Recent Economic Developments and Background Issues

This paper reviews economic developments in Hungary during 1993–94. The downward trend in measured aggregate output that had begun in 1990 reached its trough during 1993, and Hungary recorded its first positive GDP growth in five years in 1994. At the same time, progress with respect to inflation remained slow and the annual increase in consumer prices, after some decline early in the year, stood at about 21 percent at end-1994, little changed from 1993. Overall, macroeconomic developments in Hungary during 1993–94 were overshadowed by large fiscal and external imbalances.


This paper reviews economic developments in Hungary during 1993–94. The downward trend in measured aggregate output that had begun in 1990 reached its trough during 1993, and Hungary recorded its first positive GDP growth in five years in 1994. At the same time, progress with respect to inflation remained slow and the annual increase in consumer prices, after some decline early in the year, stood at about 21 percent at end-1994, little changed from 1993. Overall, macroeconomic developments in Hungary during 1993–94 were overshadowed by large fiscal and external imbalances.

I. Introduction

The downward trend in measured aggregate output that had begun in 1990 reached its trough during 1993 and Hungary recorded its first positive GDP growth in five years in 1994, estimated at about 2 1/2 percent. At the same time, progress with respect to inflation remained slow and the annual increase in consumer prices, after some decline early in the year, stood at about 21 percent at end-1994, little changed from 1993. Overall, macroeconomic developments in Hungary during 1993-94 were overshadowed by large fiscal and external imbalances. The deficit of the consolidated state sector budget averaged about 6 3/4 percent of GDP during 1993-94, and the external current account deficit swung from a small surplus in earlier years to a deficit of nearly 10 percent of GDP in 1993-94, notwithstanding a substantial tightening of monetary policy from mid-1993 onward. The external deficits resulted in a sharp increase in external debt, with the level of net external debt reaching about US$19 billion at the end of 1994 (some 46 percent of GDP and US$6 billion higher than in 1992). However, foreign reserves also increased in 1993 and marginally further in 1994; at about US$6.8 billion at end-1994, they covered 7 1/4 months of imports.

These macroeconomic developments are discussed in some detail in Chapter II, with particular focus on the reasons for the large deterioration in the external position during 1993-94. As well as reviewing in this context the evolution of fiscal, monetary and exchange rate policies over this period, the chapter also includes a brief analysis of the 1995 Budget.

Following the discussion of recent economic developments, five chapters provide more detailed background information on selected issues.

Chapter III discusses the large decline in the compensation of capital relative to that of labor during the recent transition toward a market economy. This experience in Hungary is compared with that in other countries—including other economies in transition. The chapter also reviews changes in the structure of the labor market and the wage determination system, as well as progress with enterprise reform. It suggests that a possible explanation for the shift in factor incomes during this period was the persistence of soft budget constraints together with inadequate governance in the enterprise sector, which has weakened management’s resistance to increases in labor costs. Also contributing to higher real labor costs was the multilevel system of wage determination that is geared towards the maintenance of real consumption wages.

Chapter IV reviews the main developments in household saving over the past decade and attempts to isolate some of their main determinants. A particular conclusion is that the temporary boom in household saving in 1990-91, which cushioned the economy during that period against a decline in saving by other sectors, was probably to a large extent the result of a rise in economic uncertainty at the beginning of the transition period. Preliminary econometric work suggests that real interest rates may also have played some role in raising household financial saving; the impact of interest rates on total household saving, however, was probably relatively small.

The fiscal sector is at the center of many of the economic challenges that Hungary is presently facing. Chapter V reviews key features of the present system, outlining the size of the present fiscal sector and placing it in the context of other transforming economies in Central Europe. The present revenue and expenditure systems of the general government are reviewed in detail, with special focus on welfare programs, which account for a substantial proportion of total general government outlays. The operations of different levels of government are also examined.

Hungary’s progress with banking reform between 1987 and 1994 is reviewed in Chapter VI. Following the establishment of a two-tier system in 1987, a number of measures were introduced in order to improve competitiveness in the banking sector. Nevertheless, individual bank lending remained heavily concentrated, and enterprises with major shareholdings in banks were often their largest borrowers. Major legislative reforms introduced in 1992—including mandatory provisioning against nonperforming loans and a new bankruptcy law—substantially improved the transparency of banking operations. As a result, the reported financial position of the banks deteriorated sharply. In order to shore up the state-owned banks, the authorities undertook several programs to improve the balance sheets of the banks, including swapping government bonds for bad debt, and bank recapitalization. The chapter concludes with a discussion of the current state of Hungary’s banking system, including the emergence of a group of dynamic small and medium-sized banks, which have recently made significant inroads in the domestic banking sector.

Finally, Chapter VII describes Hungary’s foreign trade and payments system. It indicates, inter alia, the considerable liberalization of external trade that has taken place in recent years, a process that continued in 1995 with the implementation of agreements with the EC, CEFTA, and EFTA and under the Uruguay Round.

II. Recent economic developments

1. Domestic economy

a. Macroeconomic developments during 1993-94

Measured output fell by 2.3 percent in 1993, taking the cumulative decline in real GDP over 1990-93 to 19 percent. However, output bottomed out during the course of 1993, and GDP growth in 1994 turned positive for the first time in five years. 1/ In 1993, developments were characterized by very asymmetric behavior of domestic and foreign demand—with a large negative growth contribution from the external sector as exports collapsed while import growth remained robust. In 1994, import and export growth were more balanced and strong investment demand led the growth in GDP, estimated at around 2 1/2 percent (Chart 1).

Chart 1
Chart 1


Citation: IMF Staff Country Reports 1995, 035; 10.5089/9781451817812.002.A001

Sources: Hungarian Statistical Office; and authorities’ estimates.1/ Includes in 1993 the import of military equipment from Russia.

Demand developments during 1993 showed a rebound in domestic demand with real demand increasing by 10 percent, led by sharply higher public consumption and investment. 2/ The growth in public consumption was dominated by an exceptional purchase of military equipment from Russia to settle outstanding claims by Hungary; however, even excluding these exceptional transactions, public consumption increased by about 3 percent in real terms. The growth in investment in 1993 reflected an end of the downsizing of stocks that occurred over the previous two years, as sharply higher stock-building contributed an estimated 6 percent to GDP in 1993 (the rise in stock building may also reflect some measurement errors in other demand components that are captured residually in this item). At the same time, fixed investment demand declined further in 1993, though by less than 1 percent. Household consumption increased by 1 1/2 percent in real terms and, with a further fall in real disposable incomes, this reflected a sharp decline in the household saving rate. This was possibly facilitated by negative real interest rates on financial saving instruments during most of the year, and precautionary savings may also have declined in 1993 as the income and employment outlook began to stabilize. 3/

Despite the increase in domestic demand, GDP growth was still negative in 1993 as a wide gap emerged between imports and exports. Exports fell sharply and the factors contributing to the fall, which are discussed in more detail in Section II.4, included possibly lagged effects from the earlier sharp appreciation of the forint in real terms; demand weakness in major trading partners; and some exogenous factors, such as the continued drought and its effects on agricultural exports and UN sanctions on the Federal Republic of Yugoslavia (Serbia/Montenegro). Some of these factors also contributed to the rise in imports. But a key factor in the 18 1/2 percent increase of imports in volume terms was also the strong expansion of domestic demand, discussed previously. The overall policy stance facilitated the acceleration in domestic demand with a positive impulse from the fiscal side and an easing of monetary policy early in the year, prior to a tightening in the face of the widening external gaps (see below).

