Hungary: Staff Report for the 2014 Article IV Consultation
Author:
International Monetary Fund. European Dept.
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Publication Date:
06 Jun 2014
eISBN:
9781498395069
Language:
English
Keywords:
ISCR; CR; financing; largely not observed; headline inflation; liability positions vis-à-vis nonresident; Hungary's economy; monetary policy; control environment; credit squeeze; support Hungary's advancement; labor market condition; risk perception; Loans; Credit; Global; potential GDP; transmission mechanism; short-term debt; investor base
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1. Hungary achieved a welcome reduction in vulnerabilities, but the economy remains susceptible to shocks. Since the 2008 global financial crisis, the country underwent sizeable fiscal consolidation, the current account turned into surplus, external debt declined, and inflation decelerated sharply. These improvements in fundamentals helped Hungary weather recent financial market volatility well and maintain market access. However, external and public debt levels are still among the highest in the region resulting in large financing needs and heavy reliance on nonresident funding. A shift in market sentiment could thus destabilize the economy, particularly given the high balance sheet exposure of the private and public sectors to exchange rate risk. Therefore, reducing the still-high vulnerabilities should be the focus of policies going forward.

Abstract

1. Hungary achieved a welcome reduction in vulnerabilities, but the economy remains susceptible to shocks. Since the 2008 global financial crisis, the country underwent sizeable fiscal consolidation, the current account turned into surplus, external debt declined, and inflation decelerated sharply. These improvements in fundamentals helped Hungary weather recent financial market volatility well and maintain market access. However, external and public debt levels are still among the highest in the region resulting in large financing needs and heavy reliance on nonresident funding. A shift in market sentiment could thus destabilize the economy, particularly given the high balance sheet exposure of the private and public sectors to exchange rate risk. Therefore, reducing the still-high vulnerabilities should be the focus of policies going forward.

Context

1. Hungary achieved a welcome reduction in vulnerabilities, but the economy remains susceptible to shocks. Since the 2008 global financial crisis, the country underwent sizeable fiscal consolidation, the current account turned into surplus, external debt declined, and inflation decelerated sharply. These improvements in fundamentals helped Hungary weather recent financial market volatility well and maintain market access. However, external and public debt levels are still among the highest in the region resulting in large financing needs and heavy reliance on nonresident funding. A shift in market sentiment could thus destabilize the economy, particularly given the high balance sheet exposure of the private and public sectors to exchange rate risk. Therefore, reducing the still-high vulnerabilities should be the focus of policies going forward.

2. Growth performance continues to lag behind that of some regional peers that are also participants in the German-Central European supply chain. Hungary has endured a prolonged period of stagnation largely attributed to significant deleveraging, fiscal consolidation (to a lesser extent), and the government’s interventionist policies (Box 1). These have included frequent and unpredictable policy changes and placing the brunt of the adjustment on particular sectors, e.g., banking, energy, retail, and telecom, all of which appear to have weakened market confidence and undermined the business climate and private investment. As a result, growth performance remains weak and real GDP now stands at about 5 percent below its pre-crisis level. Moreover, Hungary faces subdued growth prospects. This calls for a strategy to comprehensively address obstacles to stronger growth.

Real GDP. Hungary and Peers

(2008q1=100)

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: Haver and IMF staff calculations.

3. The ruling party’s convincing win in the April 2014 elections suggests no major change in the thrust of economic policies. Fidesz retained its two-third majority in parliament and full control over the legislative process. The party’s economic policy platform features a continuation of efforts to increase disposable income (including by adopting a debt relief scheme for FX mortgage holders), reducing utility prices, and maintaining the sizable public work programs. Fidesz has also vowed to ease the tax burden on labor, to boost the industrialization of the economy by signing strategic agreements with large multinational manufacturers, to increase domestic ownership in the banking sector, and to create a non-profit utility sector.

Response to Past Fund Policy Advice

The authorities have actively engaged in a policy dialogue with the Fund, but policies deviated from previous IMF advice in a number of areas.

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Background and Recent Developments

4. The economy has started to turn around in recent months. Following the 2012 recession, GDP posted 1.1 percent growth in 2013, with domestic demand as the main driver—for the first time since 2008. This largely reflected higher public spending, including on projects co-financed with the EU and—to a lesser extent—a recovery of private investment and consumption on the back of accommodative monetary conditions and improved market confidence. Better external conditions, alongside increased production capacity in the automotive industry, boosted exports and contributed to the widening in the current account surplus to 2.9 percent of GDP in 2013 from 1 percent in 2012. High frequency indicators suggest that growth remained strong in the first quarter of 2014.

Real GDP growth and Business confidence

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Source: Haver.

5. Inflation has fallen to a record-low level. Against excess production capacity, utility price cuts, and a moderation of import prices, headline inflation decelerated sharply to 0.4 percent at end-2013. More recently, it has remained around zero reflecting in part another round of utility price cuts. Core inflation and inflation expectations have decelerated as well, albeit more gradually, and have remained around the National Bank of Hungary’s (MNB) 3 percent inflation target.

Inflation and inflation expectations

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Source: MNB

6. Unemployment has declined sharply, but labor market conditions are still weak. Labor market participation increased by about one percentage point to 65.1 percent at end-2013. At the same time, public works programs continued to expand (Box 2), with the number of registered individuals exceeding 400,000 (or about 10 percent of total employment) at end-2013. Largely as a result of this expansion, the unemployment rate declined to 9½ percent in 2013:Q4 from 11 percent (both seasonally-adjusted) in 2012:Q4. Meanwhile, job creation in the private sector has been weak and real wage growth in this sector moderated further to about 3 percent at end-2013.

7. The fiscal deficit remained well below the EU limit in 2013. Following the substantial adjustment in 2012 (3½ percent of GDP) and additional measures in 2013 to ensure that the fiscal deficit remains below 3 percent of GDP, Hungary exited the EU’s Excessive Deficit Procedure in June 2013. With lower-than-budgeted tax revenues more than offset by strict expenditure control, the 2013 fiscal deficit (2.2 percent of GDP) over-performed the 2.7 percent target, thus keeping the policy stance broadly neutral. Public debt declined only slightly to just above 79 percent of GDP.

8. The central bank continued to ease monetary policy through both conventional and unconventional measures. Against decelerating inflation, low risk premia, and a negative output gap, the Monetary Council reduced the policy rate—albeit at a slowing pace—to a record-low level of 2.5 percent. Furthermore, the central bank introduced the Funding for Growth Scheme (FGS) with the aim of easing access to finance for SMEs and improving their credit conditions, inter alia, through a subsidized lending interest rate (Box 3). After the implementation of the Scheme’s first phase under which the equivalent of 2.4 percent of GDP was lent by commercial banks, the MNB extended the Scheme with a possible increase in the allocated amount to up to 6.6 percent of GDP.

