V Foreign Trade and Exchange Rate Reform

János Somogyi, and Anthony Boote
Published Date:
March 1991
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Hungary’s foreign trade system consisted until 1991 of two separate regimes of approximately equal importance in terms of the volume of trade: one with market economies and one with the socialist world. Reform of the trade system focused on the regime governing trade with market economies. The system governing trade with the socialist world—especially with other CMEA members—remained relatively unchanged until the introduction of trade at world market prices in 1991.

Trade with Market Economies

The state monopoly of foreign trade, instituted in 1948, remained intact after the 1968 economic reform, with commercial exports and imports continuing to be carried out by authorized state-owned economic organizations. The state-owned entities included specialized foreign trade organizations and domestic producers and trading companies, with a general or specific permit to engage in foreign trade transactions on their own account or on a commission basis. The authorities took major steps toward more liberal foreign trading rights in 1981, when the role of “parallel” foreign trade transactions—allowing different foreign trade organizations to trade a particular product—was expanded, and in 1986, when the authorities made more flexible the approval process for applications and widened the scope for general export and import rights. In mid-1987, the authorities extended general foreign trading rights to any enterprise in the socialized sector whose convertible currency exports amounted to at least $1 million in the previous year. Such enterprises could export and import any product not specified in negative lists, while other enterprises with foreign trading rights could export their own products and import inputs needed for their own activities.

A further major change, which ended the system of foreign trade as a state monopoly, was introduced at the beginning of 1988. Under the new regime, every organization registering with the Ministry of Trade, including private entities, was authorized to engage in commercial foreign trade transactions without prior application and approval. The registration was automatic at the request of the enterprise and upon a declaration that certain organizational and personnel conditions were fulfilled. As a result, the number of enterprises authorized to engage in foreign trade increased to more than two thousand in 1989 from three hundred and fifty in 1986. Registered companies were entitled to trade any product not included in negative lists of exports and imports, whose trade required formal authorization. The negative list was reduced to 36 percent of convertible currency exports at the beginning of 1989. The authorities maintained the list to monitor the compliance of exporters with voluntary export restraint agreements and to regulate exports of farm products to meet the requirements of the European Community (EC). At the same time, the negative list of trading rights for imports was reduced to 20 percent of convertible currency imports. These lists were reduced further in 1990.

In addition, all exports and imports were subject to a licensing requirement, designed mainly to ensure that only authorized entities engaged in foreign trade. No export controls were applied to ensure adequate domestic supplies or for trade policy purposes. Apart from imports of consumer goods, which were subject to a global quota, most import licensing was semi-automatic, with the pace of processing and the issuance of licenses influenced periodically by balance of payments considerations. The value of the import quota for consumer goods was published annually, and licenses against the quota were issued on an order-of-arrival basis.

The authorities took an important step toward liberalizing imports vis-à-vis the convertible currency area at the beginning of 1989. They lifted the licensing requirement for products included in a positive list and reduced the coverage of the consumer goods quota; these measures affected about 40 percent of convertible currency imports, competing with an estimated 16 percent of domestic industrial production (excluding energy). In 1990, the share of convertible currency imports free from quota or licensing restrictions was raised to 65 percent of total imports, competing with around 30 percent of domestic industrial production. In addition, the quota on imports of consumer goods was increased by 30 percent to $250 million.

The new Government plans to construct a modern European social market economy integrated into the world economy. It aims to become part of the European economic region in the fullest possible sense. Linking Hungary’s economy to Europe will be furthered by gradually adjusting taxes, customs duties, standards, and quality control to European norms. The Government recognizes the positive role of imports for quality improvements and competitiveness. It introduced further major liberalization beginning in 1991. The share of liberalized imports was increased to about 90 percent of total imports, exposing fully to foreign competition approximately 70 percent of industrial production. The consumer goods quota was increased to $630 million, and the coverage of the quota was reduced to those goods requiring import licensing (mainly processed foods and clothing). The licensing requirement was shifted from a positive list to a negative list consisting mainly of products requiring licensing for health and safety reasons (such as drugs and weapons), textiles, leather, certain chemicals, telecommunication equipment, and agricultural products. With the liberalization of trading rights, the number of agents with general trading rights is estimated to triple in 1991, from the 1990 level of ten thousand. The Government is committed to further import liberalization, which it will implement in the context of multilateral negotiations with General Agreement on Tariffs and Trade (GATT) partners. The Government expects to conclude an association agreement with the European Community in 1992.