In 1994, developments were more balanced across different demand components. The highest growth rate—some 14 percent in real terms—is estimated for gross fixed investment. This occurred despite sharply rising real interest rates for market-based domestic enterprise credits, and reflected improvements in the profit situation of some enterprises (including in the industrial sector); follow-up investments to earlier foreign direct investment; and also the overall improvement in domestic and external demand. Private consumption increased in 1994 by about 1 1/2 percent in real terms, about the same rate as in the previous year. Nevertheless, with considerable growth in household incomes in real terms, the household saving rate increased in 1994. This may have partly reflected cyclical factors as well as the higher returns on some financial instruments (see Chapter IV).

The sectoral performance in 1993 was characterized by stabilization or only small reductions in value-added in most sectors compared to the previous year, with the notable exception of the agricultural sector. The latter contracted by about 15 percent reflecting foremost the fourth consecutive year of drought conditions. Financial difficulties and the lack of a well-functioning credit system for the agricultural sector in the wake of property transfers also contributed to a further reduction in livestock and area under cultivation, and the share of agriculture in total GDP fell below 10 percent in 1993. On the other hand, a recovery took hold in the manufacturing sector and in several service areas, and the rebound gained momentum in 1994. Industrial production increased by 9 1/2 percent in 1994, accompanied by strong gains in productivity. At the same time, weather conditions also improved and the agricultural sector is expected to record its first year of positive growth since the recent transformation process began in 1989.

The turnaround in output during 1993/94 was, with some lag, also reflected in the labor market. Based on labor force survey data, the year-on-year decline in employment was only 1 1/2 percent in the second half of 1994 compared to an almost 10 percent decline at the beginning of 1993. A substantial share of the reduction in employment was accompanied by outflows from the labor force, partly into early retirement and also as a result of discouraged worker effects. In the event, the official unemployment rate peaked in the first quarter of 1993 at 13.6 percent and gradually declined to 10.4 percent by end-1994.

In contrast to several other transition economies, wage developments in Hungary have shown little responsiveness to the fundamental worsening of labor market conditions in the transition period. 1/ With a fairly centralized bargaining system, relatively ineffective representation of employers’ interests—partly due to still soft budget constraints in the public sector, including public enterprises—and an orientation of general wage developments on the centrally agreed minimum wage, real wages (deflated by consumer prices) declined very little in 1990-93 even as employment fell sharply. With output also falling—and despite the sizable decline in employment—this led to a considerable redistribution in the income shares in favor of labor incomes (especially when incomes in kind and fringe benefits are included; see Chapter III). In 1993, net real wages remained essentially unchanged as higher increases in the gross wage were offset by a widening of the tax wedge. However, in 1994 when the deterioration in labor market conditions began to bottom out, net real wages increased by an estimated 5 1/2 percent, led by higher public sector wages. Most tradeable sector firms were able to offset the wage increases in 1994 with gains in productivity, reflecting advances in output and, in many cases, further labor shedding.

Consumer price inflation in 1993 remained at about the same rate (22 1/2 percent) as in the previous year (Chart 1). This reflected several factors, including a loosening of monetary conditions early in 1993, indirect tax measures (notably increases of the VAT), and an acceleration of food prices in the face of the drought. In 1994, consumer price inflation decelerated at first, reaching a low of 16.6 percent in February on a year-on-year basis, as the 1994 budget contained relatively few measures with direct price effects. However, the progress in reducing inflation was short-lived. With the external position requiring repeated adjustments of the exchange rate in 1994—by a cumulative 16.8 percent (in terms of domestic currency) against the basket, including an 8 percent devaluation in August—tradeable prices accelerated. Moreover, from the cost side, rapidly rising wages affected especially those sheltered sectors that could not achieve commensurate productivity gains, and world market prices of raw materials increased also faster than in previous years. Under these circumstances, annual consumer price inflation accelerated to 21.2 percent by December 1994. However, with the relatively low 12-month inflation rates recorded earlier, average annual inflation in 1994 was less than 19 percent, the lowest rate since 1989.

Price increases at the producer level have been well below those of consumer prices, averaging about 11 percent in 1993-1994. The difference reflects primarily the impact of tax and other administrative price measures and the relatively larger weight of the service sector in the consumer price index. With services starting the transition with low price levels by international comparison, and being also more insulated from international competition, they have recorded persistently above average inflation rates in recent years. More recently, though, with the strong impact of the larger depreciations of the forint on producer prices, the gap between consumer and producer price inflation rates has narrowed falling to some 6 1/2 percentage points by end-1994 from about 11 1/2 percent in 1992-93.

b. Structural reforms

Even though many reforms were introduced relatively gradually in Hungary, the role of the private sector expanded significantly, accounting for more than 50 percent of measured GDP in 1994. The private sector expanded in part through the creation of new private enterprises. By end-1993, almost 700,000 individual entrepreneurs were registered and the number of incorporated enterprises had increased more than five-fold since 1989 to over 85,000, increasing further to 95,000 by August 1994.

A second avenue for increasing the role of the private sector has been the privatization of existing enterprises. In the past, the authorities have pursued a mixture of privatization techniques—including outright sales, auctions, compensation vouchers, spontaneous privatization, and privatization through subsidized loans. By August 1994, the main agency initially charged with privatization, the State Property Agency, had completely or partially sold off 810 of the over 1,800 companies in its initial portfolio, with an additional 433 companies entering into liquidation proceedings. The largest single privatization to date involved the partial privatization of the telecommunications company, with revenues of US$875 million. In general, though, net revenues to the budget from privatization have been limited, with a considerable proportion of gross receipts expended on maintaining the companies still in state ownership, recapitalizing companies to be sold, and on costs associated with the privatization process itself.

During 1994, little progress was made in the area of privatization, partly as a result of the Parliamentary elections in May. As a consequence, the privatization process remains far from complete with about 40 percent of value-added in the economy still produced by the state. The new government, which took office in July 1994, has developed a strategy for the acceleration of privatization, and a revised privatization law is currently before parliament. The new privatization strategy is to emphasize cash sales, with revenues accruing to the budget rather than being used for enterprise restructuring; open-bidding procedures; speed of sales with privatization to be largely completed by 1998; and would sharply curtail the areas where the state would want to reserve for itself a long-term stake. It is envisaged that for small state-owned companies privatization could be initiated at the company level; but the majority of revenues are expected from the sale of several large enterprises in the energy sector (electricity, gas, and oil), telecommunications, and, to a lesser extent, from the banking sector.

Aside from privatization, bankruptcy and liquidation proceedings have formed a second pillar of enterprise restructuring. The bankruptcy law introduced in 1992 initially included strict regulations under which firms automatically entered into bankruptcy if they were more than 90 days overdue on their debt service. This may have forced some economically viable firms into bankruptcy. At the same time, bankruptcy proceedings for some firms were excessively protracted. Modifications to the law were introduced in 1993 to address these deficiencies. In all, the courts have accepted close to 3,500 bankruptcy applications over the period from 1992 through September 1994, with about 1/3 of the cases ending in an agreement between debtor and creditors. Over the same period, declared enterprise liquidations amounted to almost 21,000, but as in the case of bankruptcies, the number of applications for liquidation proceedings has fallen sharply since 1992. However, many enterprises, especially in the public sector, have been shielded from the bankruptcy procedures, partly through the continued provision of bank credit, and have continued to remain loss makers. In parallel to the bankruptcy and liquidation procedures, a new debt reconciliation scheme was introduced in late 1993 which is to allow some greater flexibility for out-of-court settlements, and some 2,000 debtors have applied to the various options offered under this scheme. 1/

c Social indicators and poverty

Many social indicators, including measures of the incidence of poverty, have deteriorated since the late 1980s. This reflected the general decline in economic activity and the associated sharp fall in overall income and rise in unemployment; an increase in income disparity between richer and poorer households has also been a factor. Moreover, many government programs intended to offset some of these effects are not well targeted and, per forint spent on them, relatively unsuccessful in addressing the situation of the poorest segments of the population.