9. The banking sector is still under pressure and bank balance sheets continued to contract. While aggregate capital and liquidity positions remained adequate, many banks posted losses for a third year in a row, due to high levels of NPLs (16.9 percent, 2013:Q4), weak economic activity, and a heavy tax burden. Portfolio cleaning remained sluggish, and speculation about future debt relief for FX mortgage holders has incentivized some borrowers to suspend their debt service payments, thereby adding further pressure on bank balance sheets. Despite the accommodative monetary conditions and improving economic activity, credit to households and corporates continued to contract in 2013, albeit at a slowing pace (by 3 percent and 2 percent, respectively). The deleveraging process has brought the loan-to deposit ratio further down to 102 percent in 2013:Q4 from about 150 percent in early 2009, and contributed to a further decline in banks’ foreign funding. In an effort to boost the lending capacity of cooperative credit institutions, the government integrated them into a single body under the ownership of the state-owned Development Bank. The integration process is expected to be completed by end-2014 and is likely to add a key market player to the banking system.1

External Positions of BIS-reporting banks, 2009Q1-2013Q3

(Change, Percent of 2013 GDP, exchange-rate adjusted)

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: BIS, Locational Banking Statistics; and IMF staff calculations.

10. External stability has improved, but still-high external debt and financing needs are a reason for concern. The current account is in surplus, reflecting in part elevated savings in response to ongoing deleveraging, and external debt has fallen substantially. However, despite the decline, external debt is 119 percent of GDP, the net international position is at -93 percent of GDP, open FX positions on private sector balance sheets are about 21 percent of GDP; and gross external financing needs average 26 percent of GDP per year over the medium term. Moreover, reliance on nonresidents for local currency-denominated government securities continues, and such holdings stood at 32 percent of the end-March 2014 outstanding stock, with a high concentration in the investor base (see accompanying Selected Issues Paper).

11. Staff’s assessment is that the real exchange rate is broadly in line with medium-term fundamentals. Econometric estimates based on the EBA methodology have low explanatory power and yield mixed results for Hungary. Specifically, the Current Account Balance approach suggests that the current account norm is a small deficit, about 5 percent of GDP below the cyclically-adjusted balance in 2013; thus, Hungary’s real effective exchange rate (REER) appears to be undervalued. However, in staff’s view, this approach does not adequately capture savings (and therefore the current account) remaining elevated due to Hungary’s still-large external liabilities, and the need to substantially reduce them over the medium term. The Real Effective Exchange Rate approach reveals an overvaluation of the exchange rate by about 20 percent, and the External Sustainability approach finds the REER undervalued by just under 10 percent. Other price indicators, such as unit labor costs, do not point to competitiveness problems.

12. However, non-price indicators point to an erosion in Hungary’s market share and attractiveness for FDI. After an impressive expansion in export markets starting in the mid-1990s, reflecting growing links with the German supply chain, Hungary’s export market share has been recently underperforming its regional peers (Box 4).2 At the same time, the FDI stock in manufacturing, which peaked at 23 percent of GDP in 2007, has declined sharply since then. Additionally, Hungary’s ranking in the global competitiveness index has slipped 11 places since 2010/11 (63 out of 148 in 2013/14), with the institutional framework providing a drag on overall competitiveness—transparency of government policy making, property rights, and public trust in politicians received exceptionally low ranking.

Share in the EU’s Exports

2007q1=100

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: IMF Direction of Trade Statistics.

13. Hungary withstood various bouts of emerging market turmoil over the past year relatively well. Financial markets seem to have taken confidence in the recent economic recovery, current account surplus, sizeable fiscal consolidation, and low headline inflation. Domestic issuance of government bonds has continued smoothly and yields—although increasing by 50–60 basis points toward end-2013—have eased somewhat recently. The exchange rate depreciated by 3½ percent against the euro in the first quarter of 2014 and has since been broadly stable, while the equity market recorded moderate losses (6 percent in 2014:Q1). Sovereign CDS spreads have moderated recently to just above 200 basis points (end-April). Taking advantage of favorable external conditions, the government secured financing for most of its maturing external debt in 2014 (US$7¼ billion, 5½ percent of GDP) with the US$2 billion and US$3 billion Eurobond placements in November 2013 and March 2014, respectively.

5-year CDS spreads in selected European emerging markets*

(May 22, 2013=100)

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: Bloomberg and IMF staff calculations.* Countries included are Slovak Rep., Poland, Slovenia, Russia, Turkey, Bulgaria, Croatia, Romania, Estonia, Latvia, and Lithuania.

Outlook and Risks

14. Staff expects the economic recovery to gather further momentum, with excess productive capacity narrowing slowly. Real GDP is projected to grow 2 percent in 2014 as investment and private consumption continue to improve on the back of more favorable financing conditions and a lower drag from deleveraging. Driven by a significant expansion in automobile production, exports are expected to expand further, but given their high import content and the expected surge in imported consumer and investment goods, the overall contribution to growth from net external demand would be limited. At the same time, the current account is projected to remain in surplus this year. Over the medium term, output growth is set to stabilize at around 1¾ percent. The impetus from domestic demand is expected to strengthen somewhat, and the contribution from net external demand is set to decline as import growth recovers. The latter together with slowing deleveraging and aging population dynamics would help normalize savings and turn the current account to a deficit, in line with its norm. Underlying inflationary pressures are expected to gradually build up, as spare capacity diminishes and the impact of one-off effects on prices wanes.

15. Risks to the outlook—highlighted in the Risk Assessment Matrix—are tilted to the downside. Staff noted that in an unchanged policy scenario, external vulnerabilities would pose risks to financial and economic stability in case of adverse external shocks. Uncertainty regarding advanced economies’ monetary policies or a further re-pricing of emerging markets or other risks could erode demand for Hungarian assets, spilling over through the banking (deleveraging) and balance sheet (exchange rate) channels. Moreover, escalation of geopolitical tensions in the region would exacerbate downside risks through trade and financial linkages, including through exposure to common nonresident financial institutions and investors (Box 5). A protracted slowdown in key trading partners could also hurt Hungary’s recovery through its impact on exports. On the domestic front, continued government interference in the economy could exacerbate deleveraging with adverse confidence effects, undermine Hungary’s international competitiveness further, and hurt investment and growth. On the upside, the expansion of the FGS may temporarily boost growth further and so could upside surprises to euro-area growth.

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Sources: Hungarian authorities, and IMF staff projections.

Excluding special purpose entities. Including inter-company loans, and nonresident holdings of forint-denominated assets.

