My Hungarian authorities thank staff for the candid discussion and their report, which presents the economic developments and policy challenges in a very balanced way. The authorities broadly agree with staff’s assessment of Hungary’s economic and financial position and appreciate the thorough and constructive policy dialogue and policy recommendations.
Economic growth remains strong, supporting economic convergence and building resilience amid a gloomy global outlook. Hungary has been one of the fastest growing economies in Europe, registering 5.1 percent growth in 2018, and similar performance is expected to be achieved in 2019. Unemployment is at historic low levels at close to 3 percent and the employment rate exceeds EU average. The growth momentum has been preserved despite the significant deterioration of the global economic outlook and the slowdown in Hungary’s main trading partners, with strong signs of a decoupling from the German business cycle. Growth has primarily been driven by strong domestic demand, while the external balance has been maintained. Investment has been buoyant in recent years, with a steadily rising investment rate exceeding 26 percent by 2019.
Although growth is expected to decelerate in the medium term, the authorities intend to maintain a 2-percentage point growth surplus over the euro area which would continue to support convergence. The authorities broadly share staff’s assessment on the sources of global risks and plan to preemptively implement a series of measures to preserve Hungary’s economic results and further build resilience. Hence, the government decided in May on the Economy Protection Action Plan, which is now in the course of legislation, and includes several tax cuts, simplification of tax administration, various supportive measures for SMEs, and increased spending on R&D. Additional impetus would also come from the implementation of the competitiveness reform, outlined in this Buff statement.
Fiscal performance remains strong with prudent fiscal planning and execution, and a steadily declining debt trajectory. The public debt-to-GDP ratio has decreased from above 80 percent in 2011, to around 68 percent by the end of 2019, and is expected to decline further in the coming years. External debt has declined significantly too. The composition of the debt has shifted to a healthier and less vulnerable structure as a result of the debt management strategy to reduce the share of foreign debt and replace it by domestic debt on one hand, and refinance maturing FX debt with domestic currency-denominated debt on the other hand. The central bank’s self-financing program, and the domestic wholesale bond and retail bond issuances were helpful in this respect. In addition, the new domestic retail bond (MAP+) is instrumental in lengthening maturities, reducing external vulnerabilities, building a stable domestic investor base, and not least in alleviating pressure in the real estate market.
The budgetary balance is expected to decrease to historically low levels in 2020 and 2021. After a 1.8 percent deficit in 2019, the 2020 budget foresees a further reduction in the overall deficit to 1 percent. In addition, exceptionally high contingency reserves of about 1 percent of GDP are budgeted, as a buffer that would allow for the operation of the automatic stabilizers, should the downside risks to the economy materialize. The budget is built on a rigorous expenditure control resulting in a countercyclic fiscal stance, in line with the IMF staff’s previous recommendations. In the medium term, the authorities aim for a zero overall deficit, which is in line with staff’s proposed medium-term target, and attainable under realistic macro assumptions.
On the revenue side, the continuously improving efficiency in tax collection and the whitening of the economy has been crucial for the fiscal performance in recent years. Owing to the installation of the on-line cash registers and the electronic billing system, the VAT-gap has decreased significantly in recent years, and is now well below the EU average. The previously imposed taxes to mitigate the impact of the global financial crisis, directly affecting certain sectors, have been mostly phased out. Some of them were replaced with consumption-turnover type taxes having a less distortive effect on investment and growth. The bank levy has been significantly reduced.
Having said this, and given staff’s overall positive assessment of the fiscal developments, we are puzzled by staff’s categorization in the context of the pilot Fiscal Space Assessment Framework, that fiscal space is “at risk”. Within this framework we would deem more appropriate the usage of the term “some fiscal space”.