Only approximate estimates are available for most poverty indicators. Measured as the share of the population receiving less than the minimum subsistence level as calculated by the Hungarian Central Statistical Office (CSO), poverty affected some 1.5 to 2 million people in 1992, or at least 15 percent of the population. The poverty incidence based on this measure may have doubled since the late 1980s. However, the CSO’s measure of the subsistence level is quite high in relation to the general income level of the economy, amounting to between 50 percent and 85 percent of the average net wage in 1994. 2/ While the absolute size of poverty may be overstated by this measure, the trend that emerges from various indicators would point in the same direction, indicating a significant increase in recent years. On the other hand, income disparities within the poorer segments of the population are relatively small in Hungary.

The deterioration in recent years is not confined to the incidence of poverty, but extends also to a variety of other social indicators, especially in the health area. For example, life expectancy at birth has declined considerably, especially for males where it amounted to less than 65 years in 1992 compared to 73 years in neighboring Austria. At the same time, death rates have increased while the birth rate declined from already low levels. Public health expenditures have also declined in real terms since the late 1980s; however, with an even faster decline in GDP, their share in GDP has increased considerably. The new government emphasizes that better expenditure targeting and a fundamental reorientation of some services is needed to reverse the past deterioration in this area and achieve a more efficient use of health care expenditure.

2. Public finance

a. Structure of the public sector

The structure of the public sector in Hungary is relatively decentralized and complex. The general government comprises the consolidated central government and the local government sector (LGs). The consolidated central budget, in turn, contains the state budget (SB), the activities of the 31 budgetary chapters (which are, for the most part, spending ministries) and 1,395 central budgetary institutions (CBIs) they administer, 29 extra-budgetary funds (EBFs) and two social security funds (SSFs). The local government sector comprises 8 regional bodies, 19 county governments and about 3,155 municipalities. 1/ The activities of these various entities are intertwined with a multitude of financial flows between them—including transfers from the state budget to the CBIs, EBFs, SSFs and the LGs; transfers from the EBFs to CBIs, the SB, LGs, and other EBFs; and transfers among the CBIs.

As comprehensive data on the general government sector for 1994 is not yet available, the present section is focussed on a more narrow definition of the government sector—the so-called consolidated state budget sector. 2/ This definition subsumes the net operations of the state budget and the social security funds and two EBFs (the Employment and Solidarity Funds) plus transfers made to CBIs, the remaining EBFs and the LGs.

The consolidated state budget sector covers most of the main taxes—the profits tax (CIT), personal income tax (PIT), social security levies, customs duties, the VAT, and a number of excise and turnover taxes. However, a share of the personal income tax is paid directly to the LGs and a number of earmarked taxes are collected by the EBFs. EBFs, CBIs and the LGs also collect substantial own account revenues which are not included in the consolidated budget presentation.

The consolidated state budget also covers the bulk of spending made directly by the central government itself (including on subsidies, centrally directed investment, debt service and international transactions) and transfers to the CBIs and the EBFs and LGs. However, as each of these other levels of government have their own sources of revenue, the concept understates the true size of general government spending. Based on information prepared for the period 1990 to 1993, it appears that the state consolidated public sector may understate general government revenues by about 5-8 percent of GDP and general government expenditures by a similar amount.

b. Developments during 1990 to 1993

The consolidated state budget moved from a surplus equivalent to almost 1 percent of GDP in 1990 to a deficit of 7.5 percent of GDP in 1993 (Tables 18-19, and Chart 2). Much of this deterioration can be traced to the substantial decline in real output in this period—directly affecting both revenues and, to a lesser extent, expenditures—and to reform measures taken to deal with the transition. Measures falling within this latter category included the issuance of debt to finance recapitalization of commercial banks (Chapter VI); the introduction of a bankruptcy law which initially required enterprises with overdue payments of more than 90 days to place themselves under court protection and allowed them to suspend all payments, including tax and social security liabilities; the take-over of subsidized loans for housing from the National Savings Bank; and the switch to financing budget deficits by issuing securities at market-related interest rates from 1991.

Chart 2
Chart 2


(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 035; 10.5089/9781451817812.002.A001

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

The decline in GDP tended to mask the extent of fiscal effort undertaken by the authorities. Thus revenues were held at between 46 percent and 48 percent of GDP during this period despite the substantial decline in real activity which eroded tax bases. Revenues were sustained by strong increases in personal income taxes and social security contributions (as the relative share of wages in GDP rose and real effective income tax rates increased as rate scales were held relatively constant in the face of rising inflation) and by substantially increased contributions from VAT, excises and taxes on foreign trade (as the bases for these taxes expanded relative to GDP).

Meanwhile, there was a rise in the ratio of expenditure to GDP from around 48 percent to 55 percent. This increase was explained entirely by increases in current expenditures. Although subsides were reduced substantially, this effort was more than offset by increased expenditure on goods and services and on social security (including substantial increases in unemployment related payments) as well as rising interest payments.

Although the fiscal situation had begun to deteriorate already in 1991, it worsened sharply in the middle of 1992—with corporate revenues collapsing and unemployment rising—initially catching the authorities by surprise. The original budget for 1993 projected a deficit of Ft 230 billion or 6.2 percent of GDP. However, substantial overruns in expenditure became evident as the year progressed. Midyear wage increases, drought-related assistance and additional spending on CBIs, including the defence forces, together with prospective shortfalls in some revenues, contributed to a deteriorating budget outlook. By midyear, it appeared likely that the deficit could approach 7 percent of GDP.

In the face of this deterioration, a fiscal adjustment package was announced in mid-1993 that, together with the measures contained in the original budget, amounted to about 4 percent of GDP on a full-year basis. On the revenue side, the measures included an increase in the preferential VAT rate from zero to 6 percent and a. reclassification of some items; a freezing of the personal income tax brackets and some broadening of the tax base; a reduction from 50 percent to 30 percent of the share of the personal income tax transferred to local authorities; and an increase of unemployment contributions by employers and employees. On the expenditure side, the main measures proposed included a partial freeze in nominal expenditure on goods and services, a cut in pharmaceutical subsidies, a partial indexation of pensions, and tightening of eligibility requirements for unemployment benefits.

Additional measures designed to affect primarily the 1994 budget were also announced at that time including further limits on VAT exemptions and another increase on the VAT minimum rate from 6 percent to 10 percent (yielding Ft 10.7 billion in 1993 and Ft 21 billion in a full year); further broadening of the PIT and CIT tax base; and introduction of a minimum tax under the PIT and CIT. On the expenditure side, the main measures included elimination of a number of central budgetary institutions and an improved targeting of family allowances. To limit the deficit of the social security administration, measures were taken to broaden the base for social security contributions, reform the sickness payments system, lower subsidy rates on pharmaceuticals, and introduce health care copayments for some services.

Subsequent to the announcement of this package of measures, substantial progress was made in reducing the deficit in the last five months of 1993 and the final outcome would have been 5.4 percent of GDP but for the special defence items discussed below.

