## 1. Fiscal Indicators

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---

### Recent developments: growing imbalances
- Sequence of shocks beginning in 2021:H2 widened imbalances: rising commodity prices, supply-chain disruptions, and Russia’s war in Ukraine increased inflation and the current account deficit.
- Hungary implements EU-level sanctions on Russia; other spillovers (financial exposures and refugees) were less important.
- Large pre-election stimulus in early 2022 included:
  - income-tax refunds;
  - six-month bonuses to armed forces;
  - an additional month of pension benefits;
  - a 20 percent minimum-wage increase;
  - caps on the price of motor fuels, some food products, and mortgage rates for some borrowers.
- Corrective fiscal measures to meet deficit targets included temporary profit taxes on financial and energy sectors, sectoral levies and indirect taxes, untargeted operational spending cuts, and postponement of investment projects.
- A one-off purchase of natural gas reserves raised the 2022 deficit target to 6.1 percent of GDP; in early January 2023 the government relaxed its 2023 target to 3.9 percent of GDP, primarily because of higher energy subsidy costs.
- Contentions with the EU delayed conditional agreements on EU funds until December 2022, worsening risk perceptions and contributing to market pressure on borrowing costs and the exchange rate.
- Borrowing costs rose and the exchange rate depreciated more than peers in 2022.

### Real activity and labor market
- GDP growth dynamics:
  - GDP growth decelerated from nearly 8 percent y/y in 2022:Q1 to about 4 percent in 2022:Q3.
  - Real private consumption: nearly 13 percent y/y in Q1, slowed to 5.4 percent y/y in Q3.
  - Investment decelerated from 10.6 percent to 4.2 percent.
  - Inventories: large build-up in 2021 and 2022:Q1; contribution to GDP growth turned negative in Q2 and Q3 y/y.
  - Quarterly GDP contracted in Q3 primarily due to a nearly 40 percent decline in agriculture production from a severe drought; manufacturing and services kept growing.
- Labor market:
  - Unemployment and labor force participation near historical low and high, respectively.
  - Working-age population is declining due to aging and emigration.
  - Private- and public-sector wages each grew around 16 percent y/y in 2022:Q3.

### Price and interest rate caps (highlights)
- Household utility price (2014-): household gas and electricity fixed at around 24 and 75 euros per MWh; cap increased in August 2022 for consumption above national average; cost borne by utility companies and government.
- Motor fuels price (Nov. 15, 2021 to Dec. 6, 2022): capped at HUF 480 per liter (EUR 1.3 euros at 11/15/21 exchange rate); coverage narrowed to residents in July 2022; cost borne by wholesalers.
- Food price cap (Feb. 2022 to Apr. 30, 2023): prices of specified staples capped at their 10/15/21 levels; expanded in Nov. 2022; cost borne by retailers.
- Mortgage interest cap (Jan. 2022 to mid-2023): capped at Oct. 27, 2021 levels until June 30, 2023 for certain mortgages; analysts estimate capped mortgages amount to about 2.3 percent of GDP or 22.7 percent of own funds (total bank lending for housing purchases was 8.1 percent of GDP at end-August 2022); cost borne by banks.
- SME interest cap (Nov. 15, 2022 to Jun. 30, 2023): estimated cost to banks about 0.1 percent of GDP.
- Large deposits interest cap (Nov. 21, 2022 to Mar. 31, 2023): applies to depositors with at least HUF 20mn; objective to divert funds toward government securities; cost borne by large depositors (foregone interest).
- Student loan interest (Jan. 2023-): interest stays at 4.99 percent as of January 2023 for 100,000 borrowers rather than increasing to 10 percent; other student loans interest free; cost borne by state-owned student loan provider.

### External balance and reserves
- External position assessment: 2022 assessed as substantially weaker than implied by fundamentals and desirable policies.
- Current account:
  - Declined rapidly mid-2021, reaching -7.3 percent of rolling GDP by 2022:Q3.
  - Expected to decrease to about 5 percent of GDP in 2023 (baseline).
- Financing and reserves:
  - Continued strong FDI net inflows, EU funds, and FX bond issuances financed most of the current account deficit and supported reserves, which remain above the Fund’s metric adequacy threshold.
  - Gross external debt-to-GDP broadly stable at around 85 percent of rolling GDP through 2022:Q3.
- Exchange rate movements:
  - Exchange rate depreciated in 2022 by as much as 17 percent through October, and around 9 percent by year-end after MNB actions in mid-October and conditional EU agreements in mid-December.

### Trade balance and terms of trade
- Trade balance swung to deficit with declining volume balance and deteriorating terms of trade (ToT).
- ToT deterioration almost entirely led by energy prices.
- Energy and food volume balances held steady; other balances deteriorated.
- Imports grew strongly while exports mostly lagged.

### Inflation and monetary policy
- Inflation developments:
  - Headline CPI surged from 2.7 percent in early 2021 to 24.5 percent in December 2022 (y/y), led by food and energy prices, notably after the relaxation of the utility price cap in August and lifting of the motor fuels price cap in December.
  - Core inflation reached 24.8 percent.
  - Producer-price inflation: 63.7 percent in November (domestic PPI).
- Central bank (MNB) response:
  - MNB started raising rates mid-2021 and phased out unconventional measures.
  - One-week deposit rate increased cumulatively by 12.4 percentage points to 13.0 percent.
  - In September 2022, MNB announced stopping rate increases but continuing tightening via liquidity drainage: increase in minimum reserve requirement from 1 to 5 percent, central bank bills, and a new long-term deposit instrument.
  - Following rapid depreciation, in mid-October the MNB raised the upper limit of its interest rate corridor from 15.5 percent to 25 percent, introduced daily overnight deposit tenders at 18 percent, accelerated liquidity mopping up, and committed to meeting major foreign currency liquidity needs for energy imports through end-2022 (later extended into early 2023). The forint appreciated by over 4 percent during the following week.
- Inflation expectations and real rates:
  - Inflation expectations have been rising.
  - Real short-term rates recently reached positive territory when deflated by 1 year-ahead inflation expectations.
- Hungary’s HICP core inflation is the highest in the EU.

### Financial sector and housing market
- Banking system metrics:
  - Average return on assets of 1.2 in 2021.
  - Average capital-adequacy ratio of 17.6 percent in 2022:Q3.
- Loan moratoria and credit:
  - Moratorium extended to end-2022 (changed to opt in); covered about 1 percent of corporate loans and 3 percent of households’ as of August 2022.
  - Agricultural loan moratorium introduced Sep. 2022, effective till end-2023, covers about 25 percent of eligible loans, amounting to about 1.3 percent of bank loans to the private sector.
  - Credit growth to corporates increased in 2022; lending to households decelerated as mortgage demand cooled.
  - Net interest margins grew as deposit rates stayed low while lending rates rose until interest rate caps introduction.
- Banking events:
  - Sberbank-Hungary was promptly closed early in the war; insured deposits paid out.
- Housing market:
  - Nominal house price inflation remains rapid, but less so when deflated by construction prices.
  - Credit transaction growth began to moderate led by cooling household demand, including mortgages.

### Outlook, scenarios, and risks
- Baseline projection (under authorities’ current policy plans discussed):
  - Growth slows from close to 5 percent in 2022 to about ½ percent in 2023 as policy tightens, external demand weakens, and uncertainty weighs on investment.
  - Headline and core inflation expected to peak in early 2023 after a pick-up from expiring price caps, then slow as commodity prices retreat, demand cools, and the output gap turns negative.
  - Current account deficit expected to decrease to about 5 percent of GDP in 2023.
- Medium-term:
  - Gradual recovery expected: demand recovers, policy tightening lessens, output gap gradually closes from below.
  - Inflation may only return within the tolerance band by end-2025.
  - EU funds under the RRF and MFF 2021-27 expected to start flowing in 2023:Q2 assuming related conditions are met in Q1, supporting recovery in potential output.
  - Continued FDI inflows and EU funds expected as main external financing sources.
- Downside risks:
  - Untimely or incomplete delivery of expected EU funds would increase risk premia, intensify exchange rate pressures, increase inflation, and lower output as investment drops.
  - A full shut-off of Russian gas to Europe would increase energy prices and likely cause physical gas shortages for the 2023-24 winter, driving higher inflation and output losses.
  - Other risks: further commodity price shocks from the war in Ukraine or supply disruptions, a cold winter, firm closures from high energy costs, faster-than-expected tightening in global financial conditions, disappointing global demand, and entrenched inflation.
  - Worse-case scenario: disorderly market conditions, capital outflows.
  - Upside possibility: faster-than-expected drop in commodity prices reducing inflation and the external deficit faster.