Trade with the Ruble Area

Until the end of 1990, the bulk of Hungary’s trade with the ruble area was conducted under bilateral quotas negotiated in annual official trade agreements. These agreements ensured essential imports of energy and raw materials, against which the Government committed to export Hungarian agricultural and industrial products. In this market, Hungarian enterprises faced a sizable volume of demand, which promoted economies of scale and involved requirements concerning quality, packaging, punctual delivery, and servicing of products less stringent than in the convertible currency or domestic markets. Bilateral balances arising from transactions with a particular CMEA partner country could not be used to settle imbalances with other CMEA countries.

Pricing rules guiding intra-CMEA trade changed over the years, from fixed prices in the 1950s, to an adjustment of prices at five-year intervals in the 1960s and early 1970s; and since the mid-1970s, to annual adjustments based on moving five-year averages of world market prices according to the “Bucharest formula.” These rules were combined in practice, however, with extensive bargaining over technical aspects, rebates, discounts, and payment terms. As CMEA foreign trade prices remained distorted relative to world market prices, the Hungarian authorities applied a system of taxes and subsidies to ensure that enterprises achieved similar profitability in ruble trade transactions as in trade with convertible currency and domestic partners. On the import side, so-called producers’ differential turnover taxes were generally applied, whereas on the export side, predominantly subsidies were paid to enterprises. Under this system, adjustments in the exchange rate of the forint vis-à-vis the transferable ruble were less important for influencing the attractiveness of ruble trade transactions than for determining the volume of transfers between the budget and enterprises engaged in ruble trade operations.

Until the beginning of 1988, enterprises received full and automatic compensation from the budget for the difference between the profitability of transactions with convertible currency or domestic customers and the profitability of ruble trade based on their own calculations of the amounts to which they claimed to be entitled. The system of guaranteed profitability allowed enterprises broad scope for budgetary support by shifting overhead costs to ruble exports. For ruble exports under the bilateral quotas considered essential to ensuring priority energy and raw materials imports, enterprises were in a particularly strong position to make the fulfillment of the ruble export contracts contingent on favorable guaranteed profit rates.

At the beginning of 1988, the Government acted to tighten the loose financial discipline inherent in ruble trade regulations. The method of self-assessment was replaced by a system under which the rate of budgetary compensation was set in advance for the subsequent year for every enterprise. In response to the surging ruble trade surplus in 1989, which undermined the effectiveness of domestic monetary policy, further measures were taken to curb ruble exports. The forint was appreciated by 5.5 percent vis-à-vis the transferable ruble to Ft 27.5 = TR 1 from September 1, 1989; some export licenses were canceled and a new settlement system for above-quota exports was introduced. Effective October 1, the National Bank of Hungary (NBH) stopped encashing into forints transferable rubles earned on above-quota exports, with such rubles instead freely traded with other enterprises wishing to import outside the quota system. The forint traded in this market at a premium of 25-30 percent. Following a substantial trade surplus early in 1990, the authorities withdrew CMEA export licenses and began issuing licenses monthly, and subsequently quarterly, in light of trade developments.

Events in 1989 and in early 1990 underlined the obstacles posed by the unreformed CMEA trade system to structural reform in Hungary. Administrative measures during this period were used to check the influence of CMEA arrangements on financial discipline. Since January 1, 1991, trading with CMEA countries has been at world market prices, with settlement in convertible currencies. This involves a significant terms of trade loss for Hungary and a major loss of revenues for the budget (see Section X). It will entail major economic restructuring, yielding improved economic efficiency over the longer term.

The Exchange Rate System and Export Incentives

The 1968 reform made the exchange rate a potential instrument of economic policy by unifying a multitude of effective exchange rates. These rates had been differentiated, during the period of traditional central planning, virtually by individual products through a system of “price equalization taxes and subsidies.” In addition to an “official” exchange rate used for statistical purposes with no operational significance, the new exchange rate system included (through 1976) a commercial rate—called the “foreign trade multiplier,” originally set to equal the average cost in forints of earning a unit of foreign exchange in nonruble exports—and a noncommercial rate, called the “tourist rate.” The official rate was abolished in 1976 and the noncommercial rate—set at Ft 30 per U.S. dollar in 1968, as against a commercial rate of Ft 60 per U.S. dollar, to reflect the heavy subsidization of consumer goods and services purchased by foreign travelers in Hungary—was gradually moved closer to the commercial rate beginning in 1979 and merged with the latter in October 1981. Separate exchange rates applied vis-à-vis the transferable ruble—originally set in 1968 at Ft 40 per TR—for the settlement of trade with other members of the CMEA. Bilateral exchange rates vis-à-vis the national currencies of CMEA countries were established for noncommercial transactions based on the hypothetical consumption basket of a diplomatic family.

