Hungary: 2022 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Hungary
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International Monetary Fund. European Dept.
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Publication Date:
03 Feb 2023
eISBN:
9798400228865
ISBN:
9798400228865
Language:
English
Keywords:
student loan; potential GDP; EU funding; Core CPI inflation; demand shock; Inflation; Energy prices; Global
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1. A succession of shocks has widened economic imbalances. In 2021:H2, as the economy was recovering from the COVID-crisis, rising commodity prices and supply-chain disruptions began increasing inflation and the current account deficit. Russia’s war in Ukraine exacerbated those pressures as energy and commodity prices surged, external demand slowed, and uncertainty skyrocketed. Hungary implements the sanctions imposed at the European Union (EU) level on Russia in response to its invasion of Ukraine. Other spillover channels, including financial sector exposures and refugees, have been less important.

Abstract

1. A succession of shocks has widened economic imbalances. In 2021:H2, as the economy was recovering from the COVID-crisis, rising commodity prices and supply-chain disruptions began increasing inflation and the current account deficit. Russia’s war in Ukraine exacerbated those pressures as energy and commodity prices surged, external demand slowed, and uncertainty skyrocketed. Hungary implements the sanctions imposed at the European Union (EU) level on Russia in response to its invasion of Ukraine. Other spillover channels, including financial sector exposures and refugees, have been less important.

Recent Developments: Growing Imbalances

1. A succession of shocks has widened economic imbalances. In 2021:H2, as the economy was recovering from the COVID-crisis, rising commodity prices and supply-chain disruptions began increasing inflation and the current account deficit. Russia’s war in Ukraine exacerbated those pressures as energy and commodity prices surged, external demand slowed, and uncertainty skyrocketed. Hungary implements the sanctions imposed at the European Union (EU) level on Russia in response to its invasion of Ukraine. Other spillover channels, including financial sector exposures and refugees, have been less important.

2. Large pre-election stimulus compounded imbalances, before the government reversed course. Early in 2022, the government provided large income-tax refunds, six-month bonuses to armed forces, an additional month of pension benefits, and a 20 percent minimum-wage increase. It also capped the price of motor fuels, some food products, and mortgage rates for some borrowers (Table 1). Corrective measures were subsequently introduced to help meet the (then) deficits targets of 4.9 percent of GDP in 2022 (from 7.1 percent of GDP in 2021) and 3.5 percent of GDP in 2023. They include temporary profit taxes on the financial and energy sectors, sectoral levies and indirect taxes, untargeted operational spending cuts, and the postponement of investment projects. A one-off purchase of natural gas reserves subsequently raised the 2022 deficit target to 6.1 percent of GDP, while in early January 2023, the government decided to relax its 2023 target to 3.9 percent of GDP, primarily on account of higher energy subsidy costs.

Table 1.

Hungary: Price and Interest Rate Caps

article image

3. Wide imbalances and increased risk perceptions, including related to EU funds, added to market pressure on borrowing costs and the exchange rate. Amidst tightening global financial conditions and increased market risk aversion, Hungary’s large current account deficit driven by energy imports and investors’ skepticism about the government’s ability to meet its fiscal targets contributed to pressure on the exchange rate and government bond yields. Contentions with the EU, which centered around the rule of law, human rights, sanctions against Russia, and minimum corporate taxation, delayed conditional agreements on EU funds until December 2022 and worsened risk perceptions. Borrowing costs rose and the exchange rated depreciated more than peers’ in 2022 (Figures 1 and 5).

Figure 1.
Figure 1.

Hungary: Fiscal Indicators

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Figure 2.
Figure 2.

Hungary: Real Activity Indicators

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Figure 3.
Figure 3.

Hungary: Trade Balance and Terms of Trade

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Figure 4.
Figure 4.

Hungary: Inflation

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Figure 5.
Figure 5.
Figure 5.

Hungary: Inflation Expectations, Exchange Rate, and Monetary Policy

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Figure 6.
Figure 6.

Hungary: Financial Sector and Housing Market Indicators

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

4. After accelerating early in the year, economic growth began to slow. GDP growth decelerated from nearly 8 percent y/y in 2022:Q1 to about 4 percent in 2022:Q3 as strong domestic demand began to lose momentum. A tight labor market, pre-election stimulus, and drawdown of high household savings boosted real private consumption to nearly 13 percent y/y in Q1 before it slowed to 5.4 percent in Q3. Similarly, investment decelerated from a strong 10.6 percent to 4.2 percent. On the other hand, auto production started recovering, exports rebounded, and external demand turned positive by Q3. After an exceptional build-up in inventories in 2021 and 2022:Q1, their contribution to GDP growth turned negative in the second and third quarters y/y. On a quarterly basis, GDP contracted in the third quarter primarily due to the impact of a severe drought leading to a nearly 40 percent decline in agriculture production, though the manufacturing and service sectors kept growing.

5. The labor market has become very tight. The unemployment and labor force participation rates are near their historical low and high, respectively. The working-age population is declining due to aging and emigration, adding structural pressures to the labor market. Reflecting low slack and the minimum-wage increase, private- and public-sector wages each grew by around 16 percent y/y in 2022:Q3.

6. The external balance has deteriorated significantly. Hungary’s external position in 2022 is assessed as substantially weaker than implied by fundamentals and desirable policies (Annex II). Strong domestic demand and rising commodity prices drove import values, while exports mostly lagged. Led by the declining trade balance, the current account deficit began to rapidly deteriorate in mid-2021, reaching -7.3 percent of rolling GDP by 2022:Q3. Continued strong FDI net inflows, EU funds, and FX bond issuances financed most of the current account deficit and supported reserves, which remain above the Fund’s metric adequacy threshold. Gross external debt-to-GDP was broadly stable at around 85 percent of rolling GDP through the third quarter of 2022, with an increase in debt issuance broadly offset by revaluation effects of outstanding debt as yields rose and by the rapidly growing nominal GDP. Reflecting the deteriorating external balance and markets’ wariness, the exchange rate adjusted and depreciated in 2022 by as much as 17 percent through October, and around 9 percent by year-end following actions by the MNB in mid-October and conditional agreements with the EU in mid-December.

7. Inflation accelerated to its highest level in decades. Headline CPI inflation surged from 2.7 percent in early 2021 to 24.5 percent in December 2022 (y/y), led by food and energy prices, notably following the relaxation of the utility price cap in August and, more recently, the lifting of the motor fuels price cap in December. Second-round effects of energy prices on domestic producer-price inflation (63.7 percent in November), wage pressures, exchange rate depreciation, and pre-election fiscal stimulus intensified a broad-based rise in core inflation, which reached 24.8 percent (accompanying Selected Issues Paper).

8. In response, the central bank (MNB) significantly tightened monetary policy. The MNB started raising rates mid-2021. With inflation intensifying, expectations well-above target and exchange rate pressures, it gradually phased-out its unconventional measures and increased the one-week deposit rate—then, the main liquidity absorbing instrument—cumulatively by 12.4 percentage points to 13.0 percent. In September 2022, the MNB announced that it would stop increasing rates, but that tightening policy would continue by draining liquidity through an increase in the minimum reserve requirement from 1 to 5 percent, central bank bills, and a new long-term deposit instrument.