### Authorities’ views
- Authorities broadly shared staff’s views on the outlook and risks; they believe a recession can be avoided in 2023.
- They expect the slowdown in 2022:H2 to continue into 2023 as external and domestic demand weaken, despite a tight labor market.
- The MNB expects inflation to moderate in 2023 and reach its target tolerance band by 2024 as demand cools and food and energy prices retreat, supporting an improvement in the current account deficit.
- Authorities emphasized confidence in expected delivery in 2023 of EU funds from the RRF and MFF, recognized high uncertainty, and agreed on the need for careful and persistent monitoring.

### Selected indicators and near-term outlook (key figures 2018–24)
- Real GDP (percentage change): 5.4 (2018), 4.9 (2019), -4.5 (2020), 7.1 (2021), 4.9 (2022), 0.5 (2023), 3.2 (2024).
- CPI inflation (average): 2.8 (2018), 3.4 (2019), 3.3 (2020), 5.1 (2021), 14.5 (2022), 17.7 (2023), 5.4 (2024).
- CPI inflation (end year): 2.7 (2018), 4.0 (2019), 2.7 (2020), 7.4 (2021), 24.5 (2022), 6.8 (2023), 5.2 (2024).
- Unemployment rate (average, ages 15-64): 3.6 (2018), 3.3 (2019), 4.1 (2020), 4.1 (2021), 3.6 (2022), 4.1 (2023), 3.8 (2024).
- General government overall balance (percent of GDP): -2.1 (2018), -2.0 (2019), -7.5 (2020), -7.1 (2021), -6.1 (2022), -3.9 (2023), -2.5 (2024).
- Public debt (percent of GDP): 69.1 (2018), 65.3 (2019), 79.3 (2020), 76.8 (2021), 76.4 (2022), 73.2 (2023), 70.0 (2024).
- Current account (percent of GDP): 0.2 (2018), -0.8 (2019), -1.1 (2020), -4.2 (2021), -8.1 (2022), -4.6 (2023), -1.9 (2024).
- Reserves (billions of Euros): 27.4 (2018), 28.4 (2019), 33.7 (2020), 38.4 (2021), 38.7 (2022), 42.0 (2023), 44.3 (2024).
- Gross external debt (percent of GDP): 79.3 (2018), 73.0 (2019), 80.9 (2020), 84.6 (2021), 85.4 (2022), 77.2 (2023), 69.8 (2024).

### Debt sustainability and stress tests (selected)
- Baseline debt trajectory and financing needs:
  - Public debt-to-GDP ratio forecast to decline from 76.8 percent in 2021 to about 64 percent by 2027 in baseline.
  - Under the baseline, the primary balance will cumulatively contribute to increasing the debt-to-GDP ratio by 2.3 percentage points between 2022 and 2027.
  - The interest rate-growth differential is projected to contribute to a reduction in debt by about 15.5 percentage points over the same period.
  - Gross financing needs are forecast to drop from 21.1 percent of GDP in 2021 to 11.7 percent of GDP in 2027.
- DSA stress-test scenario highlights:
  - Growth shock: a decline in growth by one standard deviation for 2 consecutive years would push the economy into a 2-year recession; debt would reach 82.1 percent of GDP in 2024 and then decline to 76.4 percent of GDP in 2027.
  - Macro-fiscal shock: simultaneous shocks to growth, interest rate, and primary balance would increase the debt-to-GDP ratio to 85.0 percent by 2024, falling to 84.4 percent at the end of the forecast horizon.
  - Contingent liabilities shock: contingent liabilities equivalent to 10 percent of financial sector assets in 2023 would push debt and financing needs higher (text truncated in source).
- Alternative scenario summary:
  - Baseline projection: public debt reaches 81.9 percent in 2027 and financing needs would reach 17 percent of GDP.
  - No fiscal adjustment beyond 2022 scenario: public debt would reach 84 percent of GDP in five years and gross financing needs about 18.5 percent of GDP.

### External position assessment and REER estimates
- Staff conclusion: external position in 2022 is assessed as substantially weaker than warranted by fundamentals and desirable policies.
- Key figures (Table II.1):
  - CA balance -8.1
  - Cyclically-adjusted CA -6.9
  - Model CA norm (percent of GDP) -1.8
  - CA-stabilizing NFA at 2022 level -2.6
  - Model residuals: -4.8, -29.0, -3.4
  - Model CA gap: -5.1, -4.3
  - Semi-elasticity of CA/GDP to REER 0.64
  - Exchange-rate gap (percent): 8.0, -32.3, -5.6, 6.7

### Risk Assessment Matrix — major risks and policy responses (selected)
- Intensifying spillovers from Russia’s war in Ukraine — Likelihood: H; Impact: High.
  - Response: Fiscal policy should remain tight while making room for support to the vulnerable; Central bank should stand ready to smooth excess exchange rate volatility and tighten further.
- Commodity price shocks — Likelihood: H; Impact: High.
  - Response: Fiscal policy tight with room for support; monetary tightening as needed.
- Abrupt global slowdown or recession (including gas shutoff scenarios) — Likelihood: H; Impact: High.
  - Response: Pace of fiscal tightening could slow if inflation pressures do not increase; encourage price-induced demand reduction; implement contingency plans; extend targeted support to industry.
- Deepening geo-economic fragmentation — Likelihood: H; Impact: High.
  - Response: Prioritize structural reforms and investments to support potential output and productivity.

### Policy recommendations (from "Heightened imbalances..." chapter)
- Overall:
  - Implement a tighter and consistent fiscal–monetary mix to restore fiscal and external buffers, provide relief from the cost-of-living crisis, and remain flexible to changing circumstances.
  - Remove administrative price and interest rate regulations that undermine policy coherence.
- Fiscal policy:
  - Authorities plan large fiscal adjustment: reduce deficit from a targeted 6.1 percent of GDP in 2022 to 3.9 percent of GDP in 2023 and 2.5 percent in 2024.
  - Staff expects improvements in 2023 of 3.3 and 2.3 percentage points in the primary cyclically-adjusted and structural balances, respectively.
  - Revenue measures: cautious on discretionary windfall taxes; concern about ex-post windfall tax raised to 95 percent.
  - Expenditure measures: avoid reducing productivity-enhancing capital spending; prioritize efficiency gains in operational spending while preserving basic public services and human capital.
- Energy price caps and targeting:
  - Household energy utility price cap subsidies amounted to 0.7 percent of GDP in 2022.
  - Recommendation: relax the cap further; use targeted transfers through existing social safety nets or household lump-sum payments; as second-best, refine new block utility tariffs by lowering the subsidized threshold to basic consumption and increase tariff-setting frequency from quarterly to monthly.
  - Motor-fuel price cap: ended earlier than planned; caps increased demand and led to disruptive petrol station closures.
- Monetary and financial policies:
  - Monetary policy should remain data dependent.
  - Interest rate caps disconnect transmission channels and are untargeted and likely regressive; recommendation: abolish these caps.
  - Continue shift toward conventional liquidity-absorbing tools; avoid multiplicity of unconventional tools that blur guidance.
  - Exchange rate flexibility should be maintained; FX intervention limited to containing excess volatility.
  - Financial sector: continue vigilant monitoring, encourage timely provisioning; MNB increased the countercyclical capital buffer by 0.5 percentage points effective July 2023 for resident exposures.
- Structural reforms:
  - Prioritize energy security: foster demand adjustment, accelerate energy efficiency, pursue long-term energy transition investments.
  - Investment needs: total capital expenditures on such investments could exceed EUR 20 billion (13 percent of 2021 GDP).
  - Timely and complete delivery of expected EU funds critical to foster investment and avoid added pressure on risk premia.

