In contrast to other previously centrally planned countries in Central and Eastern Europe, Hungary has always been distinguished by the “gradualist” approach it has taken toward economic and institutional reforms. Its “goulash” communism was the label given to an economic system that, while retaining central planning, allowed for significant enterprise autonomy. In many respects, this served the population well and shortages were largely absent. Moreover, decisions to keep domestic relative prices close to their international counterparts since the early 1980s implied that the degree of enterprise restructuring thought to be necessary was less than in other members of the former Council for Mutual Economic Assistance (CMEA).

In contrast to other previously centrally planned countries in Central and Eastern Europe, Hungary has always been distinguished by the “gradualist” approach it has taken toward economic and institutional reforms. Its “goulash” communism was the label given to an economic system that, while retaining central planning, allowed for significant enterprise autonomy. In many respects, this served the population well and shortages were largely absent. Moreover, decisions to keep domestic relative prices close to their international counterparts since the early 1980s implied that the degree of enterprise restructuring thought to be necessary was less than in other members of the former Council for Mutual Economic Assistance (CMEA).

On the other hand, the gradualist approach has resulted in recurrent macroeconomic imbalances. The lack of adjustment in response to the first oil price shock contributed to the initial buildup of international debt. Similarly, recurrent excessive demand throughout the 1980s led the authorities to reverse previous attempts at liberalization. Moreover, following the return of democratically elected governments in 1990, failures to undertake significant reforms in the excessively broad and actuarially unsound system of social expenditures as well as in reducing the scope and scale of governmental activities, has resulted recently in the re-emergence of substantial fiscal and external imbalances.

Nonetheless, Hungary has, in many areas, completed necessary structural and institutional reforms. This is reflected, among other things, in a fairly vibrant private sector (even more so if the underground economy is included) and in foreign direct investment equivalent to over half of the total amount in the region. Nevertheless, significant structural reforms and, more immediate though interrelated, macroeconomic measures are necessary to place the economy on a sustainable path of high growth.

Structural Reforms

Of all the transition economies, Hungary was the first to introduce, in 1968, market-oriented reforms. Many were reversed, however, or, as the theory of second-best suggests, led to inconsistencies with other yet-to-be reformed features of the economy. As a result, economic efficiency remained low throughout the 1970s and 1980s. Reform efforts were broadened in the late 1980s and further accelerated under the first freely elected government in forty years, and the later reform efforts constitute the main focus of this section.

Pre-1990 Reforms

A process of market-oriented reforms began in Hungary in 1968, with the adoption of the New Economic Mechanism (NEM), and encompassed three distinct liberalizing periods.1 The first, covering roughly 1968–73, entailed a substantial broadening of enterprise autonomy in decision making within the national plan. However, a lack of reforms in other areas, as well as growing political and social tensions, led to reregulation of the economy in the mid-to late 1970s. The 1970s ended with a renewed attempt at liberalization of enterprise decision making, as well as a broad alignment of domestic relative prices with their international counterparts. But continued soft budget constraints again resulted in macroeconomic imbalances, including further increases in external debt levels. These, in turn, led to a reimposition of direct controls.

A third, and under the communist regime final, attempt at market-oriented reforms began in the latter half of the 1980s. In many respects these reforms were the broadest based and most ambitious, embracing substantial institutional reforms, as well as legal and regulatory dimensions. While they embraced social and political, as well as economic spheres, the most important among the latter related to fiscal reforms, restructuring of the banking sector, and changes in enterprise structure and governance.

Fiscal Reforms

While Hungary has almost continuously implemented marginal adjustments in tax and expenditure policies, prior to the mid-1980s fiscal policy was in general simply a tool for implementing the financial counterpart to the central plan. Thereafter, the authorities initiated reforms in public finances in a number of areas, including tax simplification and reform, early steps toward reductions in subsidies, and initial efforts to improve transparency, openness, and public accountability of the budget process.

Hungary was the first country in transition to institute a system of taxation consistent with a market economy. In 1988, a value-added tax with three rates, zero, 15, and 25 percent, was adopted. It was buttressed by a number of significant excises, focusing on motor fuels, alcohol, and some luxury goods. Regarding the taxation of personal income, the implicit taxation through rigid wage and interest rate controls was replaced in the early 1980s by taxes on incomes from the second economy,2 and in 1988 by a narrowly based tax primarily on wage income, and withholding taxes on dividend and interest incomes. A uniform parametric tax on enterprise profits was adopted in 1989, replacing the highly discretionary and invasive taxation of firms’ cash flows and various funds. Nevertheless, a large number of tax reliefs, mainly through reduced statutory rates, continued to exist to reward or induce particular activities.

Hungary, like other countries in Eastern Europe, made extensive use of subsidies to households and enterprises through the budget, through low fixed prices for basic commodities and services, and through selective access to foreign exchange and domestic credits at preferential rates. Efforts were undertaken in the 1980s to increase and later to liberalize prices to reflect their international counterparts.3 Interest rate liberalization necessitated budgetizing what had previously been largely a quasifiscal subsidy for mortgage subsidies.

The structure of government became de facto increasingly decentralized throughout the 1980s.4 Facing steadily increasing financing pressures, the Government allowed central budgetary institutions greater latitude to collect, retain and determine the spending of own revenues. Beginning in 1986, budgets of local councils were separated from the state budget, with the latter ceding particular tax revenues and providing specified transfers to the former. As with central budgetary institutions, local councils’ own revenues, which often were significant, could be spent without central guidance or carried over to the next year. In 1989, the social security budget was similarly separated.

Banking and Capital Market Reforms

In contrast to reforms in other areas, the New Economic Mechanism left the banking sector with the subordinated role of financing the national plan. Aside from a few specialized financial institutions, the National Bank of Hungary (NBH) was responsible for both central and commercial banking functions, as well as regulating foreign exchange operations and acting as the nation’s official borrower.5 It also directly controlled credit allocation, as interest rates played only a marginal allocative role, and indirect monetary policy instruments were absent.

In general, financial savings were low. Households did not have a strong incentive to save, given virtually guaranteed employment and the provision of many services either by the state or through enterprises and a limited choice of consumer durables. Moreover, households generally faced negative real interest rates and a limited portfolio of saving instruments. Enterprises preferred physical investments, which were either self-financed or used government loans and grants or bank credit, in part because of a pattern of confiscation by the authorities of profitable enterprises’ accumulated financial assets.