9. Following a rapid depreciation of the exchange rate, the MNB accelerated its tightening in mid-October. Notwithstanding the liquidity measures, pressures on the exchange rate accelerated in the early Fall as global market nervousness and concerns about EU funds increased. To increase the cost of speculating against the currency, on October 14 the MNB raised the upper limit of its interest rate corridor from 15.5 percent to 25 percent, introduced daily overnight deposit tenders at 18 percent, and accelerated the mopping up of liquidity. It also committed to directly meeting major foreign currency liquidity needs arising from covering energy imports through end-2022 (a measure subsequently extended in early 2023). The forint appreciated by over 4 percent during the following week.

10. The banking system remains on average well-capitalized, profitable, and liquid. Despite the pandemic and debt-servicing moratorium, banks recorded an average return on assets of 1.2 in 2021, although five small banks made losses, and an average capital-adequacy ratio of 17.6 percent in 2022:Q3. The moratorium was extended to end-2022 (changed to opt in) but covered only about 1 percent of corporate loans and 3 percent of households’ as of August 2022. A moratorium of agricultural loans introduced in September 2022, effective till end-2023, currently covers about 25 percent of eligible loans, amounting to about 1.3 percent of bank loans to the private sector. Credit growth to corporates increased in 2022, reflecting working capital needs and demand for investment, which was partly front-loaded ahead of expiring subsidized lending programs. Meanwhile, lending to households decelerated as mortgage demand cooled. Net interest margins grew, as deposit rates have stayed low while lending rates rose until the introduction of interest rate caps on selected lending. Sberbank-Hungary was promptly closed early in the war, and insured deposits paid out.

Challenging Outlook, Significant Risks

11. Growth is expected to decelerate sharply in 2023 while inflation remains elevated. Under the baseline scenario, growth slows from close to 5 percent in 2022 to about ½ percent in 2023 as the policy mix tightens under the authorities’ current policy plans discussed below, external demand weakens, and uncertainty weighs on investment. Despite labor-market tightness and strong wage growth, high inflation erodes household real incomes and weighs on consumption. Headline and core inflation are expected to peak in early 2023, after a pick-up in inflation from expiring price caps (Table 1), before slowing as commodity prices retreat, demand cools, and the output gap turns negative. The current account deficit is expected to decrease to about 5 percent of GDP in 2023 with improving terms of trade and contracting import demand, financed through FDI, EU funds, and portfolio investment.

12. A gradual recovery is expected over the medium-term. As demand recovers and policy tightening lessens, growth is expected to pick up and the output gap to gradually close from below. Inflation may only return within the tolerance band by end-2025. EU funds under the RRF and MFF 2021–27 are expected to start flowing in 2023:Q2 assuming related conditions are met in Q1 (Text Table 1), supporting a recovery in potential output over the medium-term. Over the medium-term, continued FDI inflows, including in battery production and auto sector, and EU funds are expected to remain the main sources of external financing.

Text Table 1.

Status of Planned EU Transfers

article image
Source: European Commission Note: RRF funds shown refer to grants. Relevant enabling conditions relate to fulfilment of the EU Charter of Fundamental Rights.

13. Uncertainty around the baseline is high, and risks could significantly worsen the outlook (Annex III). Untimely or incomplete delivery of expected EU funds would increase risk premia, intensify exchange rate pressures, increase inflation, and lower output as investment drops. A full shut-off of Russian gas to Europe would further increase energy prices and likely result in physical gas shortages for the 2023–24 winter season, driving higher inflation and output losses (Box 2). Developments in Russia’s war in Ukraine, other supply disruptions or a cold winter could lead to further or more persistent commodity price shocks. This would drive inflation higher, weigh on firm profits and investment, reduce output and intensify balance of payments pressures. Widespread firm closures from high energy costs would magnify those impacts. Faster-than-expected tightening in global financial conditions could adversely affect capital flows. Global demand could disappoint. Inflation could become entrenched. Any combination of these risks could occur, with the direction and magnitude of the net impact on the external balance, output and inflation depending on their interaction. In a worse-case scenario, market conditions could become disorderly and drive capital outflows. On the positive side, a faster-than-expected drop in commodity prices could reduce inflation and the external deficit faster.

Authorities’ Views

14. The authorities broadly shared staff’s views on the outlook and risks. They agree that 2023 will be a challenging year but believe that a recession can be avoided. After a strong recovery in the first half of 2022, they expect that the slowdown in 2022:H2 will continue into 2023 as external and domestic demand weaken, notwithstanding a tight labor market. The MNB expects inflation to moderate in 2023 and reach its target tolerance band by 2024, as demand cools and food and energy prices retreat, in turn supporting an improvement in the current account deficit. The authorities recognized the high level of uncertainty and broadly agreed with staff on the key downside risks to the outlook. However, they emphasized their confidence in the expected delivery in 2023 of EU funds from the Recovery and Resilience Facility (RRF) and the 2021–27 Multiannual Financial Framework (MFF). They noted that risks are rapidly evolving and warrant careful and persistent monitoring.

Policy Discussion: Consistently Addressing Imbalances

15. Heightened imbalances, significant risks, and major uncertainty require a tighter and consistent policy mix. Within a tighter stance, policies need to carefully balance restoring fiscal and external buffers in an orderly fashion, providing relief from the cost-of-living crisis, and flexibly responding to changing circumstances. Under the baseline, the planned fiscal adjustment will complement tight monetary policy to fight inflation, but administrative price and interest rates regulations work at cross-purposes of fiscal and monetary policies and need to be lifted. Under a scenario in which further supply-side shocks significantly weakens growth and increases inflation, monetary policy should tighten faster to contain second-round effects and fiscal policy would need to remain tight while making room for additional support the vulnerable. Disorderly market conditions would require an even tighter policy mix. A demand shock that lowers both growth and inflation would call for somewhat looser policies, including a slower pace of fiscal adjustment, provided market confidence is maintained. Longer-term structural issues were discussed in the context of their impact on short-term pressures, including on energy security and governance.

A. Fiscal Policy: Consolidating While Protecting the Vulnerable

16. A tight fiscal policy stance is critical to contain economic imbalances and rebuild fiscal buffers. The government plans a large fiscal adjustment for 2023, aiming to reduce the deficit from a targeted 6.1 percent of GDP in 2022 to 3.9 percent of GDP in 2023 and 2.5 percent in 2024. Under the baseline, staff expects an improvement in the primary cyclically-adjusted and structural balances of 3.3 and 2.3 percentage points in 2023, respectively, with smaller improvements thereafter. Such front-loaded fiscal adjustment will complement monetary policy in dampening demand and inflation. However, keeping the original deficit target at 3.5 percent of GDP would have been preferable considering the continued increase in inflation to date. Considering significant risks, an ambitious adjustment is also important to firmly place debt on a downward path amidst sizeable financing needs and rising financing costs, and to restore market confidence. Under the baseline, public debt (76 percent of GDP in 2022:Q3) remains elevated but is sustainable under the most plausible shock scenarios (see Annex I for medium-term debt sustainability considerations).

