Macroeconomic developments and outlook

Hungary’s robust economic recovery from the COVID-19 pandemic has been adversely impacted by Russia’s war against Ukraine and the escalation of sanctions, but has nevertheless remained on a solid footing. The Hungarian economy had returned to its pre-pandemic level by mid-2021, and registered a remarkable annual GDP growth of 7.1 percent in 2021. Spillovers from geopolitical tensions have subsequently been weighing on the performance of the Hungarian economy through multiple channels, including through surging energy prices, disrupted trade relations and heightened external uncertainties, but the growth momentum was nevertheless maintained in the first half of 2022 and the Hungarian economy is estimated to have grown by at least 4.5 percent in 2022. Market services and industry, even though with decreasing contributions, remained the main drivers of economic growth, while agriculture hampered growth due to an extraordinary drought in the country. Looking ahead, in parallel with weakening domestic demand and rising corporate costs, economic activity is also showing signs of moderation, but the Hungarian economy can still avoid recession and the overall growth performance will likely be above regional peers in 2023. The investment rate is projected to stabilize around 29 percent. Meanwhile, employment is still at historically high levels, and the unemployment rate is projected to stay below 4 percent.

Due to a worsening energy balance, the current account deficit has temporarily but significantly increased in 2022, before starting to shrink in 2023. Like in the whole region, the terms-of-trade deteriorated significantly due to surging mineral fuel prices. The costs of imported energy more than doubled, causing the imported energy bill to reach around 10 percent of GDP in 2022. The strong fundamentals of the Hungarian economy are well reflected in the fact that the current account balance excluding the energy account remained in surplus. Meanwhile, net foreign direct investment has continued to rise, largely related to new investments by manufacturing companies. With the normalizing global economic environment and the utilization of new export capacities, the external position is expected to improve significantly from 2024 onwards.

After steady price increases which were mostly driven by supply side shocks, inflation is projected to peak in the coming months, and then to decline in a progressive manner. Average annual inflation reached 14.5 percent in 2022, which largely corresponds to the data in several EU countries in the CEE region. The high price increases were mainly attributable to the soaring global energy and food prices, but the unusual severe drought in Hungary also added to the inflationary pressures. Accordingly, processed food prices contributed the most to the rise in core inflation. Although the annual headline inflation remained above 20 percent in December 2022, falling commodity prices and other global factors as well as a cooling of the domestic economy will have an increasingly strong disinflationary effect going forward. From the middle of the year, base effects will also contribute to a faster decline in the consumer price index, which may subsequently moderate to single-digits by end-2023. Looking further ahead, inflation is expected to return to the central bank’s tolerance band in 2024. In that regard, it is important that longer-term inflation expectations of analysts are still anchored and remained around the upper side of the tolerance band of 4 percent. However, with due attention to the persistent nature of inflationary pressures, including changes in companies’ repricing practices, close monitoring of second-round effects as well as guarding against the risk of high inflation becoming more entrenched, remain essential.

While risks to the outlook have recently become more balanced, vigilance against still elevated downside risks is warranted. Adverse risk scenarios are largely linked to the uncertain course of the war in Ukraine, the energy crisis in Europe as well as structural changes in inflation developments. As one of the most open economies in the world, Hungary is exposed to deteriorating external conditions; the policy measures, however, remain strongly focused on strengthening economic resilience. Equally, the authorities remain vigilant against the build-up of macroeconomic vulnerabilities and stand ready to address risks.

Fiscal policies

Facing a series of external shocks, fiscal policy has been proactively calibrated with the explicit aim of protecting the fundamentals of economic activity and limiting the socio-economic scars, while also safeguarding debt sustainability. Consequently, the government continued to put a high premium on preserving achievements in the labor market as well as on policies supporting families. With a view to support stability and security goals, it also set up a special utility protection and a defense fund within the budget. In the course of 2022, a broad set of measures was implemented to keep the fiscal target within reach, even in spite of the sharply deteriorating external environment. These adjustments were mostly driven by streamlining expenditures but were also underpinned by revenue mobilization measures. The government postponed a large proportion of public investments, while current expenditures in ministry budgets were also cut. Cognizant of the persistent energy crisis, the government decided to narrow the access to the long-standing system of subsidized utility prices available to households, maintaining this system up to the average consumption only. On the revenue side, in the spirit of social responsibility, the government – like a range of countries at a later stage – introduced windfall taxes on energy, banking and a few other sectors. These taxes have been typically imposed on a temporary basis and affected only a part of extra profits. Furthermore, the authorities have continuously been providing targeted assistance to refugees fleeing from the war in Ukraine. The government sector’s accrual-based deficit as a percentage of GDP may amount to 6.1 percent in 2022 in relation to the special natural gas reserve accumulation accounting for about 1.2 percent of GDP.

