greatest risk is that the countries that have large current account deficits – the Baltics, Romania and Bulgaria – are suddenly less able to finance them through capital inflows and are forced into an economic contraction. This is particularly true for countries like Hungary that are highly dependent on more volatile portfolio inflows than on FDI. Banking sector foreign borrowing which is the main financing source in the Baltics is generally less volatile than portfolio flows, but the extreme surge in the Latvian CAD (to 30% of GDP in the 12 months to end July ) clearly cannot be financed in this way in a sustained manner. There are other potential risks as well. A general retreat from mortgage lending provoked by US experience would lead to broad based credit tightening and weaken the booming construction sector in the EU8+2. Moreover, the increased risk sensitivity may cause the unwinding of carry trades making external finance more difficult for higher interest, carry trade destination countries.


In the latest quarters unemployment rates have either continued to fall or have remained fairly stable despite upward seasonal pressures. In several countries unemployment rates declined to historical minima (the Baltic States, the Czech Republic, and Poland). Employment rates in Latvia, and also in Estonia reached the highest levels since the start of transition and are around 68% for people aged between 15 and 64 years, which is close to the Lisbon strategy target of 70%. Nevertheless, further employment increases may be limited because of structural nature of joblessness due to skills mismatches and unwillingness to relocate or retrain, which is particularly relevant for those who stayed out of the labor market longer.

The recent trends have undoubtedly strengthened the power of employees in the wage bargaining process. Real wages have begun to grow rapidly in Poland where their expansion had been moderate so far. The highest growth is occurring in sectors which suffer most from shortages of workers (for example, construction). Rising employment and strong dynamics of real wages are pushing the growth of the wage bill into double digits. Nevertheless, demands of higher wages for public sector employees come into sight in most countries in the region. In Bulgaria and Poland, trade unions are prepared to resort to strikes or the threat of strikes in wage setting negotiations.

In all countries apart from Slovakia and Slovenia, wages are growing faster than labor productivity. Rising unit labor costs provoke central bankers in the region to tighten monetary policies (Poland and the Czech Republic). Apart from inflationary pressures, excessive ULC growth may undermine competitiveness and prospects for sustained long-term output growth and further labor market improvement.

Monday, September 24, 2007

Hungarian Central Bank Cuts Interest Rate

Hungary's central bank have just cut their benchmark interest rate for a second time this year. The rate-setting Monetary Council, led by bank President Andras Simor, cut the two-week deposit rate by a quarter of a percentage point to 7.5 percent after having left it unchanged since June.

Hungarian inflation, which is the European Union's second-fastest after Latvia, has slowed ever so slightly of late, after reaching a six-year high in March. In fact the annual inflation rate fell to 8.3 percent in August from 8.4 percent the month before, reaching the lowest level since January 2007. The central bank last month said it expects the pace of price increases to slow further.The Banks is rather caught at the moment in a deep sea between the rock of falling domestic demand and the hard place of having 80% of the outstanding mortgages in swiss francs, and thus needing to defend the forint. Stubborn inflation would occuply the middle ground in this panorama. According to the Bank press statement:

"Our 3 percent inflation target is attainable in 2009, if the increase in agricultural, food and energy prices doesn't lead to second-round effects... the bank....expects inflation to gradually moderate in the next two years. The Monetary Council sees room to lower the benchmark rate."

Forward-rate agreements show that investors have already stepped up their expectations of rate cuts in the next five months. They now expect more than 50 basis points, compared with less than 25 basis points a month ago. We must now wait and see what effect all of this has on the forint.

Friday, September 21, 2007

Migrants and Hungary

The BBJ ran this article this morning:

EC: Hungary needs more immigrants

Thanks to an aging population, Hungary will have to get ready to attract a great amount of immigrants over the next years – the European Commission said.

The EC added that migration is the solution for the EU as a whole, as it is facing acute shortage of workforce in the near future. The Commission also pointed out that Germany, Italy, Hungary and Latvia will be hit by the heaviest shortage of qualified workers. In the next 20 years the EU – currently the home to 18.5 million non-European immigrants - will need an additional 20 million immigrants to ensure its work force.

The article is covering a speech by Justice, Freedom and Security Commissioner Franco Frattini which is well summarised here. Among other things - and over and above the fact that Hungary was specifically singled out as having a specific problem which needs addressing - Frattini said the following:

"Countries with rapid economic growth in recent years, such as Spain and Ireland, have clearly benefited from the in-flow of skilled workers from both within and outside the EU. Across the EU all skill levels are required. The challenge is to attract the workers needed to fill specific gaps. Working together makes the EU stronger not just when dealing with problems such as illegal migration and border management, but also in seizing the opportunities which migrants embody. Common action at EU level also gives member states a stronger voice on the international stage, bearing in mind that there is competition between different countries and regions of the world for skilled migrants, especially with high qualifications."

Now I have recently been advocating increased migration as one of the ways to reduce the massive wage pressure that is building up in Latvia and the Baltic economies generally. I also have a post here on the more general underlying demographic issues in Hungary here.

