Hungary Joins Czechs in Recession on Budget Cuts, Crisis

The Czech economy extended its decline and Hungary returned to a recession in the second quarter as government budget cuts sapped domestic demand and the euro-area crisis weakened exports.

The Czech and Hungarian economies, the second- and third- largest among post-communist European Union members, each contracted 0.2 percent from the first three months of the year, according to preliminary data released by statistics offices in Prague and Budapest today. Gross domestic product declined 1.2 percent from a year earlier in both countries.

The worsening economic performance is adding to the governments’ financial strains as they struggle to curb budget deficits with measures including tax increases, which depress consumer spending. Exports from factories including Skoda Auto AS, Daimler AG (DAI) and Audi AG (NSU) continue to support the Czech and Hungarian economies, even as the manufacturers face weakening demand from their main markets in the 17-nation euro area.

“For now, the drop in output in both countries seems to have been driven as much by domestic austerity as by weaker export demand from Europe,” Neil Shearing, chief emerging- markets economist at Capital Economics Ltd. in London, said in an e-mail. “But with external headwinds likely to build over the second half of this year and into 2013, the growth prospects for the entire region are pretty grim.”

German Data

The contractions came even as Germany, the biggest trading partner for both nations, reported today a faster-than-expected economic expansion. The Hungarian forint advanced 0.4 percent to 278.51 to the euro and the Czech koruna gained 0.3 percent to 25.024 per euro as of 5:03 p.m. in Budapest and Prague.

Neighboring Slovakia, which also relies on exports to the euro region, grew 0.7 percent from the first quarter. Romania’s economy expanded for the first time since the July-September period last year. Growth in Poland’s economy, the biggest in the EU’s east, probably slowed to the weakest pace in nine quarters, a Bloomberg survey of 18 analysts shows. Poland will report second-quarter GDP Aug. 30.

The two-year-old Cabinet of Czech Prime Minister Petr Necas is pushing through measures including an increase in sales levies, a new tax bracket for higher earners and spending cuts as it seeks to trim the budget deficit.

Necas defended the plan today, saying it is needed for the government to cut the shortfall to less than the EU’s limit of 3 percent of GDP next year, according to the CTK newswire.

Private consumption will fall this year because of weak real disposable-income growth and negative sentiment, with full- year GDP to shrink 0.9 percent in 2012, according to a central bank forecast published on Aug. 2. Retail sales declined in every month in the second quarter, while consumer confidence fell to the lowest level in almost 13 years in May, according to the statistics office data.

Czech Cut

An absence of demand-driven inflation prompted the central bank to cut the benchmark two-week interest rate to a record low 0.5 percent in June, bringing it a quarter-point below the European Central Bank’s main rate. Policy makers in Prague may further reduce rates or use other measures to meet inflation goals, Vice-Governor Vladimir Tomsik said Aug.2.

“Domestic factors are to blame for the mild but lengthy recession,” David Marek, the chief economist at Patria Finance in Prague said in a note to clients. “Household consumption remains depressed as real disposal income declines. Government eased its consolidation effort, but it cannot provide any significant positive stimulus.”

Investors stepped up bets the Czech central bank will reduce borrowing costs after the GDP data were published.

Bond Yields

Forward-rate agreements fixing interest in February dropped to 41 basis points below the Prague interbank offered rate by 11:05 a.m. in Prague, the strongest bet on lower funding costs since at least 2010. Two-year government bond yields slid one basis point, or 0.01 percentage point, to 0.58 percent, the lowest since Bloomberg began tracking the generic index in 1997.

In Hungary, Prime Minister Viktor Orban is focusing on keeping the budget deficit within the EU limit. Hungary resumed talks with the IMF and the EU in July after a seven-month delay as it seeks about 15 billion euros ($18.2 billion) to reduce financing costs and protect against contagion from the euro area’s debt crisis.

Junk Status

IMF and EU officials are focusing on untangling policies that contributed to the downgrade of Hungary’s credit to junk as recessions in the euro region curbed demand for exports.

They included the flat personal income tax, which cut revenue without lifting consumption and prompted the Cabinet to close budget holes using extraordinary industry taxes that reduced investment and halted economic growth.

The second-quarter figures “aren’t surprising,” the Economy Ministry in Budapest said in a statement, saying the slowdown in Hungary’s export markets caused a “temporary loss of momentum.”

The Czech and Hungarian economies are unlikely to rebound in the coming months, Stanislava Pravdova, an analyst at Danske Bank AS in Copenhagen, said in an interview.

“The outlook for both economies looks pretty gloomy for the remainder of this year as demand for Czech and Hungarian exports is expected to decline further on the back of the deepening economic crisis in euro zone,” Pravdova said.

To contact the reporters on this story: Peter Laca in Prague at placa@bloomberg.net; Zoltan Simon in Budapest at zsimon@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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