Supporting households and SMEs in coping with high energy and food prices has become a key priority for the government, with an ever-increasing emphasis on the appropriate targeting of these measures. In the government’s view, a set of price caps have allowed more space for domestic actors to adjust to the new economic environment and thus played an important role in the transition period. There is broad agreement on the need to phase out these regulatory measures, but the government is in favor of a gradual approach. Some important steps, however, have already been taken. The above-mentioned overhaul of the utility price caps deserves particular attention in that regard. With the introduction of a so-called ‘block pricing’ system, in which higher-usage households pay more for natural gas and electricity, there are clear incentives to lower consumption. As a result, also considering other measures in public institutions, the natural gas consumption significantly declined from the beginning of the heating season – even if controlled for the effects of milder weather. After gradually narrowing the access to price-capped motor fuels, this scheme has been completely phased out at the end of 2022. Interest rate caps, mainly aimed at outstanding loans, have been introduced by the government with the aim of temporarily alleviating burdens on the household and SME sectors. To cushion the impact of surging food prices, the government also fixed the price of certain staple food products. These latter administrative measures are still in place but have been introduced in a time-limited manner.

Fiscal prudence remains a key priority for 2023. Since the external environment has fundamentally changed following the first adoption of the 2023 budget, the government submitted a revised version of the annual budget to Parliament in January 2023. Although the maintenance of the block pricing energy system necessitated a slight increase in the initial deficit target from 3.5 to 3.9 percent, this still envisages a decisive fiscal consolidation for the year. In addition to Hungary’s proven track record in meeting deficit targets, it is also important to note that the government, in line with the recommendations of the Fiscal Council, is also determined to use any revenues stemming from higher-than-expected economic growth to reduce the fiscal deficit.

The government, in conformity with their constitutional obligation, is firmly resolved to keep public debt on a declining path. To anchor the sustainability of debt dynamics and keep fiscal risks stemming from adverse scenarios in check, the government has been embarking on a growth-friendly multi-year fiscal consolidation. With this aim, the government envisages continuously decreasing deficit targets, dipping below 3 percent of GDP in 2024. Together with a dynamic expansion in nominal GDP and a more subdued debt issuance, the authorities expect a steady decline in the debt ratio over the forecast horizon. The gross government debt-to-GDP ratio is projected to fall to around 70 percent by end-2023. Taking advantage of proactive debt management operations, the authorities attach high importance to lengthening average debt maturity, while also keeping the share of FX dominated debt below 30 percent.

Monetary and financial policies

The primary objective of the MNB is to achieve and maintain price stability. In full compliance with its mandate, the central bank of Hungary (Magyar Nemzeti Bank, MNB) has played a prominent role in buttressing macrofinancial stability and resilience over the past decade. Without prejudice to its primary objective, the MNB preserves financial stability and supports the government’s economic policy, as well as its policy on environmental sustainability. The MNB appreciates that staff took a closer look at its operations over a decade’s horizon, with special attention to the links between its objectives and instruments. Relatedly, the MNB also welcomes staff’s general conclusion that changes of monetary operations have fallen within its statutory mandate, while being clearly communicated and generally smoothly implemented. The MNB firmly believes in taking a proactive approach to monetary policy formulation and implementation, which evidently generated outstanding improvements in a number of areas during the examined period.

As for recent developments, the MNB has acted resolutely to rein in inflationary pressures and anchor inflation expectations. The MNB also welcome staff’s assessment that monetary tightening to date has been appropriate. Recognizing the early signs of changing patterns of global inflation developments during the recovery from the COVID-19 pandemic and associated domestic developments, the MNB launched an interest rate hiking cycle already in June 2021, as the first central bank in the EU. The MNB subsequently raised the central bank base rate in a data-dependent manner, with a total of 17 steps, by more than 12 percentage points, to 13 percent. After the forward-looking real interest rates have entered into positive territory and risks around inflation became symmetric by September 2022, the Monetary Council decided to stop the base rate hike cycle and continued the tightening of monetary conditions in a more targeted way with the tightening of liquidity.

While keeping its focus on ensuring price stability, the MNB’s recent policy measures have also been centered on maintaining market stability and strengthening monetary policy transmission along with mopping out excess liquidity. While the Monetary Council has maintained its assessment that the current level of the base rate is adequate to manage fundamental inflation risks, in a more turbulent period for financial markets in the middle of autumn, the Council, inter alia, also introduced new o/n deposit quick tenders with higher interest rate conditions than the base rate and significantly raised the upper bound of the interest rate corridor altogether with the explicit aim of warding off financial stability risks and thus, a potential new round of inflationary pressures. In parallel, a broad set of instruments has been introduced to absorb interbank HUF liquidity on a longer term as well; i.e., the one-week discount bill, the long-term deposit tender and the revised reserve requirement system. To this end, the MNB has recently also announced to increase the minimum reserve requirements to 10 percent from April 2023.