The strange thing is perhaps that at the present time all of this seems to be a bit "unworldly" in the Hungarian context, since with the dramatic slowdown which is taking place Hungary is presently the only EU 10 economy where there is NOT a serious labour shortage developing (although there may, even in Hungary, be skill shortages in some specific areas). But we need to think in the longer term here, and look to an eventual economic recovery, and try to consider the specific problems Hungary will be facing given its demographic profile. So changes are needed. Changes in paperwork, changes in regulations, and above all changes in the way people see this particular problem.

Wednesday, September 19, 2007

Wages and Employment in Hungary July 2007

The latest wages and employment report is now out from KSH. Real wages in Hungary dropped by 5.2% year on year in July when compared with the harmonised CPI, but this was a slight improvement over a 5.3% decline registered in June. What is obvious is that there has been a severe process of wage deflation in Hungary since the start of this year, although the pace is now slowing somewhat, with he sharpest fall in real wages being registered in February (-9%).

Here is the relevant chart:

Public sector gross wages have maintained a slightly higher rate of increase than last month (9.3% y/y up from 8.6% y/y last month) as expected due to a jump in bonus payments. Private sector gross average wages were up to by 10.8% y/y slightly under 11.4% y/y last month.

Despite the ongoing drop in real wages, employment has remained stubbornly stationary all this year, as the following chart illustrates.

Tuesday, September 18, 2007

Construction Activity July 2007

Well, the construction index was up 1.3% month on month, but that is about the only good thing which can be said about the latest set of construction activity data released by the statistics office.

In July 2007 the volume of the construction activity decreased by 13.7% according to unadjusted indices and by 14.6 according to ones adjusted by working days related to July 2006. In the first seven months the output was by 5.8% under level of the same period of 2006. In comparison with the previous month the production grew by 1.3%, according to indices adjusted seasonally and by working days.

Given that the drop was so substantial in June it is really quite hard to know how to interpret this data. It could, I suppose have been worse. We really need to see some more industrial output data and some more retail sales data before we can get a clearer indication of what Q3 GDP is going to look like.

Anyway, here are the charts:

Friday, September 14, 2007

Hungary Aug 2007 CPI

I'm a bit late posting about this, but somehow or other I didn't find the time. Hungary's CPI surprised on the upside last week, according to data released last week by the statistical office, rising 8.3% year on year in August from 8.4% in July. Core inflation fell to 5.4% from 5.6% yr/yr. Food prices seem to have been the main culprit and they continue to remain a key inflationary risk.

“The surprise came entirely from food prices, with other categories behaving as expected," Silja Sepping of Lehman Brothers said. The closely watched market services price fell modestly on an annual basis, as did tradable goods.

Inflation in unprocessed foods seems to have ticked up to 12% yr/yr from 9% in July while processed food inflation (that's part of core CPI) remained broadly unchanged. There are two main factors at work: i) sharp rises globally in wheat and maize prices; and ii) adverse weather conditions in Hungary over spring/summer this year.

Global trends have started to be reflected in items such as flour prices (up 7.1% m/m), egg prices (up 6.9% m/m), poultry meat (up 3.2% m/m, milk (up 4.3% m/m) etc. Given the modest increase in bread (1.7% m/m) in August. According to the Hungarian press, bread prices could rise by as much as 10-15% in the autumn.

This is obviously going to complicate the work of the central bank in terms of interest rate policy. As if things weren't already complicated enough.

Here is the chart of the annual rates by month, and as we can see annual changes in the CPI are remaining stubbornly high:

Friday, September 07, 2007

Hungary Q2 2007 Revision , Is Recession Near?

The Hungarian economy grew in the second quarter at the slowest annual pace in more than a decade following the introduction late last year of a strong austerity programme which involved the government cutting public jobs and raising taxes, with a consequent strong knock on effect on consumer spending and investment. The statistics office today revised downwards the second-quarter 2007 GDP growth figure today from 1.4 percent reported earlier. This means - at 0.1% growth in the second quarter itself - the Hungarian economy is now in effective zero growth mode, and the outlook entering the second half of the year seems set for negative growth.

Hungary's year on year growth rate fell in the second-quarter economic growth to 1.2 percent, the slowest pace among the European Union's eastern members. It compares with 2.7 percent in the previous three-month period, the statistics office said today. Here are the relevant charts:

The engine of growth continued to be the industrial sector with 7.8% yr/yr growth, which was largely driven by a 14.6% increase in export demand. Household consumption fell 3.3 percent, after declining 0.8 percent in the first quarter. Government consumption was 2.8 percent lower. Gross fixed capital formation rose 0.8 percent.

The decrease in the services provided by the government sector took its toll as public consumption declined significantly as a consequence of the austerity measures.

