## 1. Main Economic Indicators, 2003–09 (_cr08313)

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### Staff appraisal and main findings
- The sharp fiscal consolidation and current account improvement in 2007 are welcome, but government debt and the net external liability position are still large.
- The combination of high vulnerabilities and the deterioration in global financial conditions over the past year has led to a large increase in government bond yields.
- Financial system risks—especially credit and liquidity risks—have risen.
- Looking forward, economic growth is expected to pick up in 2008–09, but risks to external stability remain high.
- Gross external financing needs in 2008–09 are high, though short-term debt is roughly covered by net international reserves.
- It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

### Policy priorities and recommendations
- Reduce vulnerabilities by further fiscal consolidation to put the government debt-to-GDP ratio on a downward path and narrow the current account deficit.
- Monetary policy should aim to reduce CPI inflation to the 3 percent target over two years.
- Financial sector policies should focus on improving banks’ risk management and reviewing safety nets.

Specific fiscal recommendations:
- Further fiscal consolidation in line with the targets in the latest Convergence Program is essential.
- For 2008, the fiscal deficit target seems attainable; any revenue overperformance should be saved and devoted to reducing public debt.
- Achieving the 2009 target will require strict spending restraint and continued strong revenue growth; there is no room for tax relief unless offset by spending cuts.
- The 2009 budget should include sizable contingency reserves given uncertainties (recommendation: contingency reserves of ½ percent of GDP).
- Introducing a rules-based fiscal framework would help deliver the required further fiscal consolidation.
- To boost potential GDP growth: a smaller size of government (and corresponding overall tax burden) and a shift in the tax burden would help.
- Further reforms of the pension, health, and education sectors are needed to reduce the ratio of government spending to GDP.
- A revenue-neutral shift in the tax burden away from labor and to consumption and wealth would improve work incentives and increase employment.

Monetary policy guidance:
- Elimination of the exchange rate band in early 2008 is welcome; in the new floating exchange rate regime, monetary policy can focus exclusively on the inflation target.
- Given the rise in inflationary pressures in the first half of 2008, the tightening of monetary policy has been appropriate.
- Looking forward, the policy interest rate may need to rise further, depending on the effects of the recent exchange rate appreciation and the evolution of underlying inflationary pressures.
- Policymakers should be prepared to react quickly and—if necessary—forcefully to inflationary shocks.

Financial sector recommendations:
- Establish a credit registry for households and strengthen stress testing, including of households’ foreign currency exposures.
- If the Hungarian Supervisory Authority judges that banks are not adequately capitalized, it should not hesitate to use its supervisory tools to require increases in capital.
- Expedite the review of banks’ liquidity management practices, develop liquidity management guidelines, and ensure banks have effective contingency arrangements.
- Accelerate the review of financial safety nets.

### Outlook and risks to external stability
- Real GDP growth slowed from 4 percent in 2006 to 1¼ percent in 2007, reflecting mainly the impact of fiscal consolidation on domestic demand.
- Private consumption fell by 2 percent in 2007.
- Fixed investment increased by just 1 percent in 2007.
- The unemployment rate has drifted up and the staff estimate of the output gap decreased from 1½ percent of potential output in 2006 to slightly above zero in 2007.
- Despite the slowdown, private sector credit growth (adjusted for changes in the exchange rate) stayed well above nominal GDP growth.
- Households’ debt service burden kept rising; mortgage debt as a share of GDP is still well below the EU average.
- With most new borrowing in foreign currency, households’ and corporates’ net foreign currency liabilities increased, raising indirect credit risk to the banking system.
- The current account deficit narrowed from 6 percent of GDP in 2006 to 5 percent of GDP in 2007; in 2008Q1 the current account deficit remained at 5 percent of GDP.
- Staff estimate that the underlying current account deficit is 9½ percent of GDP.
  - Text Table derivation (in percent of GDP): 2007 Current account balance -5.0; Temporary effects 0.0; Hungarian business cycle 0.1; Export partners' business cycle -0.2; Real exchange rate movements (through June 2008) -4.4; Underlying current account balance -9.5.
- Real effective exchange rate (REER) assessments (selected results):
  - Macroeconomic Balance Approach: equilibrium CAD of 5 percent of GDP; implied exchange rate overvaluation 5½ percent after accounting for medium-term EU capital transfers of 1½ percent of GDP.
  - External Sustainability Approach: NFA-stabilizing CAD of 3½ percent of GDP; implied real exchange rate overvaluation 8½ percent after EU transfers.
  - Equilibrium Real Exchange Rate Approach: actual REER about 12½ percent more appreciated than the equilibrium REER (forecast error 10-15 percent).
  - Overall assessment: 10 above (Text Table. Hungary: Real Exchange Rate Misalignment (in percent)).
- Although external financing needs declined in 2007, the composition of financing remained largely debt-creating; net non-debt-creating flows were negative in 2007 (largely due to one-off transactions).
- The net international investment position stabilized in 2007 but remains about 100 percent of GDP.
  - Gross external debt amounted to 97 percent of GDP.
  - Short-term debt on a residual maturity basis is 18 percent of GDP and is roughly covered by net international reserves.
- Staff projections:
  - Real GDP growth: 2008 2 percent; 2009 2¾ percent.
  - Over the medium term, potential GDP growth estimated at about 3–3½ percent.