### Box 1 — Hungary’s Recovery and Resilience Plan (RRF) — financing and priorities
- RRF: EUR 5.8bn in grants (3.8 percent of 2021 GDP) through 2026 and access to EUR 9.6bn (6.2 percent of 2021 GDP) in loans.
- Grants allocation highlights:
  - Green transition (48 percent of grant financing): sustainable transport EUR 1.4bn; renewable energy sources EUR 825mn; energy efficiency of buildings EUR 386mn.
  - Digital transition (30 percent): digital skills and equipment in education EUR 570mn; digitalization of healthcare EUR 488mn; safer and digital public transport EUR 212mn.
  - Economic and social resilience: modern healthcare EUR 1.3bn; quality education and social inclusion EUR 266mn; reforms in anti-corruption, judicial independence, pension sustainability, and tax efficiency.
- Conditionality:
  - Disbursement linked to meeting 27 super-milestones on rule of law, judicial independence, and anti-corruption.
  - Timely and effective implementation required to unlock EU funds and improve business environment and efficiency of public spending.

_Italic: Source — International Monetary Fund, Hungary: Recent Developments and Outlook (extracted from 1hunea2023001 - selected sections)._

### 1. Fiscal Indicators ________________________________________________________________________________ 5

### 1. Fiscal Indicators

### Recent developments: growing imbalances
- A succession of shocks widened economic imbalances beginning in 2021:H2: rising commodity prices, supply-chain disruptions, and Russia’s war in Ukraine increased inflation and the current account deficit.
- Hungary implements EU-level sanctions on Russia; other spillovers (financial exposures and refugees) were less important.
- Large pre-election stimulus in early 2022 included:
  - income-tax refunds;
  - six-month bonuses to armed forces;
  - an additional month of pension benefits;
  - a 20 percent minimum-wage increase;
  - caps on the price of motor fuels, some food products, and mortgage rates for some borrowers (see Table 1).
- Corrective fiscal measures introduced to meet deficit targets included temporary profit taxes on financial and energy sectors, sectoral levies and indirect taxes, untargeted operational spending cuts, and postponement of investment projects.
- A one-off purchase of natural gas reserves raised the 2022 deficit target to 6.1 percent of GDP; in early January 2023 the government relaxed its 2023 target to 3.9 percent of GDP, primarily because of higher energy subsidy costs.
- Contentions with the EU (rule of law, human rights, sanctions, minimum corporate taxation) delayed conditional agreements on EU funds until December 2022, worsening risk perceptions and contributing to market pressure on borrowing costs and the exchange rate.
- Borrowing costs rose and the exchange rate depreciated more than peers in 2022.

### Real activity and labor market
- GDP growth dynamics:
  - GDP growth decelerated from nearly 8 percent y/y in 2022:Q1 to about 4 percent in 2022:Q3.
  - Real private consumption: nearly 13 percent y/y in Q1, slowed to 5.4 percent y/y in Q3.
  - Investment decelerated from 10.6 percent to 4.2 percent (no explicit period for 10.6 percent given in source beyond context).
  - Inventories: large build-up in 2021 and 2022:Q1; contribution to GDP growth turned negative in Q2 and Q3 y/y.
  - Quarterly GDP contracted in Q3 primarily due to a nearly 40 percent decline in agriculture production from a severe drought; manufacturing and services kept growing.
- Labor market:
  - Unemployment and labor force participation near historical low and high, respectively.
  - Working-age population is declining due to aging and emigration.
  - Private- and public-sector wages each grew around 16 percent y/y in 2022:Q3.

### Price and interest rate caps (Table 1 highlights)
- Household utility price (2014-): household gas and electricity fixed at around 24 and 75 euros per MWh; cap increased in August 2022 for consumption above national average; cost borne by utility companies and government.
- Motor fuels price (Nov. 15, 2021 to Dec. 6, 2022): capped at HUF 480 per liter (EUR 1.3 euros at 11/15/21 exchange rate); coverage narrowed to residents in July 2022; cost borne by wholesalers.
- Food price cap (Feb. 2022 to Apr. 30, 2023): prices of specified staples capped at their 10/15/21 levels; expanded in Nov. 2022; cost borne by retailers.
- Mortgage interest cap (Jan. 2022 to mid-2023): capped at Oct. 27, 2021 levels until June 30, 2023 for certain mortgages; analysts estimate capped mortgages amount to about 2.3 percent of GDP or 22.7 percent of own funds (total bank lending for housing purchases was 8.1 percent of GDP at end-August 2022); cost borne by banks.
- SME interest cap (Nov. 15, 2022 to Jun. 30, 2023): estimated cost to banks about 0.1 percent of GDP.
- Large deposits interest cap (Nov. 21, 2022 to Mar. 31, 2023): applies to depositors with at least HUF 20mn; objective to divert funds toward government securities; cost borne by large depositors (foregone interest).
- Student loan interest (Jan. 2023-): interest stays at 4.99 percent as of January 2023 for 100,000 borrowers rather than increasing to 10 percent; other student loans interest free; cost borne by state-owned student loan provider.

### External balance and reserves
- External position assessment: 2022 assessed as substantially weaker than implied by fundamentals and desirable policies (Annex II).
- Current account:
  - Declined rapidly mid-2021, reaching -7.3 percent of rolling GDP by 2022:Q3.
  - Expected to decrease to about 5 percent of GDP in 2023 (baseline).
- Financing and reserves:
  - Continued strong FDI net inflows, EU funds, and FX bond issuances financed most of the current account deficit and supported reserves, which remain above the Fund’s metric adequacy threshold.
  - Gross external debt-to-GDP broadly stable at around 85 percent of rolling GDP through 2022:Q3.
- Exchange rate movements:
  - Exchange rate depreciated in 2022 by as much as 17 percent through October, and around 9 percent by year-end after MNB actions in mid-October and conditional EU agreements in mid-December.

### Trade balance and terms of trade
- Trade balance swung to deficit with declining volume balance and deteriorating terms of trade (ToT).
- ToT deterioration almost entirely led by energy prices.
- Energy and food volume balances held steady; other balances deteriorated.
- Imports grew strongly while exports mostly lagged.

### Inflation and monetary policy
- Inflation developments:
  - Headline CPI surged from 2.7 percent in early 2021 to 24.5 percent in December 2022 (y/y), led by food and energy prices, notably after the relaxation of the utility price cap in August and lifting of the motor fuels price cap in December.
  - Core inflation reached 24.8 percent.
  - Producer-price inflation: 63.7 percent in November (domestic PPI).
- Central bank (MNB) response:
  - MNB started raising rates mid-2021 and phased out unconventional measures.
  - One-week deposit rate increased cumulatively by 12.4 percentage points to 13.0 percent.
  - In September 2022, MNB announced stopping rate increases but continuing tightening via liquidity drainage: increase in minimum reserve requirement from 1 to 5 percent, central bank bills, and a new long-term deposit instrument.
  - Following rapid depreciation, in mid-October the MNB raised the upper limit of its interest rate corridor from 15.5 percent to 25 percent, introduced daily overnight deposit tenders at 18 percent, accelerated liquidity mopping up, and committed to meeting major foreign currency liquidity needs for energy imports through end-2022 (later extended into early 2023). The forint appreciated by over 4 percent during the following week.
- Inflation expectations and real rates:
  - Inflation expectations have been rising.
  - Real short-term rates recently reached positive territory when deflated by 1 year-ahead inflation expectations.
- Hungary’s HICP core inflation is the highest in the EU.

### Financial sector and housing market
- Banking system metrics:
  - Average return on assets of 1.2 in 2021.
  - Average capital-adequacy ratio of 17.6 percent in 2022:Q3.
- Loan moratoria:
  - Moratorium extended to end-2022 (changed to opt in); covered about 1 percent of corporate loans and 3 percent of households’ as of August 2022.
  - Agricultural loan moratorium introduced Sep. 2022, effective till end-2023, covers about 25 percent of eligible loans, amounting to about 1.3 percent of bank loans to the private sector.
- Credit trends:
  - Credit growth to corporates increased in 2022 (working capital and investment demand, partly front-loaded).
  - Lending to households decelerated as mortgage demand cooled.
  - Net interest margins grew as deposit rates stayed low while lending rates rose until interest rate caps introduction.
- Banking events:
  - Sberbank-Hungary was promptly closed early in the war; insured deposits paid out.
- Housing market:
  - Nominal house price inflation remains rapid, but less so when deflated by construction prices.
  - Credit transaction growth began to moderate led by cooling household demand, including mortgages.