17. The composition of the fiscal adjustment could be improved. The planned adjustment appears achievable owing to higher revenues boosted by inflation in 2022–23 and new tax measures, the unwinding of one-off bonuses and other expenses carried out in 2022, discretionary cuts in goods and services spending, and the postponement of investment projects. In addition, the government has the discretion to re-allocate and cap spending if additional measures are needed to meet the 2023 deficit target. Improvements in current adjustment measures could minimize their impact on growth:

  • Revenue. Discretionary windfall taxes are easy to implement but can impede a growth-friendly allocation of resources. Though Hungary’s exemption from the EU’s oil embargo has provided a windfall for state-owned energy company MOL, staff cautioned that the ex-post nature of the windfall tax (recently raised to 95 percent) risks discouraging investment, an argument that also holds for the ex-post tax on banking sector profits. Furthermore, for the banking sector, it is unclear that profits are due to an exogenous windfall. In addition, the newly extended financial transaction tax is distortive and may incentivize informality.

  • Expenditure. Staff cautioned against reducing productivity-enhancing capital spending and advised a careful prioritization of projects to delay. With one of the highest goods and services expenditure shares in the EU, staff agrees that there is likely scope to reduce operational spending. This should first be achieved through efficiency gains where feasible and should preserve basic public services and spending on human capital (e.g., health, education).

Figure 7.
Figure 7.

Hungary: Government Expenditure on Goods and Services

(Percent of GDP, average 2015–2019)

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Sources: IMF, World Economic Outlook; National Authorities; and IMF staff calculations

18. The household energy utility price cap should be further relaxed to encourage energy saving and reduce fiscal costs. The long-standing cap has shielded households from surges in energy costs but is regressive, prevents demand adjustment, and undermines climate objectives. The subsidies to state-owned utility companies as compensation for the cap amounted to 0.7 percent of GDP in 2022. The cost is likely to be higher in 2023, as long-term contracts between the state-owned utility company and wholesale energy providers, last made in 2020, are renewed at prevailing market prices. The recent reform of this utility price cap through the introduction of a market-based, quarterly-adjusted rate for consumption above average was welcome, but more is needed to compress energy demand considering the risk of persistent energy-supply shocks. Targeted transfers through existing social safety nets or household lump-sum payments would protect the vulnerable, maintain price signals, and be less costly. As a second best, if existing mechanisms to provide targeted transfers prove inadequate, the new block utility tariffs could be refined by lowering the threshold for the subsidized rate to a basic consumption amount per household with the rest charged at market prices and by increasing the frequency of tariff-setting from quarterly to monthly. This would improve targeting of the existing system and price signals.

19. The motor-fuel price cap ended slightly earlier than planned after it triggered supply shortage. The cap increased demand and led to disruptive closures of petrol stations. The state-owned energy company MOL had been the only wholesale supplier of fuel domestically, and its challenges worsened during the maintenance of the domestic oil refinery. This is a welcome step as this regressive price caps had contributed to increasing demand and worsening the current account, while weighing on the budget through reduced profits taxes and dividends from the oil state-owned enterprises.

Figure 8.
Figure 8.

Hungary: Household Gas Prices and Demand

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

20. Timely and complete delivery of expected EU funds will help foster much-needed investment and avoid added pressure on risk premia and financing costs. EU funds have played an essential role in boosting Hungary’s growth over many years and should be instrumental in supporting medium-term convergence through investments in physical and human capital. Therefore, steady progress in the reforms and investments agreed with the EU in the context of the rule-of-law procedure, the partnership agreement covering financing under the EU’s multiannual financial framework (MFF), and the financing under the resilience and recovery fund (RFF) is critical so expected funds can be timely disbursed (Text Table 1). Under a downside scenario of persistent delays and heightened uncertainty in receiving fresh disbursements, pressure on the exchange rate and financing costs could intensify. Should the funds not be delivered in full or in a timely manner, the budget may need to adjust as fiscal policy cannot afford to be relaxed considering the need to reduce inflationary pressures and lower the current account and the fiscal deficits.

Authorities’ Views

21. The authorities agreed on the need for a tight fiscal stance consistent with monetary policy. The government did not consider that fiscal policy early in the year was inflationary. It noted that the 2022 fiscal stance is overall tighter than in 2021 and stressed the one-off nature of some fiscal measures to increase household incomes. Looking ahead, the authorities shared staff’s view that fiscal and monetary policies should be consistent and tight and highlighted the strong coordination between the MNB and Ministry of Finance. The Ministry of Finance took steps to meet the 2022 target and stressed its determination to achieve its 2023 and 2024 fiscal targets, noting its track record in this regard. It is closely monitoring risks and stands ready to introduce corrective measures if needed. The authorities consider that prudent fiscal policy will be key to sustaining medium-term growth. Regarding EU funds related to the RRP and 2021–27 MFF, they stressed their determination to reach an agreement with EU partners, which was subsequently achieved in December. They were confident that funds will eventually be delivered in a timely manner, despite what they saw as higher demands from the European Commission than in the past and for other countries. In the short-term, EU funds from the previous MFF continue to flow, and the government does not anticipate any liquidity issue in meeting its financing needs.

B. Monetary and Financial Policies: Reducing Inflation and Preserving Financial Stability

22. Monetary policy has significantly tightened since mid-2021. The MNB was one of the first European central banks to start raising interest rates in June 2021 from a low base of 0.6 percent, although until end-2021, liquidity was still added through the MNB’s asset purchase program. At this stage, the overnight one-day deposit tender has become the de facto policy rate. At 18 percent, it amounted to a significant tightening in monetary policy, particularly in 2022. In that context, recent liquidity-absorbing measures were welcome. Considering the rapid acceleration in core inflation, which is now among the highest in Europe, such large overall tightening was appropriate.

23. Maintaining a tight monetary policy stance is critical to drive inflation towards its target. Notwithstanding the impact of expiring price caps, under the baseline, inflation is expected to decrease to about 7 percent y/y by the end of 2023, as policy tightening cools demand and commodity prices decline. However, it will remain above the MNB’s target until end-2025. Structural tightness in the labor market, and de-anchored, backward-looking expectations add persistence to core inflation and risk feeding a wage-price spiral. While core inflation is also expected to decrease as domestic demand decelerates, it will likely remain somewhat higher than headline inflation until 2024:H2. Furthermore, food price caps, which were recently extended, have added to food price inflation by diverting price increases to uncapped foods. In this context, in weighing policy tradeoffs under high uncertainty, the potential costs of under-tightening (including entrenched high inflation and a higher eventual cost of controlling it) outweigh the risks of excessively lowering output through over-tightening. As the recent rate hikes transmit to the economy with a lag, monetary policy should remain data dependent, including on monthly core inflation dynamics, changes in expectations, and the evolution of credit.

