Hungary has succeeded in achieving several years of high economic growth as well as reduction of debt and other vulnerabilities. However, external and public debt remain high. Growth decelerated in 2016 partly due to slower absorption of EU funds and related investment. The output gap is closing, unemployment has declined to about 41/2 percent--partly reflecting a still appreciable public employment scheme, and reflation is gaining traction.
The Hungarian authorities would like to thank staff for the open and constructive consultations and their report, which presents the economic developments and policy challenges in a very balanced way. The authorities broadly agree with staff’s assessment of Hungary’s economic and financial position and appreciate the thorough and constructive policy dialogue and policy recommendations.
When the global financial crisis hit, Hungary had already been in a weak macroeconomic position. The long-lasting twin deficit since the mid-2000s, the high public debt and the enormous amount of mortgage loans denominated in foreign currencies weighed heavy on the Hungarian economy, which relied on international assistance to get back on a sustainable path. Since then, the Hungarian authorities implemented bold and in some cases unconventional measures, which were effective in restoring macroeconomic stability, relaunching growth and increasing employment while also preserving political stability. Major macroeconomic balances, including fiscal and balance of payments, have been restored, and public debt has continuously declined. This achievement had been confirmed by the upgrade of Hungary’s sovereign debt rating to investment grade by all three major credit rating agencies in 2016.
The economy has stabilized and growth has returned. In 2016, growth was slightly above the EU average at 2 percent of GDP, and is estimated to rise to between 3.6 and 4.3 percent in 2017 owing to a higher EU funds inflow and absorption as well as the continuing recovery of consumption. The current low unemployment rate of 4.5 percent was accompanied by a dynamic wage growth. This will increase households’ disposable income and should also stimulate productivity increasing investments by corporates, which are in turn expected to boost import dynamics. As growth picks up, the current account surplus is expected to decline by 1.8 percentage points to around 3.7 percent of GDP in 2017, according to the authorities’ projections. The Hungarian authorities thus concur with staff that some unconventional measures should be phased out gradually and structural reforms should be implemented to foster potential growth. Moreover, the authorities already took some steps in this direction: the extra levy on the banking sector, which was already halved, is on a downward path, the Central Bank of Hungary (MNB) is selling its asset management company (MARK) and stopped providing conditional financing to banks for SME lending under the Funding for Growth Scheme, while improving competitiveness is high on the government’s agenda.
The government is strongly committed to implement prudent fiscal policy to achieve fiscal consolidation and comply with EU fiscal rules. Public debt remains relatively high at 74 percent of GDP, having decreased from 81 percent in 2011. The Hungarian Fiscal Council has approved the 2018 budget on April 27. It has been submitted to the Parliament on May 2, 2017, and foresees a further decline in public debt in the near term, reaching 61.2 percent of GDP at the end of 2021. The government is committed to achieve its 2.4 deficit target for 2018 notwithstanding the general elections in 2018.
Inflation has returned in 2017, but the central bank keeps monetary conditions loose until the underlying inflation becomes stable. Headline inflation retreated to 2.7 percent in March, from the 4-year high of 2.9 percent in February, while core inflation remained stable. The MNB forecasts inflation to 2.4 - 2.5 in mid-2017, but any impact of the recent dynamic wage increases on inflation will be carefully monitored. Also, the cost effect of these wage increases will be partially offset by the reduction in the social contribution tax and the lower corporate income tax. Overall, consumption is still subdued and expected to rebound only gradually, supporting the MNB’s projection of reaching its inflation target of 3 percent sustainably by the first half of 2018. The authorities are of the view that maintaining the current loose monetary conditions for an extended period is consistent with achieving the inflation target.
The MNB’s Funding for Growth Scheme (FGS) achieved its objectives and will be phased out. The MNB introduced the FGS in 2013 to boost the subdued credit growth by providing refinancing to banks for SME lending. The program facilitated financing for almost 40,000 micro, small- and medium-sized enterprises, and contributed substantially to the 12 percent SME credit growth in 2016. While the FGS has been phased out at the end of March, the transition to lending under market-based conditions will be supported by the existing MNB’s Market-Based Lending Scheme (MLS). This program provides favorable interest rate swaps (IRS) for banks, which lend to SMEs a net amount corresponding to one quarter of the allocated IRS. Thus, market-based new lending in Q4 2016 for non-financial corporates turned into positive territory after almost 8 years.