### Outlook, scenarios, and risks
- Baseline projection (under authorities’ current policy plans discussed):
  - Growth slows from close to 5 percent in 2022 to about ½ percent in 2023 as policy tightens, external demand weakens, and uncertainty weighs on investment.
  - Headline and core inflation expected to peak in early 2023 after a pick-up from expiring price caps, then slow as commodity prices retreat, demand cools, and the output gap turns negative.
  - Current account deficit expected to decrease to about 5 percent of GDP in 2023.
- Medium-term:
  - Gradual recovery expected: demand recovers, policy tightening lessens, output gap gradually closes from below.
  - Inflation may only return within the tolerance band by end-2025.
  - EU funds under the RRF and MFF 2021-27 expected to start flowing in 2023:Q2 assuming related conditions are met in Q1, supporting recovery in potential output.
  - Continued FDI inflows and EU funds expected as main external financing sources (including battery production and auto sector).
- Downside risks (Annex III):
  - Untimely or incomplete delivery of expected EU funds would increase risk premia, intensify exchange rate pressures, increase inflation, and lower output as investment drops.
  - A full shut-off of Russian gas to Europe would increase energy prices and likely cause physical gas shortages for the 2023-24 winter, driving higher inflation and output losses (Box 2).
  - Other risks: further commodity price shocks from the war in Ukraine or supply disruptions, a cold winter, firm closures from high energy costs, faster-than-expected tightening in global financial conditions, disappointing global demand, and entrenched inflation.
  - A worse-case scenario: disorderly market conditions, capital outflows.
  - An upside possibility: faster-than-expected drop in commodity prices reducing inflation and the external deficit faster.

### Authorities’ views
- Authorities broadly shared staff’s views on the outlook and risks; they believe a recession can be avoided in 2023.
- They expect the slowdown in 2022:H2 to continue into 2023 as external and domestic demand weaken, despite a tight labor market.
- The MNB expects inflation to moderate in 2023 and reach its target tolerance band by 2024 as demand cools and food and energy prices retreat, supporting an improvement in the current account deficit.
- Authorities emphasized confidence in expected delivery in 2023 of EU funds from the RRF and MFF, recognized high uncertainty, and agreed on the need for careful and persistent monitoring.

*International Monetary Fund — Hungary: Recent Developments and Outlook (extracted from 1hunea2023001 - 1. Fiscal Indicators).*

### 15.      Heightened imbalances, significant risks, and major uncertainty require a tighter and

### 15.      Heightened imbalances, significant risks, and major uncertainty require a tighter and consistent policy mix

### Overview
- Policies should implement a tighter and consistent fiscal–monetary mix to restore fiscal and external buffers, provide relief from the cost-of-living crisis, and remain flexible to changing circumstances.
- Under the baseline, planned fiscal adjustment complements tight monetary policy; administrative price and interest rate regulations undermine policy coherence and need removal.
- Scenario guidance:
  - Further supply-side shocks: monetary policy should tighten faster; fiscal policy remain tight while making room for additional support to the vulnerable.
  - Disorderly market conditions: require an even tighter policy mix.
  - Demand shock lowering growth and inflation: call for somewhat looser policies, including a slower pace of fiscal adjustment, provided market confidence is maintained.
- Longer-term structural issues (energy security, governance) affect short-term pressures.

### A. Fiscal Policy: Consolidating While Protecting the Vulnerable
Findings and targets
- Government plans large fiscal adjustment for 2023: reduce deficit from a targeted 6.1 percent of GDP in 2022 to 3.9 percent of GDP in 2023 and 2.5 percent in 2024.
- Staff expects improvements in 2023 of 3.3 and 2.3 percentage points in the primary cyclically-adjusted and structural balances, respectively.
- Public debt: 76 percent of GDP in 2022:Q3; remains elevated but sustainable under most plausible shock scenarios.

Composition and recommendations
- Revenue measures:
  - Discretionary windfall taxes are easy to implement but can impede growth-friendly resource allocation.
  - Hungary’s exemption from the EU oil embargo produced a windfall for state-owned MOL; recent ex-post windfall tax was raised to 95 percent — staff cautioned this risks discouraging investment.
  - Ex-post tax on banking sector profits may be misattributed to exogenous windfalls; newly extended financial transaction tax is distortive and may incentivize informality.
- Expenditure measures:
  - Caution against reducing productivity-enhancing capital spending; prioritize projects to delay.
  - With one of the highest goods and services expenditure shares in the EU, scope likely exists to reduce operational spending through efficiency gains while preserving basic public services and human capital (e.g., health, education).

Energy price caps and targeting
- Household energy utility price cap:
  - Subsidies to state-owned utility companies for the cap amounted to 0.7 percent of GDP in 2022.
  - The cap is regressive, prevents demand adjustment, and undermines climate objectives.
  - Recent reform: market-based, quarterly-adjusted rate for consumption above average is welcome but insufficient.
  - Recommendation: relax the cap further; use targeted transfers through existing social safety nets or household lump-sum payments; as second-best, refine new block utility tariffs by lowering the subsidized threshold to basic consumption and increase tariff-setting frequency from quarterly to monthly.
- Motor-fuel price cap:
  - Ended slightly earlier than planned after triggering supply shortages; cap increased demand and led to disruptive petrol station closures.
  - Caps contributed to increasing demand, worsening the current account, and weighing on the budget via reduced profit taxes and dividends from oil state-owned enterprises.

EU funds and investment
- Timely and complete delivery of expected EU funds is critical to foster investment and avoid added pressure on risk premia and financing costs.
- Text Table 1 (status of planned EU transfers) — key figures as of 2022:
  - MFF 2021-27: Total planned allocation 35.0 EUR bn (22.7 % 2021GDP); o/w cohesion funds 22.0 EUR bn (14.3 % 2021GDP); Subject to conditions 21.7 EUR bn (14.1 % 2021GDP); Suspended 6.3 EUR bn (4.1 % 2021GDP).
  - RRF: Total planned allocation 5.8 EUR bn (3.8 % 2021GDP); Subject to conditions 5.8 EUR bn (3.8 % 2021GDP).
  - MFF 2014-20: Total planned allocation 5.4 EUR bn (3.5 % 2021GDP); Available through 2023.
- Under a downside scenario of persistent delays and heightened uncertainty, exchange rate and financing-cost pressures could intensify; budget may need to adjust if funds are not delivered in full or timely.

Authorities’ fiscal stance view
- Authorities agree on need for a tight fiscal stance consistent with monetary policy and stress coordination between the MNB and Ministry of Finance.
- Government noted 2022 fiscal stance is overall tighter than 2021 and emphasized the one-off nature of some measures; confident EU funds will eventually be delivered.

### B. Monetary and Financial Policies: Reducing Inflation and Preserving Financial Stability
Monetary tightening and inflation outlook
- Monetary policy tightening since mid-2021:
  - MNB started raising rates in June 2021 from a low base of 0.6 percent.
  - Overnight one-day deposit tender became de facto policy rate; at 18 percent it represented significant tightening, particularly in 2022.
- Inflation projections and persistence:
  - Under the baseline, inflation expected to decrease to about 7 percent y/y by the end of 2023, but remain above the MNB’s target until end-2025.
  - Core inflation expected to decrease as domestic demand decelerates but likely remain somewhat higher than headline inflation until 2024:H2.
  - Food price caps (recently extended) have added to food price inflation by diverting increases to uncapped foods.
- Policy guidance:
  - Monetary policy should remain data dependent (monthly core inflation dynamics, expectations, credit evolution).
  - Potential costs of under-tightening (entrenched high inflation and higher eventual control costs) outweigh risks of over-tightening.

Interest rate caps and transmission
- Interest rate caps (mortgage, SMEs, student loans, large deposits) disconnect key monetary transmission channels, hampering effectiveness of tightening and are untargeted and likely regressive (especially mortgage caps); recommendation: abolish these caps.
- MNB’s shift toward conventional liquidity-absorbing tools is welcome; multiplicity of unconventional tools risks blurring guidance and credibility.

Exchange rate policy
- Continued exchange rate flexibility is needed as a shock absorber; FX intervention should be limited to containing excess volatility and not prevent needed adjustment.
- MNB’s temporary measure to provide foreign exchange directly to energy importers should not be extended.

