## cr18252 - HUNGARY STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION (selected excerpts)

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### Fiscal outlook and stance
- Staff projects the 2018 overall fiscal deficit at about 2.4 percent of GDP, in line with the budget’s target.
- The structural primary balance is expected to deteriorate by close to one percent of potential GDP.
- The overall deficit narrowed to 2 percent of GDP in 2017 (versus the budgeted 2.4 percent), helping reduce public debt by 2.4 percentage points to 73.6 percent of GDP; however, the structural primary balance deteriorated by about 1.2 percent of potential GDP.
- 2018 overall fiscal deficit projected at about 2.4 percent of GDP, almost half a percentage point more than the 2017 deficit, despite a booming economy.
- Tax cuts in 2017 and 2018: staff expects tax revenue as a share of GDP to remain unchanged due to rapid growth in labor earnings and private consumption.
- Total revenue expected to improve by about 1 percentage point of GDP, mostly on account of strong EU funds.
- Spending projected to increase by 1.4 percent of GDP, mostly due to large increase in capital spending.
- 2019 budget: authorities target an overall deficit of 1.8 percent of GDP; staff projects overall fiscal deficit at 2 percent of GDP for 2019.
- 2019 measures: lower spending on goods and services, social transfers, and interest payments; savings to more than compensate for planned increase in capital expenditure and reduction in social security contribution rate paid by employers (rate expected to be reduced from 19.5 to 17.5 percent effective on July 1st, 2019).
- Medium-term: public debt projected to decline steadily to about 63 percent of GDP, compared to 73.6 percent at end-2017; gross financing needs-to-GDP ratio forecast to remain broadly stable at about 20 percent of GDP.

Staff fiscal recommendations and illustrative impact
- Recommended sequencing and measures:
  - Expedite reversal of the pro-cyclical fiscal stance and reduce public debt.
  - Implement growth-friendly consolidation starting in the second half of 2018 to build fiscal space and ease the burden on monetary policy.
  - Revenue measures: phase out remaining sectoral taxes; broaden the tax base; enhance tax administration; transform existing property taxes into a modern real estate tax to help local governments raise revenue while protecting the vulnerable; avoid additional tax rate cuts or offset them if implemented.
  - Expenditure measures: reform public administration to reduce the wage bill; reduce spending on goods and services; eliminate generalized subsidies while protecting the poor with targeted measures.
- Illustrative fiscal impact (average per year, 2018–2023, percent of GDP):
  - Total 0.40
  - Revenue -0.10
  - Phasing out of sector-specific taxes -0.30
  - Streamlining VAT rates 0.10
  - Elimination of excise exemptions for fuel 0.10
  - Expenditure 0.50
  - Reduction in the wage bill 0.30
  - Rationalization of spending on goods and services 0.10
  - Rationalization of transport and fuel subsidies 0.10
- Staff-recommended measures would result in additional saving, compared to the baseline, that average about 0.4 percent of GDP annually between 2018 and 2023.
- This path would secure the authorities' medium-term target of 1.5 percent of GDP structural surplus by 2019 and reduce public debt to below 60 percent of GDP by 2023.

### Monetary policy, housing, and financial sector
- The MNB further relaxed its monetary stance during 2017 and in early 2018, mostly using unconventional tools.
- Policy rate and overnight overdraft rate remained unchanged at 0.9 percent in 2017.
- Cap on the 3-month deposit facility was gradually decreased.
- Overnight deposit rate was reduced from -5 bps to -15 bps in September 2017.
- Amounts and maturity of liquidity-providing FX swaps were increased.
- In late 2017, MNB announced introduction of unconditional interest rate swaps, and a mortgage bond purchase program (effective in 2018).
- The MNB intends to let the Market-Based Lending Scheme expire by end-2018, as originally scheduled; staff welcome this commitment.
- Recommended monetary normalization sequencing:
  - Gradually scale back monetary stimulus once inflation sustainably approaches the upper half of the tolerance band (3±1 percent), starting with unwinding unconventional measures (e.g., reduce ample FX liquidity swaps).
  - Reassess unconditional interest rate swaps and reconsider mortgage bond purchase program incentives.
- Housing and macroprudential measures:
  - Most household loans carry variable rates or fixed-rates up to one year; result: more than 80 percent of new lending is now at fixed rates.
  - April 2017: mortgage funding adequacy ratio (MFAR) introduced.
  - December 2017: Budapest Stock Exchange introduced three mortgage bond indices.
  - Early 2018: MNB launched mortgage bond purchase program.
  - New interbank funding ratio (IFR) introduced July 1, 2018.
  - MFAR/ PTI changes effective October 1, 2018: PTI ratio reduced for loans with variable rates or fixation below 5 years and for loans with fixation between 5 and 10 years; PTI for loans with fixed rates of at least 10 years or for the whole term unchanged; MFAR ratio increased from 15 to 20 percent; amendments discourage cross-financing and facilitate stable funding.
  - Note: PTI calculation change in 2016 removed discouragement of fixed-rate borrowing.
- Banking system soundness and credit developments:
  - Banking system: on average profitable, liquid, and well-capitalized.
  - NPL ratio declined from 7.4 to 4.2 percent during 2017, trend continued during Q1 2018.
  - Bank lending to non-financial companies—particularly to SMEs—is growing by around 11 percent.
  - Credit to households—mainly mortgages—is also growing.
  - Preliminary 2017: average Tier I capital ratio at 14.4 percent and CAR at 16.4 percent.
  - Despite branch reductions and consolidation of credit cooperatives, operating and staff costs remain relatively high.

### Growth, labor market, and external sector
- Growth projections:
  - Real GDP growth: 2017 4.0; 2018 4.0; 2019 3.3
  - Staff projects growth in 2018 to plateau at 4 percent and decelerate as EU funds absorption tapers off and capacity constraints tighten.
  - Authorities expect 2018 growth in the range of 4.3–4.4 percent; MNB projects 2019 growth at 3.5 percent; Ministry of Finance projects 2019 growth at 4.1 percent.
- Drivers of expansion:
  - Strong domestic demand supported by private consumption and EU funds-related investments.
  - Public investment boosted by accelerated absorption of EU funds.
  - Private consumption strengthened due to wage and employment growth and tax reductions.
- Inflation and labor market:
  - CPI inflation (average): 2017 2.4; 2018 2.8; 2019 3.3
  - CPI inflation (end year): 2017 2.1; 2018 3.1
  - Core inflation close to 2½ percent over the past 6 months (reported).
  - Unemployment fell to 3.7 percent in May 2018; unemployment rate (average, ages 15-64): 2017 4.2
  - Average gross earnings growth exceeded 12 percent in 2018 Q1.
  - Labor shortages intensifying across sectors, especially construction.
- External position:
  - Current account: 2016 6.0; 2017 3.1; 2018 2.3; 2019 1.9
  - Hungary’s external position broadly in line with medium-term fundamentals and desirable policies.
  - External current account surplus moderating from 2016 peak; rising domestic demand and falling current account surpluses point to accelerating domestic demand.
  - Hungary’s IIP improved; international reserves are adequate according to the Fund’s metric.
  - Exports remained buoyant and largely driven by participation in the German supply chain.
  - FDI gross inflows preliminary 2017: 4.6 percent of GDP (2016: 2.8 percent).
  - Gross external debt: 2016 97.2; 2017 84.6; 2018 76.2; 2019 70.7
  - Reserves (billions of Euros): 2016 24.4; 2017 23.4; 2018 26.9; 2019 30.1

Key statistics (selected, preserved exactly as reported)
- Real GDP (percentage change): 2017 4.0; 2018 4.0; 2019 3.3
- CPI inflation (average): 2017 2.4; 2018 2.8; 2019 3.3
- CPI inflation (end year): 2017 2.1; 2018 3.1
- Unemployment rate (average, ages 15-64): 2017 4.2
- Gross fixed capital formation (percent of GDP): 2016 19.2; 2017 21.5; 2018 23.1; 2019 23.3
- Gross national saving (percent of GDP, from BOP): 2016 25.3; 2017 24.7; 2018 25.4; 2019 25.2
- Overall balance (general government): 2016 -1.7; 2017 -2.0; 2018 -2.4; 2019 -2.0
- Primary balance: 2016 1.5; 2017 0.8; 2018 0.1; 2019 0.2
- Primary structural balance (percent of potential GDP): 2016 1.8; 2017 0.6; 2018 -0.3; 2019 -0.5
- Public debt: 2016 76.0; 2017 73.6; 2018 71.3; 2019 69.1
- Current account: 2016 6.0; 2017 3.1; 2018 2.3; 2019 1.9
- Reserves (billions of Euros): 2016 24.4; 2017 23.4; 2018 26.9; 2019 30.1
- Gross external debt: 2016 97.2; 2017 84.6; 2018 76.2; 2019 70.7
- Broad money (end-of-period): 2016 7.0; 2017 7.8; 2018 7.0; 2019 6.2
- Lending to the private sector, flow-based: 2016 2.0; 2017 6.4; 2018 7.2; 2019 6.5
- Government bond yield (5-year, average): 2016 2.1; 2017 1.7; 2018 2.0
- Exchange regime: Floating
- Exchange rate, HUF per euro, period average: 2014 309; 2015 310; 2016 311; 2017 309; 2018 329
- Nominal GDP (billions of Forints): 2017 38,183; 2018 40,823; 2019 43,435
- Per capita GDP (EUR): 2017 12,600; 2018 13,449; 2019 14,286