While monetary policy accommodated the National Plan’s projected inflation rates, the latter remained fairly low until the late 1980s. However, the periodic tightening of credits during periods of excess aggregate demand, the virtual guaranteed granting of credits for working capital purposes to ensure the payment of wages (and the resulting weakening of enterprise financial discipline), and the periodic financing of intra-enterprise arrears by perennial loss-making enterprises left the balance sheet of the NBH, as well as of the State Development Bank, with large amounts of impaired loans.

As the authorities became increasingly aware of the problems posed by the financial system, several institutional reforms were implemented. In 1987, a two-tier banking system was introduced, with the domestic commercial banking operations of the NBH and State Development Bank taken over by three new commercial banks, although the latter remained owned by the state and state enterprises. These banks inherited the loans (both good and bad) and deposits of their predecessors; and the Foreign Trade Bank was also allowed to provide commercial banking services. A number of joint venture banks with foreign participation were also created. Also in that year, banks were allowed to use interest rates to compete for enterprise deposits. In 1988–89, banks were granted additional rights to provide foreign exchange related services to their clients.

As regards the household financial sphere, in 1989 the Government halted the issuance of low interest rate (at most 3 percent) mortgages to households, replacing them with standard mortgages, with one-time capital grants, and interest subsidies financed by the budget. The outstanding stock of below-market mortgages was purchased from the NSB with bonds paying market-related interest rates and transferred to a newly created extrabudgetary fund. This allowed the NSB to pay higher deposit rates, although ceilings remained in place.

With the creation of the two-tier banking system, the NBH gradually shifted from direct credit ceilings to the use of indirect monetary instruments. It instituted refinancing quotas, and increasingly relied on interest rate policy as a principal instrument of monetary control. The latter became more flexible in 1988 with the auctioning of treasury bills. The NBH established a system of prudential regulations and banking supervision and imposed a system of reserve requirements.

Enterprise Structure and Governance

Amendments to the State Enterprise Act of 1975, which took effect January 1, 1985, established a new institutional framework for state enterprises based upon self-management with worker participation. However, continued poor enterprise performance, the result of a lack of effective exercise of ownership rights, soft budget constraints, and the continued periodic interference by central authorities, motivated the introduction of the Law on Transformation in 1989, which sought to provide the legal framework for transforming state enterprises and cooperatives into joint-stock companies. Attempts to regularize the privatization process also began, in response to growing popular resentment over “spontaneous” privatization of state assets initiated by enterprises. This included the adoption in 1988 of the Act on Foreign Investment, which codified rights and obligations for foreign investors, as well as allowing for the formation of wholly foreign-owned enterprises.

In 1989, the Law on Association provided for greater freedom in forming a variety of corporate entities, as well as permitting individuals to acquire stakes in state enterprises, and established liberal rules for foreign joint-venture activities. Combined with trade liberalization, relating to both import licensing, as well as freedom of enterprises to directly engage in foreign trade, it was hoped that increased competition would result.

Attempts were also made to further improve enterprise governance. Multiyear restructuring plans were adopted in a number of sectors and a bankruptcy law was adopted in 1986. The latter, however, relied on negotiations between creditors and debtors for out-of-court settlements of claims. If unsuccessful, the Ministry of Finance would determine if state-financed restructuring was necessary, in light of regional employment, national defense, or external trade commitments. If not, as a last resort, court proceedings could be initiated. As a result of this protracted process, few significant proceedings were actually initiated.

Reforms Since 1990

With the end of the socialist era in 1990, numerous economic and social challenges came to the forefront. While, as seen above, efforts had been made previously to adapt the system of central planning to increase its responsiveness, wholesale changes were needed to make activities consistent with a market economy, including changes in enterprise structure and governance, and in labor and capital markets. Moreover, a number of the previous reforms, including trade and price liberalization, and those relating to the budget, tax policy, and the banking system, needed to be further extended and refined.

The incoming government formulated a broad-based, four-year plan for structural and macroeconomic reforms during its first year in office. The so-called Kupa program, named after the Minister of Finance, spelled out a detailed plan, specifying the problems to be addressed, the intended goals, the necessary tasks of the government, the forms of remedy (laws, regulations, creation of new institutions), their scheduled dates of enactment or creation, and the relevant government institutions responsible.6

Success with structural reforms has been uneven. Considerable progress was achieved with respect to price and trade liberalization, where the Hungarian economy now enjoys a relatively liberal system. On the other hand, progress has proven more difficult in many areas of fiscal reform, as well as enterprise and bank restructuring. As a result, the state’s continued pervasive role, including in its redistributive function with associated high marginal tax rates, has hampered economic activity and, more generally, contributed to the macroeconomic tensions currently facing the Hungarian economy.

Price Liberalization

As already noted, the pricing system had been liberalized in stages since 1968. By 1989, only 17 percent of consumer prices remained “flexible,” that is, fixed unless officially adjusted, with the remainder freely determined.7 The share of free consumer prices was increased to 89 percent in 1991, 92 percent in 1992, and 94 percent in 1993.8 Government-determined prices remain only for electric energy, public transport, and pharmaceuticals. In 1991, the Price Office, which was responsible for controlling prices, was eliminated.

Trade Liberalization

The new government was the leading international advocate of dismantling the CMEA trading system. Compared with 1987, in which 49 percent of exports and 47 percent of imports were settled in transferable rubles, the corresponding figures had already declined in 1990 to 26 percent and 29 percent, respectively. This in part reflected the inability of the former Soviet Union to fulfill its obligations in energy exports. Moreover, the nation had recorded significant surpluses in its nonconvertible overall balance of payments in 1990–91, with limited expectations for transforming its accumulated surplus into valuable assets. The system was dismantled from 1991, with almost all transactions thereafter being conducted at world prices and in convertible currencies.9

The newly elected government intended to align its trade policies with those of the European Community (EC) members. By 1991, about 90 percent of total imports were free of quantitative or value limitations. Moreover, in early 1992, an association agreement was adopted with the EC, mandating an asymmetric timetable for the dismantling of trade barriers. Also, the Central European Free Trade Agreement (CEFTA), comprising Hungary, Poland, the Czech and Slovak Republics, and subsequently Slovenia, was adopted, including a timetable for a free-trade area among its partners. At the beginning of 1995, further trade liberalization was implemented under agreements with the European Union (EU), CEFTA, and the European Free Trade Association (EFTA), as well as under the Uruguay Round.

Fiscal Reforms

The reform program included an ambitious strategy to modify the budgetary sector to make it consistent with a market economy.10 This included further reforming the tax system, reducing the scope and scale of fiscal activities, and increasing the efficiency of remaining activities. While partial but significant progress was made on the first objective, the other two were largely not achieved.