Authorities’ views

16. While broadly agreeing with the near-term outlook, the authorities were more upbeat about Hungary’s medium-term prospects and the balance of risks. They agreed that, despite the recent improvement, external vulnerabilities remain high, and concurred that deterioration in the external environment would adversely influence Hungary through trade, financial, and confidence channels. To this end, they agreed that developments in Russia and Ukraine could affect Hungary; but they had not observed any immediate impact. The authorities viewed the risks to the outlook as broadly balanced and argued that the likelihood of capital outflows is low, particularly given that Hungary’s investor base has become more stable in recent years following the increase in the share of real-money investors. They also argued that the economy’s improved fundamentals have instilled confidence in foreign investors as evidenced by the recent decline in the sovereign CDS spreads and the heavily-oversubscribed auctions of government paper. Finally, they were more upbeat about Hungary’s growth potential and also noted considerable upside risks to growth, including from a pickup in corporate lending and on the back of the stimulatory impact of the FGS; as well as from a stronger external environment.

Policy Discussions

Policies should be geared toward boosting potential growth, and reducing public and external debts. Discussions thus focused on the need to build policy buffers further and adopt a comprehensive growth strategy that would encompass a growth-friendly fiscal adjustment, revival of financial intermediation, and structural reforms. Such a strategy would contribute to a faster reduction in risk premia and a higher level of investment and growth.

A. Fiscal Policy—Finding the Right Balance

17. Staff welcomed the authorities’ commitment to fiscal consolidation, but noted that policies appeared insufficient to reduce the public debt ratio.

  • The fiscal stance is projected to relax in 2014. With the deficit target increasing to 2.9 percent of GDP, mainly on the back of increases in expenditure on health, education and projects co-financed with the EU, the structural deficit is set to widen by about one percentage point of GDP, leaving public debt roughly unchanged at about 79 percent of GDP. Moreover, in staff’s assessment, the budget over-estimates potential revenue collection, which implies that the deficit target is likely to be met only if all budget reserves (0.7 percent of GDP) are saved.

  • Over the medium term, staff projects the fiscal deficit to come down only modestly. In the updated convergence program, the government targets a reduction in the deficit to 1.9 percent of GDP by 2017. However, based on staff’s baseline macro scenario, current policies, and the authorities’ ambitious investment agenda, partly funded by EU transfers, the fiscal deficit would decline only slightly to 2¾ percent of GDP. This would imply a further easing of the fiscal stance as the output gap closes and revenues recover back to their potential. Public debt, at around 78 percent of GDP, would remain a significant vulnerability (Appendix I).

18. There is a need for a clear and credible strategy to gradually but steadily reduce public deficits and debt over the medium term. Staff sees scope for a smooth fiscal consolidation path that would strike a balance between sustaining the economic recovery and putting the debt-to-GDP ratio decisively on a downward trajectory. To this end, staff recommended containing the fiscal impulse in 2014 to ½ percent of GDP, which would entail an adjustment of about ½ percent of GDP compared with the approved budget, followed up by a structural tightening of about ½ percent of GDP annually throughout 2015-19. Such a strategy—which would help build much-needed fiscal buffers and strengthen confidence—would bring the structural deficit to about zero and reduce public debt to just below 70 percent of GDP by 2019.3

19. The adjustment strategy should rely on durable expenditure consolidation, enhanced composition of expenditure, and gradual elimination of distortionary taxes.4 At over 50 percent of GDP, government spending is among the highest in the region, financed increasingly by distortionary sectoral taxes. A sustainable expenditure retrenchment would, therefore, create the needed fiscal space to rationalize the tax system.

Fiscal Stance of the General Government

(In percent of GDP)

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: Hungarian authorities and IMF staff calculations.1/ In 2011 excludes one-off revenues of 9.6 percent of GDP from the transfer of private pension assets to the government.

  • Staff sees room for: (i) better targeting of social benefits, employer tax breaks, and price subsidies; (ii) rationalizing remaining loss-making SOEs; (iii) containing discretionary spending on goods and services; and (iv) rationalizing the wage bill.5 The growth impact of expenditure can be enhanced by re-directing spending on public works to individualized employment services and training, and re-directing savings in family benefits towards the provision of child-care.

  • On the tax front, there is a need to: (i) streamline the tax regime through a reduction of exemptions, special regimes, and elimination of distortionary sectoral taxes; (ii) reduce the high tax wedge for low-income workers; and (iii) decisively tackle VAT fraud, particularly in the basic food sector (See: Box 7, Country Report No. 13/85).

Fiscal impact of potential measures

(in percent of GDP)

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Sources: IMF staff estimates, based on data provided by the authorities, and FAD and LEG TA reports.

The total reflects the needed adjustment to compensate for the elimination of sectoral taxes and the staff’s recommended structural consolidation. The individual impacts do not add to the total due to rounding.

Reduce employment (rather than wages) through attrition; rationalize local government employment further.

Assumes measures to eliminate 75 percent of the estimated total fraud.

20. Strong fiscal institutions are critical to boost policy credibility and investor confidence. Frequent changes in the fiscal targets and adoption of ad-hoc measures weaken policy predictability. The fiscal rules currently in place are broadly in line with the requirements of the Stability and Growth Pact, and are supplemented by a framework of domestic fiscal rules that exhibits a number of design flaws (see: Box 1, Country Report No. 12/13). Staff thus recommended simplifying the system and stressed the need to set the rules in structural terms to avoid pro-cyclicality. The authorities’ intention to adopt a binding multi-year budget framework, which would help anchor market expectations and contain spending pressures are welcome. Finally, staff called for providing the Fiscal Council adequate resources and greater operational independence to assess the sustainability of the fiscal stance and risks ahead.

Authorities’ views

21. The authorities reaffirmed their commitment to fiscal consolidation. While they acknowledged some risks to the 2014 budget, including due to the inclusion of substantive gains in tax collection through administrative improvements, they believe that saving only part of the budget reserves will be more than sufficient to meet their deficit target. Over the medium term, they expect the deficit to come down mainly by continuing their policies of partial freezes in government wages and in spending on goods and services; but also benefitting from past reforms to restrict eligibility and reduce the generosity of social transfers.

22. Regarding structural fiscal policies, differences in views centered on ways to boost demand and supply of labor and appropriate tax policies. The authorities felt strongly about the merits of the public works program and targeted reductions in employer contributions under the Job Protection Act. They were hesitant about potential intervention based on reported income, such as lowering the substantial tax-wedge for low income workers which has increased in recent years. The authorities pointed to progress in rationalizing loss-making SOEs and putting the pension system on a firmer footing. Regarding sectoral taxes, they stressed that they do not intend to phase them out in the near future given the lack of fiscal space. Furthermore, they disagreed with the mission’s characterization of the taxes as distortionary sectoral taxes arguing that taxes such as the financial transactions tax or the telecom levy are relatively broad-based consumption taxes.