### Structural reforms, competitiveness, and labor market policies
- Improving productivity through structural reforms is key to achieving convergence and higher living standards.
- Staff welcome the establishment of the Competitiveness Council and some implementation of recommendations to improve the business environment.
- Priority reforms and measures:
  - Improve business environment by reducing red tape, simplifying the regulatory environment, and leveling the playing field for SMEs and FDI.
  - Address challenges in obtaining construction permits and electricity connection, ease of paying taxes, and perceived corruption.
  - Improve education and vocational training to address skills mismatches.
  - Continue reducing participants in public works schemes to release them to the primary labor market (target: reduce participants to about 160,000 persons).
  - Increase availability of child-care facilities to improve labor market participation, especially among women.
- Competitiveness indicators and labor costs:
  - Hungary’s ULC in 2017, measured by hours worked, increased by 6.17 percent (peers: Czech Republic 3.3; Poland 2.1; Slovak Republic 2.9; Slovenia 0.4).
  - Productivity picked up in 2017 to 3 percent (from -1 percent in 2016).
  - Doing Business: Hungary requires 17 permits for construction of a commercial building versus EU average of 12.
  - Electricity connection time: 257 days in Hungary versus EU average of 90 days.
  - Global Competitiveness Index: Hungary remained in the 60th place in 2017/2018.

### External sustainability, debt dynamics, and risks
- Gross external debt declined from 97.2 percent of GDP in 2016 to 84.6 percent in 2017; projected under baseline to continue declining "towards 50 percent of GDP in 2023."
- Gross financing needs have been on a downward trend since 2011, reaching 9.6 percent of GDP in 2017 (compared to 25.3 percent in 2014); projected to decline to 6.1 percent of GDP by 2023.
- International reserves declined by about € 1 billion in 2017, but coverage of short-term debt increased; reserves remain broadly adequate according to the Fund’s metric.
- External Sustainability model results (selected):
  - CA Norm (percent of GDP): -1.6
  - CA-stabilizing NFA at 2016 level: -2.6
  - CA gap (percent of GDP): 4.5; 5.7
  - Exchange-rate gap (percent): 20.0; 9.6; -13.5
- Staff assessment: adjusting for Hungary’s need to sustain current account surpluses to reduce external debt, staff estimates an adjusted current account norm in the range of 2 percent of GDP.
- Debt and financing stress scenarios (selected findings):
  - Macro-fiscal shock: debt-to-GDP would reach 80 percent at the end of the projection horizon; financing needs would reach about 30 percent of GDP.
  - Growth shock (one standard deviation): debt-to-GDP around 75 percent; financing needs around 25 percent of GDP.
  - Contingent liabilities shock (10 percent of financial sector assets): debt-to-GDP almost 80 percent; financing needs would exceed 25 percent of GDP.
  - Width of symmetric fan chart estimated at around 20 percent of GDP, illustrating uncertainty.
- Debt Sustainability Analysis — Baseline projections (selected, percent of GDP unless noted):
  - Nominal gross public debt: 2016: 75.9; 2017: 76.0; 2018: 73.6; 2019: 71.2; 2020: 69.0; 2021: 67.3; 2022: 65.7; 2023: 64.2; 2023 (later row): 62.8
  - Public gross financing needs: 2016: 21.2; 2017: 16.4; 2018: 8.4; 2019: 17.2; 2020: 15.8; 2021: 15.2; 2022: 20.4; 2023: 21.2; 2023 (later row): 20.9
  - Real GDP growth (in percent): 2016: 0.6; 2017: 2.2; 2018: 4.0; 2019: 4.0; 2020: 3.3; 2021: 2.6; 2022: 2.4; 2023: 2.2; 2023 (repeat): 2.2
  - Effective interest rate (in percent): 2016: 5.8; 2017: 4.3; 2018: 4.0; 2019: 3.7; 2020: 3.4; 2021: 3.5; 2022: 3.4; 2023: 3.4; 2023 (repeat): 3.4
- Sensitivity analysis (external debt):
  - A real currency depreciation by 30 percent would augment external debt by about 25 percent of GDP.
  - A permanent current account (growth) shock of ½ standard deviation would increase external debt by just 6–10 percentage points of GDP by the end of the projection horizon.

### Risks to the outlook
- Overall risks tilted to the downside.
- External risks: softening conjunctural indicators in Europe, emerging markets developments, growing trade tensions, normalization of U.S. and euro area monetary policy raising financing costs, adverse EU developments affecting exports or foreign-owned banks’ subsidiaries.
- Domestic risks: procyclical fiscal policy and continued rapid wage growth increasing upward pressures on CPI inflation and asset prices, raising need for significant monetary tightening later; second-round effects from oil price increases and HUF depreciation; continued strong domestic demand growth accelerating deterioration in the external current account.
- Upside risks: higher-than-estimated slack and/or faster growth in Hungary’s trading partners could lead to faster and more sustained growth.

### Authorities’ views and response to Fund advice
- Authorities view they will meet their budget targets in 2018 and 2019 and plan to use budgeted expenditure reserves within the overall budget envelope if needed.
- Authorities view most sectoral taxes as targeting consumption and an important revenue source; expressed concern about the impact of real estate tax on disposable income and noted municipalities already collect similar property taxes.
- Authorities broadly agree with staff on risks and point to an additional upside risk: labor shortages could incentivize firms to innovate and upgrade capital, and favorable domestic demand trends may continue longer due to wage increases and tax cuts.
- Response to past Fund advice (selected):
  - Fiscal consolidation: 2017 general government balance overperformed budget and public debt ratio declined moderately; but structural balance deteriorated.
  - Monetary policy: inflation remained below expectations and MNB eased policy in 2017; recent MNB communication emphasized commitment to inflation target.
  - Financial sector: MNB tightened macroprudential tools and is monitoring the real estate market, while fiscal incentives continue to stimulate demand.
  - Labor market: participants in PWS reduced and number of child-care facilities increased.
  - Competitiveness: Competitiveness Council established; MNB issued Competitiveness Report; government working with OECD on SME productivity.

*International Monetary Fund — staff report excerpts (cr18252).*

### 1.2 percent of potential GDP. Staff projects the 2018 overall fiscal deficit at about 2.4 percent

### cr18252 - 1.2 percent of potential GDP. Staff projects the 2018 overall fiscal deficit at about 2.4 percent

### Fiscal outlook and stance
- Staff projects the 2018 overall fiscal deficit at about 2.4 percent of GDP, in line with the budget’s target.
- The structural primary balance is expected to deteriorate by close to one percent of potential GDP.
- The overall deficit narrowed to 2 percent of GDP in 2017 (versus the budgeted 2.4 percent), helping reduce public debt by 2.4 percentage points to 73.6 percent of GDP; however, the structural primary balance deteriorated by about 1.2 percent of potential GDP.
- Policy guidance:
  - Expedite reversal of the pro-cyclical fiscal stance and reduce public debt.
  - Implement growth-friendly consolidation starting in the second half of 2018 to build fiscal space and ease the burden on monetary policy.
  - Fiscal measures suggested: phase out remaining sectoral taxes, broaden the tax base, enhance tax administration, transform existing property taxes into a modern real estate tax to help local governments raise revenue, reform public administration to reduce the wage bill, reduce spending on goods and services, and eliminate generalized subsidies while protecting the poor with targeted measures.