After unifying the commercial exchange rate in 1968, exports and imports were valued in domestic currency at foreign currency prices multiplied by this exchange rate and adjusted for customs tariffs, import turnover taxes, and subsidies. Since the introduction of the competitive price system in 1980, a producers’ differential turnover tax was imposed on the prices of energy and raw materials imported from the CMEA area to raise them to the level of corresponding domestic prices, which, in turn, were linked to world market prices (see Section IV). Although this tax was levied to correct distortions stemming from CMEA pricing rules, a tax rebate for exporters on the differential producers’ turnover tax was in effect from 1980 to 1988 to stimulate exports to the convertible currency area.

Further efforts to promote convertible currency exports included subsidies for agriculture and food processing proportional to the value of the agricultural content of such exports; so-called modernization grants provided to improve international competitiveness; preferential treatment of exporters under various wage regulations; investment incentives based on preferential credits; equity allocations; various forms of tax rebates; and preferential interest rates on the refinancing of export credits. The fees attached to imports—including the licensing fee, statistical fee, and customs clearance fee—were also varied over time for balance of payments reasons.

Limiting the influence of foreign inflation on domestic prices was a main priority in the conduct of exchange rate policy with respect to convertible currencies (Chart 4).1 Although the official principles of exchange rate policy also included a need to maintain adequate export profitability, the conduct of exchange rate policy was dominated by the perception that devaluations led primarily to a loosening of the financial discipline of exporters and helped only to sustain intramarginal exports without contributing to stronger export competitiveness. The authorities thus avoided currency devaluations aimed at bolstering competitiveness through 1982.2 Through 1988, the authorities frequently discouraged the full pass-through of the effect of devaluations to domestic prices, in order to strengthen the expenditure-switching effect of devaluation under the competitive price system that relied on export prices to guide domestic prices.

Chart 4.Exchange Rate Developments, January 1980–January 1991


Sources: IMF International Financial Statistics; and IMF staff estimates.

1Trade-weighted index; based on average monthly exchange rates.

2Trade-weighted relative consumer price indices in common currency; based on average monthly exchange rates and prices. For the purpose of calculating the real effective exchange rate, Hungary’s price index was reduced by 7.8 percent from January 1988 on, in order to neutralize the effect of the introduction of value-added tax on January 1, 1988.

Even though the authorities increasingly used the exchange rate as an instrument of external adjustment, concerns about the inflationary effect of devaluation continued to constrain exchange rate policy. Nevertheless, in December 1989 and in the first two months of 1990, the forint was depreciated by 15 percent against the basket of convertible currencies (Chart 4). A first step toward introducing a limited foreign exchange market was the Government’s authorization, in March 1989, of commercial banks to act as agents for their customers in buying foreign exchange from the NBH (see Section VIII).

Beginning in 1988, every Hungarian citizen was given the right to obtain a passport valid for five years and to travel freely with convertible foreign currency of at least Ft 5,000 (about $100). In 1988, travel allowances were raised to the equivalent of $360 for all adult residents for the period 1988-90, with allowances also available for railway or airline tickets or gasoline. However, faced with substantial travel-related outflows, the authorities in November 1989 reduced these allowances to $50 a person annually, during 1988-91, with bonuses if the allowances were not used until 1990 or 1991. In addition, from December 1989, a VAT of 25 percent was imposed on private imports that were a main source of foreign exchange outflows recorded in the travel account. From September 1989 on, the authorities eased regulations on the declaration requirements for resident foreign currency deposits in Hungarian banks, effectively permitting all residents to hold such deposits. The authorities hoped that such deposits—on which a competitive tax-exempt interest was paid—would constitute an attractive alternative to deposits in foreign banks or cash holdings.

The new Government, faced with large external shocks (see Section X), depreciated the forint by a further 15 percent in January 1991. With the demise of the old CMEA trading arrangements, this rate applies to all trade transactions. With the sharp reduction in trade restrictions in 1991, and the end of the CMEA trading arrangements, the role of exchange rate policy has been considerably enhanced. The Government has announced its intention to achieve convertibility of the forint for current transactions by 1993. It will achieve this objective in a way that does not endanger domestic or external stability. As an intermediate step, the Government intends to create in the second half of 1991 an interbank currency market. With the liberal approval of trade-related foreign exchange transactions, convertibility has already been achieved for most current transactions of the enterprise sector. Given that exchange regulations guarantee the transfer of foreign investors’ profits and capital, convertibility for most transactions by foreign investors has also been achieved in 1991.

The exchange rate relative to convertible currencies was pegged to a basket of nine currencies, each of which accounted for at least 1 percent of convertible export receipts, weighted with the share of those currencies in Hungary’s convertible trade turnover.

A major revaluation vis-à-vis convertible currencies and the transferable ruble took effect on January 1, 1976; at that time, the authorities formally introduced the commercial exchange rate to replace the foreign trade multiplier.

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