The budget outturn for 1993 included a special defence purchase of Russian military aircraft which added Ft 70.5 billion or 2 percent of GDP, bringing the budget deficit to Ft 262.8 billion or 7.5 percent of GDP. The transaction was part of an intergovernment agreement with the Russian Federation involving the exchange of aircraft in return for cancellation of debt obligations of US$800 million incurred by the former Soviet Union. Under this arrangement, the authorities made expenditures totalling Ft 101.5 billion in 1993 and received revenues (mainly VAT and other taxes levied on the import of the aircraft) of Ft 31 billion in 1993, resulting in a net increase in the measured deficit of Ft 70.5 billion in 1993. 1/

c Developments in 1994

The original consolidated state budget for 1994 projected a deficit of Ft 246 billion or 5.8 percent of GDP. These estimates reflected a projected resumption in output growth and took account of the substantial full-year effect of the supplementary fiscal measures presented in 1993. However, the impact of the originally announced 1993 package was reduced by the failure to fully implement some measures (particularly the tax base broadening and social security measures). Moreover, the 1994 budget incorporated some discrete tax measures that lowered the revenue outlook, including a 4 percent reduction in the CIT, and introduction of deductions for social security contributions to the PIT. Large privatization revenues were also assumed and sizeable asset transfers and arrears collection were expected to assist the finances of the social security funds. In the absence of such privatization revenues, the projected deficit was equivalent to 7.5 percent of GDP—broadly comparable with the equivalent deficit outcome in 1993.

During the course of the year, there was again concern that the deficit would come in well above the budget estimate. This concern largely reflected prospective shortfalls in company profits and turnover taxes; faster than expected increases in interest costs, subsidy payments and other current expenditures, including wage increases to government workers; 2/ and shortfalls in privatization revenues. A larger than-expected deficit in the social security funds also seemed likely as a result of a retroactive pension increase, and the failure to meet targets for the transfer of state assets and collection of contribution arrears.

Against this background, a supplementary budget was formulated which included measures designed to raise about 1 1/4 percent of GDP on a full-year basis. On the revenue side, it included an increase in excise taxes on alcohol and tobacco, petroleum products, and motor vehicles. Measures with respect to the VAT—in particular, an increase in the preferred rate from 10 percent to 12 percent, and the reclassification of telecommunication services to the 25 percent rate—were included in the supplementary budget, but would take effect only from the beginning of 1995. The measures on the revenue side were supplemented by expenditure reductions, concentrated on the CBIs and EBFs, agricultural subsidies (where substantial overruns occurred relative to the originally budgeted amounts), investment spending, and political compensation payments.

The savings outlined in the supplementary budget together with revenue gains associated with the faster than originally anticipated pace of devaluations (which boosted the domestic value of import duty collections), higher demand and income growth in the second half of 1994 and general restraint on expenditures led to an improvement in the financial position notwithstanding several subsequent fiscal measures which acted to increase the deficit. 1/ Estimates of the final outcome for 1994 suggest that the deficit will be about 6 percent of GDP, only slightly above that projected in the initial budget and some 1 1/2 percent of GDP lower than in 1993.

For the year as a whole, revenues fell as a share of GDP by about 2 percent compared to 1993, with substantial reductions in both PIT and social security contributions relative to GDP. The reduction in PIT collections reflected the budget measures, including the decision to make social security contributions deductible. The fall in social security contributions in relation to GDP reflected mainly collection difficulties, including a further increase in arrears.

Meanwhile, expenditures fell by about 3 1/2 percent of GDP notwithstanding a 2 percentage point increase in interest expenditure. The fall was concentrated in goods and services expenditures (which fell by over 4 percentage points) and social security spending (which fell by 2 percentage points). The decline in unemployment-related expenses, the non-recurrence of special defence related transactions, and a reduction in the public sector wage bill on account of the estimated decline in public employment contributed to these developments. However, preliminary data for the general government indicate that the expenditure reductions at the consolidated state level were partly offset by expenditure increases at other levels of government (see Chapter V).

Defence department spending in 1994 is estimated to be Ft 71.5 billion or 1.6 percent of GSP including an amount of Ft 11.6 billion carry over costs of the 1993 purchase of military equipment from Russia (see above). This compares to an estimated spending equivalent to about 4.5 percent of GDP in 1993 (or about 1.6 percent of GDP excluding the military equipment from Russia). Defence department employment in 1994 totalled about 90,000 plus 57,000 enlisted men.

d. The 1995 budget

The consolidated state budget deficit in 1995 is projected to fall slightly to 5.8 percent of GDP. However, that estimate includes expected revenues of Ft 150 billion from privatization; excluding such revenues, the budget deficit would rise from 6.8 percent to 8.7 percent of GDP. This deterioration reflects both a sharp fall in the ratio of tax revenues to GDP, while expenditures remain at over 50 percent of GDP—less than 1 percent below estimated 1994 levels. The composition of expenditures will change sharply with interest payments projected to rise by almost 2 percent of GDP and a somewhat larger drop in noninterest expenditures. The macro-economic projections underlying the 1995 Budget envisage stagnation in real GDP, a rise in the GDP deflator of about 20 percent, and a considerable redistribution of incomes towards the enterprise sector, associated with a projected decline in real wages.

Tax revenues are estimated to fall relative to GDP as a result of three main factors. First, the authorities introduced a number of new tax measures (for details see Chapter V) which are estimated to lead to a net reduction in revenue of about Ft 35 billion. Second, customs duties are expected to decline mainly as a result of a reduction in tariffs and fees associated with international trading agreements. Third, the projected stagnation in output and fall in real wages will impact on both direct and indirect taxes.

The main discrete tax measures were with respect to the corporate profit tax, including a reduction in the rate on reinvested profits from 36 percent to 18 percent, and with respect to the personal income tax. The changes to the personal income tax included a replacement of the former tax deductions by a more equitable system of tax credits; and introduction of a fringe benefits tax on the personal use of business cars. Other measures included in the budget were the abolition of the interest withholding tax; a halving in the dividend withholding tax rate to 10 percent; and an increase in the road fund levy. Changes to the coverage of social security levies are also proposed and collections in this area are expected to benefit from measures to improve compliance and reduce arrears.

The budgeted decline in customs revenue reflects a number of factors. The growth in imports is projected to slow sharply; statistical fees will be reduced as part of agreements associated with the Uruguay Round; and there will be substantial reductions in tariffs under the association agreements with the EU, CEFTA, and EFTA, as well as in connection with the Uruguay Round agreement.

The projected zero growth in real GDP and decline in real wages will have a broad-based negative impact on revenues in 1995. However, the impact on excise and VAT collections is masked by the full-year effect of higher rates introduced in the 1994 supplementary budget package. This applies particularly to the VAT as the changes announced in the 1994 package were not introduced until January 1, 1995.

As noted earlier, the growth in expenditures in 1995 is dominated by a projected 56 percent increase in interest payments. The growth in this item reflects both an increase in central government debt and a rise in effective interest rates. The increase in public debt reflects both the cumulative effect of state budget deficits in the period to 1994 as well as debt issued to fund specific off-budget measures, such as bank recapitalization and the conversion of foreign exchange losses incurred by the NBH into interest bearing government securities (see below). The 1995 Budget assumed an average interest rate on market-based domestic debt of 26-28.5 percent. While this is higher than the average rates prevailing in 1994, the sharp rise in interest rates in the second half of 1994 and in early 1995 may still make this assumption overly optimistic. On the other hand, the budgeted interest projections assumed substantial savings from the direct marketing of public debt instruments to households that was to increase in 1995 as new venues, including post offices and saving cooperatives, were to be used for this purpose.