Regarding tax reforms, the Government intended to broaden direct tax bases by reducing and eliminating the large number of tax reliefs and exemptions granted under enterprise profit and personal income taxation. In addition, it intended to introduce realistic depreciation rates and to eliminate the zero bracket in the value-added tax (VAT).

To this end, new laws were adopted in 1992 on accounting, which, inter alia, allowed institutions to adopt more realistic depreciation rates, and tax reform, which resulted in a significant leveling and broadening of effective enterprise profit tax rates across sectors.11 However, measures to broaden personal income tax and social security contribution bases were not adopted. Moreover, VAT reforms were delayed until fiscal pressures dominated in January 1993. At that time, the zero bracket was eliminated (with minor exceptions) and the 15 percent bracket was replaced by a two-bracket, 8 and 25 percent, system. Similar pressures necessitated an increase in the lower rate to 10 percent from August 1993 and to 12 percent from January 1995.

As to the intended goal to reduce the scope and scale of governmental activities, the authorities were even less ambitious and successful, compared with their stated intentions. The share of general government expenditure is estimated at around 60 percent of GDP in 1993/94, a higher share than at the beginning of the reform process in 1990 and also considerably higher than in most of the other transition economies in Central Europe. It should be noted, however, that the reduction in subsidies to producers and consumers was followed through as intended. In spite of budgetizing previous quasifiscal subsidies related to below-market interest rates charged on housing mortgages, the Government reduced overall subsidies from an amount equivalent to 12.2 percent of GDP in 1990 to a budgeted 5.3 percent of GDP in 1994. The composition has also changed radically: all consumer subsidies were eliminated except those related to transportation, while agricultural subsidies increased (in part due to significant droughts in recent years).

Regarding other aspects of government activity, the authorities ultimately failed to carry out many of their stated intentions. The new budgetary framework law, adopted in June 1992, failed to address the fundamental weaknesses in the structure of government. In this regard, three areas in particular illustrate the weakness of structural reforms in the fiscal domain.

First, the new budgetary framework law of 1992 continued to allow decentralized central (and local) budgetary institutions freedom to collect and spend own revenues without central supervision and to allow the same to maintain independent bank accounts and purchase treasury paper, and it failed to institute centralized treasury (i.e., cash and debt management) operations. This has limited control of budgetary operations, including the ability to adjust fiscal behavior during the year as may become warranted by unexpected developments.

Second, despite the Government’s stated goals, no serious efforts were undertaken to create a timely and comprehensive fiscal information system and to evaluate the activities of government institutions in light of their consistency with a market economy. Given that the Government employs (including those in health and education) some 25 percent of the workforce, there is a clear need to undertake a wholesale re-evaluation and reduction in public sector activities and employment. Moreover, many central (and local) budgetary institutions are engaged either primarily or secondarily in providing commercial goods and services. Therefore, the need for a wholesale re-examination of the role of government remains unanswered.

The third area concerns the presently large and unsustainable level of social expenditures. In spite of combined social insurance contributions equivalent to 60.8 percent of the wage bill, among the highest in the world and with deleterious effects for factor market efficiency and external competitiveness, the pension system remains actuarially unsound.12 Moreover, despite a government-prepared white paper in 1991 stating the need for increases in pension ages, they have yet to be increased. In addition, family allowances remain among the most generous in Europe and are not means tested (although the Government, in mid-March 1995, presented a package that would include a switch to means testing later in 1995). Also, pharmaceutical subsidies, which exceed 1 percent of GDP, remain a nagging area for reform.

Monetary Policy and Banking Reforms

Reforms initiated by the previous regime concerning the conduct of monetary policy and the regulation and structure of the banking system have continued. While the National Bank of Hungary turned increasingly toward the use of indirect monetary instruments, the effectiveness of these instruments in transmitting their intentions was weakened by the reactions of commercial banks to rapidly growing, nonperforming segments of their portfolios, and government guarantees and subsidized credits insulated important segments of the market from the effects of indirect monetary instruments.

The NBH has made steady progress in introducing and increasingly relying on indirect instruments to effect monetary policy. The practice of providing automatic refinancing credits was gradually replaced with a system of auctions. Moreover, the cost of such credits was progressively increased, to induce banks to compete for deposits. Ceilings on household deposit rates were eliminated by 1992. An interbank market, created in 1990, played an increasing role in supplying banks with marginal short-term funding. The NBH also streamlined, reduced, and began paying interest on banks’ mandatory reserves.

A number of legal acts also directly influenced the structure and actions of the banking system. In December 1991, Parliament passed both central banking and commercial banking laws.13 Among the more important features of the former are an explicit statement concerning the NBH’s legal independence; its primary responsibility for ensuring the value of the currency; and a stricter limit, to be phased in over a number of years, on the amount of direct financing of the state budget deficit.14

Regarding the latter legislation, one of its most important components was in requiring banks to provision out of pretax income for impaired or non-performing assets and to provision fully for all loans, whether performing or not, by firms under bankruptcy proceedings. This requirement, combined with stringent bankruptcy and modern accounting laws adopted in 1992, resulted in large increases in required provisioning. Banks, which had previously booked “phantom” incomes (from accrued but not paid interest receipts) and had paid tax liabilities on these, sharply increased interest spreads to generate necessary cash flows. Moreover, a surge in the number of firms in bankruptcy proceedings in early 1992 created a climate among banks that strongly discouraged new lending and refinancing loans falling due to creditworthy customers. As a result, significant nongovernmental financial disintermediation occurred, as banks instead chose to hold government paper or to maintain excess reserves with the NBH.

The Government increasingly recognized that it must take action both to improve the financial integrity of the banking system and to alter incentives such that banks would be willing to reduce operating spreads and resume lending to creditworthy customers. Mindful that it was in part responsible for the emergence of subsequent doubtful loans (e.g., by failing to shut down loss-making enterprises with large labor forces), the Government introduced the first loan consolidation scheme at the end of 1992. Under the scheme, government bonds were swapped for variable proportions of classified loans, depending upon their date of creation and whether the enterprises concerned were to remain in state hands. The scheme, however, was hastily prepared, insufficient in size, and contained a number of flaws. Despite increasing risks of moral hazard, a second scheme was adopted at the end of 1993, in which participating state-owned banks retained their doubtful loans but received capital injections in the form of interest-bearing government bonds. Under this program, the capital adequacy ratio of participating banks was increased to zero by the end of 1993, to 4 percent in mid-1994 and, for selected banks, to 8 percent by the end of 1994. Together, the amount of consolidation bonds issued by the state to banks under the various schemes amounted to some 7½ percent of 1994 GDP. While this appears to have largely addressed the “stock” problem concerning the banks’ minimum capital adequacy, difficulties in fully altering incentives relating to bank lending behavior based upon sound banking principles continue.