Financial sector resilience
- Banking sector:
  - Aggregate buffers comfortable but unevenly distributed.
  - Credit risks expected to rise as growth slows; energy-intensive industries face high costs; rising construction costs and interest rates test real estate market imbalances.
  - Mortgage demand recently slowed; nominal house price growth remains elevated.
  - Bank profitability may be pressured if higher net-interest margins do not offset windfall and indirect taxes and interest-rate caps.
  - Bank holdings of tradeable fixed-income securities face valuation losses from rising interest rates.
  - Bank exposures to Ukraine and Russia appear manageable, including for OTP.
  - MNB increased the countercyclical capital buffer by 0.5 percentage points effective July 2023 for resident exposures.
- Non-bank sector:
  - Insurance companies' assets amounted to about 6 percent of GDP at end-2021, compared to 113 percent of GDP for the banking system; they are also affected by higher interest rates and should be closely monitored.
- Supervisory recommendation: continue vigilant monitoring, encourage timely provisioning.

AML/CFT
- Progress noted per May 2022 MONEYVAL report in correspondent banking relationships, internal controls, and transparency and beneficial ownership.
- Remaining technical deficiencies: non-profit organizations, virtual asset providers, cash couriers, and effective implementation of requirements.

Authorities’ monetary policy view
- MNB committed to maintaining a tight stance to achieve price stability; views high inflation and large current account deficit as main inter-related challenges.
- MNB expects overall inflation to peak in early 2023 and recede thereafter; sees inflation reaching the tolerance band in 2024 (earlier than staff).
- MNB considers base rate high enough to drive inflation toward target and views overnight deposit tender as ensuring market stability.

### C. Structural Reforms: Achieving Energy Security, Driving Convergence
Energy security and investment needs
- Hungary has taken emergency measures: filling gas storages to a high level, expanding domestic production, and contracting additional imports from Gazprom; granted exception from EU oil embargo.
- Risk: an extended interruption in Russian gas supply would likely result in shortages for the 2023-24 winter given Hungary’s high dependence on Russian gas and limited alternative options.
- Policy priorities: foster demand adjustment, accelerate energy efficiency improvements, and pursue long-term energy transition investments.
- Government long-term strategy: expand nuclear power generation, enhance electricity grid, develop storage capacities, and reduce gas share of energy consumption.
- Demand shifts: households moving from gas to electricity-powered heating and growth in energy-intensive battery industry will raise electricity demand.
- Investment scale and financing:
  - Total capital expenditures on such investments could exceed EUR 20 billion (13 percent of 2021 GDP).
  - Financing these plans is critical and exceeds amounts available through EU funds.

Structural governance and EU funds
- The approved RRP finances priorities in line with Next Generation EU objectives (energy transition, digitalization, governance).
- Meeting initial super-milestones on governance in 2023:Q1 required to allow disbursements to begin.

*Source: IMF staff assessment in the chapter titled "15.      Heightened imbalances, significant risks, and major uncertainty require a tighter and consistent policy mix."*

### Box 1. Hungary’s    Recovery and Resilience Plan

### Box 1. Hungary’s Recovery and Resilience Plan

### Overview and financing
- The RRF provides for EUR 5.8bn in grants (3.8 percent of 2021 GDP) through 2026 and access to EUR 9.6bn (6.2 percent of 2021 GDP) in loans to support reforms and investments to facilitate economic recovery from the COVID-19 crisis and promote the green and digital transition.
- Hungary can begin to request disbursements after 27 super-milestones on the rule of law, judicial independence, and anti-corruption are met.
- The government is considering tapping into the RRF loans, particularly for energy investments.

### Grant allocation and priorities
- Grants aim to support the green transition (48 percent of grant financing), including:
  - sustainable transport: EUR 1.4bn
  - renewable energy sources: EUR 825mn
  - energy efficiency of buildings: EUR 386mn
- Grants aim to foster the digital transition (30 percent of grant financing), including:
  - digital skills and digital equipment in education: EUR 570mn
  - digitalization of the healthcare sector: EUR 488mn
  - safer and digital public transport: EUR 212mn
- Grants aim to reinforce economic and social resilience, including:
  - investments in modern healthcare: EUR 1.3bn
  - quality education and social inclusion: EUR 266mn
  - reforms in anti-corruption, strengthening of judicial independence, and quality of public finances such as in the sustainability of the pension system and efficiency of the tax system

### Conditionality and governance links
- Disbursement of RRF grants (and access to cohesion funds) is linked to meeting 27 super-milestones focused on rule of law, judicial independence, and anti-corruption.
- Governance reforms noted in the broader text include establishing an independent integrity authority for public procurements, an anti-corruption task force, commitments to amend public procurement and criminal legal frameworks, adopting a national anti-corruption strategy, and extending the scope of the asset declaration system.
- Timely and effective implementation of remedial measures is required both to unlock EU funds and to improve the business environment and efficiency of public spending.

*Source: Box 1. Hungary’s Recovery and Resilience Plan (from the provided IMF content).*

### 43.      It is recommended that the next Article IV consultation be held on the standard 12-

### 1hunea2023001 - 43. It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

### Recommendation
- It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

### Selected economic indicators and near-term outlook (2018–24, key figures)
- Real GDP (percentage change): 5.4 (2018), 4.9 (2019), -4.5 (2020), 7.1 (2021), 4.9 (2022), 0.5 (2023), 3.2 (2024).
- CPI inflation (average): 2.8 (2018), 3.4 (2019), 3.3 (2020), 5.1 (2021), 14.5 (2022), 17.7 (2023), 5.4 (2024).
- CPI inflation (end year): 2.7 (2018), 4.0 (2019), 2.7 (2020), 7.4 (2021), 24.5 (2022), 6.8 (2023), 5.2 (2024).
- Unemployment rate (average, ages 15-64): 3.6 (2018), 3.3 (2019), 4.1 (2020), 4.1 (2021), 3.6 (2022), 4.1 (2023), 3.8 (2024).
- Gross fixed capital formation (percent of GDP): 24.7 (2018), 27.0 (2019), 26.5 (2020), 27.2 (2021), 31.0 (2022), 30.7 (2023), 29.7 (2024).
- Gross national saving (percent of GDP, from BOP): 24.9 (2018), 26.2 (2019), 25.4 (2020), 23.0 (2021), 22.8 (2022), 26.0 (2023), 27.8 (2024).
- General government overall balance (percent of GDP): -2.1 (2018), -2.0 (2019), -7.5 (2020), -7.1 (2021), -6.1 (2022), -3.9 (2023), -2.5 (2024).
- Primary balance (percent of GDP): 0.2 (2018), 0.1 (2019), -5.3 (2020), -5.0 (2021), -3.7 (2022), -0.8 (2023), 0.6 (2024).
- Public debt (percent of GDP): 69.1 (2018), 65.3 (2019), 79.3 (2020), 76.8 (2021), 76.4 (2022), 73.2 (2023), 70.0 (2024).
- Current account (percent of GDP): 0.2 (2018), -0.8 (2019), -1.1 (2020), -4.2 (2021), -8.1 (2022), -4.6 (2023), -1.9 (2024).
- Reserves (billions of Euros): 27.4 (2018), 28.4 (2019), 33.7 (2020), 38.4 (2021), 38.7 (2022), 42.0 (2023), 44.3 (2024).
- Gross external debt (percent of GDP): 79.3 (2018), 73.0 (2019), 80.9 (2020), 84.6 (2021), 85.4 (2022), 77.2 (2023), 69.8 (2024).

### Medium-term scenario and projections (2018–28, selected series)
- Real GDP growth (proj.): 0.5 (2023), 3.2 (2024), 3.3 (2025), 3.4 (2026), 3.5 (2027), 3.5 (2028).
- Inflation (CPI; year average basis, proj.): 17.7 (2023), 5.4 (2024), 4.2 (2025), 3.6 (2026), 3.2 (2027), 3.1 (2028).
- General government overall balance (percent of GDP, proj.): -3.9 (2023), -2.5 (2024), -2.9 (2025), -2.2 (2026), -2.1 (2027), -1.1 (2028).
- General government debt (percent of GDP, proj.): 73.2 (2023), 70.0 (2024), 68.2 (2025), 66.1 (2026), 64.1 (2027), 61.3 (2028).
- Gross official reserves in percent of the IMF ARA metric (proj.): 119.8 (2023), 122.0 (2024), 128.3 (2025), 139.4 (2026), 136.7 (2027).