B. Monetary and Exchange Rate Policies

23. Under the baseline scenario, with the economic recovery gathering momentum, inflationary pressures are set to build up, but only gradually. At the current level of the policy rate, staff projects headline inflation to revert towards the MNB’s inflation target of 3 percent as the output gap narrows and one-off effects on prices wane. The pace of inflation acceleration, however, is likely to remain moderate because weak labor market conditions and the recent moderation of inflation expectations would help keep private sector wage growth contained, while the deceleration of import prices is projected to offset the impact of recent exchange rate depreciation.

The policy rate and the term structure

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: Haver and IMF staff calculations.*The spread between the yields on 3-year and 3-month government bonds.

24. At the same time, there is considerable uncertainty surrounding the external environment. Hungary’s interest rate differentials have reached a record low, and further compression—also due to normalization of monetary policies in advanced economies—may reduce the attractiveness of Hungarian securities. This, together with possible re-pricing of emerging market risk in the wake of a slowdown in some large emerging markets and geopolitical tensions in the region, could potentially lead to a disorderly movement of capital flows. The recent steepening of the yield curve may point to increased uncertainty regarding the inflation outlook, and forward rate agreements are pricing a policy rate hike of 40 basis points by end-2014.

25. With these considerations in mind, staff recommended keeping the policy rate on hold and adopting a monetary policy tightening bias. The proposed monetary policy stance strikes a balance between cyclical considerations and financial stability concerns. The former set of considerations would justify maintaining the current accommodative stance before commencing the tightening cycle later in the year. However, the economy is still susceptible to shocks and remains highly vulnerable to exchange rate risk given its large open FX position. Sharp and persistent exchange rate depreciation could also endanger price stability.6 Staff, therefore, urged the authorities to keep the policy rate on hold, maintaining the present accommodative policy stance until there are signs that inflationary pressures are building up. In the event that external conditions deteriorate sharply, the MNB should also stand ready to tighten. Staff emphasized the importance of maintaining the confidence of market participants in the central bank’s inflation targeting framework and recommended a clear communication strategy to guide market expectations.

Reserve Adequacy

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Source: IMF staff estimates.

26. Maintaining sufficient reserves is imperative for supporting financial stability. While Hungary’s reserve position is projected to remain within the Fund’s adequacy range over the medium term, large financial sector vulnerabilities, including from heavy reliance on FX swaps with nonresidents, and risk of market volatility are expected to remain elevated. Accordingly, staff underscored the need to maintain adequate reserve coverage to support financial stability and smooth exchange rate volatility if the FX market dries up.

Authorities’ views

27. The authorities broadly agreed that changes in market sentiment continue to pose risks, but didn’t see a need for adopting a tightening bias. With inflation expectations moderating to around the MNB’s inflation target and the still-sizeable negative output gap, the authorities argued that inflationary pressures are likely to remain contained in the period ahead. In their projections, headline inflation is set to remain below 3 percent in 2014 and reach the inflation target in 2015. They concurred, however, that the increased volatility in the global financial markets requires enhanced vigilance, as risk perceptions can shift rapidly. In this connection, they reiterated the view of the Monetary Council to reassess the policy stance in light of market conditions. Finally, they considered the current level of reserves comfortable, and reaffirmed their commitment to maintain reserves within the adequacy range in the period ahead.

C. Financial Sector—Repairing Financial Intermediation

28. There is an urgent need to restore financial intermediation. Despite the recent improvement in economic activity, credit is projected to contract further in 2014. Staff argued that long-lasting restoration of financial intermediation should rely primarily on a sustainable improvement in banks’ operating environment, including a reduction in the heavy tax burden on banks and higher policy predictability. Staff cautioned about the high level of restructured loans (about 18 percent of total loans) and argued that the high level of NPLs continues to hinder credit growth.

This underscores the need for a faster cleanup of banks’ asset portfolios, including by removing legal, regulatory, and tax impediments.7 To this end, staff welcomed MNB’s efforts to address such impediments, and stressed that a swift adoption and implementation of a personal insolvency framework in line with best international practice would be important. Staff also stressed that a possible new FX mortgage debt relief scheme should envisage appropriate burden sharing among all stakeholders.

Bank Credit

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: MNB and IMF staff calculations.

29. Lending under the FGS should be limited, targeted, and time-bound, with fiscal costs clearly recognized. The first phase of the FGS helped extend SME loan maturity, and reduce borrowing costs and exposure to exchange rate risk. Weak demand for the second phase, along with the broad market expectation that the overall amount is unlikely to be utilized, suggest a limited impact on economic growth. While supporting the authorities’ objective to reduce fragmentation and improve SME access to finance (Box 6), staff saw scope to alter some of the Scheme’s modalities to increase its impact on growth and better support the effectiveness of monetary policy transmission. More specifically, there is a need to link the lending rate to the policy rate, so as to remove the monetary policy easing bias embedded in the scheme, in a manner that adequately compensates banks for lending to more risky SMEs. Moreover, this Scheme should remain time-bound and limited to SMEs, while fiscal costs should be transparently reported.

Credit growth of SMEs and credit standards applied for small and micro firms

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Source: MNB.

30. The ongoing integration of the co-operative credit institutions responds to the increasing need of improving their financial standing and operations. The integration process should help ensure adequate risk management practices, enhance their lending capacity, and ultimately increase their market share. As their overall role in the banking system is expected to increase substantially over time, it is important to put in place appropriate safeguards to ensure no state interference in their lending activity and strategic decisions.

31. Staff welcomed recent improvements in the financial stability framework, which would help safeguard the Hungarian financial system against a wider range of risks. The adoption of the new MNB Act, which facilitated the integration of the Hungarian Financial Supervisory Authority into the MNB and equipped it with micro-prudential instruments, also reinforced the MNB’s macro-prudential tool kit, and thus allowed the MNB to address financial gaps in a more efficient and effective manner. 8 While noting that financial and price stability are interlinked, staff stressed the importance of establishing adequate checks and balances to ensure that financial stability concerns will not override the MNB’s objective of price stability. In this regard, the establishment of the Financial Stability Council, which is responsible for financial sector stability, and decides about macro-and micro-prudential supervisory and regulatory instruments, is a step in the right direction. While the authorities have yet to decide whether to join the European Banking Union, staff stressed the importance of not falling “behind the curve” and encouraged the authorities to strengthen the supervisory framework further, including by adopting a bank resolution framework.