### Monetary policy and inflation
- The Magyar Nemzeti Bank (MNB) further relaxed its monetary stance during 2017 and in early 2018, mostly using unconventional tools.
- Imported inflation has been low; large wage increases have been mitigated by lowering social security contributions.
- The MNB intends to let the Market-Based Lending Scheme expire by end-2018, as originally scheduled.
- Once inflation sustainably approaches the upper half of the tolerance band (3±1 percent), monetary stimulus should be gradually scaled back, starting with unconventional measures.
- Recent MNB communication emphasizing commitment to its inflation target and keeping options open to achieve it is welcomed by staff.
- Staff welcome the commitment to let the Market-Based Lending Scheme expire as scheduled by end-2018.
- Staff also recommend continued monitoring of the housing market, reviewing macroprudential tools as needed, and phasing out fiscal incentives that stimulate housing demand.

### Growth, labor market, and external sector
- GDP growth:
  - Growth is expected to be around 4 percent in 2018, similar to 2017.
  - Growth projected to decelerate to 3.3 percent in 2019 as EU funds absorption tapers off and capacity constraints tighten.
- Drivers of recent expansion:
  - Strong domestic demand supported by private consumption and EU funds-related investments.
  - Public investment boosted by accelerated absorption of EU funds.
  - Private consumption strengthened due to wage and employment growth and tax reductions.
- Inflation and labor:
  - CPI inflation (average) rose to 2.4 percent in 2017 and picked up to 3.1 percent in June 2018; core inflation close to 2½ percent over the past 6 months.
  - Unemployment fell to 3.7 percent in May 2018; labor shortages are intensifying across sectors, especially construction.
  - Average gross earnings growth exceeded 12 percent in 2018 Q1.
- External position:
  - Hungary’s external position is broadly in line with medium-term fundamentals and desirable policies.
  - The external current account surplus has been moderating from its 2016 peak; rising domestic demand and falling current account surpluses point to accelerating domestic demand.
  - Hungary’s IIP has improved and international reserves are adequate according to the Fund’s metric.

### Structural reforms and competitiveness
- Improving productivity through structural reforms is key to achieving convergence and higher living standards.
- Staff welcome the establishment of the Competitiveness Council and implementation of some recommendations to improve the business environment.
- Priority reforms and measures:
  - Improve business environment by reducing red tape, simplifying the regulatory environment, and leveling the playing field for SMEs and FDI.
  - Address challenges in obtaining construction permits and electricity connection, ease of paying taxes, and perceived corruption.
  - Improve education and vocational training to address skills mismatches.
  - Continue reducing participants in public works schemes to release them to the primary labor market.
  - Increase availability of child-care facilities to improve labor market participation, especially among women.

### Key statistics and projections (selected, preserved exactly as reported)
- Real GDP (percentage change): 2017 4.0; 2018 4.0; 2019 3.3
- CPI inflation (average): 2017 2.4; 2018 2.8; 2019 3.3
- CPI inflation (end year): 2017 2.1; 2018 3.1
- Unemployment rate (average, ages 15-64): 2017 4.2
- Gross fixed capital formation (percent of GDP): 2016 19.2; 2017 21.5; 2018 23.1; 2019 23.3
- Gross national saving (percent of GDP, from BOP): 2016 25.3; 2017 24.7; 2018 25.4; 2019 25.2
- Overall balance (general government): 2016 -1.7; 2017 -2.0; 2018 -2.4; 2019 -2.0
- Primary balance: 2016 1.5; 2017 0.8; 2018 0.1; 2019 0.2
- Primary structural balance (percent of potential GDP): 2016 1.8; 2017 0.6; 2018 -0.3; 2019 -0.5
- Public debt: 2016 76.0; 2017 73.6; 2018 71.3; 2019 69.1
- Current account: 2016 6.0; 2017 3.1; 2018 2.3; 2019 1.9
- Reserves (billions of Euros): 2016 24.4; 2017 23.4; 2018 26.9; 2019 30.1
- Gross external debt: 2016 97.2; 2017 84.6; 2018 76.2; 2019 70.7
- Broad money (end-of-period): 2016 7.0; 2017 7.8; 2018 7.0; 2019 6.2
- Lending to the private sector, flow-based: 2016 2.0; 2017 6.4; 2018 7.2; 2019 6.5
- Government bond yield (5-year, average): 2016 2.1; 2017 1.7; 2018 2.0
- Exchange regime: Floating
- Exchange rate, HUF per euro, period average: 2014 309; 2015 310; 2016 311; 2017 309; 2018 329
- Nominal GDP (billions of Forints): 2017 38,183; 2018 40,823; 2019 43,435
- Per capita GDP (EUR): 2017 12,600; 2018 13,449; 2019 14,286

*Source: HUNGARY STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION (selected excerpts).*

### 5.      The MNB further relaxed its monetary stance in 2017 and early 2018, mostly with the

### 5. The MNB further relaxed its monetary stance in 2017 and early 2018, mostly with the

### Monetary stance, unconventional tools, and yield developments
- Policy rate and overnight overdraft rate remained unchanged at 0.9 percent in 2017.
- Cap on the 3-month deposit facility was gradually decreased.
- Overnight deposit rate was reduced from -5 bps to -15 bps in September 2017.
- Amounts and maturity of liquidity-providing FX swaps were increased.
- In late 2017, the MNB announced:
  - the introduction of unconditional interest rate swaps, and
  - a mortgage bond purchase program (effective in 2018) to reduce the yield curve’s relative slope and to support the mortgage bond market.
- The relative slope of the Hungarian yield curve declined at the time of the announcement, but long-term yields have since increased again, reflecting developments in market sentiment.
- At end-2017, all 16 banks participating in the Market-Based Lending Scheme (MBLS) had observed their commitments.
- From end-March to end-June (period noted), the 3-month money market rate increased (by almost ¼ percentage point) and the exchange rate depreciated (by about 5 percent during the same period).

### Measures to encourage longer-term fixed-rate lending and macroprudential tools
- Most household loans carry variable rates or fixed-rates up to one year.
- Result: more than 80 percent of new lending is now at fixed rates.
- April 2017: mortgage funding adequacy ratio (MFAR) was introduced to encourage banks to issue longer mortgage bonds.
- December 2017: Budapest Stock Exchange introduced three mortgage bond indices to promote transparent pricing.
- Early 2018: MNB launched its new mortgage bond purchase program.
- Housing prices are booming, but household debt in percent of GDP is low compared to EU peers and is denominated in local currency.
- New interbank funding ratio (IFR), introduced preemptively on July 1, 2018, aims to discourage excessive reliance on wholesale funding.
- MFAR-related note: Effective October 1, 2018, the PTI ratio will be reduced for loans with, respectively, variable rates or fixation below 5 years, and for loans with fixation of interest rates between 5 and 10 years. The PTI ratio for loans with fixed rates of at least 10 years or for the whole term will remain unchanged. The MFAR ratio will be increased from 15 to 20 percent. In addition, amendments to the MFAR regulation will discourage cross-financing and facilitate stable funding.
- Note on PTI calculation: Already in 2016, the calculation of the payment-to-income (PTI) ratio was changed to not discourage fixed-rate borrowing.

### Banking system soundness and credit developments
- Banking system: on average profitable, liquid, and well-capitalized.
- Profitability was high in 2017 helped by revoked provisions; only a few small banks reported losses.
- NPL ratio declined from 7.4 to 4.2 percent during 2017, mainly due to sizable NPL sales, increased lending, and better debt service by borrowers.
- Trend continued during Q1 2018 (reported).
- Bank lending to non-financial companies—particularly to SMEs—is growing by around 11 percent.
- Credit to households—mainly mortgages—is also growing, albeit at a slower pace.
- Lending surveys suggest both demand and banks' willingness to lend have improved.
- Deposits increased rapidly, reducing the loan-to-deposit ratio.
- Preliminary 2017 data: average Tier I capital ratio at 14.4 percent and CAR at 16.4 percent.
- Despite branch reductions and consolidation of credit cooperatives, Hungarian banks have relatively high operating and staff costs compared to peers.

### External sector, reserves, and external debt
- Current account surplus was halved to 3.1 percent of GDP in 2017 due to imports and foreign investors’ profit.
- Exports remained buoyant and largely driven by participation in the German supply chain.
- Capital and financial account inflows strengthened mostly on the back of increased EU-funds utilization.
- Excluding one-off exceptional transactions, preliminary data indicate FDI gross inflows were 4.6 percent of GDP in 2017, compared to 2.8 percent a year earlier.
- External debt declined by nearly 13 percentage points to about 84 percent of GDP (2017) on the back of active debt management.
- Non-resident debt holders were replaced with domestic holders and maturing debt was converted into longer-maturity and cheaper borrowing.
- Reserves declined slightly in 2017, but short-term debt also declined; adequacy of reserves improved somewhat against the IMF's metric.
- Net IIP improved by close to 6 percentage points, to net liabilities of about 62 percent of GDP in 2017.
- Exchange rate has been on a moderate depreciating trend over past years.
- Non-price competitiveness continues to be hindered by the tight labor market and lagging structural reforms.
- The large improvement in net IIP was mostly due to substantial external current account surpluses and active public debt management.