Noninterest expenditures are estimated to fall by about 7 percent in real terms. This projected outcome reflects restraint in most categories: the wage bill is to be held to a nominal increase of only 6 1/2 percent in the public sector; social security spending policies are to be tightened, particularly in the health area; family allowances are to be held constant in nominal terms; producer subsidies, particularly to agriculture, are to be reduced; centrally-decided and state enterprise capital expenditures will be tightly controlled; and the grants to the LGs are to be held virtually unchanged in nominal terms. Defence spending is projected at Ft 76 billion or 1.5 percent of GDP.

e. Public sector debt

The debt of the general government increased by almost 25 percent of GDP to over 90 percent in the three-year period 1990-93, before falling moderately to an estimated 88.4 percent of GDP at the end of 1994 (Table 20). Despite the previously described sharp increase in the fiscal deficits over this period, the underlying debt dynamics were generally favorable and would have led to a decline in the debt-to-GDP ratio. However, movements in this ratio have been dominated in recent years by nondeficit related security issues of the state, mainly related to enterprise and banking sector support.

The generally favorable underlying debt dynamics reflect that a considerable portion of the domestic debt still carries below market interest rates. In this regard, the most important items concern historical debt held by the NBH, and debt linked to devaluation-related losses of the NBH. The latter are securitized with government debt in recognition that these largely reflect quasi-fiscal deficits of the NBH, the sovereign external borrower in the case of Hungary. However, this debt carries a zero interest, and the related debt stock amounted to about 1/3 of GDP at end-1993. 1/

With the effective interest payments substantially below the nominal growth of GDP, the rise in the debt-to-GDP ratio was primarily due to a sharp increase in nondeficit related debt operations. Over the past years, the main factors in this context were the replacement of subsidized housing loans by treasury bonds in 1992; and the issuance of bank consolidation bonds in 1993/94 totaling an estimated Ft 324 billion.

Since much of the government debt that carries below-market rates is domestic debt and principally held by the central bank, a clearer picture of the underlying debt dynamics emerges when the debts of the general government and the central bank are consolidated. This consolidated debt of the public sector amounted to an estimated 82.5 percent of GDP at the end of 1994, with the largest share—70 percent of the total or 58 percent of GDP—consisting of external debt obligations. However, the fastest growing component in recent years has been domestic debt, which has increased from about 5 1/2 percent of GDP in 1991 (or 8 percent of total consolidated public sector debt) to almost 25 percent of GDP in 1994. This reflected several of the previously discussed nonrelated security issues of the state, and also the increasing reliance by the state on other domestic sources than the NBH for its large deficit financing needs.

3. Monetary policy and developments

Since 1993, monetary policy in Hungary has been characterized by two distinct phases. The first half of 1993 saw a continuation of the easing that began in mid-1992 that was intended to stimulate domestic demand through lower interest rates. However, following a sharp deterioration in the external current account balance in mid-1993 and a growing budgetary financing requirement, monetary tightening was initiated beginning in the third quarter of 1993. This relatively tight stance of monetary policy was maintained throughout 1994 and early 1995 as the external position continued to deteriorate.

a. Developments in 1993

In the first half of 1993, Hungary’s monetary policy sought to boost domestic demand and secure economic recovery mainly by lowering domestic interest rates. Given the extent of slack in the domestic economy, the monetary policy stance was not seen as compromising the underlying primary policy objective of lowering inflation. Monetary policy conditions were eased at the beginning of 1993 when, on January 1, the NBH lowered its basic refinancing rate by 1 percentage point to 20 percent (following a similar reduction in October 1992), and reduced the mandatory reserve ratio from 16 percent to 14 percent.

The effect of these changes should be viewed alongside the increase in household demand for precautionary savings in 1992 and early 1993 in response to the downturn in economic activity. These savings were held primarily in the form of bank deposits and, as a result, household bank deposits increased by 37 percent in the 12 months to June 1993. Due to the lower cost of central bank refinancing and the sharp increase in the volume of deposits, the banks’ cost of funds declined significantly, and this was reflected in a reduction in enterprise deposit rates of nearly 15 percentage points between May 1992 and June 1993.

Even though banks typically had excess reserves, they were in general reluctant to lend to enterprises out of concern for potential further deteriorations in the quality of their loan portfolios. Instead, they opted to use their reserves to purchase lower-risk assets, including treasury bills. Reflecting this switch towards government securities, bank credit to enterprises declined by 3 percent in nominal terms during the 12 months to June 1993, and credit to government grew by some 23 percent over the same period. 1/ The pickup in demand for government securities contributed to a sharp decline in their yield, with average rates on 90-day Treasury bills falling from 25 percent in June 1992 to 10 1/2 percent in April 1993.

The easing of monetary policy in early 1993 resulted in smaller reductions in lending rates than in deposit rates. For example, by June 1993, enterprise credit rates had declined on average by about 10 percentage points (relative to May 1992), while deposit rates had fallen by about 15 percentage points over the same period. This differential response is attributable to two main factors. First, banks were required to accumulate provisions against their nonperforming loans which created incentives to increase intermediation spreads so as to boost bank profitability. Second, the structure of the Hungarian banking system remained highly segmented so that, in practice, little competition existed among banks for the bulk of corporate clients. As a result, banks did not fully pass on to their corporate debtors the lower cost of funds. 2/ These two factors contributed to the persistence of very large intermediation spreads from mid-1992 to mid-1993. 3/

In part reflecting the easing of monetary policy and the central bank financing of the state budget, inflation remained at about 21 percent in mid-1993, relatively unchanged from its average level in 1992. Consistent with the policy of maintaining the existing level of external competitiveness through small, periodic adjustments in the exchange rate, the NBH devalued the forint five times in 1993 by a cumulative 15 percent.

In combination with the reductions in nominal interest rates in the first half of 1993, the failure of inflation to decline caused real enterprise deposit rates and real yields on government paper to fall sharply. 1/ Based on the producer price deflator, real enterprise deposit rates declined to low but positive levels in mid-1993. However, based on the consumer price deflator, real enterprise deposit rates turned sharply negative. In contrast, reflecting stickiness of lending rates, real enterprise credit rates (based on either the consumer or producer price deflator) remained significantly positive (see Chart 3). 2/ In summary, therefore, the main impact of the monetary policy measures enacted since the second half of 1992 was to depress the real return on financial savings. This may have played a role in the sharp deterioration in economy-wide saving, and with it the external current account balance, in mid-1993.

Chart 3
Chart 3


Citation: IMF Staff Country Reports 1995, 035; 10.5089/9781451817812.002.A001

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

In response to the significant deterioration in the external position, the National Bank raised interest rates on its key repurchase agreements in both June and October, 1993. As the structure of interest rates moved upwards, the yield on Treasury bills increased sharply, reaching 24 1/2 percent for 90-day bills by the end of the year, up from a low of 10 1/2 percent in April. 3/

The progressive tightening of monetary policy in the second half of 1993 was reflected in a slowdown in monetary growth. The year-on-year growth rate of broad money declined from 24 percent in June to less than 17 percent in December. Reflecting the increase in interest rates on non-monetary assets, the (end-year) velocity of broad money increased in 1993, following several years of decline.