Authorities’ views

32. The authorities emphasized the role of the FGS in repairing financial intermediation and didn’t share staff’s concerns about its modalities. They agreed that credit is likely to remain weak in the period ahead, reflecting both demand and supply-side factors. In this regard, they viewed the FGS as a useful monetary tool to boost bank lending to SMEs. The authorities considered the FGS’s modalities appropriate and were confident that demand would pick up later in the year. They agreed that the FGS involves costs, but considered them as relating to the MNB’s monetary operations that could be offset by balance sheet management. While agreeing that commercial bank profitability is likely to remain subdued in the period ahead, they considered the bank levy and the bank transaction tax necessary given the limited fiscal space. On NPLs, the authorities concurred that their high level impedes credit growth and expected the task force responsible for identifying measures to facilitate faster portfolio cleaning to submit its recommendations to the Financial Stability Council in the coming months. As for their efforts to strengthen the supervisory framework, the authorities are in the process of drafting a new law that will implement the Bank Recovery and Resolution Directive, with full implementation envisaged early next year.

D. Structural Policies—Engendering Higher Potential Growth

33. Improving Hungary’s growth prospects remains a key challenge. Potential output growth is currently estimated at around 1 percent and is projected to increase modestly to around 1½− 1¾ percent over the medium term (see accompanying Selected Issues Paper). As such, it remains well below that of Hungary’s regional peers—thus weighing on domestic and external vulnerabilities and impeding Hungary’s convergence towards a higher income level. The subdued growth potential is driven by low investment and total factor productivity, which appear to be a reflection of the adverse business environment. Moreover, weaknesses in the labor market, including the low participation and employment rates, also weigh on long-term growth.

Contributions to Potential Output Growth

(Production Function Approach, in percent)

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Source: IMF staff calculations.

34. The erosion in market share and the drop in FDI undermine Hungary’s growth prospects. In staff’s assessment, this mainly reflects structural factors rather than exchange rate developments and it could undermine Hungary’s current role in the German-Central European Supply Chain. Staff underscored the need to move up in the value chain. This should entail measures to upgrade labor force skills, promote entrepreneurship and innovation, reduce the tax burden, and improve the business climate to support investment and growth.

35. Renewed structural reform momentum is needed to remove obstacles to growth. Past reforms to boost labor demand and supply have borne fruit, but further steps are required. Consideration should be given to boosting labor demand by differentiating the minimum wage across different groups and linking future increases to productivity growth; and reducing labor market skills mismatches by strengthening the training component of active labor market policies (see accompanying Selected Issues Paper). Moreover, there is a need to increase policy predictability, and reduce the regulatory and tax compliance burden on businesses. Finally, staff called for the restructuring of the remaining loss-making transport SOEs, and cautioned against recent measures to reduce utility prices further as part of the government’s strategy to make the energy sector non-profit, arguing that it may compromise the quality of services and undermine investment plans.

36. Staff analysis suggests that a comprehensive and ambitious structural reform package could lift Hungary’s potential growth substantially. Such a policy package could entail measures to: (i) increase labor participation; (ii) improve the quality of fiscal policy, including by eliminating distortionary sectoral taxes; and (iii) enhance the business environment. While considerable uncertainty surrounds the quantification of reforms and their impact on potential growth, model simulations suggest that in such a reform scenario, potential growth could return to its pre-crisis rates over the medium term (see accompanying Selected Issues Paper).

Authorities’ views

37. The authorities were more optimistic about Hungary’s medium-term growth prospects citing strong impetus from structural reforms and recent policy measures. They viewed medium-term potential growth at about 2½ percent, largely on account of higher investment due to increased EU funds, more favorable financing conditions for SMEs, and labor market reforms. The authorities noted that the recent decline in Hungary’s export market share is mainly linked to the changing structure in the manufacturing sector, particularly in the telecom sector, and argued that the increase in the peers’ market shares mainly reflects a catching-up process. However, they indicated that the diversification of Hungary’s export destinations, including through trade links with Asian countries, the expansion of Eximbank operations, and the planned increase in the production capacity in the automobile industry, would boost export performance. Finally, the authorities added that the utility price cuts were part of their strategy to develop a non-profit energy sector, which is critical to reduce high energy costs and enhance competitiveness.

Staff Appraisal

38. The Hungarian economy is strengthening but continues to face vulnerabilities. The economy has emerged from the 2012 recession and growth is gaining momentum. External demand has been supportive, but the economic upturn is largely driven by a pickup in domestic demand, on the back of stimulative macroeconomic policies. Inflationary pressures have subsided, and external vulnerabilities have declined somewhat, thanks to persistent current account surpluses and improved market sentiment, which allowed the government to secure most of its external financing needs for this year. While these developments are welcome, still-high public debt and related financing needs, heavy reliance on nonresident financing, and a large open FX position continue to pose significant risks. Hungary’s subdued medium-term growth prospects further exacerbate these vulnerabilities.

39. A stronger policy framework would help tackle these challenges. The improved economic conditions provide an opportune time to reduce vulnerabilities and unlock Hungary’s untapped growth potential. To this end, a recalibration of macroeconomic policies to build the necessary policy buffers, alongside a renewed reform momentum aimed at addressing structural impediments, strengthening institutions, and increasing policy predictability would contribute to a faster reduction in risk premia, sustain market access, and boost investment and potential growth.

40. Growth-friendly fiscal consolidation is necessary to put the public debt ratio firmly on a downward path. To this end, the authorities’ commitment to fiscal adjustment over the medium term is welcome, and it will need to be backed by a clear and credible strategy encompassing ambitious growth-friendly fiscal reforms. Those could include better targeting of social benefits, restructuring the remaining loss-making SOEs, and streamlining public sector employment. This, along with measures to reduce tax exemptions and address VAT fraud, would free up fiscal space for growth-enhancing tax and expenditure measures. The government’s plan to introduce a binding multi-year budget framework with the 2015 budget would bolster fiscal policy predictability and help contain spending pressures. However, a more independent and adequately-resourced fiscal council is essential to monitor the risks ahead and ensure the sustainability of public finances.

41. The monetary policy easing should end and a tightening bias should be adopted. While underlying inflationary pressures have eased and inflation expectations have come down to around the MNB’s inflation target, uncertainty about the external environment justifies a cautious monetary policy stance, particularly given Hungary’s vulnerability to exchange rate risk. In this regard, the policy rate should be kept on hold and the current accommodative monetary stance can continue to support economic activity. The precise timing of commencing the tightening cycle should depend on signs that inflationary pressures are building up. However, the central bank should also stand ready to tighten if external conditions deteriorate sharply. Adequate international reserves need to be maintained to mitigate excessive exchange rate volatility and support financial stability.