### Consolidated general government (2018–28, selected fiscal items)
- Revenue, total (percent of GDP): 44.0 (2018), 44.0 (2019), 43.5 (2020), 41.3 (2021), 43.9 (2022), 43.6 (2023), 44.4 (2024).
- Expenditure, total (percent of GDP): 46.2 (2018), 46.1 (2019), 51.1 (2020), 48.4 (2021), 50.0 (2022), 47.5 (2023), 46.9 (2024).
- Primary balance (percent of GDP): 0.2 (2018), 0.1 (2019), -5.3 (2020), -5.0 (2021), -3.7 (2022), -0.8 (2023), 0.6 (2024).

### Monetary and financial indicators (selected)
- Broad money (M3, period growth, end-of-period): 11.8 (2018), 8.1 (2019), 21.1 (2020), 16.3 (2021), 11.5 (2022), 9.6 (2023), 8.7 (2024).
- Credit to private sector (flow-based): 10.6 (2018), 15.3 (2019), 11.8 (2020), 12.8 (2021), 10.9 (2022), 8.8 (2023), 8.6 (2024).
- Note on banking statistics: The dissolution of Sberbank in 2022, which accounted for about one percent of total bank assets, affected banking statistics; its credit, securities, and deposits not taken over by other banks are shown under financial intermediaries beginning end-March 2022.

### Annex I — Debt Sustainability Analysis: key findings and assumptions
- Context and recent developments:
  - After the steep pandemic-driven increase in 2020, the public debt-to-GDP ratio declined by almost 3 percentage points in 2021.
  - Unprecedented policy stimulus in 2020 pushed the public debt-to-GDP ratio to almost 80 percent of GDP.
  - In 2021, real GDP growth was 7.1 percent and real interest rates were around –3 percent, contributing to lower debt-to-GDP.
  - External financing share in total debt increased by about ½ percentage point in 2021.
  - Average term to maturity of public debt was further increased in 2021.

- Baseline assumptions underpinning the DSA:
  - Real GDP growth slows to 4.9 and 0.5 percent in 2022 and 2023, respectively, rebounding to 3.2 percent in 2024. The growth path assumes the expected disbursement of grants from the 2021–27 EU structural funds, the RRF, and 2021-26 Next Generation EU funds.
  - GDP deflator decelerates from 8.4 percent in 2023 to 3 percent in 2027.
  - Primary fiscal deficit improves from 5.0 percent in 2021 to 3.7 percent in 2022, and 0.8 percent in 2023. Starting in 2024, a primary surplus of 0.6 percent of GDP, on average, is projected over the forecast horizon.
  - The improvement in the primary deficit is driven by inflation (which boosts revenues in 2022) and a package of discretionary measures underpinning the fiscal adjustment plans.

- Risks and uncertainty:
  - Exceptionally large uncertainty surrounds baseline assumptions and projections.
  - Past growth forecast errors for Hungary have been larger (outside the interquartile range) than in other countries; forecast errors for the primary balance and inflation have been less pronounced.
  - The projected fiscal adjustment lies in the top quartile of a distribution of relevant comparators, although the authorities have a track record of restoring fiscal balances (sustained deleveraging during 2011-20).
  - Global risks (Annex III) pose large risks for the macroeconomic, fiscal, and debt outlook.

- Authorities’ debt management strategy:
  - Average term to maturity of domestic debt increased to 5.1 years (from 4.1 years in 2019).
  - Foreign currency denominated debt share recently accepted slightly higher than 20 percent; commitment to keep it below 25 percent.
  - Target share of fixed-rate financing instruments (domestic and foreign-currency denominated) between 70 and 90 percent.
  - Foreign currency obligations―after swaps―are aimed to be 100 percent in euros to mitigate cross-currency risks.

- Baseline debt trajectory and financing needs:
  - Public debt-to-GDP ratio forecast to decline from 76.8 percent in 2021 to about 64 percent by 2027.
  - Under the baseline, the primary balance will cumulatively contribute to increasing the debt-to-GDP ratio by 2.3 percentage points between 2022 and 2027.
  - The interest rate-growth differential is projected to contribute to a reduction in debt by about 15.5 percentage points over the same period.
  - Gross financing needs are forecast to drop from 21.1 percent of GDP in 2021 to 11.7 percent of GDP in 2027.
  - Despite these improvements, the maturity structure (about 5 years) and debt repayments’ schedule keep financing needs sizeable.

### DSA stress-test scenarios and impacts (selected results)
- Growth shock:
  - A decline in growth by one standard deviation for 2 consecutive years would push the economy into a 2-year recession.
  - Debt would reach 82.1 percent of GDP in 2024 and then decline to 76.4 percent of GDP in 2027, about 12 percentage points higher than under the baseline.
  - Under this scenario, gross financing needs would peak at about 20 percent of GDP in 2024, then decline to 14 percent of GDP at the end of the forecast horizon.

- Macro-fiscal shock:
  - Simultaneous shocks to growth, interest rate, and primary balance would increase the debt-to-GDP ratio to 85.0 percent by 2024, falling to 84.4 percent at the end of the forecast horizon.
  - Financing needs would reach almost 17 percent in 2027.

- Contingent liabilities shock:
  - Should the government have to absorb contingent liabilities equivalent to 10 percent of financial sector assets in 2023, the debt-to-GDP ratio would reach (text truncated in source).

_Italic: Source — Hungarian authorities; IMF, International Financial Statistics; Bloomberg; and Fund staff estimates and projections._

### 81.9 percent in 2027 and financing needs would reach 17 percent of GDP.

### 1hunea2023001 - 81.9 percent in 2027 and financing needs would reach 17 percent of GDP.

### Debt sustainability: baseline and alternative scenarios
- Baseline projection: public debt reaches 81.9 percent in 2027 and financing needs would reach 17 percent of GDP.
- No fiscal adjustment beyond 2022 scenario:
  - An unchanged primary deficit after 2022 would place the public debt-to-GDP ratio on an unsustainable path.
  - Under this scenario, in five years, public debt would reach 84 percent of GDP and gross financing needs about 18.5 percent of GDP.
- Authorities’ commitment to restoring fiscal prudence and track record of doing so make the no-adjustment scenario unlikely; nevertheless, adverse global shocks, tighter financial conditions, and the war in Ukraine create a non-negligible risk that fiscal adjustment could be postponed or softened.

### Fiscal framework and implications
- Hungary’s fiscal policy is bound by the European Stability and Growth Pact (SGP):
  - General government deficit must not exceed 3 percent of GDP (with SGP escape clauses).
  - Parliament may only adopt budget laws that result in the reduction of the government debt-to-GDP ratio, until this ratio falls to below 50 percent of GDP.
  - The rule on debt reduction can be suspended when real GDP contracts.
- Under the baseline, real GDP growth is projected to decelerate but remain positive next year and over the medium term; the fiscal framework therefore requires budgets that put debt on a downward trajectory.

### External debt vulnerabilities and external sector assessment
- External vulnerabilities have increased amid tightening global financing conditions:
  - Spreads increased during 2022; spreads are within risk assessment benchmarks but have risen.
  - Adverse terms-of-trade shocks have negatively affected the current account.
  - External financing needs are above the upper risk-assessment benchmark.
  - Public debt in foreign currency and public debt held by non-residents are within the risk-assessment benchmark range.
- Current account and external position (Annex II):
  - Hungary’s current account deficit widened significantly in 2021 and 2022 due to major terms-of-trade shocks, supply-chain disruption, slowing external demand, and pumped-up domestic demand.
  - Hungary’s external position in 2022 is assessed as substantially weaker than warranted by medium-term fundamentals and desirable policies.
- Key external statistics and assessments:
  - International reserves: 38.4 billion euros in 2021 and 38.7 billion euros in 2022.
  - Net international investment position (NIIP): -49 percent of GDP in 2020; -46 percent of GDP in 2021; -37 percent of GDP by 2022:Q3.
  - Current Account (CA) approach: current account gap of -5.1 percent of GDP, implying an exchange rate overvaluation of 8.0 percent.
  - Policy gap contribution: -0.3 percent of GDP.
  - Fiscal gap contribution: -1.2 percent of GDP overall and -4.0 percent domestically.
  - Cyclical-adjustment contribution: -1.2 percent of GDP.
- Financing composition and risks:
  - Gross FDI inflows have been a crucial and stable source of external financing.
  - Other sources include government borrowing, EU funds inflows, and other capital flows.
  - In a downside scenario, wider current account deficits and larger external financing needs would require greater government and private external borrowing amid increased risk premia and tighter global conditions.
  - Faster drawdown in liquid external assets, rapid inflation, and a plummeting exchange rate could trigger euroization and disorderly adjustment risks.

