Press Release No. 15/156

Press Release: IMF Executive Board Concludes Article IV Consultation with Hungary

April 3, 2015

On March 27, 2015 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Hungary.

The Hungarian economy is growing at a strong pace helped by accommodative macroeconomic policies and improved market sentiment. Driven by strong domestic demand, output grew by 3.6 percent in 2014. Unemployment declined sharply reflecting the expansion of public works programs and job creation in the private sector. Headline and core inflation decelerated sharply, and inflation expectations fell below the National Bank of Hungary’s (MNB) inflation target. Improving terms of trade and strong export volume growth helped maintain a sizeable current account surplus. Private sector credit continued to contract and the banking sector remains under pressure reflecting the heavy tax burden and high non-performing loans.

Vulnerabilities continued to decline thanks to large and persistent current account surpluses, and recent policy measures, including the conversion of foreign exchange mortgages into local currency loans. However, debt levels remain high and the associated financing needs together with heavy reliance on nonresident financing, large concentration of the investor base and the economy’s large open FX position continue to pose risks. At the same time, the state has been increasing its role in the economy including through acquisition of stakes in the banking and energy sectors thereby contributing to a buildup of contingent liabilities.

The 2014 fiscal deficit came in below target, as revenues were propelled by accelerating economic activity and tax administration improvements, and were only partially offset by higher expenditures. However, the fiscal stance eased significantly and public debt declined only moderately to just below 77 percent of GDP. For 2015, the deficit is projected at 2.7 percent of GDP, implying a broadly neutral fiscal stance despite relatively favorable cyclical conditions, and the debt ratio is expected to decline only modestly.

Comforted by decelerating inflation, low risk premia, and a negative output gap, the MNB kept its policy rate at 2.10 percent since July 2014 and cut it to 1.95 percent on March 24. It also doubled the allocation for the second phase of the Funding for Growth Scheme (FGS) and extended the program to end-2015.

Going forward, output growth is projected to decelerate to 2.75 percent this year, on account of a smaller domestic-demand impetus due to less supportive fiscal stance and lower investment growth. Private consumption is expected to continue to grow, reflecting lower household indebtedness, accommodative monetary conditions, and higher employment. Headline inflation is projected to remain very low in the coming months on account of a still negative output gap and lower import prices. Over the medium-term, growth prospects remain subdued, as private consumption is still constrained by the ongoing deleveraging; while the difficult business environment continues to weigh on private investment. Labor participation, while somewhat increasing, remains low, particularly among women and older workers. These challenges are further compounded by competitiveness pressures and lack of attractiveness for foreign direct investment.

Executive Board Assessment²

Executive Directors welcomed Hungary’s strong economic rebound, which has been underpinned by supportive policies and improved market sentiment. However, they noted that medium-term prospects appear subdued, and the economy continues to face risks arising from high debt levels and heavy reliance on non-resident funding. Against this background, Directors agreed that policies in the period ahead should focus on further reducing vulnerabilities and boosting medium-term growth, while enhancing policy predictability and limiting the role of the state in the economy.

Directors welcomed the authorities’ continued commitment to fiscal discipline. Given the favorable near-term outlook, most Directors encouraged more ambitious efforts to curb the public debt ratio. They recommended pushing ahead with growth-friendly consolidation centered on improving the efficiency and composition of public spending, and rationalizing the tax system, including by gradually reducing sectoral taxes. Continued efforts are also needed to tackle VAT fraud and improve the targeting of social benefits.

Directors concurred that monetary conditions have supported the recovery. They agreed that persistent disinflation warrants further cautious easing of monetary policy, particularly in light of the improved resilience of households’ balance sheets to exchange rate risk and the weak external demand. Directors noted, however, that the central bank should stand ready to tighten the policy stance if external financing conditions deteriorate sharply. They also underscored the need to maintain adequate foreign exchange reserves to mitigate excessive exchange rate volatility and support financial stability.

Directors emphasized the importance of improving financial intermediation to sustain the recovery. In this regard, they welcomed the government’s commitment to gradually reduce the tax burden on banks. Noting that the recent establishment of a national asset management company would help clean up bank balance sheets, Directors stressed the need for transparency and good governance and called on the authorities to mitigate financial and operational risks that might be associated with the new institution. More broadly, Directors cautioned against the increasing role of the state in the banking sector.

Directors stressed that sustained progress on wide-ranging structural reforms is essential to boost Hungary’s growth potential. Noting progress in improving the labor market, Directors saw scope for additional reforms to increase labor participation, particularly among women and older workers, and address skill mismatches. Directors agreed that these steps, together with measures to enhance competitiveness and strengthen the business climate, would stimulate higher investment and strong private-sector-led growth.