### Government finances and fiscal outlook
- Fiscal adjustment in 2007 was substantial but government debt remains high.
  - General government deficit narrowed from 9¼ percent of GDP in 2006 to 5½ percent of GDP in 2007.
  - Increase in revenue came from tax hikes and improvements in tax administration (the latter contributing ¼–⅓ percent of GDP).
  - Expenditure reduction sources: lower wage bill (nominal wage freeze and a 10 percent fall in public sector employment), lower capital expenditure, improved means-testing of energy and housing subsidies, and lower health spending.
- Despite the sharp decline in the fiscal deficit, government debt stabilized at 66 percent of GDP.
- With substantial amortization due in 2008–09, the government’s gross financing needs are high.
- Trailing four-quarter fiscal deficit amounted to 4¼ percent of GDP in 2008Q2.
- Deficit target for 2008 as a whole: 4 percent of GDP (assessed as attainable).
- Most of the 2008 adjustment is on the spending side: 1¾ percentage points of GDP.
- Structural fiscal adjustment in 2008 estimated at ¾ percentage points of GDP.
- Text Table projections (General Government, 2006-10, in percent of GDP):
  - General government balance: 2006 -9.2; 2007 -5.5; 2008 -3.8; 2009 -3.3; 2010 -3.2
  - Revenues: 2006 42.6; 2007 44.6; 2008 44.7; 2009 44.2; 2010 44.2
  - Expenditures: 2006 51.8; 2007 50.1; 2008 48.6; 2009 47.5; 2010 47.4
  - Cyclically adjusted overall balance: 2006 -9.7; 2007 -5.5; 2008 -3.5; 2009 -2.9; 2010 -2.9
  - Primary balance (memorandum): 2006 -5.5; 2007 -1.7; 2008 0.2; 2009 0.8; 2010 0.6
  - General government debt: 2006 65.6; 2007 66.0; 2008 64.9; 2009 64.2; 2010 63.3
- For 2009:
  - Authorities committed to Convergence Program target deficit of 3.2 percent of GDP.
  - Staff project a fiscal deficit of 3.3 percent of GDP based on a more conservative growth forecast.
  - Staff consider implied improvement in the structural fiscal balance of ½ percentage point of GDP appropriately ambitious.
- For 2010:
  - Staff support further fiscal consolidation in line with Convergence Program implying adjustment of ½ percentage point of GDP.
  - Staff projections assume only very small reductions in the fiscal deficit in 2010 and beyond; in this scenario, public debt would fall modestly from 66 percent of GDP in 2007 to 61 percent of GDP in 2013.

### Government securities market developments and AKK responses
- Early 2008: bid-ask spreads widened sharply and an auction was less than fully subscribed.
- Contributing factors: deterioration in global financial market conditions; rapid shift in pension funds’ asset allocations toward equities; doubts about future fiscal consolidation given increased political uncertainty.
- Since early 2008:
  - Bid-ask spreads have narrowed and auctions have been fully subscribed, though government bond yields have remained elevated.
  - Primary dealers have been gradually selling their overhang of government bonds.
- AKK responses and plans:
  - Issue relatively more short-term bills and remain responsive to market participants’ preferences across maturities.
  - Abolish requirement that primary dealers have a physical presence in Hungary to facilitate foreign entry.
  - Study legislative changes to accounting rules to deepen bond market liquidity by improving the functioning of the repo market.

### Monetary policy, inflation outlook, and risk scenarios
- Exchange rate regime: exchange rate band removed in early 2008; Hungary moved to a floating exchange rate regime.
- Recent tightening: monetary policy tightened over the past half year in response to increased inflationary pressures.
- CPI inflation: fell to 6¾ percent in June 2008; core CPI inflation rose in the first half of 2008.
- Household inflation expectations roughly stable in recent quarters.
- CPI weights (HICP weights): Food 17, Energy 14 (Hungary); NMS-9: Food 21, Energy 14; Euro area: Food 14, Energy 10.
- Baseline (staff and MNB): appreciation of the nominal effective exchange rate and projected below-potential growth in 2008–09 open a negative output gap and are expected to reduce inflation to the 3 percent target by the first half of 2010.
- Two financial-shock scenarios (small, two-economy macroeconomic model):
  - Risk premium shock on forint-denominated assets:
    - A 10 percent exchange rate depreciation could require a higher policy rate over time by as much as 300 bps, depending on exchange rate pass-through to inflation.
  - Euro area demand shock:
    - A large adverse shock to euro area aggregate demand that results in euro area GDP growth falling by ½ percentage point below baseline could imply a cut in the policy rate in Hungary over time by as much as 125 bps.
- Other risks: further increases in global food and energy prices; increase in the risk premium on forint-denominated assets.