### Outlook and inflation
- Staff projects growth in 2018 to plateau at the 4 percent observed in 2017, and to decelerate gradually over the medium term as EU funds absorption tapers off and capacity constraints tighten further.
- Imported core inflation remains subdued, but inflationary impact of the tight labor market is expected to become more pronounced.
- Staff projects inflation to slightly overshoot the 3 percent target in the near term, given rising energy prices and weaker HUF.
- Fiscal balance projected to gradually improve starting with the 2019 budget.
- Current account surplus expected to continue to moderate due to continued strong imports and foreign investors’ earnings.

### Risks to the outlook
- Risks tilted to the downside.
- Increased risks from softening conjunctural indicators in Europe, recent developments in emerging markets, and growing trade tensions.
- Normalization of monetary policy in the U.S. and euro area and tighter global financing conditions could increase financing costs.
- Negative developments in the EU could spill over to Hungary via lower exports or through subsidiaries of foreign-owned banks.
- Hungary’s interest rate spreads have recently increased in line with regional peers.
- EU funds could be adversely impacted by new proposals on their allocation.
- Domestic risks: procyclical fiscal policy and continued rapid wage growth would increase upward pressures on CPI inflation and asset prices, raising need for potentially significant monetary tightening later.
- Second-round effects of recent oil price increases and HUF depreciation could lead to upward pressures on inflation.
- Continuation of strong domestic demand growth could cause faster deterioration in the external current account.
- Upside risks: presence of higher-than-estimated slack and/or faster growth in Hungary’s trading partners would lead to faster and more sustained growth compared to the baseline.

### Authorities’ projections and views
- Authorities expect 2018 growth in the range of 4.3–4.4 percent.
- MNB projects 2019 growth at 3.5 percent.
- Ministry of Finance projects 2019 growth at 4.1 percent on the back of strong consumption and investment trends.
- Authorities broadly agree with staff regarding risks and point to an additional upside risk: labor shortages could incentivize firms to innovate and upgrade capital, and favorable domestic demand trends may continue longer due to wage increases and tax cuts.
- Authorities plan to examine further opportunities to reduce taxes, increase wages, and support growth, while acknowledging the need to rebuild fiscal buffers.

### Policy agenda: rebalancing of policy mix
- Desirable actions:
  - Implement growth-friendly fiscal consolidation to build buffers and fiscal space for future downturns.
  - Gradually scale back monetary policy stimulus once inflation sustainably approaches the upper half of the target band by unwinding unconventional tools first and raising the interest rate as needed.
  - If fiscal policy becomes less pro-cyclical, monetary tightening can be more gradual and support the current account and reduction in external debt.
  - Accelerate structural reforms to improve weak productivity.

### A. Fiscal policy — recent developments and projections
- 2018 overall fiscal deficit projected at about 2.4 percent of GDP, almost half a percentage point more than the 2017 deficit, despite a booming economy.
- Tax cuts in 2017 and 2018: staff expects tax revenue as a share of GDP to remain unchanged due to rapid growth in labor earnings and private consumption.
- Total revenue expected to improve by about 1 percentage point of GDP, mostly on account of strong EU funds.
- Spending projected to increase by 1.4 percent of GDP, mostly due to large increase in capital spending.
- Deterioration in the structural primary balance expected to be close to one percent of potential GDP.
- 2019 budget: targets an overall deficit of 1.8 percent of GDP (authorities); staff projects overall fiscal deficit at 2 percent of GDP for 2019.
- The 2019 deficit reduction would be achieved through lower spending on goods and services, social transfers, and interest payments; savings to more than compensate for planned increase in capital expenditure and reduction in social security contribution rate paid by employers (note: rate expected to be reduced from 19.5 to 17.5 percent effective on July 1st, 2019).
- Medium-term projections:
  - Tax revenue projected to remain constant as a share of GDP; total revenue will gradually decline assuming further reductions in social security contribution rates.
  - Disbursement of EU-related funds expected to slow down from 2020 onwards.
  - Staff projects a larger decline in expenditure predominantly due to steady moderation in EU funds-related expenditure starting in 2020 and declining social transfers to households.
  - Yields on government bonds and T-bills expected to increase in line with tightening global financial conditions, but interest payments projected to gradually decline, reflecting improving primary surpluses and reduction in public debt.
  - Increases in public wages likely to be more than compensated by lower social security contributions, leading to a decrease in the total public wage bill as a ratio to GDP.
  - Structural primary balance would improve gradually; fiscal stance would turn slightly counter-cyclical.
  - Public debt projected to decline steadily over the medium term to about 63 percent of GDP, compared to 73.6 percent at end-2017.
  - Note: The projected (almost 10 percentage points) decline in public debt reflects mainly favorable developments in the interest rate-growth differential; the primary balance will contribute only mildly. Gross financing needs-to-GDP ratio forecast to remain broadly stable at about 20 percent of GDP.

### Staff fiscal recommendations and illustrative impact
- Staff recommends growth-friendly fiscal measures to achieve smaller deficits starting in the second half of 2018 and over the medium term to create fiscal buffers.
- Staff-recommended measures would result in additional saving, compared to the baseline, that average about 0.4 percent of GDP annually between 2018 and 2023.
- This path would secure the authorities' medium-term target of 1.5 percent of GDP structural surplus by 2019 and reduce public debt to below 60 percent of GDP by 2023.
- Revenue measures recommended:
  - Further enhance tax administration and broaden the tax base by reducing exemptions and preferential regimes.
  - Phase out remaining sectoral taxes and consider modernizing the real estate tax to help local governments raise revenue for healthcare, education, and infrastructure while protecting the vulnerable.
  - Avoid additional tax rate cuts; if cuts are implemented, adopt offsetting revenue measures.
- Expenditure measures recommended:
  - Reform public administration to contain the public wage bill while facilitating a competitive public salaries scale and improving provision and quality of public services.
  - Rationalize spending on goods and services, which is elevated compared to peers.
  - Eliminate generalized subsidies that are inefficient and regressive, while ensuring adequate and better-targeted protection for vulnerable groups.
- The recommendations are broadly similar to those in the 2017 Article IV Consultation.

*Source: IMF staff report (excerpt).*

### 20.      The authorities are of the view that they will meet their budget targets in 2018 and

### cr18252 - 20.      The authorities are of the view that they will meet their budget targets in 2018 and

### Fiscal policy: authorities' stance and staff recommendations
- Authorities view they will meet their budget targets in 2018 and 2019, citing substantial reserves budgeted on the expenditure side and intend to use these reserves within the overall budget envelope to counter a deterioration in economic conditions as needed.
- Authorities view most sectoral taxes as targeting consumption and constituting an important source of revenue; they expressed concern about the impact of the real estate tax on disposable income and noted municipalities already collect similar, albeit smaller, property taxes.
- Staff-recommended fiscal measures and their average per year fiscal impact (2018-2023), in percent of GDP:
  - Total 0.40
  - Revenue -0.10
  - Phasing out of sector-specific taxes -0.30
  - Streamlining VAT rates 0.10
  - Elimination of excise exemptions for fuel 0.10
  - Expenditure 0.50
  - Reduction in the wage bill 0.30
  - Rationalization of spending on goods and services 0.10
  - Rationalization of transport and fuel subsidies 0.10
- Staff appraisal recommendations:
  - Expedite reversal of the pro-cyclical fiscal stance and reduce public debt.
  - Adopt growth-friendly fiscal measures to achieve smaller deficits starting in the second half of 2018 and over the medium term.
  - Phase out remaining sectoral taxes, broaden the tax base, and enhance tax administration.
  - Transform existing property taxes into a modern real estate tax to help local governments finance healthcare, education, and infrastructure while protecting the vulnerable.
  - Reform public administration to reduce the wage bill and improve public service provision and quality; reduce spending on goods and services; eliminate generalized subsidies while protecting the poor by targeted measures.
  - Recommendation to hold the next Article IV consultation on the standard 12-month cycle.

