IMF Executive Board Concludes First Post-Program Monitoring Discussions and the Ex-Post Evaluation of Exceptional Access under the 2008 Stand-By Arrangement with HungaryPublic Information Notice (PIN) No. 11/73
June 15, 2011
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the First Post-Program Monitoring Discussion with Hungary is also available.
On June 8, 2011, the Executive Board of the International Monetary Fund (IMF) concluded the First Post-Program Monitoring Discussions and the Ex-Post Evaluation of Exceptional Access under the 2008 Stand-By Arrangement with Hungary.1
The Hungarian economy is slowly rebounding from the global economic crisis. After contracting nearly 7 percent in 2009, real GDP rose 1.2 percent in 2010, due to strong export growth. Meanwhile, domestic demand has remained muted amid a limited recovery in credit, wages, and employment. In this context, the external adjustment has continued, with the current account balance reaching a surplus of over 2 percent in 2010—a substantial change from the large deficits recorded during much of the past decade.
The Central Bank began a tightening cycle in late 2010, ultimately increasing the policy rate by 75 bps before pausing at 6 percent. The hike in rates largely reflected above-target inflation forecasts during the relevant horizon period. However, even though headline inflation has continued to rise due to shocks to food prices, growth in underlying market prices and wages has remained contained, suggesting ongoing spare capacity in the economy and less risk to the medium term inflation target than initially envisioned.
Fiscal policy turned accommodative in 2010. The general government deficit of 4.2 percent exceeded its target by 0.4 percentage points and resulted in a widening in the structural balance by 1¾ percent of potential GDP. The underlying deficit is expected to weaken further in 2011. However, large one-off revenues from the transfer of second pillar pension assets to the government will allow the headline fiscal balance to be in surplus and public debt to fall considerably. Going forward, the authorities have announced measures to implement roughly 3 percent of GDP in adjustment over the course of 2012–13, which, if implemented in full, should allow the debt-to-GDP ratio to fall over the medium term.
The financial sector has generally shown resilience due to increased financing from parent banks, which helped subsidiaries increase liquidity and capital buffers during the crisis. However, obstacles remain, particularly because roughly 17 percent of GDP in household credit is denominated in the Swiss franc, which has appreciated considerably during the last year, making loan repayment more difficult. Furthermore, the foreclosure moratorium continues to prevent banks from cleaning balance sheets while the bank levy has lately induced parent banks to deleverage their exposure to Hungary. As a result of these challenges, credit growth is expected to remain subdued in 2011.
Looking forward, economic growth is expected to remain below its medium term potential during the coming two years. Structural bottlenecks in the financial sector and notable fiscal adjustment starting in 2012 are expected to hold back the recovery in domestic demand. Nonetheless, increasing export capacity and strong demand from Germany will allow GDP growth to rise to about 2½ percent this year and next. In this context, the current account is projected to be in surplus until above-potential growth begins in 2013. A key risk to the economy is that significant vulnerabilities remain, notably high public and external debt, a demanding sovereign amortization schedule, and large currency mismatches.
Executive Board Assessment
Executive Directors noted that Hungary’s economic program, supported by the 2008 Stand-By Arrangement, had been successful in strengthening the economy and stabilizing market conditions, while also providing lessons for macro-financial surveillance and bank support packages. Directors also recognized the positive collaboration between the European Union and the Fund during the program period. At the same time, Directors regretted that much of the fiscal achievements under the program had been unwound since the program lapsed. The recovery from the crisis has been modest and important vulnerabilities remain.
Against this background, Directors emphasized the importance of consolidating public finances, while accelerating structural reforms to support economic growth. They welcomed recent policy announcements, which aim to shore up the fiscal position and remove key structural bottlenecks in the financial sector.
Directors considered the Szell Kalman structural reform plan as a step in the right direction as it would put public debt on a declining path. While the size of the package and its emphasis on expenditures are appropriate, Directors saw scope for improving the nature of the measures. They recommended replacing levies on specific sectors, in particular on the banking sector, with more ambitious expenditure consolidation in areas such as civil service reform and the restructuring of public transport companies. Social benefits should be strictly means tested to avoid placing a disproportionate burden of adjustment on the most vulnerable. Directors expressed concern about the partial use of returned pension assets to finance current expenditures.
Directors noted that the lack of detail about key fiscal measures raises implementation risks. Given Hungary’s high public debt and large financing needs, they emphasized the need for full and timely implementation of consolidation measures. Directors welcomed the new constitutional debt limit, but saw merit in introducing transitional rules. Ensuring the effectiveness of the new Fiscal Council will be especially important in view of its narrower mandate.
With respect to the financial sector, Directors welcomed plans to reduce stress in real estate portfolios to support a recovery in credit growth. At the same time, they cautioned that any support schemes for distressed or defaulted borrowers need to be carefully designed so as to limit moral hazard and fiscal risks. There was also concern about the gradual approach to removing foreclosure and eviction moratoria.
Directors agreed that the monetary stance is appropriate. While food prices have pushed up headline inflation, the limited recovery in domestic demand and still high unemployment point toward weak underlying price pressure.
Directors broadly agreed that a further increase in reserve coverage would provide additional insurance in the period ahead, given the considerable external amortizations in 2012–14 and ongoing tensions in the European financial markets. Banks’ continued reliance on direct external funding and the foreign exchange swap market poses additional risks. Against this background, Directors expressed concern about the authorities’ recent decision to draw down foreign exchange buffers to purchase a stake in the MOL energy utility.