Capital Market Reforms

In 1990, the Budapest Stock Market reopened, the first in the European countries in transition, after a more than forty-year hiatus. Within the following few years, a large number of acts supporting private capital markets were adopted.15 An interbank market for foreign exchange was created in 1992, and a futures market for these assets was created the following year. Also, an act in 1993 established a bank-financed deposit insurance fund, and the adoption in 1994 of a law allowing for the creation of private pension schemes further strengthened and began to broaden capital markets in Hungary.16

Despite these measures, capital market developments to date have been rather lopsided. In part reflecting the privatization path chosen in Hungary, the number of enterprises listed on the stock exchange is rather limited. Moreover, trading activity in nonbank capital markets is dominated by government paper.17 Nevertheless, activity in the private placement of commercial paper (and some bonds) has shown some growth and direct borrowing from abroad by well-known domestic or foreign joint-venture firms has grown substantially in the past three years.

Enterprise Governance and Structure

The Government was determined to accelerate the transformation of state enterprise behavior consistent with a market economy. This involved hardening budget constraints, instituting a broad-based privatization plan, and further increasing the autonomy granted to enterprise decision making. While the growing segment of privatized enterprises, combined with the explosion of de novo private ventures, soon accounted for the majority of activity, the economy continues to be hampered by persistent problems posed by a number of significant large loss-making state-owned enterprises.

The Government’s subsidy reduction program, as well as the newly adopted accounting, auditing, bankruptcy, and commercial banking laws, all acted to effectively harden budget constraints for the vast majority of private and state-owned enterprises. The Government built upon this foundation by adopting a privatization plan emphasizing the transferring of ownership rights to those who had significant incentives to either directly manage or actively monitor the actions of hired managers.18

Moreover, the Government acted to further increase the autonomy granted to managers of state-owned enterprises by abolishing in 1993 the system of excess wage taxation. With hardened budget constraints, and a newly adopted social safety net (including unemployment compensation and, subsequently, social assistance payments), it was thought that firms would retain only those employees necessary for profitable production.

The economic structure of production has changed dramatically since 1989. The number of economic organizations with legal entity has increased from 15,000 to 97,000 in September 1994, while the number of registered unincorporated businesses has increased from 245,000 to 766,000 during the same period (although some of the increase reflects a tax treatment that is more favorable for self-employed than for employees). Moreover, enterprises employing over 300 employees accounted for 19 percent of total legal economic organizations in 1989; in 1993, they accounted for only 1 percent. The number of newly created private and privatized economic organizations is estimated to have accounted for well over 50 percent of activity in 1994.

Nevertheless, the tightening of budget constraints, combined with the sharp fall in external and domestic demand and change in production and trade patterns, exposed a large number of state-owned enterprises as fundamentally unsound. While most small and medium-sized enterprises were forced to confront their situation through downsizing, bankruptcy, or liquidation proceedings, a number of large enterprises, employing significant shares of the labor force, were able to continue operating while accumulating large losses.19 Plans are under way for enterprise restructuring and debtor consolidation concerning these enterprises; however, it is anticipated that this will result in substantial additional unemployment.

Labor Market Reforms

A number of significant reforms have taken place regarding labor issues in recent years. A system of centralized bargaining has been created, and institutions facilitating labor market mobility have emerged. The labor market, however, remains extremely inflexible, with little mobility between employment and unemployment, and within employment. Moreover, real wages appear to be excessively rigid, especially when nonwage compensation is taken into account.

A tripartite Interest Reconciliation Council (IRC), comprising representatives of trade unions, employers’ organizations, and the government, was formed in 1988.20 It was reorganized in 1990, and decisions now are made on the basis of consensus. While its main role remains consultative, its decisions in deter-mining the minimum wage rates are taken as binding. These decisions serve as the basis for subsequent, less comprehensive, wage arrangements at industry and firm levels.

In the early 1990s, a number of institutions to promote labor mobility and provide a social safety net were created. The Solidarity Fund, which provides unemployment compensation, was created in 1991.21 The Employment Fund, which had existed since the late 1980s, was enlarged, with greater emphasis placed on labor market information services and worker retraining. In 1992, a social assistance law was adopted, providing cash benefits and specific services for those that have either exhausted or are not eligible for unemployment compensation.

Some features of present labor market practices have hindered its smooth functioning. First, the centralized wage recommendation system through the IRC has de facto led to a tying of wage increases to increases in the minimum wage. Because the latter is so close to the calculated minimum subsistence wage, maintaining its real value may be justified. However, resulting general real wage rigidity has undoubtedly depressed the level of employment. Moreover, subsequent rounds of industry and firm-specific agreements exacerbate insider-outsider problems, disenfranchising the unemployed in influencing wage patterns, and inducing negative spillover effects, thereby imparting an upward bias to wage patterns.22

Second, wage bargaining has paid insufficient attention to nonwage (e.g., fringe benefit) compensation, possibly because of continued soft budget constraints in many large state-owned enterprises, discussed in the previous section. However, in light of its exclusion from personal income and social insurance contribution bases, nonwage compensation has been the most rapidly growing form of compensation, accounting now for a substantial (over 20 percent) share in total compensation. Third, centralized bargaining has impeded geographic wage dispersion, which is sorely needed, given unemployment rates in the eastern half of the country that are double their western half counterparts. In many of these areas of labor market weakness, a contributing factor has been the role of large loss-making state-owned firms that have failed to exercise an effective voice for capital, inducing wage increases in excess of those suggested by micro-and macroeconomic circumstances.

Macroeconomic Performance

Hungary entered the postcommunist era in many respects in a relatively favorable position compared with its partner countries in Central and Eastern Europe. Aside from the above-mentioned history of progress toward economic liberalization in the structural area, favorable features included a less distortionary price system; a more stable internal macroeconomic position at the outset than in many other countries; a smaller, even though still dominant, share of external trade that was conducted within the CMEA trading bloc; a skilled labor force; and proximity to Western markets. On the other hand, Hungary was burdened by very high external debt levels that temporarily impeded private market access in the period of uncertainty surrounding other nation’s halting of debt servicing and the changeover to the first freely elected postcommunist government.