24. Interest rate caps undermine monetary policy transmission and work at cross-purposes with policy tightening. The MNB’s shift toward more conventional tools is welcome. The MNB has used many unconventional tools and changed them frequently, aiming to mitigate temporary market dysfunction. Historically, it adjusted or revoked tools when they met their objectives or proved ineffective. However, the multiplicity of tools risks blurring the MNB guidance and, ultimately, affecting MNB’s credibility (Selected Issues Paper). The recent shift toward more standard liquidity-absorbing tools should help strengthen monetary policy transmission. 1 However, the government’s caps on mortgage, SMEs, and student loans interest rates and on large deposits are disconnecting key transmission channels of monetary policy. By hampering the effectiveness of monetary tightening, they will result in pressure to raise rates further than otherwise warranted. Furthermore, they are untargeted, are likely regressive (especially caps on mortgage interest rates) and discourage prudent credit demand. They should be abolished.

25. In a period of high uncertainty, continued exchange rate flexibility is needed to serve as a shock absorber in the face of numerous external risks. Foreign exchange intervention should be limited to containing excess volatility and should not prevent the exchange rate from adjusting as needed. In this regard, the MNB’s temporary measure to provide foreign exchange directly to energy importers should not be extended further.

26. Banking sector buffers can absorb the most plausible shocks but continued supervisory vigilance is warranted in a challenging environment. Although aggregate buffers are comfortable, they are somewhat unevenly distributed. Furthermore, credit risks are expected to rise even under the baseline, as growth slows, energy intensive industries face exceptionally high costs, and rising construction costs and interest rates test imbalances in the real estate market. Mortgage demand has recently slowed, though nominal house price growth remains elevated (Figure 6) and may take time to stabilize. Bank profitability may come under pressure, if higher net-interest margins do not fully offset the costs of additional windfall and indirect taxes, and caps on selected interest rates. Moreover, bank holdings of tradeable fixed-income securities are subject to valuation losses from rising interest rates. Currently, bank exposures to Ukraine and Russia appear manageable, including for OTP, the largest Hungarian bank, which has subsidiaries in both Russia and Ukraine. The MNB should continue to closely monitor these risks and encourage timely provisioning. Within its comprehensive set of macroprudential rules, including borrower-based limits, its decision to increase the countercyclical capital buffer by 0.5 percentage points effective July 2023 for resident exposures was appropriate. Among non-bank financial institutions, insurance companies (assets of which amounted to about 6 percent of GDP at end-2021, compared to 113 percent of GDP for the banking system) appear to be also affected by higher interest rates and should continue to be closely monitored.

27. Continued progress in strengthening the AML/CFT framework in line with the international FATF standard is important to improve its effectiveness. Per the May 2022 MONEYVAL report, Hungary made progress in improving the legal framework in the areas of correspondent banking relationships, internal controls in financial institutions, and transparency and beneficial ownership of legal persons. 2 The authorities should continue to address the remaining technical deficiencies relating to non-profit organizations, revised requirements for virtual asset providers, and cash couriers, and to strengthen the effective implementation of all requirements.

Figure 9.
Figure 9.

Hungary: AML/CFT Indicators

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Authorities’ Views

28. The MNB underscored its commitment to maintaining a tight monetary policy stance to achieve price stability. It considers that high inflation and the large current account deficit are the main, inter-related, challenges facing the economy. With hindsight, continuing the asset purchase program through the end of 2021, albeit at a slowing pace, made the efforts of the MNB to tighten monetary policy through rate increases that began mid-2021 more difficult but the high degree of uncertainty around the post-covid recovery justified cautious tapering. Looking ahead, as staff, the MNB expects overall inflation to peak in early 2023. It will then recede as food and energy prices, which the MNB considers were the primary drivers of inflation, begin to retreat and domestic demand cools. Both factors will also help improve the current account. The MNB sees inflation reaching the tolerance band earlier than staff, in 2024. It agrees that monetary policy should remain data dependent and tight until inflationary pressures consistently ease and the current account deficit retreats. However, it considers that the base rate is high enough for driving inflation toward its target, while the overnight deposit tender rate is geared toward ensuring market stability. On monetary operations, the MNB suggested that its use of a wide variety of instruments has resulted in a successful track record in achieving its objectives. It sees financial stability risks as low given adequate overall buffers and an expected soft landing in the real estate market.

C. Structural Reforms: Achieving Energy Security, Driving Convergence

29. Discussions on longer-term structural challenges centered around energy security, governance, and the importance of EU funds in financing related investments. Hungary’s recently approved RRP provides financing for key and appropriate structural priorities of the government in line with Next Generation EU objectives (Box 1), including energy transition, digitalization, and governance. Meeting in 2023:Q1 the initial super-milestones, which are related to governance issues, will be required to allow for disbursements to begin.

30. Hungary is working to improve its energy security. The authorities have taken emergency measures to avoid winter shortages, including filling gas storages to a high level, expanding domestic production, and contracting additional imports from Gazprom. Hungary was also granted an exception from the EU’s embargo on Russian oil. However, an extended interruption in Russian gas supply would likely result in shortages for the 2023–24 winter as Hungary, a landlock country, is the most dependent EU country on Russian gas and has limited alternative supply options. This puts a premium on fostering demand adjustment and accelerating improvements in energy efficiency. Under its long-term energy transition strategy, the government aims to invest in expanding nuclear power generation, enhance the electricity grid, further develop storage capacities and, ultimately, reduce the gas share of overall energy consumption. Meanwhile, demand for electricity will rise as households shift from gas to electricity-powered heating and the energy-intensive battery industry grows. Overall, total capital expenditures on such investments could exceed EUR 20 billion (13 percent of 2021 GDP). Securing the financing for these plans, which exceed amounts available through EU funds, is critical.

Hungary’s Recovery and Resilience Plan

Hungary’s RRP was approved by the European Council in December 2022. The RRF provides for EUR 5.8bn in grants (3.8 percent of 2021 GDP) through 2026 and access to EUR 9.6bn (6.2 percent of 2021 GDP) in loans to support reforms and investments to facilitate economic recovery from the COVID-19 crisis and promote the green and digital transition. Hungary can begin to request disbursements after 27 super-milestones on the rule of law, judicial independence, and anti-corruption are met. The government is considering tapping into the RRF loans, particularly for energy investments. In Hungary’s plan, grants aim to:

  • Support the green transition (48 percent of grant financing), through reforms and investments in sustainable transport (EUR 1.4bn), renewable energy sources (EUR 825mn), and energy efficiency of buildings (EUR 386mn).

  • Foster the digital transition (30 percent), via reforms and investments in digital skills and digital equipment in education (EUR 570mn), digitalization of the healthcare sector (EUR 488mn), and safer and digital public transport (EUR 212mn).

  • Reinforce economic and social resilience, including investments in modern healthcare (EUR 1.3bn), quality education and social inclusion (EUR 266mn), and reforms in anti-corruption, strengthening of judicial independence, and quality of public finances such as in the sustainability of the pension system and efficiency of the tax system.

Energy Security

Hungary depends on Russian gas and oil for around 40 percent of its energy needs, with limited alternative in the short-term. In turn, Russian gas and oil imports account for nearly 70 percent of Hungary’s gas and oil consumption, respectively. Landlocked, Hungary is reliant on pipeline flows for gas and oil. Turkstream (via Serbia) is now the primary channel of Russian gas imports. Potential non-Russian sources of gas, including LNG, are limited by transmission capacity constraints (Croatia, Romania) and production constraints (Central Asia suppliers). Furthermore, repurposing refineries, currently equipped for Russian-grade oil, for alternatives takes time. In addition, nearly all nuclear fuel is sourced from Russia, though Hungary maintains a two-year reserve of nuclear fuel supply.

