I. Overview of Macroeconomic Developments in Hungary: 1968–89
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Hungary is a relatively small country with a population of 10.5 million, and a per capita income of just under US$3,000. 1/ During the 1980s the population declined.


Hungary is a relatively small country with a population of 10.5 million, and a per capita income of just under US$3,000. 1/ During the 1980s the population declined.

From the late 1940s until 1990 political and economic power was monopolized by the Hungarian Socialist Workers’ Party, and the economic system was dominated by the state and socialized cooperative sectors. In 1989 exports and imports were each equivalent to about one-third of GDP; about 45 percent of this trade was with partner countries of the Council for Mutual Economic Assistance (CMEA), largely at administered prices.

Past policies favoring extensive industrialization have transformed Hungary from an agricultural society to one in which industry accounted for about 30 percent of both GDP and employment in 1989. Almost all industry is in the socialist sector. Energy and basic materials account for approximately 25 percent of industrial production. About 15 percent of output and employment stem from agriculture.

The 1970s

An important feature of developments during the 1970s was the steps taken to implement the New Economic Mechanism. Introduced in 1968, it initiated the first comprehensive market-oriented reforms of a centrally planned economy. 2/ While the official plan continued to be important, enterprises were released from mandatory directives and greater scope was given for private and small cooperative activities. At the time of the worldwide economic shocks of the early 1970s, Hungary was pursuing expansionary growth policies. During 1968–73 real growth averaged over 6 percent annually, and convertible currency exports grew by 23 percent per year.

The sharp increase in world prices for oil and other imported raw materials led to a 20 percent deterioration in Hungary’s terms of trade over 1974–78. Growth did not immediately suffer as external borrowing financed a rapid expansion in the volume of imports from the West. Between 1973 and 1978 external debt tripled to over 40 percent of GDP. However, following the second oil price shock in 1978–79, policy shifted towards strengthening the external balance at the expense of growth, which decelerated from nearly 8 percent in 1977 to zero in 1980. With demand pressures primarily being reflected in the balance of payments, shortages during this period were prevented and inflation in the consumer market remained limited.

The 1980s

From the late 1970s through the 1980s, in an effort to maintain creditworthiness and access to capital markets, while clinging to medium-term growth targets, economic policy was reversed frequently, shifting between expansion and restraint. In the event, output growth averaged a mere 2.1 percent annually over 1980–89, while external debt in relation to GDP steadily rose to reach over 70 percent during the second half of the decade (Table 1).

Table 1.

Hungary: Selected Economic Indicators

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Source: IMF Institute data base.

Excluding other items (net)

End of period external debt divided by GDP for the year as a whole in local currency units and converted into U.S. dollars at the period average forint/U.S. dollar exchange rate.

As a percent of merchandise exports, travel and investment credits.

1. 1982:84: A period of stabilization

With the resumption of growth in 1981–82, the external current account deficit swelled, reserves fell substantially, and creditor confidence waned. Hungary joined the Fund and the World Bank in 1982, seeking their support to help restore its access to international financial markets.

Two annual stand-by arrangements with the Fund were concluded during 1982–84. By 1984 macroeconomic balance was restored, if only temporarily, rescheduling had been avoided, and Hungary had regained its creditworthiness. Notably, the government budget shifted into surplus; balance in the external convertible current account was achieved; gross convertible currency reserves reached the equivalent of 6 months of imports; and growth recovered, although remaining modest. However, the turnaround largely reflected compression of imports and investment; there was no comprehensive effort to address the structural sources of excess demand, low productivity, and the uncompetitiveness of industry in Western markets.

2. 1985–86: Re-emerging difficulties

Macroeconomic imbalances resurfaced in 1985–86 and output growth again stagnated. The deterioration resulted in part from external factors, such as successive droughts and the weakening of important external markets, notably in the Middle East. There were also sizable losses in terms of trade, though these were at least partly caused by failure to change the composition of output in favor of those sectors where foreign demand was stronger. But imbalances were also the result of deliberate policy decisions to relax financial policies. This coincided with a renewed effort at economic reforms aimed at increasing decentralization, enterprise autonomy, and reliance on market-based signals. The greater autonomy provided to enterprises, together with the ready availability of subsidies and bank credit, resulted in wage increases that substantially exceeded productivity growth.

Despite heavier taxation of state enterprises, the proliferation of government subsidies and transfers resulted in a re-emergence of an overall general government deficit in 1985, which widened to 3.1 percent in 1986. These deficits were largely financed by domestic credit from the banking system; 1/ total domestic bank credit grew by nearly 20 percent in 1986.