### Financial stability assessment and supervisory measures
- Financial system risks increased over the past year due to global financial market turbulence and continued rapid credit growth.
- Banking system health:
  - System is well-capitalized and profitable, though indicators deteriorated in 2007.
  - Capital adequacy ratio close to 11 percent, but has fallen every year since 2004.
  - Return on equity fell to 18 percent in 2007.
  - Nonperforming loan ratio stable in part because banks have sold overdue loans to work-out companies.
- Credit risks:
  - Rapid credit growth driven in part by easing lending standards for households (longer maturities, higher loan-to-value ratios for mortgages, new higher-risk products such as yen-based loans).
  - Prudential responses: MNB and HFSA announced guidelines on foreign currency risk management and consumer protection; HFSA published criteria to implement Pillar II assessments.
  - Hungarian banks have no direct exposure to the U.S. subprime market.
- Liquidity and funding risks:
  - Rising loan-to-deposit ratios, decline in liquid asset ratios, and increase in external funding to 30 percent of total liabilities.
  - External funding from non-parent sources amounts to about half of total external funding and is potentially more volatile than funding from parent banks.
  - Financial strains in mature markets are driving a slowdown in parent banks’ lending growth, likely affecting emerging market countries.

Authorities' measures and staff recommendations on supervisory and safety-net matters:
- MNB conducts top-down stress tests; MNB and HFSA working on bottom-up stress-testing.
- Full-list credit registry for corporate borrowers exists; officials and staff agreed that a mandatory, full-list credit registry for households would improve banks’ credit risk management and enhance consumer protection, though officials pointed to privacy concerns.
- HFSA conducting a review of banks’ liquidity management practices; staff recommend HFSA publish explicit liquidity management recommendations and ensure banks have effective contingency arrangements.
- HFSA has supervisory tools to encourage corrective action (order cessation of activities; replace management; require increase in capital); staff suggested consideration of introducing a formal system of early remedial action.
- Deposit insurance scheme complies with relevant EU directive; authorities reviewing co-insurance rules and procedures to ensure rapid payments to depositors.
- Cross-border coordination: cross-border MOUs in place; crisis simulation exercise being planned.

### Key statistics (selected figures and projections)
- Real GDP growth (year-on-year percent): 2005 4.1; 2006 3.9; 2007 1.3; 2008 2.0; 2009 2.8.
- Private consumption (percent change): 2005 3.6; 2006 1.9; 2007 -1.9; 2008 0.6; 2009 2.2.
- Gross fixed investment (percent change): 2005 5.3; 2006 -2.5; 2007 0.1; 2008 2.8; 2009 3.5.
- Exports of goods and services (percent change): 2005 11.5; 2006 19.0; 2007 14.2; 2008 13.3; 2009 9.6.
- Imports of goods and services (percent change): 2005 6.8; 2006 14.7; 2007 12.0; 2008 11.0; 2009 11.7.
- CPI (end-year): 2005 3.3; 2006 6.5; 2007 7.4; 2008 5.5; 2009 3.4.
- Unemployment rate (average, percent): 2005 7.2; 2006 7.5; 2007 7.4; 2008 7.8; 2009 7.7.
- Nominal wage growth (average): 2005 8.7; 2006 8.2; 2007 8.0; 2008 7.7; 2009 6.0.
- General government balance (percent of GDP): 2005 -7.8; 2006 -9.2; 2007 -5.5; 2008 -4.0; 2009 -3.4.
- Current account balance (percent of GDP): 2005 -6.8; 2006 -6.1; 2007 -5.0; 2008 -4.9; 2009 -5.4.
- Net international investment position (percent of GDP): 2005 -92.4; 2006 -100.9; 2007 -100.5; 2008 -99.6; 2009 -99.9.
- Gross external debt (percent of GDP): 2007 96.4; 2008 94.2; 2009 93.3.
- Short-term external debt (residual maturity): 18 percent of GDP (2007), roughly covered by net international reserves.
- Net international reserves (reserves in billions of US dollars): 2007 24.0; 2008 26.4; 2009 27.6.

### External position and medium-term outlook (from _cr08313 - 19)
- Current account deficit expected to widen gradually to 6½ percent of GDP by 2013.
- In 2008, trade balance, net income, and current transfers projected to remain roughly stable; thereafter deterioration in the trade balance expected to exceed improvements in net income and EU current transfers.
- EU capital transfers projected to rise over the medium term.
- Net IIP and external debt (relative to GDP) projected to remain broadly stable in 2008–09 but then rise gently over the medium term.

Uncertainties and risks:
- Upside risk: better-than-projected agricultural production.
- Downside risks: worsening external financing conditions; large depreciation of the forint hurting household balance sheets; wealth effects from exchange rate movements that could worsen credit quality and banking system stress.