Against this background of initial conditions, developments in external accounts were a focal point for macroeconomic developments in Hungary. Accordingly, one can divide the past five years or so into two broad episodes. First, a period of external stabilization during 1990–92 when the current account recorded small surpluses, access to external capital markets was re-established, and inflation rates declined following an initial, though by international comparison relatively small, upsurge. A second macroeconomic phase started already in late 1992, but became fully apparent in 1993–94. A deterioration in the private saving-investment balance was accompanied by high public sector dissaving and, as a result, the external current account deteriorated markedly. Moreover, progress toward lower inflation stalled. Throughout this period, employment fell sharply, and officially reported output contracted until 1994.

This section provides a selective overview of macroeconomic developments since 1990. It high-lights factors underlying the output decline in 1990–93, and the inflation and external performance of the Hungarian economy. In this context, it becomes evident that a lack of progress in several areas of structural reform, as previously discussed, has also impeded macroeconomic stabilization and growth.

Output and Employment Performance

The cumulative fall in official GDP during the first years of adjustment—by about one fifth over 1990–93—was broadly similar in Hungary, Poland, and the Czech Republic. For Hungary, the sharp decline followed a decade of slow growth (about 1½ percent a year) in spite of high investment-to-GDP ratios, which were partly financed by external borrowing. The first robust growth in GDP in seven years, estimated at some 2 percent, occurred in 1994 (Chart 3.1). The earlier output decline was accompanied by a broadly similar, albeit lagged, proportional decline in employment. Official unemployment rates increased rapidly to over 10 percent, even as a considerable part of the reduction in employment was followed by a reduction in the active labor force.23

Chart 3.1.
Chart 3.1.

Hungary: GDP Growth and Inflation

Source: Hungarian Statistical Office.1Includes in 1993 the import of military equipment from Russia.

For the period 1990–93, the decline in output affected most sectors and all major demand categories (Table 3.1). In the beginning, it was particularly pronounced in industry and construction, while agricultural output fell very sharply in 1992–93 as a result of severe droughts the effects of which were further aggravated by uncertainties and initial inefficiencies related to the transfer of property claims in this sector. More modest declines were recorded in most service sectors, reflecting an increase in some subsectors following their neglect in prior decades. Among demand categories, gross investment declined from some 26 percent of GDP in 1989 to around 15 percent in 1992, but has since regained about 6 percentage points of GDP.24 Although the growth contribution from the external sector was overall somewhat negative during 1990–92, a sharp deterioration occurred only in 1993. At that time, a rebound in domestic demand contributed to a strong acceleration in imports while exports fell by about 12 percent in real terms, resulting in a sharp widening of the external gap. In 1994, the external balance remained broadly unchanged and the recovery of GDP growth reflected a strong expansion of domestic demand, in particular investment but also private consumption, as households’ disposable real income increased by over 3 percent.

Table 3.1.

Hungary: Selected Economic Indicators

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Sources: Ministry of Finance; National Bank of Hungary; and IMF, International Financial Statistics.

Excludes in 1993 imports of military equipment from Russia in lieu of outstanding claims by Hungary.

Includes the activities of the State Development Institution; in 1990, adjustments are made to both revenues and expenditures relating to the financing of local councils to render these comparable with later data.

Consolidation of general government and central bank debt.

Current account deficit is on a settlements basis and differs from the saving-investment balance, which is on a national accounts basis.

End-September 1994.

In percent of exports of goods and nonfactor services.

While it seems clear that the official statistics overestimate the actual decline in output,25 it is still generally acknowledged that a substantial decline indeed occurred.26 It also seems likely that the decline was caused by a multitude of shocks rather than a single one. And while some of the shocks were exogenous to Hungarian policies, others probably also reflected what, in hindsight, have turned out to be home-grown policy mistakes.

The disruption of trade among the CMEA countries obliterated some of the existing productive structure and interrupted long-standing business links that could only be replaced to a limited extent by trade with other markets in the short run. And even though the importance of CMEA trade disruptions may have been less in Hungary than in several other countries—with ruble trade accounting for about 42 percent of exports toward the end of the communist era in 1988 (and an additional 10 percent was conducted in convertible currencies with the then-socialist countries), these disruptions clearly presented a major shock to the domestic economy. On the other hand, if the CMEA dissolution had been the only, or overwhelming, shock, one would have expected that external trade would also record the sharpest contraction in its aftermath. Yet this was not the case and the share of exports in GDP remained fairly stable during the years 1991–92.27

The Hungarian state has been slow to retreat from its dominant influence in the economy (see also Chart 3.2). The large role of the state, including through its part in income redistribution, has required a heavy tax burden with disincentives for work and investment, and negative effects on overall production in the economy. The fiscal revenue burden remained high at over 50 percent, and the share of general government expenditure in GDP indeed increased, by almost 10 percentage points, in 1991–93 to over 60 percent. While the increase reflected in part social expenditures related to declining economic activity, adequate targeting in this and substantial cuts in other areas has not been achieved (as discussed earlier) and the state’s role would appear to be too large for the development of a dynamic market-based economy. In all, inadequate progress in structural fiscal areas—including fiscal and social security reforms—has thus impeded the macroeconomic stabilization task. In addition to the level of state involvement, the widening borrowing requirement of the public sector is likely to have resulted in some crowding out of private credit, with negative effects on investment.

Chart 3.2.
Chart 3.2.

Hungary: Selected Fiscal Indicators

(In percent of GDP)

Sources: National Bank of Hungary; and Ministry of Finance.1Consolidated state budget.2Overall balance excluding interest payments.3Consolidated debt of general government and National Bank of Hungary.

The effect of uncertainty on investment may have slowed the transformation process initially as enterprises postponed investment activities until at least some of the uncertainties were resolved (Dixit and Pindyck (1994). However, in view of its political stability and the sizable inflow of foreign direct investment, this argument is probably less persuasive in Hungary for the years 1990–93 than in most other countries of Central and Eastern Europe.

Official data indicate a redistribution of income toward labor in these years, reflecting predominantly the rising burden of social security contributions. The underlying worsening of the enterprise sector became clear and was to some extent aggravated by the 1992 bankruptcy law, and enterprise losses reached nearly 15 percent of GDP in 1992. Aside from direct output effects as some enterprises entered liquidation, the deterioration in enterprise profits had negative repercussions on investment and thus on the near-term growth capacity of the economy.

A sharp rise in household saving rates at the beginning of the transformation process in 1991–92 may have weakened demand and output in this period. It seems likely that this reflected in part precautionary saving in the face of rising unemployment and general economic uncertainty. Temporarily rising real returns on financial assets after mid-1991 may also have played a role in these saving trends (Chart 3.3). The situation changed dramatically in 1993 when the share of household saving in GDP fell by about 6 percentage points.