Reflecting the loosening of policies, the convertible external current account shifted back into deficit, equivalent to 4.1 percent of GDP in 1985 and nearly 6.3 percent of GDP in 1986. Export volumes fell in both years while import volumes increased. With debt in convertible currencies approaching three-quarters of GDP at end-1986, the debt service ratio with the West reached 87 percent of convertible currency exports travel and investment income credits. Despite these adverse developments, convertible currency reserves peaked in 1985–86 at around 8 months of imports as a result of heavy official borrowing in the international capital markets following the restoration of Hungary’s creditworthiness in the aftermath of 1982–84. In obtaining new credits, Hungary was also able to improve its future debt service profile by restructuring the terms of its debt.

In contrast to developments with the convertible currency area, the external current account in nonconvertible currencies shifted into surplus in 1985, for the first time in a decade, largely due to a strong export growth.

3. 1987: First steps toward a solution

The disappointing results of 1985–86 continued into the first part of 1987. With the introduction of a two-tier banking system at the beginning of the year, the newly established banks were initially extended generous lines of credit from the National Bank of Hungary. However, faced again with possible external financing difficulties, the authorities tightened financial policies in the course of the year and allowed the forint to depreciate significantly in real effective terms (the cumulative real effective depreciation was over 20 percent in 1986–87). Finally, in September, the Government presented to Parliament a comprehensive three-year program of stabilization and structural change. A major aim of this program was to stop, by 1990, the accumulation of convertible currency debt. As part of the program of structural change, it was announced that a value added tax and personal income tax would be introduced at the beginning of 1988.

There was a considerable narrowing in the current account deficit in convertible currencies in 1987 (from 6.3 percent of GDP to 3.4 percent of GDP). An important reason for this was the improvement in competitiveness brought about by the real effective depreciation of the forint which had occurred in the previous two years. Some of the export gain may also have reflected a speeding-up of export deliveries toward the end of the year following the announcement in November that certain export subsidies would be terminated in 1988. Sizable outflows in short-term capital contributed to the overall balance of payments shifting into deficit, the first since 1982.

After two years of stagnation, growth surged to nearly 4 percent in 1987. This reflected both strong export and investment growth as well as a pick up in consumer demand. Following the announcement that a new tax package would be introduced at the beginning of 1988, there was a run on consumer goods, which was reflected in a depletion of inventories, and upturn in production and imports, as well as in increased pressures on wages and prices.

4. 1988: A year of stringency

The authorities’ economic program for 1988 was supported by a stand-by arrangement from the Fund. A substantial share of the initial adjustment was borne by demand restraint. The aim was to reduce the external current account deficit through an improvement in the fiscal balance, tightening of credit policy, a decline in private consumption—for the first time in 30 years—and improved incentives for tradables. Structural reforms included the initiation of a tax reform, a further liberalization of prices, and improvements in the financial system.

The fiscal position improved significantly, adjusting by 3.5 points of GDP to reach a position of balance. Although there were significant overruns in expenditure—largely in subsidies and social programs—these were more than offset by larger-than-budgeted revenues. Credit and monetary conditions were tightened following three years of lax monetary controls. Broad money grew by 2.0 percent, or about a fifth of the previous year’s rate, and the domestic credit expansion, at 9 percent, was cut by over one half. Although the overall rate of expansion of domestic credit was deemed satisfactory, more credit was given to households than planned, as overruns in housing credits occurred in anticipation of the introduction in 1989 of a tax on housing finance.

Although in the direction intended, developments in 1988 fell somewhat short of initial targets. The 16 percent increase in consumer prices, which included the effects of cuts in consumer subsidies and the introduction of the value added tax, and stagnant economic activity were broadly in line with program expectations. However, the improvement in net household financial savings and in the external current account deficit in convertible currencies—to 2.9 percent of GDP—were much less than originally envisaged, primarily because of a substantial increase in travel expenditure resulting from relaxation of passport regulations and exchange restrictions.

On the positive side, the trade account in convertible currencies improved sharply. Export volume expanded by nearly 9 percent in response to favorable weather and external market conditions and to the lagged effects of the previous years’ real effective depreciations. Also, convertible currency imports declined sharply owing to reductions in consumer and investment spending, and there was some improvement in the terms of trade. A reversal of short-term capital outflows that had occurred in 1987 allowed convertible currency reserves to be maintained at about 5 months of imports.