As to the implementation of monetary policy, the NBH continued to strengthen its instruments of indirect monetary control in 1993. Beginning in 1990 and continuing through 1993, direct refinancing of the banking sector (including for export prefinancing) by the NBH decreased substantially, although the NBH maintained several long-term refinancing facilities related to specific subsidized activities. Also, the NBH launched in January 1993 repurchase and reverse repurchase facilities based on government securities. This step provided the NBH with a wider range of instruments with which to conduct open market operations. By the end of the first quarter of 1993, repurchase agreements had become the primary source of short-term central bank refinancing, and by the end of the year represented about one third of total lending by the NBH to financial institutions. In addition, the National Bank also introduced refinancing through foreign-exchange deposit swaps at the beginning of 1993, with the NBH bearing the exchange rate risk.

b. Developments in 1994 and early 1995

Against the background of a sharply deteriorating external position and an annual inflation rate above 20 percent, the National Bank continued to tighten monetary policy throughout 1994. Interest rates on repurchase agreements were raised in several steps during the year, and by the end of 1994 rates on one-month agreements had reached 31 1/4 percent. Furthermore, the NBH’s base rate—which applies to credits for the state budget and also to loans (with maturities in excess of one year) to financial Institutions—was increased from 22 percent to 25 percent in mid-1994, remaining at that level for the rest of the year. The base rate was subsequently increased to 28 percent on February 1, 1995. In addition, interest rates on repurchase agreements were raised by 1 3/4 percentage points to 3 3/4 percentage points, depending on the maturity, on February 22, 1995. As concerns the exchange rate instrument, the NBH maintained its policy of periodic devaluations of the forint in 1994, in line with its objective of preventing an erosion of international competitiveness (see Section II.4 below).

The tightening of monetary conditions in 1994 was not confined to upward movements in official interest rates. In 1994 and early 1995, the NBH modified its set of refinancing instruments in order to strengthen control of bank liquidity and shorten the maturity structure of its refinancing credits. On February 14, 1994 the NBH terminated its two-week, six-month, and one-year active repurchase facilities, while simultaneously introducing a one-week passive facility. Additional adjustments to the set of instruments were made on September 5, 1994, when the NBH eliminated its three-month active and passive repurchase facilities and its three-month foreign-exchange deposit swaps, and again on December 20, 1994, when the NBH terminated all foreign-exchange swap facilities, and eliminated the use of one-month active and passive repurchase agreements. As a result of these steps, only overnight and one-week active repurchase facilities and the one-week passive facility remain. In order to further restrict bank liquidity, the NBH raised mandatory reserve requirements by 2 percentage points (to 14 percent) in February 1995. 1/

Taken together, the objectives of these monetary policy measures were to secure a marked improvement in the external balance by compressing interest-rate sensitive domestic demand and boosting domestic saving, and to reduce inflation from its entrenched level of above 20 percent a year. However, a number of structural features of Hungary’s economy served to weaken the link between the instruments and targets of monetary policy. First, the increasing openness of the economy to foreign capital inflows limited the ability of the NBH to control the volume of liquidity in the economy since domestic borrowers could turn to international capital markets for financing. Reflecting this tendency, the stock of foreign-financed business sector loans grew from about US$1 billion (5 1/2 percent of broad money) at end-1992 to about US$2.2 billion (12 percent of broad money) by mid-1994. 2/ As Hungarian firms were increasingly able to obtain loans from abroad, the transmission of monetary policy instruments (particularly interest rates) to macroeconomic variables, including the level of activity and saving and investment flows, was dampened.

A second structural characteristic that weakened the linkages between monetary policy instruments and the real economy related to the rapid growth of credits allocated on preferential or nonmarket terms. Credits with preferential interest rates or state guarantees accounted for about 20 percent of the total outstanding stock of enterprise credits at end-1994 and about two thirds of the total increase in credit to enterprises during the year. 1/ The extent of lending on nonmarket terms implied that a large part of the economy was insulated from the effects of increases in official lending rates, and that the burden of macroeconomic adjustment was concentrated on a relatively small segment of the economy, including to a significant degree the emerging private sector.

In addition, for those credits that were on commercial terms, the effectiveness of monetary policy was hampered by the less than full transmission of changes in official interest rates to market lending rates. whereas enterprise deposit rates increased by about 8 percentage points between mid-1993 and October 1994, enterprise lending rates rose by only 5 percentage points during this period. Greater upward rigidity in lending rates than in deposit rates reflected previously-mentioned factors such as the increasing openness of the economy to capital inflows, which limited the extent to which banks could raise their lending rates for creditworthy enterprises above those prevailing abroad. 2/ In addition, because the financial performance of the banking sector improved markedly in 1994 owing to the implementation of programs to recapitalize the banks, there was some downward pressure on intermediation spreads and lending rates. 3/ This tendency to lower lending rates as a result of the improved financial position of the banks (in an environment in which official rates were rising) also served to weaken the extent to which changes in official rates were transmitted to market lending rates.

As regards the development of the monetary aggregates, significant reliance on direct sales of securities to the nonbank public to finance the state budget led to a sharp reduction in real money demand in 1994 as private savings were channeled away from relatively low-yielding bank deposits. Specifically, broad money increased by about 13 1/2 percent during the year, lagging growth in nominal GDP by nearly 10 percentage points, resulting in a further increase in velocity. Including holdings of government securities by the nonbank public, which are estimated to have grown from some Ft 100 billion (5 3/4 percent of broad money) at end-1993 to Ft 250 billion (12 1/2 percent of broad money) at end-1994, however, the ratio of M4 (broad money plus holdings of government securities by the nonbank public) to nominal income remained relatively constant during the year.

As regards the components of broad money, foreign currency deposits (FCDs) grew by about 23 percent in the 12 months to end-1994, resulting in a small increase in the share of FCDs in total enterprise and household deposits to about one quarter. Household FCDs, which accounted for 70 percent of total foreign currency deposits in December 1994, increased by 34 percent in 1993 and by 42 percent in 1994, reflecting an increased desire by households to safeguard the real value of their financial assets in a period of heightened macroeconomic uncertainty. 1/ 2/

Despite increases in the cost of borrowing, domestic credit of the banking sector expanded by more than 16 percent in 1994, about the same rate as in the previous year. Lending to enterprises (including small enterprises) and to the state government each accounted for about 22 percent of the total increase in domestic credit. Reflecting the importance of noninterest rate sensitive enterprise borrowing during the year, credit to enterprises grew by nearly 15 percent in 1994, compared to a decline of about 1 percent in the previous year. 3/ Credit to the consolidated state government increased by more than 10 percent, in part reflecting the increase in government debt in the form of consolidation bonds issued in connection with bank recapitalization and enterprise debt reduction schemes. 1/ 2/

4. Balance of payments and external debt

The balance of payments in Hungary deteriorated markedly in 1993-94. Following small surpluses during the preceding three years, the current account deficit averaged about US$3 3/4 billion (nearly 10 percent of GDP) in 1993-94 (Chart 4). The current account deficit was financed to a considerable extent by official and enterprise borrowing and external debt and debt service indicators deteriorated; in particular, the net external debt to GDP ratio increased by over 10 percentage points to 46 percent over the two year period to end-1994. At the same time, foreign exchange reserves reached record levels, also supported by sizable inflows of foreign direct investment.