Chart 3.3.
Chart 3.3.

Hungary: Selected Monetary Indicators

Sources: National Bank of Hungary; IMF, International Financial Statistics; and IMF staff estimates.1Less than one-year maturity.2Less than one-year, more than one-month maturity.3Three-month active repo rate. Facility terminated September 5, 1994.4Sight deposit rate.5Deflated by the producer price index.6Deflated by the consumer price index.

Domestic credit growth to enterprises increased only slowly in nominal terms in 1992–93, and this may have hindered a rebound in activity (see also Calvo and Coricelli (1993)). It is likely that the slow growth of credit to enterprises in this period reflected importantly the risk assessment that priced many enterprises out of the market; aside from risks of specific enterprises, it reflected also concern about more systemic repercussions from the previously mentioned bankruptcy law. On the credit supply side, the financial weakness of the banking sector may also have slowed credit expansion, with much of the available credit in turn being absorbed by the public sector.

Among other factors that had a negative impact on growth in Hungary during this period were the recession in Western Europe (and the depression in other transforming economies); a prolonged drought with large output losses in the agricultural sector; and the UN sanctions against the neighboring Federal Republic of Yugoslavia (Serbia/Montenegro).


Inflation rates accelerated in 1990–91 and peaked in mid-1991 at around 40 percent (Chart 3.1). Following a subsequent decline, consumer price inflation has shown considerable inertia and has remained stuck at around 20 percent early 1992.

The persistence of inflation reflects to some extent the gradual removal of subsidies, implemented over a number of years and indeed still ongoing. While this has limited the size of price increases at any particular time, it is likely that the cost of this policy has been an entrenchment of inflationary expectations. Moreover, it has led to a persistent gap between producer and consumer prices, amounting to some 10 percentage points for much of 1992–94, which may have aggravated distortions in the economy and complicated monetary policy.28

Increases in labor incomes provided a persistent cost push over this period. This reflected increases in nonwage labor costs and in-kind labor compensation, with the faster rise in the latter taking advantage of the large implicit tax differential. But even gross nominal wages for full-time employees did not show the large decrease recorded in other transforming economies. During 1990–93, real wages (nominal wages deflated by the consumer price index) fell by only about 2 percent, and the decrease was more than recovered by the 3½ percent rise in real wages in 1994.

The institutional features of the labor market, previously discussed, probably contributed to the relatively stable behavior in real wages despite the sharp contraction in output and employment. It seems that there were only weak incentives for wages to respond to these unfavorable macroeconomic conditions, due in particular to still rather soft budget constraints for some public enterprises and in the public sector more generally. Sizable support for many workers that were laid off, including through various pension schemes, also played a role, as did the centralized bargaining institutions in Hungary where outsiders, and possibly also the private sector employers, played a relatively weak role.

The conduct of monetary policy probably contributed to persistent inflation. Without well-articulated and well-understood monetary targets, including for the exchange rate, the economy lacked a clearly visible nominal anchor. Exchange rates were adjusted intermittently in an ad hoc fashion against a basket of currencies, with considerable uncertainty surrounding each devaluation and the exchange rate path. Moreover, domestic monetary conditions also lacked at times the necessary firmness and stability for reducing inflation. This was particularly apparent in 1992 and early 1993, when an easing of monetary conditions was accompanied by a sharp decline in market rates (Chart 3.2). Subsequently, budgetary financing needs and weakening external balances led to monetary tightening; in the event, three-month treasury bill rates increased from a low of about 10 percent in April 1993 to over 30 percent by late November 1994, and some 33 percent in the first quarter of 1995. However, more frequent and at times larger step devaluations—of 7½ percent in August 1994 and 81/4percent in March 1995—partly offset these developments and inflation rates began to rise again in the second half of 1994 (further fueled, at the beginning of 1995, by increases in the administered price of energy); by May 1995, the year-on-year increase in the consumer price index exceeded 30 percent.

The inability of monetary policy to address the inflation problem more decisively reflected to some extent insufficient support from other policy instruments, notably fiscal policy. Public sector dissaving also contributed to the large external current account gap that increasingly required the attention of monetary policy instruments, at times at the expense of a lower inflation rate. The effectiveness of monetary policy has been further hampered by the ample availability of government guaranteed and subsidized credits. This has effectively shielded a considerable segment of the market from the transmission mechanism of indirect monetary instruments through interest rates; these forms of credit amounted to about two thirds of the increase in credit to enterprises in 1994 (and about 20 percent of the total outstanding stock of enterprise credit at the end of 1994).

External Balances and Debt

In the early phase of the transformation process, the external accounts performed considerably better than anticipated. In terms of the saving investment balance, this reflected primarily a strong improvement in household saving in 1991—92 and weak investment demand. On the trade side, Hungary was initially successful in containing imports even as the trading system was liberalized. At the same time exports were redirected to Western markets, and the share of industrial countries in total exports increased from 40 percent in 1989 to almost 70 percent in 1992.

The external current account recorded a surplus in each year during the period 1990–92, and the net debt level decreased by $800 million to about 43 percent of GDP (Table 3.2 and Chart 3.4). Moreover, Hungary attracted larger inflows of foreign direct investment than any other country in Central or Eastern Europe, averaging over $1 billion in this period. Following the renewed access to capital markets after 1990, the central bank borrowed from abroad to bolster its foreign exchange reserves.

Table 3.2.

Hungary: Balance of Payments in Convertible Currencies1

(In millions of U.S. dollars)

article image
Sources: National Bank of Hungary; and national authorities’ and IMF staff estimates.

Excluding reinvested profit remittances.

Includes net errors and omissions.

Excluding banking system and nonguaranteed enterprise liabilities.

Chart 3.4.
Chart 3.4.

Hungary: Selected External Indicators

Sources: National Bank of Hungary; IMF, International Financial Statistics; and IMF staff estimates.1Includes in 1994 prepayment of debt amortization amounting to some 7 percent of exports of good and nonfactor services.

In 1993–94, the external current account deteriorated markedly. With sharply falling exports and continued strong growth in imports, the current account moved into a deficit of over $3½ billion (close to 10 percent of GDP) in each of these years. Among the factors contributing to these developments were accumulated problems in cost competitiveness with comparatively large increases in labor costs (and profit reductions) in Hungary during 1990–92 (Chart 3.4), which left labor costs considerably above those in other transforming economies, and the strong rebound in domestic demand discussed earlier, as well as the recession in Western Europe; moreover, the large dissavings of the state—with consolidated budget deficits excluding privatization receipts of about 7 percent of GDP—weakened the macroeconomic saving-investment balance. On the supply side, a drought-related reduction in agricultural exports, repercussions from the 1992 bankruptcy law, and the effects of UN sanctions on a neighboring country also played a role in the widening external deficits.