Hungary’s ability to rapidly reduce gas demand is limited. Households are the largest consumers of natural gas, primarily for heating. Higher price-passthrough can help reduce demand but substituting away from gas-powered heating would require major investment. Electricity generation primarily relies on nuclear, but the use of gas has grown to power energy-intensive industry to about 30 percent, including chemicals and battery. Investments in the electricity grid are also needed to reliably absorb increasing energy from renewable sources, in particular solar. The lifespan of existing coal- and nuclear-powered plants have been extended by 4 and 20 years, respectively.

If Russian gas flows to Europe were fully shut off, Hungary would likely face significant shortfalls. Under the baseline, Hungary is expected to avoid shortages this winter owing to recent measures and high storage. If Russian gas were shut-off for twelve months, however, Hungary could face shortages equivalent to 25 percent of its annual consumption. This assumes that Hungary’s only gas supply would be current gas storage, some shared gas through EU solidarity, LNG and other pipeline imports via Southeast Europe, and the unlocking of emergency strategic oil reserves to temporarily substitute gas-led power generation. Previous IMF staff estimates suggest that the impact on output from such shortages could range from -1 percent of GDP to -4 percent of GDP. However, the impact through the 2023–24 winter could be worse as storages would be depleted and new supply sources could only increase modestly. Separately, the EU’s price cap on seaborne oil imports from Russia, announced in December, may potentially trigger some diesel fuel shortages in Hungary and slow industrial production.

uA001fig01

Energy Mix

(Percent of national energy consumption)

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Sources: Hungarian Energy and Public Utility Regulatory Authority and IMF staff calculationsNotes: Average over 2016–2020. 1/ Includes non-energy uses
uA001fig02

Power Generation

(Percent of total electricity production)

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Sources: Hungarian Energy and Public Utility Regulatory Authority and IMF staff calculationsNote: Renewables consist of solar, wind and water
uA001fig03

Natural Gas Imports by Import Point

(Billions cubic meters, monthly)

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Source: Eurostat
uA001fig04

Total Gas Storage

(Percent, as of December 3, 2022)

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Sources: Gas Infrastructure Europe (AGSI+), Eurostat and IMF staff calculationsNote: Some countries may earmark gas for other purposes. Consumption data is average over past 5 years (Eurostat). Winter includes Nov-Mar.

31. Timely and effectively-implemented measures to strengthen governance and anti-corruption frameworks are critical. On some dimensions, including regarding the speed of judiciary processed and AML CFT international cooperation, governance perception indicators are better for Hungary than non-EU and EU peers (Figure 10). However, in several key areas, such as the rule of law, judicial independence, and corruption, perception indicators are below EU peers and have deteriorated significantly in recent years. Governance issues—in particular related to weakened rule-of-law, procurement fraud and corruption involving EU funds—have concerned the EC, jeopardizing EU funding. Measures to address those issues are key conditions for timely and complete disbursement of RRF and cohesion funds (Text Table 1 and Box 1). In that context, the authorities established an independent integrity authority for public procurements and an anti-corruption task force and committed to amending their public procurement and criminal legal frameworks, including adopting a national anti-corruption strategy and extending the scope of the asset declaration system. Timely and effective implementation of these remedial measures is not only important to unlock EU funds but because strengthening transparency, the anticorruption framework, and governance is crucial to improve the business environment and the efficiency of public spending.

Figure 10.
Figure 10.

Hungary: Governance Indicators

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Authorities’ Views

32. Diversification in energy supply will take time and governance is largely a perception issue. The authorities agree that, given dependency on Russian oil and gas and limited alternative supply, measures are needed to foster demand adjustment. They noted that although energy supply is secured for the 2022–23 winter, any major and sustained interruptions in Russian gas imports could lead to shortages in the 2023–24 winter. They consider that energy sanctions against Russia cause significant harm also to the European economy. They agreed that it is critical to secure the financing for large-scale energy investments to strengthen energy security in the medium-term. The authorities consider that governance in Hungary is much better than reflected in perception indicators. They stressed that they nonetheless have made significant efforts to address the EU’s concerns in this area notwithstanding what they see as moving goalposts from the EC.

Staff Appraisal

33. Economic imbalances have widened, growth momentum is slowing, and sizable risks can significantly worsen the outlook. Together with loose fiscal policy in late 2021-early 2022 that boosted domestic demand, a series of shocks, including Russia’s war in Ukraine, intensified inflation and turned the current account into a large deficit. International reserves remain adequate, but the external balance in 2022 was substantially weaker than warranted by medium-term fundamentals and desirable policies. In 2023, growth is expected to slow sharply with inflation remaining elevated while the current account deficit is expected to notably shrink as terms of trade improve and domestic demand weakens. Significant risks cloud the outlook, including untimely or incomplete delivery of expected EU funds, lower external demand, higher-than-expected commodity prices, higher-than-expected global funding costs, more entrenched inflation, and natural gas shortages.

34. Consistent overall policy tightening is needed to reduce vulnerabilities amid large uncertainty. Maintaining a tight and consistent policy mix is important to drive inflation towards the central bank’s target, reduce the fiscal and current account deficits, and lower public debt. At the same time, well-targeted support is needed to alleviate the impact of rising cost of living on vulnerable households. In a volatile global environment in which financing conditions are tightening, prudent policies are also needed to avoid the risk of disorderly market conditions.

35. The planned fiscal tightening in 2023 is broadly appropriate. The government’s large, front-loaded adjustment is needed to complement monetary policy in dampening demand and inflation and rebuild fiscal buffers considering significant risks. In this context, retaining the original 3.5 percent of GDP deficit target would have been preferable to the revised target of 3.9 percent of GDP. In a worse scenario of weaker growth and higher inflation, fiscal policy would need to remain tight while making room for additional support to vulnerable. A demand shock that lowers both growth and inflation would call for slower pace of fiscal adjustment, provided market confidence is maintained.

36. Fiscal adjustment measures should minimize their impact on growth. Temporary windfall taxes on the energy and banking sectors should end upon expiration, as ex-post taxes risk discouraging investment and their extensions could erode the credibility of tax policy. The recently-increased financial transaction tax is distortive and may incentivize informality. Careful prioritization of delayed projects is important to preserve the most productivity-enhancing investment. Reductions in operational spending should be achieved through efficiency gains to the extent feasible and preserve basic public services.

37. Direct support to vulnerable households is a better way to support them than costly and ineffective price caps. The removal of the motor fuels price cap in December was welcome. The price cap on selected food products has been ineffective in controlling food inflation and should be left to expire. While the longstanding household utility price cap has shielded households from surges in energy costs, it also benefits the richer more, disincentivizes energy savings, and contributes to deteriorating the trade and fiscal balances. In turn, this puts pressure on the exchange rate and domestic inflation. Introducing new block utility tariffs was one step in the right direction, but further refinements are needed to foster energy saving as pressures on energy supply may last long. A more effective approach to mitigating the impact of high inflation while maintaining price signals is through direct targeted support to the vulnerable.