Chart 4
Chart 4


Citation: IMF Staff Country Reports 1995, 035; 10.5089/9781451817812.002.A001

Sources: National Bank of Hungary; IMF, International Financial Statistics; and staff estimates.1/ Data from October onward are staff projections.2/ ULC = Annual average prior to January 1992. Data from October 1994 onward are projections.

a. External trade developments during 1993-94

The external trade balance in 1993 widened sharply to US$2.9 billion (8.1 percent of GDP), after a deficit of US$0.4 billion in 1992, as exports declined markedly while imports accelerated. 3/ The decline in exports by an estimated 16.8 percent reflected to some extent factors unrelated to the conduct of domestic economic policy, especially the continued drought and its detrimental impact on agricultural supply conditions, and the effects of the implementation of UN sanctions against the Federal Republic of Yugoslavia (Serbia/Montenegro). In addition, the recession in Western Europe, and especially in Germany, Hungary’s main trading partner, hampered export activity. It is also likely that the base, the 1992 level of exports, was somewhat exceptional as enterprises in the early stages of restructuring after the collapse of the CMEA sought to export their products even if it entailed significant losses, a situation that was not sustainable and eventually corrected following the implementation of the new bankruptcy regulations in 1992. Even so, Hungary’s export performance in 1993 also lagged behind that of several other transforming economies in Central and Eastern Europe, and this points also to the importance of domestic factors in the trade performance. Among these factors, external competitiveness as measured by price and labor cost indicators had deteriorated considerably in earlier years, with real effective exchange rates appreciating by over 25 percent based on consumer prices and almost 30 percent based on unit labor costs between end-1990 and end-1993. 1/ While there was only a relatively small further appreciation during 1993 itself—and the producer price based index even depreciated—it is likely that the trade performance in 1993 reflected some lagged response to the earlier appreciation, especially as concerns the highly cost elastic commissioned works, which declined by US$0.5 billion. Moreover, as the external imbalances widened, many market participants may have expected a larger discrete exchange rate adjustment, and this likely contributed to an underinvoicing of exports at the time. Further contributing to the decline in exports was the domestic macroeconomic policy setting, notably on the fiscal side, where the resource absorption of the public sector remained large favoring the nongoods sector.

Hungary. Contributions to the export decline in 1993

(In millions of US dollars)

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Source: staff estimates.

Defined here as directly related to weather conditions and international sanctions, but excluding, for example, business cycle movements in partner countries.

The growth of imports in 1993 was largely influenced by similar factors as the export developments, including the earlier deterioration in competitiveness and the negative supply shock in the domestic agricultural sector. Furthermore, the acceleration of domestic demand with a positive fiscal impulse, the deterioration in private saving and the ensuing rise in domestic consumption, and an end to the downsizing of enterprise inventories, contributed importantly to the growth in imports.

The interpretation of external trade developments in 1994 is hampered by a considerable divergence between information based on customs and settlement statistics. While these two sources had also shown quantitatively somewhat different trends in 1993, the differences were more marked in 1994; settlement data indicate a further decline in exports and essentially flat imports in US dollar terms, while customs data point to double digit growth in exports as well as imports with the latter growing at a somewhat faster pace. While it is possible to reconcile part of these differences, it is nevertheless rather difficult to provide a fully consistent analysis of the trends in 1994. 1/

Hungary. External trade indicators on a settlement and customs basis, 1992-94 1/

(In billions of US dollars, except when indicated otherwise)

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Source: National Bank of Hungary.

Excludes in 1993 import of military equipment from Russia in lieu of outstanding debt obligations.

Based on customs data, exports are estimated to have increased by 20 percent in U.S. dollar terms in 1994, led by a strong increase in exports of manufactured consumer goods. They benefitted from some gains in cost competitiveness with strong productivity growth more than compensating for rapidly rising wages in the tradable sector. Export demand expanded with the economic rebound in Western Europe, and the share of exports to EU countries recovered from the losses in the previous year, accounting for over 50 percent of total exports. On the import side, the growth in customs values was supported by strong growth in imports of machinery goods, in parallel with the rebound in domestic investment activity. Furthermore, rising disposable incomes contributed to a rapid expansion in consumer durable and food imports. Somewhat less than half of the imports originated in EU countries, while the share of the former socialist economies, which has fallen substantially since the end of the CMEA trade system, accounted for less than one quarter of total imports.

The main policy instruments employed to address the widening current account deficit were a tightening of the monetary stance in terms of increases in official interest rates (discussed in Section II.3), and discrete adjustments of the nominal exchange rate vis-à-vis the currency basket. In the event, the forint was devalued five times in 1993 and seven times in 1994 by a cumulative 13 percent and by 14.4 percent, respectively, including a 7 1/2 percent depreciation in August 1994. 1/

With these exchange rate adjustments, the real effective exchange rate based on unit labor cost regained some of the earlier losses and was, at end-1994, slightly under its level at end-1992. Taking a longer perspective, the unit-labor cost based real exchange rate at end-1994 was still some 20 percent higher than early in the transition process in 1990. Assessments of competitiveness, however, are complicated by external shocks and ongoing structural change that the Hungarian economy has experienced in recent years. Other indicators that shed some light on competitiveness include direct observations on enterprise profitability, which show large and persistent losses in many enterprises and sectors; however, they suggest that profitability of exporters, although relatively low on average, may exceed the level in the rest of the economy, and preliminary data point to some improvement in the firms’ profit situations in 1994. The external current and trade accounts themselves also provide some indication of the competitive position of Hungary, as do the market shares of Hungarian products on domestic and foreign markets, which have declined considerably, in particular in 1993.

b. Other current account transactions

Among major service account items, receipts from tourism are estimated to have increased by over 20 percent in 1994 in U.S. dollar terms, following a slight decrease in the previous year. Cyclical conditions in the countries of origin contributed to these developments. Moreover, with the number of tourist arrivals declining in 1994, the increase in receipts reflected a rise in per capita expenditure, as more tourists utilized relatively higher priced hotels as opposed to private accommodations. Expenditures by Hungarian tourists abroad have steadily increased in recent years and the net tourism surplus averaged about US$0.5 billion in 1993-94.

Interest expenditure in 1993-94 rose in line with the increase in external debt levels, but lower long-term interest rates, especially on capital markets in Europe in 1993, mitigated the increase. Under these circumstances, interest expenditure increased from US$1.6 billion in 1993 to almost US$2 billion in 1994.

In all, the service account deficit added more than US$1 billion to the gap in the trade balance in 1993-94 and, with fairly stable and relatively small net transfer inflows, the current account recorded deficits of US$3.5 billion in 1993 and an estimated US$3.9 billion in 1994 (around 9 1/2 percent of GDP).

c. Capital flows and international reserves

The sharp deterioration in the external current account in 1993-94 was more than offset by large capital inflows. Access to international capital improved in 1993 for many emerging market borrowers, and the NBH undertook an extensive borrowing program, especially on private bond markets. In all, 16 bond issues were placed during 1993, mostly in a variety of European bond markets and in Japan, with yield spreads generally averaging some 250 basis points over benchmark instruments. Following general market trends, the situation became more difficult in early 1994. However, this proved to be temporary and, for the year as a whole, the NBH was still able to place the same number of issues on international markets at broadly similar terms than in the previous year, though at smaller amounts per placement. The average maturity of the foreign borrowing by the NBH exceeded seven years in 1993/94.

Enterprise borrowing also accelerated in 1993-94 and averaged about US$1 billion, partly in response to the tightening of domestic monetary conditions since mid-1993. In addition, borrowing abroad was facilitated by the increasing presence of subsidiaries of foreign-owned companies and joint venture companies with relatively easier access to foreign capital markets.

Hungary continued to attract a large share of the foreign direct investment flows into the region. In 1993, total inflows reached US$2.3 billion (about 6 1/2 percent of GDP), strongly influenced by the partial privatization of the telecommunications company. In 1994, inflows declined to about US$1.1 billion, their lowest level in four years, partly due to the earlier discussed slowdown in privatization, and increasing competition from other countries in the region that were able to attract a larger share. Even so, Hungary’s share of total inflows into the region was still above 50 percent for the period since 1990.

Short-term capital inflows have played a relatively minor role in Hungary—with the stock remaining broadly stable at somewhat over US$2 billion—as portfolio inflows have been restricted (see Chapter VII). On the other hand, balance of payments estimates for 1994 showed a strong inflow of short-term capital including errors and omissions; while some of this is likely to reflect unrecorded trade flows, it could also include some unrecorded short-term capital flows.