The MNB remains firmly committed to bringing back inflation to the target, and consequently, also agrees with the need to maintain tight monetary conditions for a prolonged period of time. The Monetary Council continues to thoroughly assess economic and financial market developments and stands ready to take appropriate actions – using every instrument in its monetary policy toolkit – should risks increase.

In the same breath, the MNB places high value on keeping financial risks under close monitoring and facilitating futureproofing of the financial sector. As a result, the financial sector also remains resilient. The Hungarian banking sector is stable, and entered the current complex, challenging period with significant capital position and liquidity reserves as well as adequate shock resiliency. Following the phasing out of the general loan repayment moratorium, the NPL ratios remained relatively low, at around 4 percent. Although the portfolio quality is still largely favorable historically, duly considering complex effects stemming from the changing interest rate and economic environment, the MNB keeps a close eye on associated portfolio risks. Housing market developments, where early signs of a slowdown can already be seen after a multi-year upcycle, are assessed in detail. A broad set of macroprudential policy tools is in place in Hungary which greatly reduces vulnerabilities to several systemic shocks. Furthermore, with the aim of bolstering sustainable development, the MNB takes concerted efforts to promote green and digital transformations in the financial sector.

Structural policies

Ensuring energy security on a sustainable basis is a cornerstone of the authorities’ structural agenda. Being a landlocked country, Hungary’s heating systems are heavily dependent on natural gas and most natural gas has been imported through pipelines from Russia. Similarly, also in the case of crude oil, it necessarily takes time for Hungary to adjust to the rapidly evolving energy landscape and current policy choices have to be made accepting existing physical realities. Albeit the government has made important strides in upgrading the transmission system and building new interconnectors with the neighboring countries over the last decade, the integration of the European natural gas and oil markets is still not developed enough to ensure efficient and affordable access for Hungary to fully replace its energy imports from Russia. Along with that, the key to maintaining energy security continues to lie in greater diversification, both in terms of the energy sources and energy mix, and the authorities remain steadfast towards meeting this objective.

In parallel with diversification efforts, laying the foundations of a more sustainable and efficient energy system is equally important. Despite the ongoing energy crisis, the authorities remain committed to achieve their ambitious emission reduction targets by 2030 and climate neutrality by 2050. The carbon neutrality goal is also set by law in Hungary. Duly considering the appreciation of the energy and climate policies, a systemic overhaul of the Hungarian energy system is already underway, and to support these objectives, a new, separate Ministry of Energy has recently been set up. After Hungary has achieved one of the most dynamic growth rates in Europe in the field of installing new solar capacities in recent years, creating the appropriate environment for further expansion of renewables remains a high priority. In parallel, with curbing gas consumption, nuclear power generation remains a major pillar of the energy mix and a carbon-free future. Similarly, the authorities attach high importance to fostering energy efficiency through a broad set of policies. Among other things, a special energy-efficiency scheme has already been launched to support energy-intensive factories.

Governance frameworks broadly correspond to the EU average according to a wide range of objective indicators. However, to improve perceptions, the government, in close dialogue with EU institutions, decided to undertake targeted reform measures on this front. Although the government has reservations about the application of the EU’s conditionality mechanism to Hungary, taking a constructive approach, they have made significant efforts to resolve the points of disputes and elaborated a set of mutually reinforcing measures to strengthen respective governance frameworks. A new and independent Integrity Authority, tasked with investigating fraud, conflicts of interest and other violations related to the use of EU funds, has been set up. The government is also undertaking comprehensive judicial reforms, inter alia, to further underpin judiciary independence. Concurrently, promoting a more competitive public procurement system is also high on the government’s agenda. Following a substantial progress in the agreed upon commitments, the government came to agreements with the respective EU institutions at the end of 2022 on both the Partnership Agreement for 2021–27 and the Recovery and Resilience Facility, paving the way for disbursements in the course of 2023. Some remedial measures are still underway, but the government remains committed to their full implementation and intends to maintain the reform momentum demonstrated over the last few months. Consequently, the government expects that Hungary can eventually fully absorb all eligible EU funds.

Boosting competitiveness remains a key policy priority to buttress the long-term real convergence. As a result of robust economic growth, Hungary has achieved an outstanding catching-up process over the last decade. The Hungarian economy has every opportunity to stay on this track, but also considering tectonic shifts in the global economy, the importance of rejuvenating the structural reform agenda, including sectoral policies and accelerating the implementation of reform measures is also growing, in addition to the need for addressing near-term challenges. To advance digital and green transitions, the government devotes more funds to these objectives under its Recovery and Resilience Plan than the EU average and intends to mobilize additional financing to these purposes. There are active discussions on the societal level about how to promote a more resilient and sustainable growth trajectory. Within its mandate, with various analyses and recommendations on competitiveness, the MNB also actively contributes to these reform efforts.