The level of the corporate non-performing loans (NPL) significantly dropped in the last two years, and the MNB is finalizing the sale of its asset management company for commercial real estate (MARK). When the MARK started to operate in 2015, more than one fifth of the outstanding corporate loans were non-performing, while almost half of the commercial real estate loans were in default. At the end of 2016, these ratios came down to 11 and 24 percent respectively. From the outset, it was envisaged that in the medium term MARK would operate entirely through private market participants. Its success in addressing the NPL overhang in the initial period accompanied by the pre-emptive introduction of the systemic risk buffer allowed for a significant drop in the problem portfolio already after 2 years. MARK was set up with the support of IMF technical assistance and did get the European Commission’s approval for its pricing methodology in 2016. It played a crucial role in jump starting the market for non-performing commercial assets by improving the quality of information on assets and creating asset management services. It is envisaged that the company will be operated by the new private owner after the closing of the ongoing sale at end-June.
The MNB has deployed a number of macro-prudential tools1 aimed at addressing the maturity mismatch of banks’ assets and liabilities and at limiting a possible credit boom. The MNB announced a systemic risk buffer requirement for banks to incentivize them to reduce their non-performing commercial real estate portfolio. This buffer will be determined on an individual bank-by-bank basis and is set between zero and two percent of the total domestic risk-weighted exposure value. After the conversion of the foreign currency mortgage loans into forint in 2015, the maturity mismatch was also targeted by the introduction of a new regulation, which instructs banks to finance at least 15 percent of their long-term household mortgage portfolio by long-term mortgage-backed securities. Debt-to-income (DTI) and loan-to-value (LTV) cap rules have been applied since the beginning of 2015, at 80 and 50 percent respectively in case of a HUF denominated mortgage loan for an average income household, with calibration dependent on the household income level. The MNB has the authority and stands ready to adjust the calibration based on credit growth developments.
Against the backdrop of macroeconomic stabilization, implementing structural reforms aimed at enhancing potential growth is high on the authorities’ agenda. As a first step, a National Competitiveness Board has been set up in March, whose main task is to identify the impediments to economic growth and their quick resolution. The Committee is chaired by the Minister for National Economy and its members include high-level representatives from the private sector, chamber of commerce and academia. Several regulatory reforms to improve Hungary’s Doing Business (DB) indicators have been formulated and some of them are already underway, such as reducing the number of days to get connected to the electricity network. The authorities have also reached out to the World Bank for guidance and better understanding of the DB indicators and their underlying drivers. In the course of this year, the Committee will also start working on further reforms to support long-term growth, which might include inter alia education, raising female labor participation and increasing R&D.
The government is working to ease labor shortages, including through reforms of public work program. At 4.5 percent, the unemployment is historically low, and recent managerial surveys indicate that labor shortages represent a major obstacle for businesses. In 2016, the participation rate has reached a historically high level of 70.1 percent, approaching the EU average. Most of the 200,000 participants in the public work scheme (PWS) are very low-skilled workers, but according to the government’s estimates, around 30 percent have sufficient skills to get employment in the private sector. To support this transition, a limit has been set to the number of participants in the PWS and workers with certain skills are not eligible to participate in the program any longer. The government also seeks to incentivize the transition into the private sector. The general minimum wage and the guaranteed minimum wage for vocational professions increased by 15 and 25 percent respectively last year, while remuneration for those participating in the PWS has been increased only by 3 percent, with the expectation that workers will undertake more challenging jobs or commute longer distances. Furthermore, HUF 50 billion have been allocated for vocational training and other cash disbursements for those, who seek jobs in the private market. Hungarian companies are in the meanwhile trying to recruit workforce from the region and the sharp increase in wages could attract some of the approximately 300,000 Hungarians, who work in other EU countries.
The Hungarian authorities are grateful for the meaningful discussions and the IMF’s progressive approach to Hungary. They appreciate the staff’s recommendations which they are planning to accommodate to the extent possible.
Macroprudential report of the MNB, http://www.mnb.hu/en/publications/reports/macroprudential-report