Despite the slowing growth the central bank will have a hard time taking any decision to cut the benchmark interest rate from 7.75 percent for a second time this year in the current financial environment given the dependence of so much private debt in Hungary of foreign currency denominated credit and the impact rate reductions may have on the value of the forint. Rate setters will next meet to decide about any possible rate change on Sept. 24

Thursday, September 06, 2007

Industrial Output and Exports July 2007

According to the KSH preliminary release Hungary's industrial output was up again in July, which is obviously good news. Let's look at the deails. Firstly the working day adjusted volume index for industrial production.

So industrial output has turned upwards since May, and as I say, this is obviously good news. There is a lot of speculation that this is due to an upturn in exports, and this explanation seems to be a logical one, since domestic demand is basically in decline. However, as can be seen from the chart below which tracks month by month changes in output, the rate of increase in July slowed from the very strong rate achieved in June, so we need to watch carefully what happens next. This being said the position is a lot better than might have been feared. The issue will be to maintain this expansion in the export sector going into the autumn.

Now in order to interpret this data we need to examine the detailed report on industrial output when it becomes available, and the July trade figures, a preliminary version of which have today been made available by the statistics office. We also need to be aware that this data is from July, and we still do not know at this stage to what extent Hungary's main external customers are themselves slowing down following the recent financial turmoil, but this vulnerability is of course the price you pay for export dependence.

Now, according to the KSH:

During January-July 2007, the value of exports was HUF 9,603 billion, while that of imports totalled up to HUF 9,763 billion. The value of the exports is estimated to have expanded by 12 percent, while that of imports by 9 as compared to the corresponding period of 2006. In euro terms, exports grew by 18, imports by 14 percent. The trade deficit reached HUF 160 billion (EUR 639 million), which is less by HUF 256 billion (by EUR 958 million) than in the same period of the previous year.

So let's look at some charts. Firstly lets look at the year on year annual monthly changes in exports and imports:

Now the first thing that needs to be said is that while these results are obviously positive, they are nothing to start dancing up and down in glee about. July was a positive month, but not as good as June, and most of the improvement in the trade balance comes - as was to be expected - from a very slow rate of increase in imports. This becomes clearer if we look at the evolution of absolute values.

What we can see here is that the level of both exports and imports actually fell in July in comparison with June, so it is not clear that this data can explain the industrial output data, and if we take into account the very weak new order showing that Hungary registered in August as released by Eurostat I think we need to proceed with caution. It is also interesting to note the way in which imports have seemed to track exports in recent months, to get a real export lead recovery we should look for the export curve to break loose in an upward direction.

This is doubly the case if we look at a breakdown of where the exports actually go. Germany is the biggest single customer, accounting for 29,85% of the toatl in the January - June 2007 period (and a y-o-y rate of increase of 17,8%). The EU12 also take a big chunk between them - 18.7% of the total (and a massive y-o-y rate of increase in the Jan - June period). Now both of these areas must be viewed as having strong downside risk in H2 2007. Germany is obviously slowing already, and may even have a recession in the winter, the EU12 have been overheating considerably as a group (obviously this isn't the Hungarian case) and are generally slowing. So the current comparatively strong export showing has to be viewed with considerable caution. The inability of the Bank of Hungary to lower rates due to the domestic problem of Swiss Franc mortgages, and the resulting comparatively high value of the forint must be the main downside element in trying to push up export shares in n increasingly unfavourable environment, although - as I keep hammering - a drop in the value of the forint would be very bad news on the domestic demand front, indeed rather than simply bad news I would say disastrous news. But what will be will be. Watch this space.

Wednesday, September 05, 2007

Hungary July 2007 Producer Prices

This report is now a little dated but still, I think it is interesting to put the industrial output numbers in some kind of perspective, and especially the export component. According to KSH, Hungary's industrial producer prices were down by 2.8% year in July 2007 year on year. Export prices were up 0.6% m/m despite a stronger exchange rate in July, while the increase in the price index in domestic sales moderated to 0.1% m/m from 0.3% in June.
Obviously the downward trend in domestic producer prices mirrors the weakening in domestic demand, and this offers support to the disinflation process. Prices of domestic food processing industry sales showed the only outstanding price increase (0.8% m-o-m), while prices in other major manufacturing remained flat.

Prices for export sales still reflect a significant process of deflation, with the y-o-y data showing a drop of 9.9%. The m-o-m figure however is already reflecting the recent HUF weakening, and showed a 0.6% rise, the highest for more than year.

The consumer good component of the PPI - which to some extent correlates with the CPI number dropped y-o-y to 3.7%, but the m-o-m figure was 0.6%, which could constitute a warning signal - especially on the back of June's 0.4% - that the near-zero m-o-m rates achieved during the first five months of the year are now over.

Domestic price inflation for food products was 7.1% yr/yr, which was down from the 7.5% June number and the 7.6% May one, hence the short term CPI outlook may be holding steady.

Here is the chart for m-o-m changes in domestic sales prices and export prices:

and below are the year on year changes.What we can observe is that there is now a very strong disinflationary process at work.