The deterioration in the current account in 1993–94 was cushioned by non-debt and debtcreating capital inflows. Foreign direct investment was particularly strong in 1993, exceeding $2 billion and helped by the partial privatization of the telecommunication sector. In international capital markets, enterprise, and especially official borrowing, increased strongly in the period, with the latter concentrated in the bond market. This was used in part to bolster the foreign exchange reserves of the central bank, which increased to $6.7 billion at the end of 1993, with a further small increase in 1994.

The worsening of the external accounts over the past two years has resulted again in an increase in foreign debt. Net debt increased by almost $6 billion during 1993–94 to close to $19 billion at the end of 1994 (above 50 percent of GDP). Gross debt surpassed $28 billion and debt-service payments were equivalent to over 50 percent of exports in 1994.29

These developments indicate an urgent need to reduce the external imbalances and initiate steps that would put the economy on a path toward lower external indebtedness—a task that is acknowledged by policymakers in Hungary who recently initiated important steps to address these issues.

Challenges and Recent Policy Response

Hungary has undertaken reforms in almost every aspect of economic activity in the past few decades, with a sharp acceleration of efforts since 1989. The task, however, is still far from completed. Macro-economic imbalances—with large fiscal and external deficits—have emerged and domestic and external debt paths and levels require early and decisive stabilization efforts. To attain a path of high and sustainable growth, a parallel endeavor is needed to complete the sizable remaining tasks in the structural area. Indeed, the experience discussed here suggests that these two tasks are closely linked and sustained success in macroeconomic stabilization may require a more decisive pace of structural reform than Hungary has pursued in the past. The remainder of this section identifies some key outstanding structural issues and briefly describes a policy package presented by the Hungarian authorities in mid-March 1995 to address some of the stabilization and structural tasks.

The first area where structural reforms are urgently needed for both micro-and macroeconomic reasons in scale and scope is in government activities; they need to be reduced. Specifically, the level of social expenditures must be brought in line with what can be afforded. Among others things, effective pension ages will have to be raised and the contribution base broadened to place the system on a sound footing while ensuring adequate minimum pension levels. This should eventually allow for the reduction of the extremely high and distortionary social contribution rates. The size of public administration, as well as the tasks it is involved in, must also be evaluated, with a view to significantly scaling back the role of government. This can be helped by a comprehensive and timely budget information system, an area in which initial steps have begun as part of an effort to establish a centralized treasury. The latter will also improve the budgeting process, and expenditure monitoring and control.

The second area concerns the banking system. Following recapitalization, changes in incentives, and thereby in behavior, are necessary to ensure that problems do not re-emerge. This may be helped through the partial or total privatization of the banks, including potentially to foreign owners with banking experience. Moreover, the system of bank supervision needs to be substantially improved.

The third area concerns enterprise structure and governance. The new government has announced plans to reinvigorate the privatization process, including reducing the number of firms that are to remain fully or partially state owned. This should be done in a manner that is transparent and that provides firms with effective voices for capital, also in the period until privatization is completed. The latter applies particularly strongly to large state-owned, loss-making firms. It may be necessary for the Government to reintroduce direct controls over some of the actions of these firms (e.g., over wage bills) to stem their losses, and painful steps regarding their reorganization or liquidation must be undertaken.

The Hungarian Government announced in mid-March 1995 a policy package that attempts to address several of the issues raised here. Its main focus is on the immediate stabilization task, although it also contains several important structural elements. The package rests on three pillars: (1) fiscal adjustment measures that would contain the fiscal deficit excluding privatization to some 6 percent of GDP (about a 1 percentage point reduction from the similarly defined 1994 level and an over 3 percentage point correction from the deficit that would likely have occurred in the absence of measures); (2) a step devaluation of the forint by 8¼ percent against a currency basket, followed by a switch to a crawling peg exchange rate regime;30 and (3) tighter control over wages, including in the public enterprise sector.

The fiscal measures contain several elements that would address underlying structural weaknesses. In particular, they include a switch to means testing for the various forms of family benefits and incorporate some broadening of the contribution base for social security payments (however, the implementation of these measures is subject to a review by the Constitutional Court). In the social security area, the measures would also introduce copayments for some health care benefits. In all, the package, if fully and quickly implemented, would present an important initial step in overcoming the formidable—and interrelated—stabilization and structural challenges that the Hungarian economy is currently facing.


  • Berend, Ivan T., and Gyorgy Ránki, The Hungarian Economy in the Twentieth Century (London: Croom Helm, 1985).

  • Boote, Anthony R., and Somogyi, Janos Economic Reform in Hungary Since 1968, IMF Occasional Paper, No. 83 (Washington: International Monetary Fund, July 1991).

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  • Borenzstein, Eduardo, and Jonathan Ostry, Economic Reform and Structural Adjustment in East European Industry,IMF Working Paper, WP/94/80 (Washington: International Monetary Fund, June 1994).

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  • Bruno, Michael, Stabilization and Reform in Eastern Europe,Staff Papers, International Monetary Fund, Vol. 39 (December 1992), pp. 741777.

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  • Calvo, Guillermo, and Fabrizio Coricelli, Output Collapse in Eastern Europe,Staff Papers, International Monetary Fund, Vol. 40 (March 1993), pp. 3252.

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  • Dixit, Avinash K., and Robert S. Pindyck, Investment Under Uncertainty (Princeton: Princeton University Press, 1994).

  • European Bank for Reconstruction and Development (EBRD),Are Growth Estimates for Eastern Europe Too Pessimistic?Appendix 11.1 in Transition Report (London: EBRD, October 1994).

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  • Kopits, George, Hungary: A Case of Gradual Fiscal Reform,in Transition to Market: Studies in Fiscal Reform, ed. by Tanzi Vito (Washington: International Monetary Fund, 1993).

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  • Lutz, Mark S., Fiscal Structure and Developments in Hungary,in Hungary: Reform and Decentralization of the Public Sector, Volume II, Chapter 2, Report No. 10061-HU (Washington: International Bank for Reconstruction and Development, May 1992).

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  • Lutz, Mark S., (1994a),“Fiscal Adjustment”(mimeograph, Washington: International Monetary Fund, June 1994).

  • Lutz, Mark S., (1994b), “Recent Shifts in Labor and Capital Compensation in Hungary” (mimeograph, Washington: International Monetary Fund, October 1994).