### Rules-based fiscal framework and credibility (Box 3)
- Government proposal: fiscal responsibility law (FRL) with ceiling on central government debt in real terms; floor of zero on the primary balance; pay-as-you-go constraint on discretionary budget items; make currently indicative ceilings binding.
- Proposed parliamentary budget office and constitutional amendments to give the constitutional court enforcement role and tighten local government borrowing constraints.
- Staff: support rules-based framework; note uncertainty over parliamentary approval of constitutional changes (require two-thirds majority); FRL passage without constitutional changes still valuable signal.
- Empirical results (EU-25, 1990–2005): adoption/tightening of a fiscal rule typically increased cyclically-adjusted primary balance by about 0.4 percent of GDP and reduced bond yields by about 5 bps on impact and about 30 bps in the long run; higher credibility effects where institutional underpinning and independent monitoring exist.

### Revenue-neutral tax measures and structural reforms
- Discussed measures to shift tax burden away from labor to consumption and wealth; options include cutting labor taxes combined with increases in VAT and excise duties and reducing exemptions.
- Staff suggested eventual introduction of a property tax accompanied by cuts in labor taxes; authorities noted strong popular opposition to a property tax.
- Structural reforms to reduce spending ratio:
  - Pensions: further increase in the effective retirement age; recently-enacted measures to take effect by 2013.
  - Health care: improve governance of hospitals and adopt a sound regulatory framework to increase efficiency.
  - Education: enhanced coordination between local governments, expanded performance-based financing, greater autonomy of higher education institutions.
  - Social transfers: better targeting via increased means testing and tightening eligibility criteria.

### Statistical issues and data enhancements (Appendix II)
- Hungary subscribes to the SDDS; metadata posted on the Fund’s DSBB.
- Chain-linked volume measures of GDP started from 2006Q3 with backward calculations to 2001; quarterly GDP estimated using production and expenditure approaches.
- MNB launched direct reporting (DR) system for BOP and IIP effective January 2008.
- HCSO methodological refinements: direct output volume measurement for some government services; refined measurement of financial intermediation services; inclusion of illegal activities into national accounts.
- HCSO and MNB investigating high level of errors and omissions in BOP; revise trade data back to 2004 in both NA and BOP in September 2008.
- Monetary statistics: MNB compiles statistics consistent with ECB framework using national residency approach since January 2003; coverage extended to include money market funds.

### External Debt Sustainability and financing needs (selected baseline projections, 2003–13)
- External debt (percent of GDP): 2003 61.6; 2004 67.0; 2005 75.0; 2006 90.5; 2007 96.4; 2008 94.2; 2009 93.3; 2010 93.4; 2011 93.5; 2012 93.7; 2013 94.0.
- Debt-stabilizing non-interest current account: -4.0.
- Gross external financing need (in billions of euros): 2007 29.5; 2008 37.8; 2009 44.4; 2010 43.2; 2011 47.0; 2012 46.7; 2013 49.4.
- Gross external financing need (percent of GDP): 2007 29.2; 2008 35.0; 2009 39.0; 2010 35.9; 2011 36.9; 2012 34.8; 2013 35.0.
- Net non-debt creating capital inflows (percent of GDP): 2007 -0.5; 2008 -4.7; 2009 -4.2; 2010 -3.5; 2011 -3.3; 2012 -3.3; 2013 -3.2.

### Public sector debt projections and scenarios (Appendix IV)
- Public sector debt (percent of GDP, baseline): 2003 58.0; 2004 59.4; 2005 61.7; 2006 65.6; 2007 66.0; 2008 64.9; 2009 64.2; 2010 63.3; 2011 62.4; 2012 61.8; 2013 61.0.
- o/w foreign-currency denominated (percent of GDP): 2003 14.1; 2004 15.3; 2005 17.4; 2006 18.5; 2007 18.6; 2008 18.3; 2009 18.1; 2010 17.8; 2011 17.6; 2012 17.4; 2013 17.2.
- Gross financing need (percent of GDP, public sector): 2007 19.2; 2008 24.0; 2009 18.6; 2010 17.0; 2011 13.7; 2012 13.3; 2013 12.6.
- Public sector debt-to-revenue ratio: 2007 147.9; 2008 145.1; 2009 145.4; 2010 143.3; 2011 141.3; 2012 139.9; 2013 138.2.
- Identified debt-creating flows (percent of GDP): 2007 -2.0; 2008 -1.3; 2009 -1.0; 2010 -1.1; 2011 -1.1; 2012 -0.8; 2013 -0.8.
- Primary balance (percent of GDP): 2007 1.4; 2008 -0.3; 2009 -0.8; 2010 -0.7; 2011 -0.7; 2012 -0.8; 2013 -0.9.