### Stress tests and shock scenarios
- Stress-test categories analyzed include:
  - Primary Balance Shock
  - Real GDP Growth Shock
  - Real Interest Rate Shock
  - Real Exchange Rate Shock
  - Combined Shock
  - Contingent Liability Shock
- Illustrative outcomes (scenario highlights from text and figures):
  - Under baseline and alternate stress tests, gross nominal public debt and public gross financing needs vary substantially, with some shocks pushing debt and financing needs above thresholds flagged in the risk-assessment framework.
  - External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
  - The heat-map framework uses benchmarks such as 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for public debt held by non-residents; and 20 and 60 percent for share of foreign-currency denominated debt.

### Policy takeaways and vulnerabilities
- Key policy challenges:
  - Navigating terms-of-trade shocks given Hungary’s dependence on foreign energy.
  - Restoring macro-balances and unlocking conditional EU funds to buttress market confidence.
  - Maintaining fiscal adjustment to avoid unsustainable debt trajectories; postponing adjustment would materially worsen debt and financing needs.
- Reserves adequacy:
  - Reserves have remained adequate so far but are vulnerable to deterioration under downside scenarios.
- Structural and policy contributors to external imbalances:
  - Regulated retail energy price caps have sustained retail demand for gas and electricity and increased demand for motor fuels, inhibiting demand adjustment to prices and contributing to a larger current account deficit.

*Source: IMF staff, Hungary Public Debt Sustainability Analysis and Annex II: External Sector Assessment.*

### 6.7 percent. However, this is based on stabilizing Hungary’s net foreign asset position (in percent

### 1hunea2023001 - 6.7 percent. However, this is based on stabilizing Hungary’s net foreign asset position (in percent

### External position assessment and REER estimates
- Staff conclusion: the external position is assessed as substantially weaker than warranted by fundamentals and desirable policies.
- Key qualitative drivers:
  - The baseline uses stabilizing Hungary’s net foreign asset (NFA) position (in percent of GDP) at the 2022 level, which is described as an outlier year given high energy import prices and a large deterioration in the current account. This approach is inconsistent with the current account balance returning to positive territory over the medium-term.
  - Easing of commodity prices, tighter macroeconomic policies, and a relaxation of price caps would help move the external position closer to levels consistent with medium-term fundamentals and desired policy settings.
- REER approaches:
  - Index model suggests the real exchange rate is undervalued by 5 percent.
  - Level model suggests the real exchange rate is undervalued by 32 percent, but produces especially large residuals (29 percent in the level model) not explained by policy variables.

### Table II.1 — Hungary: 2022 External Balance Assessment Results (key figures)
- CA balance -8.1
- Cyclically-adjusted CA -6.9
- Model CA norm (percent of GDP) -1.8
- CA-stabilizing NFA at 2022 level -2.6
- Model residuals: -4.8, -29.0, -3.4
- Model CA gap: -5.1, (other entry) -4.3
- Semi-elasticity of CA/GDP to REER 0.64
- Exchange-rate gap (percent): 8.0, -32.3, -5.6, 6.7

### Risk Assessment Matrix — major risks, likelihood, impact, and policy responses
- Intensifying spillovers from Russia’s war in Ukraine
  - Likelihood: H
  - Impact: High — Commodity price volatility would likely intensify terms of trade deterioration, external imbalances, and inflationary pressures.
  - Policy response: Fiscal policy should remain tight while making room for additional support to the vulnerable; Central bank should stand ready to smooth excess exchange rate volatility and tighten further to reduce second-round effects on inflation.
- Commodity price shocks
  - Likelihood: H
  - Impact: High (same as above)
  - Policy response: Same as above.
- Abrupt global slowdown or recession (including gas shutoff scenarios causing EU recession)
  - Likelihood: H
  - Impact: High — Gas and power shortages in industry will lead to output and job losses; increased credit losses affect banks; fiscal borrowing costs soar; financial markets reprice risk assets.
  - Policy response: Pace of fiscal tightening could afford to slow if inflationary pressures do not increase; encourage greater price-induced demand reduction by further relaxing utility price caps; implement national emergency contingency plans; extend targeted support to industry to avoid widespread closures and spillovers to financial sector.
- Sharp tightening of global financial conditions with volatile commodity prices
  - Likelihood: H
  - Impact: Medium — Market pressures on yields and currency will raise fiscal and external imbalances.
  - Policy response: Tighten monetary policy further and intervene in the FX market if necessary; allow demand to adjust and reduce the current account deficit; tighten fiscal policy.
- De-anchoring of inflation expectations and stagflation
  - Likelihood: M
  - Impact: Medium — Higher rates for longer will prolong the recovery and make fiscal adjustment costlier.
  - Policy response: Tighten monetary policy further and intervene in the FX market if necessary; ensure fiscal policy supports monetary policy, which may require further adjustment.
- Deepening geo-economic fragmentation
  - Likelihood: H
  - Impact: High — Reduced FDI and contribution of auto industry value chains lowers actual and potential output and employment; energy supply security weakens.
  - Policy response: Prioritize structural reforms and investments that support potential output and productivity.
- Domestic risks summarized with likelihoods, impacts, and responses:
  - Incomplete or untimely delivery of Next Generation EU funds and cohesion funds
    - Likelihood: M; Impact: Medium
    - Response: Accelerate investments and reforms to unlock EU funds; central bank to stand ready to tighten or intervene in FX markets if conditions become disorderly.
  - More entrenched inflation (persistent core inflation)
    - Likelihood: M; Impact: High
    - Response: Further tighten monetary policy; fiscal policy should further tighten to complement monetary policy.
  - Widespread firm closures due to high energy prices
    - Likelihood: M; Impact: Medium
    - Response: Extend targeted and temporary support to firms while encouraging energy savings.

### Authorities’ response to past IMF policy recommendations (IMF 2021 Article IV)
- Fiscal policy recommendations and responses:
  1. Scale back accommodative stance if recovery is faster than expected.
     - Authorities: Fiscal policy loosened late 2021/early 2022. The fiscal stance subsequently tightened.
  2. Create fiscal space via growth-friendly revenue and expenditure measures and rationalizing public sector employment.
     - Authorities: No progress. Fiscal space was reduced by stimulus and energy prices. The government is tightening but composition of the adjustment could be improved.
  3. Make publicly available all COVID-related procurement contracts.
     - Authorities: As part of reforms to address rule of law concerns by the EU, the government is preparing a publicly-available online data registry on public procurement bidders, including information on beneficial ownership. Timeline is under discussion with the EC.
- Monetary and financial policy recommendations and responses:
  1. Review effectiveness of unconventional tools and only conduct asset purchases in corporate securities secondary market.
     - Authorities: Asset purchase program was discontinued end-2021; authorities now rely on more conventional policy tools.
  2. Address Moneyval recommendations in strengthening AML framework.
     - Authorities: Ongoing.
- Structural reform recommendations and responses:
  1. Review unemployment benefits structure — No progress.
  2. Enhance training and life-long learning programs — No progress.
  3. Increase carbon pricing — Energy price shocks have driven focus on mitigating impact and securing short-term gas supplies.
  4. Incentivize green investment through fiscal policy rather than macroprudential framework — Part of energy strategies.

### Fund relations, statistical and technical notes (selected points)
- Membership: Joined May 6, 1982; Article VIII.
- Quota and holdings:
  - Quota 1,940.00 SDR Million Percent Quota 100.00
  - Fund holdings of currency (Holdings Rate) 1,640.76 84.58
  - Reserve tranche position 301.18 15.52
- SDR Department:
  - Net cumulative allocation 2,850.45 100.00
  - Holdings 1,855.92 65.11
- Latest financial arrangements listed with dates and amounts (Stand-By arrangements and draws) as presented in the source.
- Data adequacy for surveillance: Data provision is adequate for surveillance, with recommendations to automate provision of certain government arrears and SOE financial statements to facilitate monitoring.
- Hungary adheres to the Fund’s Special Data Dissemination Standard (SDDS) Plus since July 2022.
- Key data reporting frequencies and latest observation dates are listed for exchange rates, international reserve assets, monetary aggregates, government finances, external accounts, GDP, and external debt as of January 13, 2023.