Monetary policy has been accommodative and continues to be data driven. The central bank of Hungary (MNB) has kept the policy rate unchanged at 0.9 percent since 2016, with some minor tightening of the interest rate corridor in March. Monetary conditions have been further fine-tuned by using the crowded-out liquidity target and FX-swaps. The MNB cautiously monitors international monetary policy developments as well as domestic inflation developments and stands ready to fine-tune monetary conditions as deemed necessary. Domestic inflation has been fluctuating within the MNB’s tolerance band, at levels somewhat lower than the earlier forecasts. A dichotomy remains between the factors determining domestic inflation, as domestic demand remained buoyant, while external activity is restraining inflation, along with global monetary policy turning dovish. Nonetheless, the MNB assesses that the previously symmetric risks to inflation became asymmetric in the second half of the year, with downside risks having strengthened further reflecting the economic slowdown in Europe.
The MNB has launched two new instruments recently: The Funding for Growth Scheme Fix (FGSfix) was launched at the beginning of 2019, targeting SMEs, in order to increase the share of predictable, fixed rate loan products within the financing of investments of SMEs. The Bond Funding for Growth Scheme (BGS) was launched in July, targeting larger enterprises, with the aim to purchase bonds issued by domestic non-financial corporations with an at least B+ rating, to promote the diversification of funding to the domestic corporate sector and develop the corporate bond market.
The financial sector is overall healthy and resilient. The shock-absorbing capacity of the Hungarian banking system continues to be robust. Banks’ capital adequacy ratios indicate strong solvency, while the liquidity coverage ratio is also well above the regulatory requirements. Banks continued to expand their balance sheet, especially their outstanding loans vis-à-vis the private sector.
In order to foster the mitigation of households’ interest rate risk, the MNB issued a recommendation to financial institutions, advising banks to offer customers with variable-rate mortgage loans the option of transition to a fixed-rate scheme. In the corporate loan segment, the share of fixed-rate loans increased for longer maturities, thanks to the FGSfix. Further improvement in the corporate sector’s resilience to crises as well as opportunities for diversifying funding may be fostered by the BGS.
Beside its regulatory mandate, the MNB is committed to tackle the existing inefficiencies in the banking and the broader financial sector, enhance competition and support the consolidation of the sector, while paying attention also to consumer protection. The launch of the frameworks for “Certified Consumer Friendly Housing Loans” and “Certified Consumer Friendly House Insurance” point into this direction.
The MNB has just published in October its FinTech strategy, which provides a comprehensive framework for the MNB’s digitalization efforts in the financial system and sets out 24 specific initiatives and proposals.
Further structural reforms aimed at enhancing competitiveness and potential growth are high on the authorities’ agenda. The government’s Program for a More Competitive Hungary, prepared under the guidance of the National Competitiveness Board, and relying on proposals from the MNB, the Hungarian Chamber of Commerce and other independent bodies, sets out the structural reform agenda in six areas: employment, business environment, taxation, public sector, education and healthcare. With its main objective to improve medium- and long-term growth prospects and competitiveness of the economy, the program targets key areas and bottlenecks where reforms can lead to substantial productivity gains. Measures include facilitating widespread access to quality health care and education, decreasing administrative burdens, improving the competitiveness of the tax system and promoting digitalization. Special attention is given to labor market reforms, facilitation of mobility, the employment of mothers with small children and retired persons. The government just published its new SME strategy with the aim to improve access to finance, reduce administrative burdens and provide targeted support in various fields including innovation, management practices, business transfers and access to export markets and to global value chains. The support of SMEs is a priority of the authorities, as SMEs employ the largest share of the work force, while their productivity and competitiveness lag behind the bigger enterprises.
The MNB has also published a 330-point proposal with measures intended to unlock the growth potential and secure convergence to the most developed economies. These were also taken into account during the formulation of the government’s Program for a More Competitive Hungary. The Competitiveness Mirror launched recently assesses the extent of the implementation of this agenda. Since the publication of the 330-points agenda in February, there has been progress in 165 points, out of which 33 have been partially or fully completed.
The Hungarian authorities are grateful for the meaningful and constructive discussions. They appreciate the staff’s recommendations which they are planning to accommodate to the extent possible. They remain committed to prudent policies, focusing their strategy on promoting growth, sustainable debt reduction, improving competitiveness, and reducing financial vulnerabilities.