Scenarios and stress tests:
- Scenario with key variables at their historical averages: sample listed baseline debt values around mid-60s for early years.
- Scenario with no policy change (constant primary balance) in 2008-2013: 2008 64.9; 2009 63.6; 2010 63.1; 2011 62.7; 2012 62.6; 2013 62.5.
- Debt-stabilizing primary balance: 0.2 (debt-stabilizing primary balance, 10/).
- Debt sustainability stress tests include growth shock, primary balance shock, combined shock, and real depreciation and contingent liabilities shocks (one-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities in 2009 as defined in footnote 3/).

### Supplementary developments and Executive Board assessment (selected)
- Supplementary developments (September 10, 2008): government proposed a package of tax measures which—if enacted—would likely increase the fiscal deficit and could increase the fiscal deficit by up to ½ percentage point of GDP.
- Impact of Proposed Tax Package on Fiscal Balance, 2009 (In percent of GDP)
  - Revenue losses: 0.9 (Social security contributions 0.5; Personal income tax 0.3; Corporate income tax (net) 0.1; Taxes on fringe benefits 0.2).
  - Revenue increases and spending cuts: 0.9 (Excise taxes 0.1; Contributions to rehabilitation fund 0.1; Unspecified expenditure cuts 0.5).
- Recent macro developments (as reported): GDP growth accelerated from 1 percent year-on-year in 2008Q1 to 2 percent year-on-year in 2008Q2; CPI inflation in July was unchanged at 6¾ percent; private sector wage growth (excluding bonuses) in June was 9 percent; central bank left the policy interest rate unchanged in August.
- IMF Executive Board Assessment (selected points): commended substantial fiscal consolidation since mid-2006 and narrowing of the current account deficit; noted risks to external stability (high government debt, large net external liability position, financial system risks); recommended continued efforts to reduce vulnerabilities; urged further fiscal consolidation in 2009 in line with the Convergence Program; advised tax cuts be avoided unless offset by specific spending cuts and recommended that the 2009 budget include sizable contingency reserves; supported planned introduction of a rules-based fiscal framework if underpinned by credible policies; recommended monetary policy aim to reduce inflation to the 3 percent target over two years and be prepared to react quickly to inflationary shocks; financial sector recommendations reiterated (credit registry for households; strengthen stress testing; ensure adequate bank capitalization; expedite review of liquidity management; accelerate review of financial safety nets; enhance cross-border supervisory collaboration).

_Italic: _cr08313 - 1. Main Economic Indicators, 2003–09 (IMF staff report content)._

### 1. Main Economic Indicators, 2003–09 .....................................................................21

### 1. Main Economic Indicators, 2003–09

### Staff appraisal and summary: main findings
- The sharp fiscal consolidation and current account improvement in 2007 are welcome, but government debt and the net external liability position are still large.
- The combination of high vulnerabilities and the deterioration in global financial conditions over the past year has led to a large increase in government bond yields.
- Financial system risks—especially credit and liquidity risks—have risen.
- Looking forward, economic growth is expected to pick up in 2008–09, but risks to external stability remain high.
- Gross external financing needs in 2008–09 are high, though short-term debt is roughly covered by net international reserves.
- It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

### Policy priorities and recommendations
- Reduce vulnerabilities by further fiscal consolidation to put the government debt-to-GDP ratio on a downward path and narrow the current account deficit.
- Monetary policy should aim to reduce CPI inflation to the 3 percent target over two years.
- Financial sector policies should focus on improving banks’ risk management and reviewing safety nets.

Specific fiscal recommendations:
- Further fiscal consolidation in line with the targets in the latest Convergence Program is essential.
- For 2008, the fiscal deficit target seems attainable; any revenue overperformance should be saved and devoted to reducing public debt.
- Achieving the 2009 target will require strict spending restraint and continued strong revenue growth; there is no room for tax relief unless offset by spending cuts.
- The 2009 budget should include sizable contingency reserves given uncertainties.
- Introducing a rules-based fiscal framework would help deliver the required further fiscal consolidation.
- To boost potential GDP growth: a smaller size of government (and corresponding overall tax burden) and a shift in the tax burden would help.
- Further reforms of the pension, health, and education sectors are needed to reduce the ratio of government spending to GDP.
- A revenue-neutral shift in the tax burden away from labor and to consumption and wealth would improve work incentives and increase employment.

Monetary policy guidance:
- The elimination of the exchange rate band in early 2008 is welcome; in the new floating exchange rate regime, monetary policy can focus exclusively on the inflation target.
- Given the rise in inflationary pressures in the first half of 2008, the tightening of monetary policy has been appropriate.
- Looking forward, the policy interest rate may need to rise further, depending on the effects of the recent exchange rate appreciation and the evolution of underlying inflationary pressures.
- Policymakers should be prepared to react quickly and—if necessary—forcefully to inflationary shocks.