### Monetary policy: stance, risks, and normalization path
- Staff recommends gradual normalization of the monetary stance once inflation sustainably approaches the upper segment of the MNB tolerance band.
- MNB communication: committed to the inflation target and will tighten monetary policy once inflation sustainably reaches the 3 percent target in a sustainable manner in the medium term.
- Observations on inflation and wage dynamics:
  - Higher wages have not spilled over into consumer prices so far, helped by lowering payroll taxes and relatively low wage share in production costs.
  - These mitigating forces may have run their course given the closed output gap, intensifying labor shortages, and other capacity constraints.
  - Non-tradable prices are on the rise; exchange rate developments may increase imported inflation.
- Recommended sequencing for normalization:
  - Start by unwinding some unconventional tools (e.g., gradually reducing ample FX liquidity swaps).
  - Let the Market-Based Lending Scheme expire by end-2018 (staff welcomes intention to let it expire as scheduled).
  - Reassess unconditional interest rate swaps (they reduce interest rate risk of banks but seem no longer effective in significantly affecting the yield curve).
  - Reconsider the mortgage bond purchase program’s incentives to ensure institutional investors are not discouraged from participating.
- Staff view: timely, data-dependent action would reduce the need for greater tightening later.

### Financial sector: credit, housing, and macroprudential policy
- Credit growth expected to remain strong; NPLs likely to decrease further.
- Regulatory and supervisory measures:
  - New MNB guidelines for independent real estate evaluators welcomed given the booming real estate market and revocation of provisions.
  - Continued strengthening of off-site reporting and emphasis on on-site inspections; consolidation of credit cooperatives progressing and should remain market-based.
- Housing market assessment:
  - Authorities and staff do not currently consider a significant general over-valuation of house prices in Hungary.
  - Housing prices began increasing in Budapest in 2014 and spread to other cities; growth recently decelerated in Budapest but remained in double digits.
  - Drivers: postponed purchases post-global financial crisis, investment purchases due to low interest rates, fiscal incentives for young families, and temporarily lowered VAT rate for certain new dwellings (set to expire by end-2019), leading to frontloaded construction.
  - Market participants report that only about 45 percent of transactions rely on borrowing.
  - A substantial part of outstanding household debt still carries variable rates.
  - Envisaged tightening of PTI and MFAR ratios can help contain financial stability risks, but their effectiveness in containing the housing boom is limited because the boom is mostly not credit-driven.
- Authorities’ view: real estate prices not currently overvalued but warrant close monitoring; macroprudential tools can contain financial sector risks; housing boom should be viewed in context of low household debt versus peers. MNB commits to continuously enhance supervisory practices in line with EU requirements.

### Structural policies: productivity, competitiveness, and labor market
- With a closed output gap, policy support should focus on structural reforms to enhance productivity and reduce supply constraints.
- Business environment challenges identified:
  - Obtaining construction permits: Hungary requires 17 permits for construction of a commercial building versus EU average of 12.
  - Electricity connection time: 257 days in Hungary versus EU average of 90 days.
  - Other impediments: protecting minority investors, paying taxes, high frequency of issuing regulations, and perceived corruption.
- SME and investment policy:
  - Authorities’ strategy successful in attracting large investors, especially in automotive sector; need to level the playing field to broaden growth base and enhance environment for SMEs.
  - SME productivity relative to large firms is lower than in peer countries; staff welcomes work with OECD on improving SME competitiveness.
  - Simplifying regulations would particularly benefit SMEs, attract more FDI, and diversify activity and exports.
- Labor market and ULC:
  - Average ULC in Hungary higher than peers participating in the German value chain. ULC in 2017, measured by hours worked, increased by 6.17 percent in Hungary, compared to 3.3 percent in the Czech Republic, 2.1 percent in Poland, 2.9 percent in the Slovak Republic, and 0.4 percent in Slovenia.
  - Productivity picked up in 2017 to 3 percent (from -1 percent in 2016), reflecting greater use of capital, efficiency gains, and innovation.
  - Policy priorities: boost innovation and productivity, improve education and vocational training to address skills mismatches, reduce participants in public works schemes to about 160,000 persons to release workers to the primary labor market, and increase availability of child-care facilities to improve female labor market participation.

### Staff appraisal: growth, external position, and policy mix
- Growth and public debt:
  - Hungary achieved several years of strong growth and substantially reduced external debt; growth expected to be around 4 percent in 2018, similar to last year.
  - Strong expansion supported by private consumption and EU funds-related investments.
  - Fiscal outcomes have overperformed budget targets in recent years but public debt ratio has fallen only to a limited extent.
- Policy recommendations reiterated:
  - Do more to reduce fiscal vulnerabilities and create space for policy to react to shocks.
  - Rebalance the policy mix and advance structural reforms to moderate reduction of the external current account surplus driven by strong domestic demand.
  - Once inflation sustainably approaches the upper half of the tolerance band (3±1 percent), gradually scale back monetary policy stimulus starting with unconventional measures.
  - Staff welcomes MNB communication emphasizing commitment to the inflation target and the commitment to let the Market-Based Lending Scheme expire as scheduled by end-2018.
- External position:
  - Hungary’s external position broadly in line with medium-term fundamentals and desirable policies; non-price indicators point to need to improve productivity and competitiveness.
  - Hungary’s IIP has improved and international reserves are adequate according to the Fund’s metric.

### Box 1 — External Sustainability and Competitiveness (high-level findings)
- Hungary’s current account surplus narrowed substantially in 2017 but remained in surplus:
  - Current account surplus declined to 3.1 percent of GDP in 2017, from 6 percent of GDP in 2016.
- Drivers and outlook:
  - Strong domestic demand (consumption and investment) contributed to rapid import growth outpacing exports, reflecting acceleration of EU funds utilization and strong growth in disposable income.
  - Merchandise trade remained in surplus; net exports of services remained strong due to buoyant tourism receipts.
  - Deficit on primary income increased substantially, mainly due to higher profit earned by foreign investors.
  - Over the medium term, the current account surplus is projected to gradually decline further as import growth continues to outpace that of exports due to strong domestic demand.
- International investment position:
  - Net IIP improved to about -62 percent of GDP in 2017, compared to about -68 percent of GDP in 2016.

*International Monetary Fund — staff report excerpts (cr18252).*

### 2016. It is expected to further improve over the medium term. This is largely driven by a continued reduction

### cr18252 - 2016

### External debt and gross financing needs
- Gross financing needs have been on a downward trend since 2011 and "declined more rapidly in recent years", reaching 9.6 percent of GDP in 2017 (compared to 25.3 percent in 2014).
- Gross financing needs are projected to decline further to 6.1 percent of GDP by 2023.
- Gross external debt declined from 97.2 percent of GDP in 2016 to 84.6 percent in 2017.
- Under the baseline scenario, gross external debt is expected to continue to decline over the medium term, "towards 50 percent of GDP in 2023."
- Drivers of the decline in external debt: low interest rates, increased reliance on domestic financing, and buoyant GDP growth.

### International reserves
- International reserves declined by about € 1 billion in 2017, but their coverage of short-term debt increased.
- The reserves continued to provide a comfortable cushion relative to the benchmark of 100 percent of short-term debt and "remain broadly adequate according to the Fund’s metric."
- The decline in reserves in 2017 decelerated markedly compared to their decline in recent years; the earlier declines reflected:
  - the reduction in the government’s net external borrowing, and
  - the banks’ redemption of MNB swaps contracts related to the household FX loan conversion scheme.
- Both the government borrowing reduction and the FX conversion-related redemptions contributed to reducing external exposures but exerted downward pressure on reserves.
- With progress in reducing external public borrowing and with the FX conversion scheme concluded, reserves are expected to increase over the medium term and remain in the recommended ranges.

### External position, EBA models, and REER
- "Hungary’s external position appears to be broadly in line with medium-term fundamentals and desirable policies."
- The EBA models yield mixed results for Hungary:
  - The two Real Effective Exchange Rate (REER) approaches suggest an overvaluation of the exchange rate of about 9 to 20 percent.
  - The models produce a large residual (up to about 27 percent) that is not explained by the policy variables.
  - These results appear inconsistent with Hungary’s buoyant current account surpluses.

### Current account balance (2009–2017)
- The document presents Hungary’s current account balance components (Primary income, net; Secondary income, net; Services, net; Goods, net) and the overall Current account balance as percentages of GDP for 2009–2017 (figure referenced).
- Aggregate statement: Hungary recorded buoyant current account surpluses over the period through 2017.