42. Well-functioning financial intermediation is essential for economic growth. While demand factors contribute to weak credit market activity, banks’ balance sheet constraints have also played a role. Removing regulatory, legal, and tax impediments, alongside a prompt introduction of a personal insolvency framework, would help accelerate the cleanup of banks’ asset portfolios and prevent repeated restructuring of non-performing loans. Reducing the tax burden on banks and improving policy predictability would also support lending activity. To this end, it is essential to ensure that future FX debt relief schemes would entail appropriate burden sharing among all stakeholders. Subsidized lending under the FGS has helped improve credit conditions for SMEs, but further refinement of the Scheme’s modalities could ensure a more effective monetary policy transmission mechanism and a higher impact on economic activity. All in all, the scheme should remain time-bound and limited to SMEs, with fiscal costs clearly recognized.

43. Sustained progress on wide-ranging structural reforms would help unleash Hungary’s full growth potential. Demand management policies cannot address the root causes of weak long-term growth. Instead, decisive implementation of structural reforms aimed at improving the business climate, promoting entrepreneurship and innovation, reducing the regulatory burden, rationalizing taxes, and boosting productivity in the services sectors, including by restructuring the remaining loss-making SOEs, is critical to boost potential growth and support Hungary’s advancement in the regional supply chain. Increased policy predictability and limited government interference in the economy would enhance market confidence and support private investment. Efforts to increase labor supply and demand should continue, and greater emphasis should be placed on mitigating skill mismatches, investing in knowledge industries to move up in the value chain and compensate for the narrowing labor cost differentials, adjusting the tax wedge on low income earners, and ensuring that minimum wage increases are in line with productivity growth.

44. It is recommended to hold the next Article IV consultation on the standard 12-month cycle.

Hungary - Risk Assessment Matrix1/

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The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks at the time of discussions with the authorities.

Public Works Program

Hungary’s public works program played a key role in the recent employment creation. Its aim is to facilitate the return of discouraged workers (many of whom were unemployed for extended periods) to the labor market by providing temporary employment opportunities with public agencies, mainly in the agricultural and construction sectors. The program was recently expanded and became a major contributor to public sector employment and to the decline in unemployment. The number of registered individuals grew from 271,600 in 2011–12 to 402,700 in 2013. As such, the size of the program reached 10 percent of total employment at end-2013.

Public Works Program: Type of employment and cost

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: Hungarian Ministry of Interior; and IMF staff estimates.

However, the program has been increasing the burden on public finances. Its focus has shifted over time, from mostly part-time employment to largely full-time employment and the cost to the budget almost tripled (to about 0.6 percent of GDP in 2013). The bulk of the funds under the program have been spent on wages, while spending on training has constituted 0.1 percent of GDP.

The expansion of the program raises questions about its long-term effectiveness. Although it directly contributes to domestic demand and employment, it resembles a social assistance scheme with questionable impact on long-term employment and growth. The 2013 data suggests that the program’s effectiveness has been limited as the share of participants finding jobs on the primary labor market within 180 days of leaving the program was 13.3 percent. 1/ However, the authorities consider this a significant result as many participants found jobs in relatively underdeveloped regions.

Horizontal skills mismatch (percent)

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: SEO Economic Research and Randstad (2012).

Raising Hungary’s growth potential should entail a more effective use of funds spent on the public works program. This could be achieved by shifting resources from increasing the number of participants and the size of wage compensation toward higher spending on vocational training, with a focus on new skills development. Hungary is amongst the group of countries that have relatively high horizontal skills mismatch (a mismatch of field of education) and retraining workers would be a relevant area to focus on.

1/ Cross country studies are skeptical about the effects of such programs on employment; e.g., Berkhout and van den Berg (2010) “Bridging the Gap: International Database on Employment and Adaptable Labour”, Randstad, Amsterdam, 2010.

The Funding for Growth Scheme

The scheme

First phase: Under the first pillar, the MNB provided zero-interest funding to banks for on-lending to SMEs at a maximum rate of 2½ percent. The amount available to banks was initially set at HUF 250 billion, but it was later raised to HUF 425 billion (1½ percent of GDP). The maximum maturity of the loans is 10 years and participating banks fully bear credit risk. The second pillar of the scheme allocated HUF 325 billion to facilitate the conversion of SMEs’ FX loans into forint at the same refinancing terms, but, given the high interest for the first pillar, the MNB enabled credit institutions to use their credit lines allocated under the second pillar for the first pillar. The scheme also established a third pillar (HUF 1,150 billion; equivalent to 4 percent of GDP) aimed at reducing foreign currency liabilities of banks and MNB’s interest expenses by making foreign exchange available to banks that would like to reduce their holdings of MNB bills and repay external liabilities.

Second phase: This phase envisages an increase in the allocated amount up to HUF 2,000 billion (6.6 percent of GDP), though only HUF 500 billion were initially allocated, to be operational until end-2014. It has the same financing terms for banks, but 90 percent of the additional funds available are required to be used for new loans only. The remaining 10 percent is available for refinancing of the FX loans. More recently, participation requirements were relaxed to include real estate companies, individual farmers, leasing companies, and non-bank financial intermediaries, and the limit of financing for an individual borrower was raised to HUF 10 billion from HUF 3 billion.

Utilization

About 93½ percent of the overall amount (HUF 701 billion) was disbursed to credit institutions. The majority of the amount was disbursed to pillar I (HUF 472 billion), divided between new investment loans (41½ percent), loans for working capital (26½ percent), and refinancing (about 43 percent), while HUF 229 billion was disbursed under pillar II (Table). The scheme also facilitated a significant decline in the interest rate for new loans, and increased the average loan maturity.

Distribution of loans provided under the first phase of the FGS

(in HUF billion)

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*As of August 1, 2013 credit institutions were allowed to use the allocation under pillar II within for pillar I.

While the first phase was met by high interest by enterprises, the expansion of the FGS seems very ambitious and its full utilization during the envisaged period does not seem to be realistic for a number of reasons. First, the initial disbursement of FGS funds has already met a substantial part of the SMEs’ demand for new credit. The lack of qualified borrowers makes the possibility of banks expanding their loans by around 30 percent during an 18-month period very distant. Related to this, Eximbank has been expanding its lending financed by issuance of external bonds, especially focusing on meeting demand by exporting SMEs which arguably are higher-quality borrowers. Second, many banks will not be able to substantially expand their lending under the FGS due to balance sheet constraints. Finally, the current maximum interest rate of 2½ percentage points may be attractive for lending to high-quality SMEs, but may be binding for more risky ones.1/

Therefore, it is highly unlikely that banks will manage to utilize the full amount of the second phase; and staff assumes that up to HUF 500 billion will be utilized. Indeed, central bank data indicate that the utilization of the second phase in the first six months (October, 2013–March, 2014) stood at about 18½ percent (HUF 92.7 billion), of which 11 percent of the allocated amount was utilized for new investment loans.

