Press Release No. 16/189

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

April 28, 2016

On April 22, 2016 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Hungary.

The Hungarian economy has been growing at a robust pace over the past few years helped by supportive macroeconomic policies, a favorable external environment, and high utilization of EU funds. Driven by strong domestic demand, output expanded by 2.9 percent in 2015. External demand was also robust thus helping maintain a sizable current account surplus. Unemployment declined sharply, despite a rise in participation rate, reflecting solid employment growth in the private sector, but also continued expansion of the public works programs. Inflationary pressures have been subdued and inflation expectations appear anchored around the lower end of the National Bank of Hungary’s (MNB) inflation target (2 percent).

Private sector credit continued to contract, non-performing loans, while declining, remain high, and bank profitability has been recovering. Steps were taken to resolve legacy NPLs, including the establishment of an asset management company and the enactment of the Personal Insolvency Law.

Vulnerabilities continued to decline thanks to large and persistent current account surpluses, and the FX-loan conversion along with MNB’s self-financing program. While many of the recent measures have reduced vulnerabilities, they have also shifted risks to the public sector and to the MNB. Moreover, debt levels remain high and the associated large financing needs together with still sizable reliance on nonresident financing, and a highly negative IIP continue to pose risks. At the same time, the role of the state in the economy has been increasing including through acquisition of stakes in the banking and energy sectors.

The 2015 fiscal deficit came in below target, as revenues were propelled by accelerating economic activity, tax administration improvements, and one-off revenues, and were only partially offset by higher expenditures. Public debt declined to 75.3 percent of GDP from 76.2 percent in 2014. For 2016, the deficit is projected to meet the 2 percent of GDP target, implying a structural fiscal relaxation of about 1 percentage point of GDP and the debt ratio is expected to decline to 74.25 percent of GDP.

Comforted by subdued inflationary pressures, low risk premia, and a negative output gap, the MNB resumed its easing cycle in March 2015, and cut the policy rate by 75 basis points in five equal steps to 1.35 percent in July 2015. With inflation projected to remain very low in the monetary policy horizon, the MNB cut the policy rate further to 1.20 percent in March 2016. Moreover, several refinements of the traditional and unconventional monetary instruments have been introduced to strengthen the transmission channel, reduce vulnerabilities, and promote lending to small- and medium-sized enterprises, while ensuring cheap government financing.

Going forward, output growth is projected to decelerate to 2.3 percent this year. Private consumption will remain robust reflecting higher disposable income and employment, while favorable terms-of-trade will underpin a further increase in the current account surplus. Headline inflation is expected to remain low on account of low import prices and a still negative—albeit closing—output gap. Over the medium-term, growth prospects remain subdued reflecting an adverse business climate, which continues to weigh on private investment, including from abroad; and weaknesses in the labor market as reflected in still low labor participation, particularly among women and low-skilled workers.

Executive Board Assessment²

Executive Directors welcomed Hungary’s favorable economic performance, including strong economic growth, a decline in unemployment and continued reduction in external vulnerabilities. They noted, however, that still elevated debt levels and financing needs leave the economy prone to shocks and medium-term growth prospects appear subdued. Moreover, the overall strategy has expanded the role of the state in the economy and shifted risks to the public sector. Against this background, Directors underscored the need for policy actions to further reduce vulnerabilities and boost medium-term, private sector-led growth.

Directors welcomed the authorities’ continued commitment to fiscal discipline and advocated growth-friendly fiscal consolidation to help build policy space, reduce fiscal risks, and firmly place public debt on a declining path. They noted that priority should be given to improving the composition and efficiency of public spending, broadening the tax base and rationalizing the tax system. These reforms would allow a further reduction in sectoral taxes and higher infrastructure spending.

Directors noted that monetary policy has been appropriately accommodative. They agreed that monetary easing may be required if downside risks to inflation and growth materialize, unless external financing conditions worsen unexpectedly. Directors underscored the need to maintain adequate foreign exchange reserves to support financial stability.

Directors welcomed steps to improve financial intermediation, including by reducing the tax burden on banks. They noted that efforts to clean up banks’ balance sheets should be complemented with increased focus on addressing impediments to credit demand. Directors encouraged the authorities to follow through with their commitment to reduce state presence in the banking sector. They also noted that additional measures to promote lending should consider risks and be time-bound. Directors welcomed the start of operations of the asset management company for commercial real estate, but underscored the need to ensure that the transfer of assets is done on a voluntary basis and at market-related prices. They also emphasized the need to further strengthen the company’s governance structure and keep its operations fully transparent.

Directors stressed the importance of structural reforms to improve the business climate and increase potential growth. They called for efforts to reduce the regulatory burden, enhance policy predictability, and limit state involvement in the economy. Directors underscored the importance of upgrading labor skills, promoting innovation and entrepreneurship, and increasing the efficiency of EU funds utilization to boost competiveness. Directors welcomed progress on improving the labor market, but saw scope for additional reforms to increase labor force participation and address skill mismatches.