*Source: Hungary — 2022 Article IV Consultation staff report and informational annex (selected excerpts).*

### 2021. Spillovers from geopolitical tensions have subsequently been weighing on the performance

### 1hunea2023001 - 2021. Spillovers from geopolitical tensions have subsequently been weighing on the performance

### Macroeconomic performance and outlook
- Growth in 2022 is estimated to have been at least 4.5 percent.
- Market services and industry remained main drivers of economic growth, with decreasing contributions.
- Agriculture hampered growth due to an extraordinary drought.
- Growth momentum was maintained in the first half of 2022.
- Looking ahead:
  - Economic activity shows signs of moderation amid weakening domestic demand and rising corporate costs.
  - The Hungarian economy can still avoid recession and overall growth performance will likely be above regional peers in 2023.
  - The investment rate is projected to stabilize around 29 percent.
  - Employment is at historically high levels and the unemployment rate is projected to stay below 4 percent.

### External sector and energy balance
- The current account deficit temporarily but significantly increased in 2022 due to a worsening energy balance, before starting to shrink in 2023.
- 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 current account balance excluding the energy account remained in surplus.
- Net foreign direct investment has continued to rise, largely related to new investments by manufacturing companies.
- With normalizing global conditions and utilization of new export capacities, the external position is expected to improve significantly from 2024 onwards.

### Inflation dynamics and outlook
- Average annual inflation reached 14.5 percent in 2022.
- Annual headline inflation remained above 20 percent in December 2022.
- Drivers:
  - Soaring global energy and food prices.
  - The unusual severe drought in Hungary added to inflationary pressures.
  - Processed food prices contributed the most to the rise in core inflation.
- Outlook:
  - Inflation is projected to peak in the coming months and then decline progressively.
  - Falling commodity prices, global factors, and a cooling domestic economy will exert increasing disinflationary effects.
  - From the middle of the year, base effects will contribute to a faster decline in the consumer price index, which may subsequently moderate to single-digits by end-2023.
  - Inflation is expected to return to the central bank’s tolerance band in 2024.
  - Longer-term inflation expectations of analysts remained around the upper side of the tolerance band of 4 percent.
- Policy implication: Close monitoring of second-round effects and changes in companies’ repricing practices is essential to guard against the risk of high inflation becoming entrenched.

### Risks to the outlook
- Risks have recently become more balanced, but 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.
  - Structural changes in inflation developments.
- Hungary’s high openness increases exposure to deteriorating external conditions.
- Policy measures remain strongly focused on strengthening economic resilience; authorities are vigilant against build-up of macroeconomic vulnerabilities and stand ready to address risks.

### Fiscal policies and public finances
- Fiscal policy has been proactively calibrated to protect economic fundamentals and limit socio-economic scars while safeguarding debt sustainability.
- Government priorities included preserving labor market achievements and supporting families; special utility protection and a defense fund were set up within the budget.
- 2022 fiscal adjustments were driven mostly by streamlining expenditures and revenue mobilization measures:
  - Postponement of a large proportion of public investments.
  - Cuts to current expenditures in ministry budgets.
  - Narrowing access to subsidized utility prices to average consumption only (block pricing system).
  - Introduction of temporary windfall taxes on energy, banking and a few other sectors, affecting only a part of extra profits.
  - Continuous 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.
- Support measures for households and SMEs:
  - Price caps (gradual phase-out preferred by the government).
  - Block pricing system incentivizing lower consumption; natural gas consumption significantly declined from the beginning of the heating season.
  - Price-capped motor fuels scheme completely phased out at the end of 2022.
  - Interest rate caps on outstanding loans introduced to alleviate burdens on households and SMEs.
  - Fixed prices for certain staple food products; administrative measures are time-limited.
- Fiscal stance for 2023 and beyond:
  - Government submitted a revised 2023 budget in January 2023; initial deficit target increased from 3.5 to 3.9 percent due to maintenance of the block pricing energy system.
  - The revision still envisages decisive fiscal consolidation for the year.
  - Government committed to using any revenues from higher-than-expected growth to reduce the fiscal deficit (in line with Fiscal Council recommendations).
  - Government aims for growth-friendly multi-year fiscal consolidation with continuously decreasing deficit targets, dipping below 3 percent of GDP in 2024.
  - Gross government debt-to-GDP ratio is projected to fall to around 70 percent by end-2023.
  - Authorities emphasize lengthening average debt maturity and 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; the MNB also preserves financial stability and supports government economic policy and environmental sustainability.
- The MNB launched an interest rate hiking cycle in June 2021 and 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 forward-looking real interest rates entered positive territory and risks around inflation became symmetric by September 2022, the Monetary Council stopped the base rate hike cycle and continued tightening via liquidity measures.
- Recent measures to maintain market stability and tighten conditions:
  - Introduction of new o/n deposit quick tenders with higher interest rate conditions than the base rate.
  - Significant raising of the upper bound of the interest rate corridor.
  - Introduction of instruments to absorb interbank HUF liquidity on a longer term: one-week discount bill, long-term deposit tender, revised reserve requirement system.
  - Announcement to increase the minimum reserve requirements to 10 percent from April 2023.
- The MNB remains committed to bringing inflation back to target and agrees on the need to maintain tight monetary conditions for a prolonged period; stands ready to use every instrument in its toolkit should risks increase.
- Financial sector resilience:
  - Hungarian banking sector entered the period with significant capital position and liquidity reserves and adequate shock resiliency.
  - NPL ratios remained relatively low, at around 4 percent, after phasing out the general loan repayment moratorium.
  - MNB monitors portfolio risks from changing interest rate and economic environment.
  - Early signs of a housing market slowdown after a multi-year upcycle.
  - A broad set of macroprudential policy tools is in place.
  - MNB promotes green and digital transformations in the financial sector.

### Structural policies and governance
- Ensuring energy security on a sustainable basis is a structural priority:
  - Hungary is heavily dependent on natural gas with most imports via pipelines from Russia; crude oil adjustment takes time given physical realities.
  - Important strides made in upgrading transmission and building interconnectors, but integration of EU natural gas and oil markets is still not developed enough for full replacement of Russian imports.
  - Key to energy security: greater diversification of energy sources and mix.
- Energy transition and emissions targets:
  - Authorities remain committed to ambitious emission reduction targets by 2030 and climate neutrality by 2050; carbon neutrality goal is set by law.
  - A systemic overhaul of the Hungarian energy system is underway; a new, separate Ministry of Energy has been set up.
  - Hungary achieved one of the most dynamic growth rates in Europe in installing new solar capacities in recent years; creating an environment for further expansion of renewables is a high priority.
  - Nuclear power generation remains a major pillar of the energy mix.
  - Authorities launched a special energy-efficiency scheme to support energy-intensive factories.
- Governance and EU relations:
  - Governance frameworks broadly correspond to the EU average according to a wide range of objective indicators.
  - Government undertook targeted reform measures in close dialogue with EU institutions to improve perceptions.
  - A new and independent Integrity Authority has been set up to investigate fraud, conflicts of interest and violations related to the use of EU funds.
  - Comprehensive judicial reforms are being undertaken to further underpin judiciary independence.
  - Promotion of a more competitive public procurement system is a government priority.
  - At the end of 2022, the government reached agreements with EU institutions on the Partnership Agreement for 2021-27 and the Recovery and Resilience Facility, paving the way for disbursements in 2023.
  - Some remedial measures are still underway; government is committed to full implementation and expects Hungary can eventually fully absorb all eligible EU funds.
- Competitiveness and reforms:
  - Boosting competitiveness is a key policy priority to support long-term real convergence.
  - Hungary achieved an outstanding catching-up process over the last decade due to robust growth.
  - Importance of rejuvenating the structural reform agenda and accelerating implementation of reform measures, alongside addressing near-term challenges.
  - Government devotes more Recovery and Resilience Plan funds to digital and green transitions than the EU average and intends to mobilize additional financing for these purposes.
  - The MNB actively contributes analyses and recommendations on competitiveness within its mandate.

*IMF staff report excerpt.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1hunea2023001.pdf_