Potential growth impact

A model-based approach (using the GIMF), which is calibrated for the Hungarian economy, is employed to assess the potential impact of the FGS on economic growth.2/ The provision of FGS funds is modeled as a temporary decrease in the riskiness of Hungarian corporate borrowers, which in turn reduces the external financing premium. Thus, as a result of the utilization of the first phase and assumed utilization of HUF 500 billion in the second phase, the cost of capital would decline and, therefore, corporate debt and business investment would increase. Real GDP would increase by approximately 0.1 percentage point compared to the baseline on impact because of the increase in domestic demand, particularly investment. In the next periods, real GDP would be higher by up to 0.2 percentage points.

1/ The FGS follows the Bank of England’s Funding for Lending Scheme (FLS), which also aims at boosting lending to SMEs. However, unlike the FGS, the FLS is based on collateral swap, with amounts depending on new lending. In addition, the FLS does not impose a cap on the lending rate. 2/ The GIMF is a multi-region, forward-looking, DSGE model developed by the IMF for policy analysis and international economic research. For details on GIMF, see Kumhof et al (2010) “The Global Integrated Monetary and Fiscal Model (GIMF)—Theoretical Structure” IMF Working Paper 10/34, Washington: International Monetary Fund.

Export Developments and External Competitiveness

Hungary’s integration into the German-Central European Supply Chain (GCESC) drove its impressive export performance until 2009.1/ Starting in the mid-1990s, many German firms outsourced or relocated part of the production process to the CE4 countries, starting with Hungary, drawn to lower unit labor costs, high-quality human capital, and proximity to markets.2/ This integration process led Hungary’s export volume to quadruple during 1995–2009, while also raising intermediate goods imports, particularly in the knowledge-intensive sectors such as the automotive industry. Hungary also received substantial foreign direct investment from Germany during that period, which brought technology transfers, raised Hungary’s external competitiveness in the knowledge-intensive sectors and its domestic value added, creating jobs and supporting income convergence.3/ Moreover, close economic ties with Germany served as a shock absorber during the global financial crisis.

At the same time, the integration into the supply chain has posed challenges. The increased trade dependency on Germany has been reflected in higher business cycle co-movement and also contributed to increased exposure to global shocks. The Cluster Report’s analysis indeed indicates that the CE4 countries are more exposed to spillovers from the rest of the world. This, together with the increased concentration of exports in the knowledge-intensive industries such as machinery and transport equipment, suggests that Hungary needs to maintain sufficient policy buffers to cope with external shocks.

Hungary’s share in world’s exports

(2007=100)

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: WEO and ComTrade.

These challenges are further complicated by mounting competitiveness pressures. Since 2009, Hungary’s export growth moderated significantly and its share in world exports has been declining. This may partly reflect peers’ catching up, but with no strong evidence of exchange rate misalignment, it also reflects declining competitiveness. This is evidenced further in the recent sharp decline of investment from 23 percent of GDP in the late 1990s to a record-low 17 percent in 2012. Moreover, Hungary’s ranking in the Global Competitiveness report slipping by 11 places in the past 3 years. As unit labor cost differentials with Germany narrow, Hungary may also face difficulties in sustaining its current role in the GCESC, particularly given that other CESEE countries are making strides in removing impediments to trade, thus becoming potential candidates for the GCESC.

Sources: Direction of Trade, World Economic Outlook, Hungarian Statistical Office, MNB, the Global Competitiveness Report. and IMF staff estimates, *Excluding DEU, NDL, FRA, AUS, and ITA. 1/ See German-Central European Cluster Report, Country Report No. 13/263. 2/ The CE4 group comprises the Czech Republic, Hungary, Slovakia, and Poland. 3/ During 1995–2009, domestic value added in Hungary’s exports increased by 14 percent of GDP, most of this in the knowledge-intensive sectors.

Hungary’s Linkages with Russia and Ukraine

The economic risks from developments in Russia and/or Ukraine, especially ones that lead to disruptions in energy trade, would affect Hungary through its impact on the other economies of the region and the global economy more than through direct linkages. Financial linkages may become more pronounced at times of market turbulence, but are less likely to have adverse spillover effects otherwise.

Russia is an important source of final demand for Hungarian goods, but mainly through indirect supply chain links. Hungary’s direct export links with Russia and Ukraine are limited, as it exports just 2 and 1¾ percent of GDP to each one, respectively—a total of 3½ percent of Hungary’s exports—largely concentrated in the “machinery and transport equipment” industries. However, final demand from Russia, in particular for automobiles produced in Hungary and supplied indirectly through the German supply chain, is an important driver of exports, and, thus, lower growth in Russia could lower Hungarian exports (see IMF European Department, Regional Economic Issues, Spring 2014.)

Hungary has a significant dependency on Russia and Ukraine for its energy imports. Hungary imports about 5½ percent of GDP from Russia and just below 1 percent of GDP from Ukraine, with the former supplying most of Hungary’s imported gas and over 60 percent of its imported fuel. In addition, there is only limited possibility for re-routing gas imports through other countries. On the other hand, with seasonally-low demand and ample gas reserves (about 3 months of consumption), Hungary can overcome short-lived disruptions. At the same time, Hungary relies heavily on imported energy: 70 percent of the energy and 40 percent of the electricity it consumes in a year. Moreover, as the entire region is heavily dependent on energy imports from Russia, lengthy disruptions in gas supply would adversely affect production in Hungary also through the impact on other countries.

Direct financial channels are limited, but a marked deterioration in market sentiment could adversely affect Hungary. Hungary’s banking system is directly exposed to Russia and Ukraine mostly through OTP’s subsidiaries, which account for 9 percent and 6 percent of the group’s total assets, respectively. A sustained deterioration in the operating environment in Russia/Ukraine would adversely affect OTP’s profitability, but given its high capital buffers, it is unlikely to endanger the group’s financial soundness or have a significant effect on its operations in Hungary. The market share of Sberbank, the only Russian bank operating in Hungary, is only 2 percent and the bank is not systemically important. That said, a broader repricing of emerging market risk in the region may have considerable repercussions for Hungary by reducing the appetite for Hungarian and/or other emerging market assets. This impact could be amplified if some investors that play a significant role in the Hungarian and Ukrainian markets decide to re-balance their portfolio and reconsider their exposure to the region.

FDI links are limited. Hungary’s FDI positions in Russia and in Ukraine are 2.2 percent and 1.6 percent of total FDI abroad, respectively.