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  • Lutz, Mark S., (1994c), “Tax Reform in Hungary” (mimeograph, Washington: International Monetary Fund, 1994

  • Ministry of Finance, Scope of Authority and Duties of the Minister of Finance, Public Finance in Hungary, No. 25 (Budapest, 1985).

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  • Ministry of Finance, (1991a), Governmental Programme of Conversion and Development for the Hungarian Economy (Stabilization and Convertibility), Public Finance in Hungary, No. 82, Vol. I (Budapest, 1991).

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  • Ministry of Finance, (1991b), Programme of Action and Economic Legislation, Public Finance in Hungary, No. 82, Vol. II (Budapest, 1991).

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  • Ministry of Finance, (1991c), Act on Compensation, Public Finance in Hungary, No. 84 (Budapest, 1991).

  • Ministry of Finance, (1991d), New Act on Accounting, Public Finance in Hungary, No. 86 (Budapest, 1991).

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For further details, see Berend and Ránki (1985), Boote and Somogyi (1991), and, regarding fiscal reforms, Kopits (1993) and Lutz (1992).


The second economy consisted of small shops, restaurants, and separate units within large enterprises, which provided goods and services to the latter, using the latter’s assets.


In this context it should be noted that the state budget made use of extensive subsidies and taxes on goods traded with Hungary’s CMEA partners so that domestic producers would find such trade to be as rewarding as engaging in production for domestic sale or for exports to the West.


At the central government level, there are budgetary chapters, comprising the spending ministries, offices of the President and Prime Minister, Parliament, and other agencies. Attached to these chapters are central budgetary institutions amounting to 1,395 at the end of 1993. In addition, a large number of extrabudgetary funds exist and are administered by the budgetary chapters. The social insurance system is also at the central government level. The general government includes the central government as well as local governments, or, as they were referred to in the 1980s, local councils. General government financial flows are also quite decentralized, with extensive transactions among the various components of the central and general government. As a result, and given an inadequate reporting system, the recorded level of fiscal activity is thought to be significantly overstated.


Specialized financial institutions included the State Development Bank (in charge of financing large investments), the Foreign Trade Bank (financing foreign currency trade), the National Savings Bank (NSB), the postal savings network, and savings cooperatives (the latter three financing household mortgages). In general, household monetary and credit flows were separated from those of the enterprise sector, and financial intermediation outside of the budget remained limited.


The share of freely determined producer prices was 77 percent.


The share of free producer prices was raised to 93 percent in 1991.


As noted above, the Government had instituted a system of taxes on and subsidies to enterprises engaged in trade with CMEA partners such that sales to domestic or convertible currency markets were equally profitable. As a result, the shift to trade at world prices resulted in a loss of net fiscal revenues of about 2 percent of GDP, compared with similar or greater losses at the enterprise level in other Eastern European countries.


For a more extensive discussion of these issues, see Lutz (1994a).


For a more complete description of the significantly damaging effects of increasing social insurance contributions, see Lutz (1994b).


Concerning the former, refer to Ministry of Finance (1992a) and to National Bank of Hungary (1991). As for the commercial banking law, see Ministry of Finance (1992c).


It should be noted that the Government undermined this independence by requiring in the 1994 budget law that the NBH directly finance an amount of the budget deficit in excess of that specified in the transitory provisions of the central banking law.


For the Acts on Compensation, Accounting, Investment Funds and Employee Stock Ownership Plans, refer to Ministry of Finance (1991c), (1991d), (1992b), (1992c), and (1992d).


See Morgan (1993). The Ministry of Finance reports that in 1992–93 trading in government securities accounted for over 80 percent of total exchange activity.


The Government’s privatization plan combined a quick “preprivatization” of some 10,000 small service establishments and initially, following the above-mentioned negative reaction to previously attempted “spontaneous” privatization, a case-by-case decision process concerning larger enterprises. When the latter proved to be too slow, the privatization process was itself “privatized,” allowing for state-approved private intermediaries to facilitate the process of bringing together potential owners and firms. In 1990, the Government created the State Property Agency (AVU), whose mandate was to privatize the enterprises within its portfolio. The State Asset Management Company (AV Rt) was formed in 1992 and was given control over about 150 enterprises in which the Government intended to retain a 100 percent, a majority, or a significant minority interest.


At their peak in 1992, losses totaled Ft 415 billion, equivalent to 14.8 percent of GDP. The 41 largest loss-makers, which accounted for 4 percent of the total employment, lost over Ft 100 billion. It is thought that these losses were financed through a building up of arrears to the tax authorities, the social security system, and other enterprises, as well as through a decapitalization of the firms themselves.


For a comprehensive description of recent labor relations in Hungary, see Plant (1993).


The initial replacement rates and benefit periods provided to the unemployed in Hungary may have retarded job search incentives; subsequent reductions in both have brought these parameters within Western European norms.


Moreover, given a persistently higher rate of consumer-over-producer price inflation, maintaining real consumption wages implies steadily increasing product wages and, with insufficient growth in productivity, until 1992, falling enterprise profits. For a more detailed discussion of these issues, see Lutz (1994b).


See Lutz (1994b).


Probably even more than other data series, there are serious problems concerning the quality of the investment figures. In particular, they include hardly plausible large swings in stock building; the share of fixed investment in GDP, on the other hand, was much more stable and was in 1994 about 1 percentage point lower than in 1989.


The overestimation is partly reflected in a lack of data coverage and the correspondingly large size of the underground economy, estimated at some 20–30 percent of official GDP. Regarding data difficulties in countries in transition, see EBRD (1994.)


For an early review of the experience in transforming economies, see Bruno (1992).


Furthermore, the transmission mechanism related to the end of the CMEA would importantly operate through a change in relative prices (presumably even in Hungary, even though prices there were more closely aligned with world market levels than in other CMEA countries). If this were a dominant feature, one would have expected considerable variations across tradable sectors in their output developments; however, some early work on this issue seems to suggest that this was not the case, and that, on the contrary, macroeconomic (i.e., more general) shocks were the dominant feature, at least in the industrial sector (see Borensztein and Ostry (1994)).


Among other things, it has contributed to high real lending rates for enterprises (with lending rates deflated by the producer price index), even at times when the return for depositors was still negative (with deposit rates deflated by the consumer price index).


The actual debt-service ratio in 1994—above 60 percent—reflected in part early repayments by the central bank in order to smooth its debt-service profile.


The rate of crawl will be 1.9 percent a month until the end of June and 1.3 percent a month for the remainder of 1995.

The Baltics, the Czech Republic, Hungary, and Russia