*International Monetary Fund, HUNGARY (excerpts).*

### Box 1. External Sustainability and Competitiveness (concluded)

### Box 1. External Sustainability and Competitiveness (concluded)

### External position: model results and staff assessment
- The External Sustainability (ES) approach suggests that the exchange rate may be undervalued by 7 percent. This assessment is based on stabilizing Hungary’s net borrower position (NFA/GDP) at its recent level, which would be consistent with a medium-term current account deficit of 2.5 percent of GDP.
- The CA approach estimates Hungary’s current account norm at -1.6 percent of GDP, which implies an exchange rate undervaluation of about 11 percent.
- The current account gap estimated by the model is therefore 4.5 percent of GDP in 2017, out of which only 2.2 percentage points are attributed to identified policies, while the model is unable to explain the residual of 2.3 percentage points.
- The bulk of the explained current account gap is attributed by the model to weak private sector credit.
- Staff judges the CA norm estimated by the model to be too low given still-elevated vulnerabilities, including the high external debt.
- Adjusting for Hungary’s need to sustain current account surpluses over the medium term to help reduce its still high external debt from 84 percent of GDP in 2017 to about 50 percent by the end of the medium term, staff estimates an adjusted current account norm in the range of 2 percent of GDP. This is consistent with the BOP baseline scenario (under current policies).
- These country-specific factors lead staff to conclude that Hungary’s external position is broadly in line with medium-term fundamentals, consistent with the assessment in the 2017 Article IV.

### Non-price competitiveness and structural challenges
- Unit labor cost has been rising due to increasing wages.
- Doing Business Indicator ranking worsened recently.
- Global Competitiveness Index: Hungary remained in the 60th place in 2017/2018.
- Key areas identified for improvement include the legal and regulatory framework, and unpredictability of policy making.

### Policy implications and recommended structural actions
- Greater export diversification and steady inflows of FDI would help support medium-term growth and reduce external vulnerabilities.
  - Exports continue to increase relative to GDP, but their share within the EU is still catching up with regional peers.
  - FDI remains a strong support to exports and can be increased and attracted to more sectors beyond the automotive industry.
- As highlighted in the MNB’s Competitiveness Report, priorities include:
  - Improve the ability of business to get electricity and obtain building permits.
  - Encourage innovation.
  - Address labor shortages, including through improved education and vocational training.

### External Balance Assessment results (selected figures from models)
- CA Norm (percent of GDP): -1.6
- CA-stabilizing NFA at 2016 level: -2.6
- CA gap (percent of GDP): 4.5; 5.7
- Exchange-rate gap (percent): 20.0; 9.6; -13.5
- Source of these model results: 2017 External Balance Assessment (data and models June 2018)

*International Monetary Fund — Box 1. External Sustainability and Competitiveness (concluded).*

### Annex I. Response to Past Fund Policy Advice

### Annex I. Response to Past Fund Policy Advice

### Key IMF recommendations and authorities' actions
- Recommendation: Take advantage of the strong economic conditions and implement a growth-friendly fiscal consolidation to achieve a faster decline in public debt and deficit.
  - Implemented policies:
    - In 2017 the general government balance overperformed the budget target and the public debt ratio declined moderately.
    - It is expected to do so in 2018 as well.
    - GDP growth and lower interest payments have contributed substantially to this outcome, and the underlying structural balance would deteriorate rather than improve as recommended by staff.
    - The proposed 2019 budget would virtually neutralize the fiscal stimulus.
    - Savings on the expenditure side have been achieved mainly on account of the introduction of tighter eligibility rules for social transfers to households, such as postponement of the retirement age and elimination of the early retirement pensions.
    - These measures are expected to slow down growth of age-related spending over the projection horizon.

- Recommendation: Keep the monetary policy stance under review, in light of inflationary pressures and pro-cyclicality of fiscal policy.
  - Implemented policies:
    - Inflation remained below expectations and the MNB continued to ease monetary policy in 2017 and adjust its unconventional monetary policy instruments.
    - Recent MNB communication emphasized its commitment to its inflation target and kept all options open to achieve it.

- Recommendation: Remain prudent and guard from financial sector risks, including those that can raise from the real estate market.
  - Implemented policies:
    - The MNB has pre-emptively tightened its macroprudential tools and is monitoring the real estate market.
    - On the other hand, fiscal incentives continue to stimulate demand.

- Recommendation: Improve labor market policies.
  - Implemented policies:
    - The number of participants in the PWS has been reduced and the number of child-care facilities has been increased.

- Recommendation: Improve competitiveness indicators and remove impediments to doing business.
  - Implemented policies:
    - The government established a Competitiveness Council, led by the Minister of Finance to recommend reforms.
    - The MNB has issued a Competitiveness Report to identify priorities.
    - The government is also working with the OECD on a plan to improve the productivity of SMEs.

*Source: Annex I. Response to Past Fund Policy Advice*

### 4.      The debt and financing needs projections are particularly sensitive to combined

### 4.      The debt and financing needs projections are particularly sensitive to combined

### Macro-fiscal and contingent-liabilities shocks
- Macro-fiscal shock:
  - If shocks to growth, interest rate, and primary balance occur simultaneously, the debt-to-GDP ratio would reach at 80 percent at the end of the projection horizon.
  - Financing needs would in this case reach about 30 percent of GDP.
- Growth shock:
  - Assuming a decline in growth by one standard deviation for 2016 and 2017, the debt-to-GDP ratio is forecast to reach around 75 percent.
  - Financing needs around 25 percent of GDP by the end of the projection period.
- Contingent liabilities shock:
  - A standardized shock of 10 percent of financial sector assets is used to represent a hypothetical realization of contingent liabilities.
  - In such a scenario, the debt-to-GDP ratio would reach almost 80 percent at the end of the projection horizon.
  - Financing needs would exceed 25 percent of GDP.

### Uncertainty around the baseline
- The width of the symmetric fan chart is estimated at around 20 percent of GDP, illustrating the degree of uncertainty for equal-probability upside and downside shocks.
- Assuming less favorable economic conditions than under the baseline scenario―upside shocks to growth and primary balance are constrained to zero―public debt dynamics would deteriorate resulting in an upward-sloping path.

### Debt profile and risk assessment
- External financing needs are below the upper risk-assessment benchmark.
- A sizeable share of foreign liabilities accounts for intra-company loans, which mitigates risk to a certain extent.
- Public debt in foreign currency and public debt held by non-residents have declined considerably in recent years, but remain above the lower risk assessment benchmark, suggesting some risks in case of pressures on the exchange rate and foreign exchange reserves.
- Spreads and short-term debt are below the lower-risk assessment benchmarks.

### Mitigating factors to debt sustainability risks
- Investor base:
  - Debt is now held predominantly by domestic financial institutions, with the non-resident component decreasing and estimated at around 20 percent of total debt.
  - Ample liquidity in the system and relatively low demand for private sector credit have incentivized banks to purchase sovereign debt.
- Buffers:
  - There is a cash cushion in the form of deposits accumulated by the public sector, which are around 5 percent of GDP.
  - This implies a lower public debt-to-GDP ratio on a net basis and some liquidity cushion that could help cover financing needs for a few months.

### B. External Debt Sustainability Analysis — key findings
- Gross external debt reached 84.6 percent of GDP at end-2017, a contraction by 12.6 percentage points of GDP year-on-year.
- The improvement reflects:
  - stepping up domestic funding replacing non-resident holders of debt,
  - active public debt management with a rebalancing towards longer maturities (and lower interest rates),
  - buoyant GDP growth.
- The share of inter-company loans involved in FDI has also declined, suggesting Hungarian subsidiaries have regained profitability and warranting a lower level of engagement by foreign investors.
- Sensitivity analysis:
  - A real currency depreciation by 30 percent would augment external debt by about 25 percent of GDP.
  - A permanent current account (growth) shock of ½ standard deviation towards historical variation or a non-interest current account shock would increase external debt by just 6–10 percentage points of GDP by the end of the projection horizon.
- Compared to a year earlier, all shocks would yield more benign results due to lower external debt level, stronger GDP growth, and differences in debt composition.