38. Tight monetary policy is needed until inflationary pressures clearly and sustainably ease. The overnight one-day deposit tender, initially introduced to counter rapid exchange rate depreciation and defend market stability, has become the de-facto policy rate to fight inflation, appropriately further tightening monetary policy. Monetary policy ahead should remain data dependent and focused on driving inflation towards its target. While the recent tightening will transmit to the economy with a lag, more may still be needed as costs of under-tightening are likely to exceed costs of over-tightening. In a period of high uncertainty, continued exchange rate flexibility serves as a shock absorber in the face of numerous external risks.

39. Interest rates caps run counter to monetary policy efforts and should be abolished. The MNB’s shift toward more conventional liquidity-absorbing tools is welcome, as it should help strengthen monetary policy transmission. However, the caps on mortgage, SMEs, and student loan interest rates and on commercial bank deposit rates of large deposits by institutional investors and retail customers hamper the transmission of monetary tightening, ultimately requiring stronger rate increases than would otherwise be needed.

40. Banking sector buffers appear adequate but continued supervisory vigilance remains important in the challenging macroeconomic environment. An expected rise in credit risks from slow growth, high inflation, and high interest rates warrant timely provisioning. Bank profitability may come under pressure if higher net-interest margins do not fully offset costs of additional windfall and indirect taxes, and caps on variable interest rates. Furthermore, the impact of rising interest rates on the insurance sector also requires close monitoring.

41. Strengthening energy-supply security is critical but will take time. A high level of gas storage and additional imports from Gazprom makes shortages unlikely for the 2022–23 winter, though an interruption in Russian energy supply would possibly lead to shortages in the 2023–24 winter. Limited short-term supply alternatives to Russian gas and oil puts a premium on measures to foster demand adjustment. Diversification away from gas will require significant investment over several years. Securing its financing is critical.

42. Strengthening transparency and the anticorruption framework will improve the business environment and the efficiency of public spending. Continued progress in regulatory and institutional reforms aiming to strengthen the rule of law, judicial independence, and the anti-corruption framework will help strengthen the business environment, long-term growth prospects, and efficiency in public spending. Continued strengthening of the AML/CFT framework in line with the international FATF standard is also important to address remaining shortcomings and improve effectiveness.

43. It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

Table 2.

Hungary: Selected Economic Indicators, 2018–24

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

Consists of the central government budget, social security funds, extrabudgetary funds, and local governments.

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

Table 3.

Hungary: Medium-Term Scenario, 2018–28

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Sources: Hungarian authorities; and Fund staff estimates and projections.

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

The difference between the cyclically-adjusted and structural balances in 2021 mostly reflect one-off health spending and time-bound tax holidays to address the covid crisis.

Table 4.

Hungary: Consolidated General Government, 2018–28

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Sources: Hungarian authorities; and Fund staff estimates.

Includes social security contributions.

The structural fiscal balance excludes one-offs: a) personal income tax refund in 2021, and b) exceptional gas purchases to replenish reserves and bonuses for selected public employees in 2022.

Table 5.

Hungary: Central Bank Survey, 2018–24

(In billions of Forints, unless otherwise indicated)

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Sources: Hungarian National Bank (MNB); and Fund staff estimates and projections.

Excluding swaps. Evaluation effects of swaps with other credit institutions are captured in other items net.

Data are from MNB’s monetary statistics Table 2.a.1 on bank assets.

Does not include holdings of shares and equity stakes issued by other residents, which are captured in other items net. The Pallas Athene Foundations are independent and not part of the MNB’s balance sheet.

The mandatory reserve requirement ratio was increased from 1 to 5 percent (without averaging) in October 2022. Banks have an option to maintain additionally 5 percent, which are averaged. Required reserves are remunerated with the base rate.

Table 6.

Hungary: Monetary Survey, 2018–24

(In billions of Forints, unless otherwise indicated)

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Sources: Hungarian National Bank (MNB); and Fund staff estimates and projections. Note: The dissolution of Sberbank in 2022, which accounted for about one percent of total bank assets, has affected the banking statistics. Its credit, securities, and deposits not taken over by other banks are shown under financial intermediaries beginning end-March 2022.

Only credit to households and firms.

Based on transaction data, i.e., adjusted for exchange rate changes.

Table 7.

Hungary: Balance of Payments, 2018–28

(in billions of Euros, unless otherwise indicated)

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Sources: Hungarian authorities; and Fund staff estimates.

A negative sign for financial accounts items indicates a net inflow from non-resident investors.

Includes financial derivatives.

Excludes Special Purpose Entities.

Excludes Special Purpose Entities and direct investment (inter-company) debt liabilities.

Table 8.

Hungary: Financial Soundness Indicators for the Banking Sector, 2018–22

(In percent, unless otherwise indicated, end of period)

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Sources: IMF’s Financial Soundness Indicators Database , while more current data from the Magyar Nemzeti Bank (MNB) are indicated in italics.

New definition to better reflect the EBA methodology and the introduction of IFRS 9.

Annex I. Debt Sustainability Analysis

After the steep pandemic-driven increase in 2020, the public debt-to-GDP ratio declined by almost 3 percentage points in 2021. Despite a projected slowdown in growth and tighter financial conditions, the large fiscal consolidation plan under the baseline would help debt stay sustainable under most plausible scenarios. Considering the exceptional uncertainty and risks that may affect the debt trajectory, frontloading the adjustment is appropriate. A scenario featuring an unchanged primary deficit after 2022 would place the public debt-to-GDP ratio on an upward path. A strong fiscal framework anchored in the EU Stability and Growth pact, dampens but does not eliminate risks to debt sustainability. The track record of sustained deleveraging in the decade preceding the Covid crisis provides further reassurance.

1. A strong post pandemic recovery contributed to reducing public debt in 2021. Unprecedented policy stimulus in 2020 pushed the public debt-to-GDP ratio to almost 80 percent of GDP. In 2021, the recovery gathered strength, and both real GDP growth (7.1 percent) and negative real interest rates (around –3 percent) contributed to lower the debt-to-GDP ratio. Hungary took advantage of favorable financing conditions ahead of the expected global financial tightening in 2022, and the external financing share in total debt increased by about ½ percentage point in 2021. Short-term debt as a share of total debt remained materially unchanged between 2020 and 2021. As part of ongoing efforts to reduce vulnerabilities and refinancing risks, the average term to maturity of public debt was further increased in 2021.

2. Under the baseline, large and frontloaded fiscal consolidation is expected to rein in the primary deficit. Fiscal consolidation efforts are expected to be sustained in the medium term. The DSA is based on the following assumptions underpinning the baseline scenario:

  • Real GDP growth slows to 4.9 and 0.5 percent in 2022 and 2023, respectively, rebounding to 3.2 percent in 2024. The growth path assumes the expected disbursement of grants from the 2021–27 EU structural funds, the RRF, and 2021–26 Next Generation EU funds.