5. 1989: The adjustment program falters

While output recovered in 1989, the adjustment program faltered as financial policies eased. Developments were dominated by the weakness of the fiscal position and a large unplanned external payments surplus in nonconvertible currencies. Wages also increased much faster than planned—19 percent compared to a planned increase of 6–7 percent—following a liberalization of the wage system in January 1989, which was bolstered by ample availability of bank credit.

Instead of the anticipated small surplus, the overall position of the government deteriorated to a deficit of over 1 percent of GDP. Targeted expenditures were overshot and the collection of tax revenues was markedly lower than planned. In particular, there was a significant shortfall in profit tax receipts, partly because profits were squeezed by larger than planned wage increases, but also because of tax relief and refunds granted to state enterprises and the accumulation of arrears to the government by enterprises in financial distress had been significantly underestimated (see Chapter VI for a more detailed discussion of fiscal developments in 1989).

In meeting the financing requirements of the government, the Treasury encountered serious difficulties. The placement of government bonds and Treasury bills was hampered by an increasing preference of the public for shares and consumer durables, in light of rising inflationary expectations and sluggish interest rates. 1/ As a result, the government resorted to renewed central bank financing on a significant scale, equivalent to about 3 percent of GDP.

The weakness of the fiscal position contributed to high banking system liquidity, which the National Bank of Hungary was unable to offset through downward adjustments in the limits set on credits extended to commercial banks. As a result, total domestic credit of the banking system increased by about 22 percent, or over twice the rate of 1988.

The effectiveness of monetary policy was further undermined by the accumulation of payments arrears among enterprises, due to the belief that they would continue to be rescued ultimately by the budget or by a further easing of credit policy. A rising trend of inter-enterprise credit was in evidence since early 1988, with these arrears estimated to have reached a level equivalent to about 7.5 percent of GDP by 1989. These arrears, which are in effect a substitute for bank credit, further complicated the task of the monetary authorities of managing the liquidity of the economy (see Chapter VII for a more detailed discussion of monetary developments).

Loose financial policies led to a widening of the convertible current account deficit to US$1.4 billion (4.9 percent of GDP), compared to US$800 million in the previous year. A small improvement in the trade balance, reflecting improved terms of trade, was more than offset by a further large deterioration in the services account. The latter was primarily due to large travel outflows following the liberalization of regulations on personal imports and travel abroad in 1988. It also reflected larger debt service payments and—increasingly during the course of the year—capital flight, by an underinvoicing of exports and over invoicing of imports, as well as by physical transport of currency.

As indicated above, problems of excess liquidity were compounded by the shift of the overall balance of payments in nonconvertible currencies from a deficit of US$77 million to a surplus of almost US$500 million. Total trade in goods fell by some 15 percent in real terms, with imports declining by considerably more than exports (see Chapter V for a more detailed discussion of external developments in 1989).

Final Remarks

After more than two decades of implementing reforms, economic performance remained mixed. On the positive side, the authorities implemented price reform early and avoided the major distortions common in other centrally planned economies. Queues and shortages were uncommon. Trade with western economies was significantly liberalized and important institutional reforms were carried out in the areas of banking and taxation.

During most of the 1980s, however, output growth and external reserves remained low while per capita external debt was the highest in Eastern Europe. This, to a significant extent, reflected a failure of the reforms to enforce financial discipline. Bankruptcy proceedings were rarely initiated, the authorities continued to affect enterprises’ financial results through ad hoc taxes and subsidies and price and wage regulations, there continued to be a fundamental reluctance to permit competition between domestic enterprises, and the stance of economic policies was reversed frequently. Although the system that evolved was no longer characterized by pervasive administrative controls, the central authorities maintained substantial informal controls. Moreover, measures were often partial, inconsistent, and subsequently reversed.


Hungary’s per capita income was calculated by dividing gross domestic product (GDP) in local currency by the forint/U.S. dollar exchange rate. Other estimates based on purchasing power parity techniques provide significantly higher estimates.


For a summary of reforms undertaken by Hungary see Boote, Anthony R. and Janos Somogyi “Economic Reform in Hungary Since 1968,” IMF, Occasional Paper No. 83, July 1991.


Negative external financing of the general government budget deficit during this period reflected repayment of ruble loans used to finance oil imports from the Soviet Union.


The increase in shareholding also reflected efforts to circumvent the newly implemented personal income tax. In certain enterprises, workers were provided with shares, whose dividends were taxed at 20 percent, rather than having their full remuneration paid in the form of wages, which were subject to higher progressive rates.