The Role of SMEs

In Hungary, SMEs account for 53 percent of the business sector’s value added (2012). While low compared to the EU median of 60 percent, it is broadly consistent with the share of other countries that have integrated into the German-Central European supply chain (e.g., Czech Republic, Poland, and Slovakia) where large multinational companies operate in the knowledge-intensive and high value added sectors. Moreover, SMEs’ employment amounts to 71 percent of business sector’s employment, which is significantly above the EU median of 67 percent, thus underscoring their pivotal role in job creation.

Performance

SMEs’ real value added fell by 28 percent during 2009–12, more than offsetting the sharp increase in the pre-crisis period, while the decline in employment was more moderate (5½ percent). The subdued activity of the SMEs sector in this period was accompanied by tightening of lending conditions. The premium on risky loans, as reflected in the widening of interest rate spreads, has increased significantly. Moreover, MNB’s lending survey indicates that lending standards to SMEs have been tightened significantly since 2008, as evidenced by the extension of smaller-size and lower-maturity credit lines, reflecting in part stricter collateral and higher credit scores requirements,. Overall, credit to SMEs contracted by 18 percent in 2012 relative to end-2008 and, although a sharp decline of credit also took place among large enterprises, estimations by the MNB suggest that supply-side factors mostly affected SMEs, while weak lending to large companies was mainly attributable to lack of demand.1/

Hungary. SMEs’Real Value added and Employment (2005 = 100)

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Source: Annual report on Small and Medium Size Enterprises in the EU, 2011/12.

Impact on economic activity and policy response

A cross-country estimation is employed to study the impact of tight credit conditions faced by SMEs on economic activity in Hungary.2/ The results suggest that a shock to lending standards that is similar in magnitude to the estimated “net tightening” in 2008 (average of 20 percent, “purged” of factors that also affect demand for credit) leads to a cumulative contraction of 1¾ percentage points of GDP in the following four quarters. This implies that nearly a quarter of the GDP contraction in 2009 (6¾ percent) can be attributed to the tight lending conditions that SMEs faced. As the adverse effect of the credit supply shock has a prolonged effect (estimated at an additional 1 percentage point in the subsequent four quarters), the drag on economic activity from the “net tightening” is likely to have persisted in subsequent years, particularly given that banks continued to tighten lending standards in 2010. In 2011–12, credit supply conditions remained broadly unchanged (on average); therefore, the adverse impact on economic activity is likely to have moderated.

Policy response

The MNB has responded to the tight credit conditions with both conventional and unconventional measures. In parallel to the gradual reduction of the policy interest rate to a record low level of 2.6 percent (as of March 2014), the MNB launched the Funding for Growth Scheme in June 2013, which, among others, aims to boost lending by providing loans to SMEs with preferential interest rate (Box 3).3/ While the program has provided some relief and shifted credit growth to SMEs to a positive territory, it is likely to have a limited impact on growth, absent complementary measures to restore the banks’ financial intermediation role, including through an improvement in the operational environment for banks. In this regard, steps to facilitate faster NPL resolution and to reduce the tax burden are imperative.

1/ Report on Financial Stability, National Bank of Hungary, May 2013. 2/ Klein, N. (2014) “Small and Medium Size Enterprises, Credit Supply Shocks, and Economic Recovery in Europe”, IMF Working Paper (forthcoming). 3/ Additional mechanisms are in place to support SMEs’ access to financing. These include (i) state-owned guarantees provided by Garantiqa, (ii) guarantees and direct lending by the Hungarian Development Bank, and (iii) government’s subsidized-short-term lending program (“Szechenyi Card”).
Figure 1.
Figure 1.

Hungary and Peers

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: Eurostat, Hungarian Statistical Office, MNB, ILO, and IMF staff estimates.
Figure 2.
Figure 2.

Hungary: Real Sector

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: Eurostat, Hungarian Statistical Office; MNB and IMF staff estimates.
Figure 3.
Figure 3.

Hungary: Banking Sector

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: MNB, IFS, WEO and IMF staff estimates.1/ For Czech Rep., Latvia, Lithuania, Romania, and Turkey data is for 2013Q3. For Poland, data is for 2013Q2.
Figure 4.
Figure 4.

Hungary: Fiscal Sector

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: Hungarian Authorities, IMF staff estimates and projections.1/ Excludes 9.6 percent of GDP in pension assets transfer to government in 2011.
Figure 5.
Figure 5.

Hungary: Inflation and Monetary Policy

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: MNB, Bloomberg, WEO and IMF staff estimates.
Figure 6.
Figure 6.

Hungary: External Vulnerabilities

Citation: IMF Staff Country Reports 2014, 155; 10.5089/9781498395069.002.A001

Sources: MNB, Haver Analytics, and IMF staff estimates.
Table 1.

Hungary: Selected Economic Indicators, 2009-16

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Sources: Hungarian authorities; IMF, International Financial Statistics; Bloomberg; and IMF staff estimates.

Includes change in inventories.

Actual final consumption of households.

Excludes change in inventories.

Consists of the central government budget, social security funds, extrabudgetary funds, and local governments. 2011 numbers reflect 9.6 percent of GDP transfer of pension assets to the state system.

Excluding Special Purpose Entities. Including inter-company loans, and nonresident holdings of forint-denominated assets.

Table 2.

Hungary: Medium-Term Scenario, 2009-19

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Sources: Hungarian authorities; and staff estimates.

Excludes change in inventories.

Excluding Special Purpose Entities. Including inter-company loans, and nonresident holdings of forint-denominated assets.

Includes interest revenue.

Table 3.

Hungary: Consolidated General Government, 2009-16 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Hungarian authorities; and staff estimates.

Data are classified following the ESA’95 methodology.

Includes sectoral levies. Also, starting 2013 includes revenues from the financial transaction levy.

Includes the levy on financial institutions.

In 2011 and 2012 includes 9.6 and 0.2 percent of GDP, respectively, from the transfer of pension assets to the state system.

Includes social security contributions.

Assumes that the extraordinary reserves, included under this spending category, will not be spent in order to reach the deficit targets.

In 2011 includes debt takeover of the transport sector company MAV (0.2 percent of GDP)and the capitalization of the National Development Bank (0.1 percent of GDP).

Table 4.

Hungary: Central Government Financing, 2010-16

(In percent of GDP)

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Sources: Hungarian authorities, and staff estimates and projections.
Table 5a.

Hungary: General Government Operations (GFSM presentation), 2009-17 1/

In percent of GDP

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Sources: Hungarian authorities, and IMF staff projections

Subcategories within tax revenues follow the ESA95 presentation.

The distinction between grants and other transfers is not available in the ESA95 main tables which are the source of data for this table.

Includes net acquisition of nonproduced nonfinancial assets.

Excludes fixed capital consumption.