Financial sector recommendations:
- Establish a credit registry for households and strengthen stress testing, including of households’ foreign currency exposures.
- If the Hungarian Supervisory Authority judges that banks are not adequately capitalized, it should not hesitate to use its supervisory tools to require increases in capital.
- Expedite the review of banks’ liquidity management practices, develop liquidity management guidelines, and ensure banks have effective contingency arrangements.
- Accelerate the review of financial safety nets.

### Outlook and risks to external stability
- Real GDP growth slowed from 4 percent in 2006 to 1¼ percent in 2007, reflecting mainly the impact of fiscal consolidation on domestic demand.
- Private consumption fell by 2 percent in 2007.
- Fixed investment increased by just 1 percent in 2007.
- The unemployment rate has drifted up and the staff estimate of the output gap decreased from 1½ percent of potential output in 2006 to slightly above zero in 2007.
- Despite the slowdown, private sector credit growth (adjusted for changes in the exchange rate) stayed well above nominal GDP growth.
- Households’ debt service burden kept rising; mortgage debt as a share of GDP is still well below the EU average.
- With most new borrowing in foreign currency, households’ and corporates’ net foreign currency liabilities increased, raising indirect credit risk to the banking system.
- The current account deficit narrowed from 6 percent of GDP in 2006 to 5 percent of GDP in 2007; in 2008Q1 the current account deficit remained at 5 percent of GDP.
- Staff estimate that the underlying current account deficit is 9½ percent of GDP.
  - Text Table derivation (in percent of GDP): 2007 Current account balance -5.0; Temporary effects 0.0; Hungarian business cycle 0.1; Export partners' business cycle -0.2; Real exchange rate movements (through June 2008) -4.4; Underlying current account balance -9.5.
- Real effective exchange rate (REER) assessments:
  - Macroeconomic Balance Approach suggests an equilibrium CAD of 5 percent of GDP; implied exchange rate overvaluation 5½ percent after accounting for medium-term EU capital transfers of 1½ percent of GDP.
  - External Sustainability Approach suggests an NFA-stabilizing CAD of 3½ percent of GDP; implied real exchange rate overvaluation 8½ percent after EU transfers.
  - Equilibrium Real Exchange Rate Approach suggests the actual REER is about 12½ percent more appreciated than the equilibrium REER (forecast error 10-15 percent).
  - Overall assessment: 10 above (Text Table. Hungary: Real Exchange Rate Misalignment (in percent)).
- Although external financing needs declined in 2007, the composition of financing remained largely debt-creating; net non-debt-creating flows were negative in 2007 (largely due to one-off transactions).
- The net international investment position stabilized in 2007 but remains about 100 percent of GDP.
  - Gross external debt amounted to 97 percent of GDP.
  - Short-term debt on a residual maturity basis is 18 percent of GDP and is roughly covered by net international reserves.
- Staff project real GDP growth of 2 percent in 2008 and 2¾ percent in 2009.
- Over the medium term, staff estimate potential GDP growth at about 3–3½ percent.

### Key macroeconomic indicators (selected projections and historical figures)
- Real GDP growth: 2005 4.1; 2006 3.9; 2007 1.3; 2008 2.0; 2009 2.8 (Year-on-year percent change).
- Private consumption: 2005 3.6; 2006 1.9; 2007 -1.9; 2008 0.6; 2009 2.2.
- Gross fixed investment: 2005 5.3; 2006 -2.5; 2007 0.1; 2008 2.8; 2009 3.5.
- Exports of goods and services: 2005 11.5; 2006 19.0; 2007 14.2; 2008 13.3; 2009 9.6.
- Imports of goods and services: 2005 6.8; 2006 14.7; 2007 12.0; 2008 11.0; 2009 11.7.
- CPI (end-year): 2005 3.3; 2006 6.5; 2007 7.4; 2008 5.5; 2009 3.4.
- Unemployment rate (average, in percent): 2005 7.2; 2006 7.5; 2007 7.4; 2008 7.8; 2009 7.7.
- Nominal wage growth (average): 2005 8.7; 2006 8.2; 2007 8.0; 2008 7.7; 2009 6.0.
- General government balance (percent of GDP): 2005 -7.8; 2006 -9.2; 2007 -5.5; 2008 -4.0; 2009 -3.4.
- Current account balance (percent of GDP): 2005 -6.8; 2006 -6.1; 2007 -5.0; 2008 -4.9; 2009 -5.4.
- Net international investment position (percent of GDP): 2005 -92.4; 2006 -100.9; 2007 -100.5; 2008 -99.6; 2009 -99.9.

*Source: _cr08313 - 1. Main Economic Indicators, 2003–09 (IMF staff report content).*

### 19.     The financing need associated with the current account deficit, which is expected

### _cr08313 - 19.     The financing need associated with the current account deficit, which is expected

### External position and medium-term outlook
- The current account deficit is expected to widen gradually to 6½ percent of GDP by 2013.
- In 2008, the trade balance, net income, and current transfers are all projected to remain roughly stable.
- Thereafter, deterioration in the trade balance (due to the real exchange rate appreciation, the pick up in domestic demand, and the slowdown in partner country demand) is expected to exceed improvements in net income (due to the higher level of outward FDI) and EU current transfers.
- EU capital transfers are also projected to rise over the medium term.
- As a result, both the net IIP position and external debt (relative to GDP) would remain broadly stable in 2008–09 but then rise gently over the medium term.