  • GDP deflator decelerates from 8.4 percent in 2023 to 3 percent in 2027.

  • The primary fiscal deficit improves from 5.0 percent in 2021 to 3.7 percent in 2022, and 0.8 percent in 2023. Starting in 2024, a primary surplus of 0.6 percent of GDP, on average, is projected over the forecast horizon. Despite the deceleration in economic activity and tighter financing conditions, the improvement in the primary deficit is driven by inflation, which boosts revenues in 2022, and a package of discretionary measures underpinning the fiscal adjustment plans.

3. Exceptionally large uncertainty surrounds baseline assumptions and projections. In the past, growth forecasts’ errors for Hungary have been larger (outside the interquartile range) than in other countries but less so for the primary balance and inflation. The projected fiscal adjustment appears ambitious, as it lies in the top quartile of a distribution of relevant comparators, but the authorities have a track record of commitment to restoring fiscal balances, as evidenced by the sustained deleveraging during 2011–20, following the GFC and euro area crisis. Still, global risks loom large (Annex III), posing large risks for the macroeconomic, fiscal and debt outlook.

4. The authorities’ debt management strategy aims to continue reducing vulnerabilities. To reduce refinancing risk, the authorities have continued to increase the average term maturity of domestic debt. They recently reached 5.1 years average maturity from 4.1 year in 2019. They have recently accepted a slightly higher than 20 percent share in foreign currency denominated debt. They remain committed to keeping it below 25 percent, while maintaining the share of fixed-rate financing instruments―both domestic and foreign-currency denominated―between 70 and 90 percent. To mitigate risks from cross-currency exchange rate movements, foreign currency obligations―after swaps―are aimed to be 100 percent in euros.

5. Public debt is projected to decline under the baseline, amid sizeable financing needs. The public debt-to-GDP ratio is forecast to decline from 76.8 percent in 2021 to about 64 percent by 2027. Under the baseline, the primary balance will cumulatively contribute to increasing the debt to GDP ratio by 2.3 percentage points between 2022 and 2027. The interest rate-growth differential is projected to contribute to a reduction in debt by about 15.5 percentage points over the same period, as the real GDP growth rate is projected to be higher than the effective real interest rate on public debt. Gross financing needs are forecast to drop from 21.1 percent of GDP in 2021 to 11.7 percent of GDP in 2027. While the projected interest rate-growth differential and planned fiscal consolidation would place debt on a descending path, the maturity structure (about 5 years) and debt repayments’ schedule on existing debt keep financing needs sizeable.

6. Growth and combined macro-fiscal shocks can have substantial impact on projected public debt and gross financing needs paths.

  • Growth shock. A decline in growth by one standard deviation for 2 consecutive years would push the economy into a 2-year recession. Debt would reach 82.1 percent of GDP in 2024 and then decline to 76.4 percent of GDP in 2027, about 12 percentage points higher than under the baseline. Under this scenario, gross financing needs would peak at about 20 percent of GDP in 2024, then decline to 14 percent of GDP at the end of the forecast horizon.

  • Macro-fiscal shock. Simultaneous shocks to growth, interest rate, and primary balance would increase the debt-to-GDP ratio to 85.0 percent by 2024, falling to 84.4 percent at the end of the forecast horizon. Financing needs would reach almost 17 percent in 2027.

  • Contingent liabilities shock. Should the government have to absorb contingent liabilities equivalent to 10 percent of financial sector assets in 2023, the debt-to-GDP ratio would reach 81.9 percent in 2027 and financing needs would reach 17 percent of GDP.

  • No fiscal adjustment beyond 2022. An unchanged primary deficit after 2022 would place the public debt-to-GDP ratio on an unsustainable path. Under such a scenario, in five years, public debt would reach 84 percent of GDP and gross financing needs about 18.5 percent of GDP. Given authorities commitment to restoring fiscal prudence and track record of doing so, this scenario is unlikely. However, given exceptionally high uncertainty clouding the global outlook, headwinds from tighter financial conditions, and the war in Ukraine, a scenario in which authorities need to postpone or soften fiscal adjustment to dampen the impact of adverse shocks, if they materialize, cannot be ruled out.

7. Hungary’s external debt vulnerabilities have increased. While the investor base remains large, Hungary, as other emerging markets, faces headwinds from tightening global financing conditions. Spreads are within the risk assessment benchmarks but have increased during 2022. Adverse terms-of-trade shocks have negatively affected the current account, and external financing needs are above the upper risk-assessment benchmark. Given Hungary’s dependence on foreign energy, navigating terms-of-trade shocks remains a key policy challenge. Public debt in foreign currency and public debt held by non-residents are both within the risk-assessment benchmark range.

8. A strong fiscal framework dampens, but does not eliminate, risks to debt sustainability. Hungary’s fiscal policy is bound by the European Stability and Growth Pact (SGP). In addition to commitments under the SGP, the authorities adopted strict fiscal and debt rules in 2008 and amended them in 2013. As a result, under the fiscal framework, the general government deficit must not exceed 3 percent of GDP (with SGP escape clauses), and parliament may only adopt budget laws that result in the reduction of the government debt-to-GDP ratio, until this ratio falls to below 50 percent of GDP. The rule on debt reduction can be suspended when real GDP contracts. Amid global and domestic headwinds, under the baseline, real GDP growth is projected to decelerate but remain positive next year and over the medium term. Consequently, the fiscal framework requires that, under the baseline, budgets would put debt on a downward trajectory.

Figure I.1.
Figure I.1.

Hungary: Public Sector Debt Sustainability Analysis – Baseline Scenario

(In percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Source: IMF staff.1/ Public sector is defined as general government.2/ Based on available data.3/ EMBIG.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r – π(1 +g) – g + ae(1 +r)]/(1 +g+π+gπ)) times previous period debt ratio, with r – interest rate; π – growth rate of GDP deflator; g – real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r -π (1 +g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1 +r).8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
Figure I.2.
Figure I.2.

Hungary: Public Debt Sustainability Analysis – Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Source: IMF staff.
Figure I.3.
Figure I.3.

Hungary: Public Debt Sustainability Analysis – Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Source: IMF Staff.1/ Plotted distribution includes surveillance countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ Hungary has had a cumulative increase in private sector credit of 80 percent of GDP, 2018–2021. For Hungary, t corresponds to 2022; for the distribution, t corresponds to the first year of the crisis.4/ Data cover annual obervationsfrom 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.
Figure I.4.
Figure I.4.

Hungary: Public Debt Sustainability Analysis – Stress Tests

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Source: IMF staff.
Figure I.5.
Figure I.5.

Hungary: Public Debt Sustainability Analysis – Risk Assessment

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ EMBIG, an average over the last 3 months, 10/5/2022–1/5/2023.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Annex II. External Sector Assessment

Impaired by major terms-of-trade shocks, supply-chain disruption, slowing external demand, and pumped-up domestic demand, Hungary’s current account deficit widened significantly in 2021 and 2022. Hungary’s external position in 2022 is assessed as substantially weaker than warranted by medium-term fundamentals and desirable policies.