### Authorities' view
- External vulnerabilities have declined significantly in the context of strong growth in EU transfers and the inflow of large inflow of foreign direct investment.
- Gross external debt halved since 2010, mainly on account of lower public debt, and to a smaller extent to lower debt level by the corporate sector.
- Net external debt continues to shrink, given high net FDI inflows over 2012–17 (cumulatively reaching

*Prepared by Kamil Dybczak and Michelle Hassine (both EUR).*

### 10.9 percent of GDP). They see risks as remaining benign in the medium and long term and deem

### cr18252 - 10.9 percent of GDP). They see risks as remaining benign in the medium and long term and deem

### Public debt and risk assessment
- Debt burden benchmarks and stress test benchmarks used:
  - Gross financing needs benchmark: 15%
  - Bond spread shocks: 200 and 600 basis points
  - External financing requirement shocks: 5 and 15 percent of GDP
  - Change in the share of short-term debt shocks: 0.5 and 1 percent
  - Public debt held by non-residents shocks: 15 and 45 percent
  - Share of foreign-currency denominated debt shocks: 20 and 60 percent
- Early-warning coloring convention:
  - Green: benchmark not exceeded under specific shock or baseline
  - Yellow: exceeded under specific shock but not baseline
  - Red: benchmark exceeded under baseline
  - White: stress test not relevant or data unavailable

### Debt Sustainability Analysis — Baseline projections (As of May 15, 2018)
- Key projected indicators (in percent of GDP unless otherwise indicated):
  - Nominal gross public debt: 2016: 75.9; 2017: 76.0; 2018: 73.6; 2019: 71.2; 2020: 69.0; 2021: 67.3; 2022: 65.7; 2023: 64.2; 2023 (later row): 62.8
  - Public gross financing needs: 2016: 21.2; 2017: 16.4; 2018: 8.4; 2019: 17.2; 2020: 15.8; 2021: 15.2; 2022: 20.4; 2023: 21.2; 2023 (later row): 20.9
  - EMBIG (bp): 115
  - 5Y CDS (bp): 90
  - Real GDP growth (in percent): 2016: 0.6; 2017: 2.2; 2018: 4.0; 2019: 4.0; 2020: 3.3; 2021: 2.6; 2022: 2.4; 2023: 2.2; 2023 (repeat): 2.2
  - Inflation (GDP deflator, in percent): 2016: 3.4; 2017: 1.0; 2018: 3.7; 2019: 2.8; 2020–2023: 3.0 each year
  - Nominal GDP growth (in percent): 2016: 4.0; 2017: 3.2; 2018: 7.8; 2019: 6.9; 2020: 6.4; 2021: 5.7; 2022: 5.5; 2023: 5.3; 2023 (repeat): 5.3
  - Effective interest rate (in percent): 2016: 5.8; 2017: 4.3; 2018: 4.0; 2019: 3.7; 2020: 3.4; 2021: 3.5; 2022: 3.4; 2023: 3.4; 2023 (repeat): 3.4
- Contribution to change in gross public sector debt (projections, percent of GDP):
  - Change in gross public sector debt: 2016: 1.4; 2017: -0.7; 2018: -2.4; 2019: -2.4; 2020: -2.2; 2021: -1.7; 2022: -1.7; 2023: -1.4; cumulative: -1.5 and -10.8 (cumulative)
  - Identified debt-creating flows cumulative: -11.0
  - Primary deficit (percent of GDP): 2016: -0.2; 2017: -1.5; 2018: -0.8; 2019: -0.1; 2020: -0.2; 2021: -0.3; 2022: -0.4; 2023: -0.3; cumulative: -0.4 and -1.7 (cumulative)
  - Primary (noninterest) revenue and grants cumulative: 264.5 (sum of annual values)
  - Primary (noninterest) expenditure cumulative: 262.8 (sum of annual values)
- Automatic debt dynamics:
  - Automatic debt dynamics annual contributions: 2016: 1.8; 2017: 0.6; 2018: -3.1; 2019: -2.2; 2020: -2.0; 2021: -1.4; 2022: -1.3; 2023: -1.2; cumulative: -9.3
  - Interest rate/growth differential cumulative: -9.3
  - Real interest rate contribution cumulative: 1.6
  - Real GDP growth contribution cumulative: -10.9
  - Exchange rate depreciation contribution (single-year example): 0.8 and -0.2 in subsequent year(s)
- Residual, including asset changes (percent of GDP): -0.2; 0.1; 1.5; 0.0; 0.0; 0.0; 0.0; 0.0; cumulative: 0.2

### Composition of public debt and alternative scenarios
- Underlying assumptions (in percent; selected series for 2018–2023):
  - Baseline scenario:
    - Real GDP growth: 2018: 4.0; 2019: 3.3; 2020: 2.6; 2021: 2.4; 2022: 2.2; 2023: 2.2
    - Inflation: 2018: 2.8; 2019–2023: 3.0 each year (2018 row shows 2.8 then repeated 2.8 elsewhere)
    - Primary Balance: 2018: 0.1; 2019: 0.2; 2020: 0.3; 2021: 0.4; 2022: 0.3; 2023: 0.4
    - Effective interest rate: 2018: 3.7; 2019: 3.4; 2020: 3.5; 2021: 3.4; 2022: 3.4; 2023: 3.4
  - Historical scenario:
    - Real GDP growth: 2018: 4.0; 2019–2023: 1.1 each year
    - Inflation: 2018: 2.8; 2019–2023: 3.0 each year
    - Primary Balance: 2018: 0.1; 2019–2023: 0.5 each year
    - Effective interest rate: 2018: 3.7; 2019: 3.4; 2020: 3.9; 2021: 4.0; 2022: 4.4; 2023: 4.5
  - Constant Primary Balance Scenario:
    - Primary Balance: 2018–2023: 0.1 each year
    - Other variables match baseline

- Composition charts presented:
  - Gross Nominal Public Debt (in percent of GDP) projection by scenario (Baseline, Historical, Constant Primary Balance)
  - Public Gross Financing Needs (in percent of GDP) projection
  - By maturity: medium and long-term vs short-term (in percent of GDP)
  - By currency: local currency-denominated vs foreign currency-denominated (in percent of GDP)

### Stress tests and scenario outcomes
- Stress test scenarios and select underlying assumptions (2018–2023):
  - Primary Balance Shock:
    - Real GDP growth: 4.0; 3.3; 2.6; 2.4; 2.2; 2.2
    - Inflation: 2.8; 3.0; 3.0; 3.0; 3.0; 3.0
    - Primary balance: 0.1; -0.4; (blank); -0.3; 0.4; 0.3; 0.4 (table has mixed placement)
    - Effective interest rate: 3.7; 3.4; 3.6; 3.4; 3.4; 3.4
  - Real GDP Growth Shock:
    - Real GDP growth: 4.0; 0.1; -0.6; 2.4; 2.2; 2.2
    - Inflation: 2.8; 2.2; 2.2; 3.0; 3.0; 3.0
    - Primary balance: 0.1; -1.6; (blank); -3.3; 0.4; 0.3; 0.4
    - Effective interest rate: 3.7; 3.4; 3.6; 3.6; 3.6; 3.5
  - Real Interest Rate Shock:
    - Inflation jumps in 2018–2019 (e.g., 2.8 then 6.9 in one row)
    - Effective interest rate increases to 4.1; 4.4; 4.9; 5.1 in later years
  - Real Exchange Rate Shock:
    - Effective interest rate path shows modest changes (e.g., 3.7; 3.5; 3.5; 3.4; 3.4; 3.4)
  - Combined Shock:
    - Real GDP growth: 4.0; 0.1; -0.6; 2.4; 2.2; 2.2
    - Inflation: 2.8; 2.2; 2.2; 3.0; 3.0; 3.0
    - Primary balance shows severe deterioration in one year (e.g., 0.1; -1.6; -3.3; 0.4; 0.3; 0.4)
    - Effective interest rate rises (e.g., 3.7; 3.5; 4.1; 4.4; 4.9; 5.1)
  - Contingent Liability Shock:
    - Primary balance has a large one-off hit in one year: 0.1; -9.6; 0.3; 0.4; 0.3; 0.4
    - Effective interest rate: 3.7; 3.6; 4.1; 3.9; 3.6; 3.4
- Stress-test outputs displayed (selected metrics, years 2018–2023):
  - Gross Nominal Public Debt (in percent of GDP) under each shock
  - Gross Nominal Public Debt (in percent of Revenue) under each shock
  - Public Gross Financing Needs (in percent of GDP) under each shock