### Uncertainties around the 2008–09 outlook
- Upside risk: better-than-projected agricultural production could spur stronger GDP growth.
- Downside risks:
  - A worsening of external financing conditions, precipitated by either global or domestic developments, would raise borrowing costs and complicate debt rollovers.
  - A large depreciation of the forint could temporarily improve competitiveness but would hurt household balance sheets, given large foreign-currency denominated liabilities.
  - Wealth effects from exchange rate movements could dampen economic growth and worsen credit quality, potentially leading to banking system stress.

### Fiscal policy—recent adjustment and remaining vulnerabilities
- Fiscal adjustment in 2007 was substantial but government debt remains high.
  - General government deficit narrowed from 9¼ percent of GDP in 2006 to 5½ percent of GDP in 2007.
  - Increase in revenue came from tax hikes and improvements in tax administration (the latter contributing ¼–⅓ percent of GDP).
  - Expenditure reduction sources: lower wage bill (nominal wage freeze and a 10 percent fall in public sector employment), lower capital expenditure, improved means-testing of energy and housing subsidies, and lower health spending.
- Despite the sharp decline in the fiscal deficit, government debt stabilized at 66 percent of GDP.
- With substantial amortization due in 2008–09, the government’s gross financing needs are high.

### Government securities market turmoil (Box 2)
- In early 2008, bid-ask spreads in the government securities market widened sharply and an auction was less than fully subscribed.
- Key contributing factors: deterioration in global financial market conditions; a more-rapid-than-expected shift in pension funds’ asset allocations toward equities; doubts about future fiscal consolidation given increased political uncertainty.
- Since early 2008:
  - Bid-ask spreads have narrowed and auctions have been fully subscribed, though government bond yields have remained elevated.
  - Primary dealers have been gradually selling their overhang of government bonds.
- AKK responses and plans:
  - Issue relatively more short-term bills and remain responsive to market participants’ preferences across maturities.
  - Abolish the requirement that primary dealers have a physical presence in Hungary to facilitate foreign entry.
  - Study legislative changes to accounting rules to deepen bond market liquidity by improving the functioning of the repo market.

### Fiscal targets, projections, and contingency planning
- Trailing four-quarter fiscal deficit amounted to 4¼ percent of GDP in 2008Q2.
- Deficit target for 2008 as a whole: 4 percent of GDP (assessed as attainable).
- Most of the 2008 adjustment is on the spending side: 1¾ percentage points of GDP (absence of one-off expenditures from 2007; decline in wage bill; lower subsidies to households).
- Structural fiscal adjustment in 2008 estimated at ¾ percentage points of GDP.
- Authorities and staff agreement: any revenue overperformance should be saved and devoted to reducing government debt.
- Text Table projections (General Government, 2006-10, in percent of GDP):
  - General government balance: 2006 -9.2; 2007 -5.5; 2008 -3.8; 2009 -3.3; 2010 -3.2
  - Revenues: 2006 42.6; 2007 44.6; 2008 44.7; 2009 44.2; 2010 44.2
  - Expenditures: 2006 51.8; 2007 50.1; 2008 48.6; 2009 47.5; 2010 47.4
  - Cyclically adjusted overall balance: 2006 -9.7; 2007 -5.5; 2008 -3.5; 2009 -2.9; 2010 -2.9
  - Cyclically adjusted overall balance (excl. one-off changes): 2006 -9.7; 2007 -4.5; 2008 -3.5; 2009 -2.9; 2010 -2.9
  - Memorandum items:
    - Primary balance: 2006 -5.5; 2007 -1.7; 2008 0.2; 2009 0.8; 2010 0.6
    - General government debt: 2006 65.6; 2007 66.0; 2008 64.9; 2009 64.2; 2010 63.3
- For 2009:
  - Authorities committed to Convergence Program target deficit of 3.2 percent of GDP.
  - Achieving target requires strict spending restraint and continued strong revenue growth (authorities forecast real GDP growth of 3½ percent).
  - Staff project a fiscal deficit of 3.3 percent of GDP based on a more conservative growth forecast.
  - Staff consider implied improvement in the structural fiscal balance of ½ percentage point of GDP appropriately ambitious.
- Contingency reserves:
  - Agreement on the importance of having sizable contingency reserves of ½ percent of GDP in the budget.
  - Fiscal risks highlighted: high government debt vulnerable to higher interest rates and exchange rate depreciation; high inflation putting upward pressure on wages, social transfers, transfers to local governments, and subsidies to state-owned enterprises; the loss-making state-owned railroad company; increasing debt of local governments.
- For 2010:
  - Staff support further fiscal consolidation in line with Convergence Program implying adjustment of ½ percentage point of GDP.
  - Enacted reforms will yield some fiscal savings; measures to fully achieve the target have not yet been outlined.
  - Staff projections assume only very small reductions in the fiscal deficit in 2010 and beyond.
  - In this scenario, public debt would fall modestly from 66 percent of GDP in 2007 to 61 percent of GDP in 2013.