The large net inflows outweighed not only the sizable amortization payments—of US$3.3 million and US$4.3 billion in 1993 and 1994, respectively—but allowed also for a build-up in international reserves to record levels. The build-up occurred mainly in 1993, as reserves remained broadly unchanged in 1994; by end-1994, reserves of US$6.8 billion covered 7.2 months of merchandise imports.

d. External debt and debt service

The current account deficits and reserve accumulation in 1993-94 was financed to a considerable extent by debt-creating capital inflows. During this two-year period (and including valuation changes), Hungary’s net debt increased by almost US$6 billion to US$19 billion (about 46 percent of GDP). With the concurrent increase in foreign exchange reserves and other assets, gross debt increased even faster over the same period reaching an estimated US$28.5 billion at end-1994.

Hungary’s external obligations are largely medium- and long-term, with average maturity of total external debt, including short-term debt, of about 4 1/2 years. As mentioned above, the stock of short-term debt has remained fairly stable at somewhat over US$2 billion, and amounted to about 8 1/2 percent of total external debt at end-1994. This relatively small level of short-term debt reflects restrictions on private portfolio inflows; in particular, nonresidents are prohibited from purchasing most government securities. Debt management has been geared at lengthening maturities and smoothing amortization payments, and the NBH seldom borrows at maturities below seven years. To smooth amortization payments, the NBH pre-paid amortizations due in 1995-96 of about US$0.9 billion in the first half of 1994. With favorable long-term interest rates on the more recent borrowing, this also reduced the interest bill for 1994 and future years.

With the recent switch in the borrowing program from commercial bank borrowing to bond financing, the share of bonds in total debt rose from an insignificant amount in 1990 to about 3/4 of total public debt extended by private creditors to Hungary by end-September 1994, or about 45 percent of total external debt.

At present, Hungary’s external debt and debt service burden exceeds the levels observed at the beginning of the transition period in 1989/90, with the gross debt-to-GDP ratio at almost 70 percent and the debt-to-export ratio at about 280 percent. While these ratios are high even by the standards of heavily indebted countries, 1/ Hungary compares favorably in terms of its level of reserves, with import coverage exceeding 50 percent, and in terms of its access to international financial markets.

Reflecting the recent increase in the external debt stock, debt service indicators deteriorated during 1993/94. In 1994, debt service reached 53 percent of exports of goods and nonfactor services; 2/ interest payments alone amounted to 19 percent of exports of goods and nonfactor services.

Table 1.

Hungary: Gross Domestic Product and Aggregate Demand, 1989-94 1/

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Sources: CSO; and data provided by the Hungarian authorities.

The data series have a break in 1991: for 1991-94, the data are based on the new System of National Accounts (SNA); earlier data are based on the old SNA (see also the following footnotes).

Under the new SNA: household consumption, including social transfers in kind; under the old SNA: private consumption.

Under the new SNA: government final consumption expenditure, excluding social transfers in kind by the government; under the old SNA: public consumption.

Includes in 1993 Ft 72 billion in imports of military equipment from Russia.

No data for this category are available under the old SNA.

Table 2.

Hungary: Aggregate Demand - Real Growth and Inflation, 1989-94 1/

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Sources: CSO; and data provided by the Hungarian authorities.

The data series have a break in 1991: for 1991-94, the data are based on the new System of National Accounts (SNA); earlier data are based on the old SNA (see also the following footnotes).

Under the new SNA: household consumption, including social transfers in kind; under the old SNA: private consumption.

Under the new SNA: government final consumption expenditure, excluding social transfer in kind by the government; under the old SNA: public consumption.

Includes in 1993 Ft 72 billion imports of military equipment from Russia. Excluding these imports, real growth in collective consumption and imports was 4.0 percent and 11.1 percent, respectively, in 1993 and 3.5 percent and 17.7 percent in 1994.

Contribution to growth.

Table 3.

Hungary: Gross Value Added by Industries, 1990-93 1/

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Sources: CSO, National Accounts Hungary, 1991-93: data provided by the authorities; and staff estimates

Growth rates after 1991 (and the forint values of 1991) are based on the new System of National Accounts (SNA); data for earlier periods are based on the old SNA methodology and not directly comparable.

From 1992, all activities of the Hungarian Oil Company (MOL Rt) are classified as manufacturing.

Table 4.

Hungary: Developments in Industry, 1985-94 1/

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Source: CSO.

For companies employing more than 20 persons.

At constant prices of 1993.

Current prices.

Output per person employed.

The percentage change figures include data for all corporations.

Table 5.

Hungary: Agricultural Production and Average Yields of Selected Crops, 1989-93

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Sources: CSO, Statistical Yearbook, Agricultural Pocketbook; and data provided by the Hungarian authorities.
Table 6.

Hungary: Investment by Origin of Capital Goods, 1989-93 1/

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Sources: CSO, Statistical Yearbook and Monthly Bulletin of Statistics.

The table contains the investments of legally registered economic organizations. Due to revisions in methodology, the data series have a break in 1992.

Total imported machinery.

Table 7.

Hungary: Sectoral Saving and Investment Balances, 1990-94

(In percent of GDP)

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Sources: Ministry of Finance; Central Statistical Office; and staff estimates and projections.

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

The nonfinancial balance is on a national accounts basis and differs from the current account in the balance of payments, which is on a settlements rather than a customs basis.

Table 8.

Hungary: Income Distribution by Sectors of Production, 1991-94

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Sources: CSO; and Ministry of Finance.
Table 9.

Hungary: Household Disposable Income, 1991-94

(In billions of forint)

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Source: CSO; and authorities’ estimate for 1994.

Deflated by the implicit individual consumption deflator.

Ratio of saving and adjusted disposable income, in percent.

Table 10.

Hungary: Employment by Sectors, 1989-94

(In thousand, beginning-of-year)

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Source: CSO; and staff estimates.

Due to revised classifications, the sectoral breakdown in 1994 is not directly comparable to earlier years.

Table 11.

Hungary: Unemployment Indicators, 1989-94

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Sources: CSO, Statistical Yearbook and Monthly Bulletin of Statistics (various issues); and data provided by the authorities.

By duration of job search, based on labor force survey for last quarter of the year. For 1992, the data are not directly comparable and refer to less than 27 weeks, less than 55 and more than 27 weeks, and over 55 weeks, respectively.

Ratio of unemployed at end of the year to the labor force in January of the previous year.

Ratio of registered unemployed to the sum of employed and unemployed in the same period.

Deflated by the consumer price index.

Table 12.

Hungary: Consumer Prices and Wages, 1989-94

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Sources: CSO, Monthly Bulletin of Statistics: and data provided by the Hungarian authorities
Table 13.

Hungary: Producer Prices, 1989-91 1/

(Average annual percent change)

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Sources: CSO, Monthly Bulletin of Statistics; and data provided by the Hungarian authorities.

Domestic and foreign sales.

Table 14.

Hungary: Producer Prices, 1992-94 1/

(Average annual percent change)

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Sources: CSO, Monthly Bulletin of Statistics; and data provided by the Hungarian authorities.

Domestic and foreign sales. Data are based on new industrial classifications and are not directly comparable to earlier series presented in Table 13.


Table 15.

Hungary: Share of Administered Prices by Category, 1990-93 1/

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Sources: CSO; Monthly Bulletin of Statistics; and data provided by the Hungarian authorities.

Includes prices subject to a maximum limit.

Petrol and gas oil.

Electricity and gas.