### External debt sustainability (Table 1 and bound tests)
- External debt and related projections (in percent of GDP, 2013–2023, selected values):
  - Baseline: External debt 2013: 121.6; 2014: 106.6; 2015: 105.7; 2016: 90.3; 2017: 83.9; 2018: 76.2; 2019: 71.2; 2020: 65.0; 2021: 60.2; 2022: 55.8; 2023: 51.3
  - Debt-stabilizing non-interest current account: -1.4
  - Change in external debt (selected): 2013: -9.6; 2014: -15.0; 2015: -0.9; 2016: -15.4; 2017: -6.4; 2018: -7.7; 2019: -5.0; 2020: -6.2; 2021: -4.8; 2022: -4.4; 2023: -4.5
  - Identified external debt-creating flows (4+8+9): 2013: -12.2; 2014: -8.3; 2015: 9.7; 2016: -13.1; 2017: -15.3; 2018: -7.0; 2019: -5.8; 2020: -4.3; 2021: -3.5; 2022: -2.9; 2023: -2.6
  - Current account deficit, excluding interest payments: 2013: -8.2; 2014: -5.3; 2015: -6.7; 2016: -8.4; 2017: -5.1; 2018: -5.0; 2019: -4.5; 2020: -4.0; 2021: -3.3; 2022: -3.1; 2023: -2.6
  - Exports (percent of GDP): 2013: 85.7; 2014: 87.7; 2015: 90.3; 2016: 87.6; 2017: 85.1; 2018: 94.0; 2019: 95.7; 2020: 97.8; 2021: 100.0; 2022: 101.2; 2023: 102.0
  - Imports (percent of GDP): 2013: 78.7; 2014: 81.4; 2015: 81.4; 2016: 77.8; 2017: 77.9; 2018: 87.4; 2019: 89.0; 2020: 91.1; 2021: 94.0; 2022: 96.2; 2023: 97.3
  - Net non-debt creating capital inflows (negative): 2013: -1.1; 2014: -2.5; 2015: -1.8; 2016: -2.0; 2017: -1.2; 2018: -1.5; 2019: -1.3; 2020: -0.7; 2021: -0.6; 2022: -0.4; 2023: -0.4
  - Automatic debt dynamics (selected): 2013: -2.9; 2014: -0.5; 2015: 18.2; 2016: -2.7; 2017: -9.0; 2018: -0.4; 2019: 0.1; 2020: 0.3; 2021: 0.4; 2022: 0.6; 2023: 0.4
  - Contribution from nominal interest rate (percent): 2013: 4.4; 2014: 3.7; 2015: 3.2; 2016: 2.5; 2017: 2.1; 2018: 2.8; 2019: 2.4; 2020: 2.1; 2021: 1.9; 2022: 1.8; 2023: 1.6
  - Contribution from real GDP growth (percent): 2013: -2.6; 2014: -5.0; 2015: -4.1; 2016: -2.2; 2017: -3.2; 2018: -3.2; 2019: -2.4; 2020: -1.7; 2021: -1.5; 2022: -1.3; 2023: -1.2
  - Residual, incl. change in gross foreign assets (2-3): 2013: 2.7; 2014: -6.7; 2015: -10.6; 2016: -2.3; 2017: 9.0; 2018: -0.7; 2019: 0.7; 2020: -1.9; 2021: -1.3; 2022: -1.4; 2023: -2.0
  - External debt-to-exports ratio (in percent): 2013: 141.9; 2014: 121.4; 2015: 117.0; 2016: 103.0; 2017: 98.5; 2018: 81.0; 2019: 74.3; 2020: 66.4; 2021: 60.2; 2022: 55.2; 2023: 50.3
  - Gross external financing need (in billions of US dollars) 4/: 2013: 36.5; 2014: 35.5; 2015: 23.1; 2016: 17.0; 2017: 14.1; 2018: 11.4; 2019: 9.1; 2020: 11.1; 2021: 10.9; 2022: 8.9; 2023: 12.6
  - Gross external financing need (in percent of GDP): 2013: 27.0; 2014: 25.3; 2015: 18.8; 2016: 13.2; 2017: 9.6; 2018: 10-Year (table includes mixed text)
- Key macroeconomic assumptions underlying baseline (selected series and averages):
  - Real GDP growth (percent): historical average and projections appear across rows (e.g., 2.1; 4.2; 3.4; 2.2; 4.0; 1.1; 3.2; 4.0; 3.3; 2.6; 2.4; 2.2; 2.2)
  - GDP deflator in US dollars (change in percent): various values including 3.7; -0.5; -15.2; 2.9; 9.7; -0.1; 8.9; 1.9; 3.0; 3.6; 2.9; 3.2; 2.8
  - Nominal external interest rate (percent): 3.5; 3.2; 2.6; 2.5; 2.7; 3.5; 0.9; 3.5; 3.4; 3.1; 3.0; 3.2; 3.0
  - Growth of exports (US dollar terms, percent): 4.8; 6.2; -9.8; 2.0; 10.9; 2.4; 12.7; 17.1; 8.3; 8.6; 7.7; 6.7; 5.8
  - Growth of imports (US dollar terms, percent): 4.4; 7.1; -12.3; 0.5; 1; 4.2; 1.8; 14.2; 18.9; 8.3; 8.8; 8.8; 7.9; 6.2
  - Current account balance, excluding interest payments (percent): 8.2; 5.3; 6.7; 8.4; 5.1; 5.5; 2.9; 5.0; 4.5; 4.0; 3.3; 3.1; 2.6
  - Net non-debt creating capital inflows (percent): 1.1; 2.5; 1.8; 2.0; 1.2; 1.6; 0.7; 1.5; 1.3; 0.7; 0.6; 0.4; 0.4

- Bound tests and scenario details (figures):
  - Interest rate shock, current account shock, combined shock, real depreciation shock (one-time real depreciation of 30 percent occurs in 2019) and growth shock scenarios are presented with baseline and historical comparisons.
  - Sample values in boxes represent average projections and ten-year historical averages for the respective variables.

### Fund relations, safeguards, and statistical issues (selected items)
- Fund relations (as of June 30, 2018):
  - Membership Status: Joined on May 6, 1982; Article VIII.
  - Quota: SDR Million 1940.00; Percent Quota 100.00
  - Fund holdings of currency (Holdings Rate): 1640.76; 84.58
  - Reserve tranche position: 299.24; 15.42
  - SDR Department net cumulative allocation: 991.05; Percent Allocation 100.00
  - SDR holdings: 5.66; 0.58
  - Outstanding Purchases and Loans: None
  - Latest Financial Arrangements (selected):
    - Stand-By Nov 6, 2008 – Oct 5, 2010: Amount Approved (SDR Million) 10,537.50; Amount Drawn (SDR Million) 7,637.00
    - Stand-By Mar 15, 1996 – Feb 14, 1998: 264.18; 0.00
    - Stand-By Sep 15, 1993 – Dec 14, 1994: 340.00; 56.70
  - Projected Payments to Fund (SDR million; based on existing use of resources and present holdings of SDRs): Principal and Charges/Interest rows list annual numbers including 2018–2022 Principal blank and Charges/Interest entries: 4.80; 9.67; 9.68; 9.67; 9.67; Total rows matching those numbers
  - Safeguards assessment: MNB safeguards assessment finalized on January 28, 2009; assessment found relatively strong safeguards framework; recommended measures to improve program data reporting and strengthen audit oversight; caution to avoid undue changes to MNB legal framework going forward
  - Exchange rate arrangements: de jure free floating; de facto floating, effective November 1, 2008; Hungary has accepted the obligations of Article VIII
  - Article IV Consultation: Hungary on 12-month consultation cycle; last Article IV Board discussion took place on May 12, 2017
- Technical Assistance (FY2010–2016 and 2018 examples; department and purpose listed with dates):
  - Examples: MCM Banking Supervision June 2009; LEG Bank Resolution Framework September 2009; FAD Expenditure Policy October 2009; MCM Monetary Policy February 2010; FAD PIT and CIT Micro-Simulation January 2018; FAD VAT Gap Analysis February 2018
  - Resident representative office closed on December 31, 2013
- Statistical issues — Assessment of Data Adequacy for Surveillance:
  - General: Data provision is adequate for surveillance.
  - Government Finance Statistics: Authorities compile and disseminate comprehensive general government annual and quarterly accrual-based data according to the ESA 2010 methodology; data bridged into GFSM 2014 framework and provided to Fund through Eurostat for the IFS and GFS yearbooks.
  - Improvements needed: automatic provision of data on revenue and expenditure arrears; local government revenues and expenditures; financial statements of state-owned enterprises to facilitate accrual-basis monitoring.
  - Data Standards and Quality:
    - Subscriber to SDDS since May, 1996.
    - Hungary published original ROSC Data Module in 2001; updates available; latest update referenced: Hungary: Report on the Observance of Standards and Codes—Data Module, 2004 Update (July 2004).

*Source: IMF staff.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18252.pdf_