1. Surging global energy prices and strong import demand put significant pressure on the current account. Energy imports led the rise in the trade deficit as prices surged while the volume balance—partly supported by domestic price caps—remained in surplus but declined. Meanwhile, exports mostly lagged behind until the third quarter when auto sector production picked up. A recovery in tourism provided some support to the services balance but was dwarfed by the surging goods deficit. Reduced incomes from temporary workers abroad lowered the income balance but an increase in EU funds absorption from the 2014–2020 MFF provided some offset. Under the baseline, declining energy prices and compressed demand would notably reduce the current account deficit in 2023 and further improvement is expected over the medium term as FDI expands export capacity and external demand gradually recovers.

2. Significant downside risks could further deteriorate the current account and heighten balance of payments pressures. Gross FDI inflows have been a crucial source of external financing and has been stable in Hungary, followed by government borrowing, EU funds inflows, and other capital flows as sources of external financing. Larger external financing needs in a downside scenario that widen the current account deficit would require greater government and private external borrowing amidst increased risk premia and tighter global conditions (Annex III). In a worse-case scenario, faster drawdown in liquid external assets may trigger rapid valuation losses and larger capital outflows as confidence collapses, while rapid inflation and a plummeting exchange rate could push households and firms to euroize, increasing the risk of disorderly adjustment. Considering a possible increase in market risk aversion and the deteriorated risk perception of the region and Hungary, restoring macro-balances and unlocking conditional EU funds would buttress market confidence and help advert such scenario.

3. International reserves have remained adequate but are vulnerable to risks. After rising to 38.4 billion euros in 2021, international reserves held broadly steady in 2022 at 38.7 billion euros. EU funds inflows and FX bonds issuances have remained sources of foreign exchange while the deteriorating current account has been a drag on reserves in 2022. High uncertainty around the baseline and significant downside risks could lower reserves below the adequacy range. So far, however, reserves have remained adequate and are expected to improve along with the current account under the baseline.

4. Hungary’s net international investment position (NIIP) improved in 2021 and by 2022:Q3. The NIIP improved from -49 percent of GDP in 2020 to -46 percent of GDP in 2021 and -37 percent of GDP by the third quarter of 2022. The improvement stems from rising holdings of financial assets abroad and lower external liabilities mainly reflecting a reduction in equity holdings by foreign investors. External debt liabilities through 2022:Q3 held broadly steady as a modest decline in long-term external public debt-to-GDP (following an increase during the pandemic in 2020) partially offset a rise in private debt-to-GDP. While transactions increased the stock of external debt, revaluation effects of outstanding debt from rising yields broadly offset it. An increase in external short-term debt at remaining maturity in 2022 is also due to maturing medium- and long-term debt of the general government and banking sectors in 2023. The NIIP is expected to remain broadly steady under the baseline.

5. Hungary’s 2022 external position is preliminary assessed to be substantially weaker than warranted by medium-term fundamentals and desirable policies. The EBA models yield mixed preliminary results with exceptionally high residuals, pointing to a range of estimates for the valuation of the real effective exchange rate (REER) of about -32 percent to +6 percent.

  • The Current Account (CA) approach estimates a current account gap of -5.1 percent of GDP, which implies an exchange rate overvaluation of 8.0 percent. The policy gap contributed -0.3 percent of GDP, with the contribution of the fiscal gap (-1.2 percent of GDP overall and -4.0 percent domestically) offset by higher contributions of credit and health expenditures. The cyclical-adjustment contributed -1.2 percent of GDP. In part, the large residual may reflect the impact of regulatory policies not captured by the model’s policy gap variable. Regulated retail energy price caps have led to stable retail demand for gas and electricity and an increased demand for motor fuels, inhibiting demand adjustment to prices and contributing to a larger current account deficit.

  • The External Sustainability (ES) approach suggests that the exchange rate is overvalued by 6.7 percent. However, this is based on stabilizing Hungary’s net foreign asset position (in percent of GDP) at the 2022 level, which is an outlier year in the baseline given high energy import prices and a large deterioration in the current account. This approach is inconsistent with the current account balance returning to positive territory over the medium-term.

  • The two REER approaches suggest that the real exchange rate is undervalued in the range of 5 (Index model) to 32 percent (level model). However, they produce especially large residuals (29 percent in the level model) that are not explained by the policy variables.

  • Staff assesses the external position as substantially weaker than warranted by fundamentals and desirable policies. Looking ahead, an easing of commodity prices, tighter macroeconomic policies, and a relaxation of price caps would help move the external position closer to levels consistent with medium-term fundamentals and desired policy settings.

Table II.1.

Hungary: 2022 External Balance Assessment Results

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Source: October 2022 External Balance Assessment.
Figure II.1.
Figure II.1.

Hungary: External Indicators

Citation: IMF Staff Country Reports 2023, 070; 10.5089/9798400228865.002.A001

Annex III. Risk Assessment Matrix 1

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Annex IV. Authorities’ Response to Past IMF Policy Recommendations

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1

The sterilization costs are expected to result in MNB losses. The authorities, in consultation with the ECB, are amending the MNB Act to smooth the expected recapitalization transfers over a longer period.

2

MONEYVAL is the Council of Europe’s AML/CFT body.

1

The risk assessment matrix (RAM) shows events that could materially alter the baseline path. The relative likelihood 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 between 30 and 50 percent).

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Cover IMF Staff Country Reports
Hungary: 2022 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Hungary
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2023: Issue 070
Publisher:
International Monetary Fund
ISBN:
9798400228865
ISSN:
1934-7685
Pages:
63
DOI:
https://doi.org/10.5089/9798400228865.002
Figure 1.

Hungary: Fiscal Indicators
Figure 2.

Hungary: Real Activity Indicators
Figure 3.

Hungary: Trade Balance and Terms of Trade
Figure 4.

Hungary: Inflation
Figure 5.

Hungary: Inflation Expectations, Exchange Rate, and Monetary Policy
Figure 5.

Hungary: Inflation Expectations, Exchange Rate, and Monetary Policy
Figure 6.

Hungary: Financial Sector and Housing Market Indicators
Figure 7.

Hungary: Government Expenditure on Goods and Services

(Percent of GDP, average 2015–2019)
Figure 8.

Hungary: Household Gas Prices and Demand
Figure 9.

Hungary: AML/CFT Indicators

Energy Mix

(Percent of national energy consumption)

Power Generation

(Percent of total electricity production)

Natural Gas Imports by Import Point

(Billions cubic meters, monthly)

Total Gas Storage

(Percent, as of December 3, 2022)
Figure 10.

Hungary: Governance Indicators
Figure I.1.

Hungary: Public Sector Debt Sustainability Analysis – Baseline Scenario

(In percent of GDP unless otherwise indicated)
Figure I.2.

Hungary: Public Debt Sustainability Analysis – Composition of Public Debt and Alternative Scenarios
Figure I.3.

Hungary: Public Debt Sustainability Analysis – Realism of Baseline Assumptions
Figure I.4.

Hungary: Public Debt Sustainability Analysis – Stress Tests
Figure I.5.

Hungary: Public Debt Sustainability Analysis – Risk Assessment
Figure II.1.

Hungary: External Indicators