### Rules-based fiscal framework and credibility (Box 3)
- Government proposal: fiscal responsibility law (FRL) to establish fiscal rules:
  - Ceiling on central government debt in real terms.
  - Floor of zero on the primary balance.
  - Pay-as-you-go constraint on discretionary budget items.
  - Make currently indicative ceilings binding.
- Proposed parliamentary budget office to provide independent scrutiny of compliance.
- Proposed constitutional amendments to provide a role for the constitutional court in enforcing fiscal rules and tighten constraints on local government borrowing.
- Staff support for rules-based framework: would help deliver further fiscal consolidation and lower borrowing costs.
- Staff note uncertainty over parliamentary approval of constitutional changes (require two-thirds majority); passage of FRL without constitutional changes would still be a valuable signal.
- Empirical results on numerical fiscal rules (EU-25, 1990–2005):
  - Adoption (or tightening) of a fiscal rule typically led to an increase in the cyclically-adjusted primary balance by about 0.4 percent of GDP, yielding a reduction in government bond yields by about 5 bps on impact and about 30 bps in the long run.
  - Credibility effect limited to countries with better fiscal track records and stronger institutional frameworks; where present, adoption (or tightening) of a fiscal rule typically reduced bond yields by about 10–40 bps on impact and up to 65 bps in the long run.
  - Institutional underpinning matters: higher credibility effects when fiscal rule accompanied by an independent monitoring body.

### Revenue-neutral tax measures and growth
- Authorities and staff discussed revenue-neutral tax measures to enhance medium-term growth:
  - Shift tax burden away from labor and to consumption and wealth to improve work incentives and boost employment.
  - Possibility: cut labor taxes combined with increases in the value-added tax (VAT) rate and excise duties; reduce exemptions to broaden the tax base.
  - Further simplification of the tax system and improvement in tax administration to cut compliance costs and limit tax evasion.
  - Staff suggested eventual introduction of a property tax accompanied by cuts in labor taxes; authorities noted strong popular opposition to a property tax.

### Structural reforms to reduce spending ratio
- Pensions:
  - Recently-enacted measures are positive; further steps legislated to take effect by 2013.
  - Most important future parametric change: further increase in the effective retirement age.
- Health care:
  - Key tasks: improve governance of hospitals and increase efficiency by adopting a sound regulatory framework.
- Education:
  - Enhanced coordination between local governments, expanded performance-based financing, and greater autonomy of higher education institutions to increase efficiency.
- Social transfers:
  - Better targeting via increased means testing and tightening eligibility criteria.
- Authorities acknowledged importance of restraining government spending growth but emphasized need for gradual changes to maintain social cohesion.

### Monetary policy stance and inflation outlook
- Exchange rate regime:
  - Exchange rate band removed in early 2008; Hungary moved to a floating exchange rate regime.
  - Monetary policy can now focus exclusively on the inflation target, factoring exchange rate movements into policy interest rate decisions.
  - Elimination of the band removed the possibility of a one-way bet against the forint and may increase awareness of risks associated with foreign-currency lending and borrowing.
- Recent tightening:
  - Monetary policy tightened over the past half year in response to increased inflationary pressures.
  - CPI inflation fell over the past year to 6¾ percent in June 2008, though high food and energy price inflation prevented a more rapid decline.
  - Core CPI inflation rose in the first half of 2008, reflecting in part high private sector wage growth.
  - Private sector wages were boosted by the increase in the minimum wage at the beginning of 2008.
  - Household inflation expectations have been roughly stable in recent quarters, in line with actual inflation.
- CPI weights (HICP weights):
  - Food and Energy weights in Hungary: Food 17, Energy 14
  - NMS-9: Food 21, Energy 14
  - Euro area: Food 14, Energy 10

### Monetary policy risks and required responses (Box 4)
- Baseline (staff and MNB): appreciation of the nominal effective exchange rate and projected below-potential growth in 2008–09 open a negative output gap and are expected to reduce inflation to the 3 percent target by the first half of 2010.
- Risks are significant and tilted to the upside.
- Two financial-shock scenarios and policy implications (small, two-economy macroeconomic model):
  - Risk premium shock on forint-denominated assets:
    - A 10 percent exchange rate depreciation could require a higher policy rate over time by as much as 300 bps, depending on exchange rate pass-through to inflation.
    - Uncertainty: impact of exchange rate depreciation on household spending given large foreign-currency denominated liabilities.
  - Euro area demand shock:
    - A large adverse shock to euro area aggregate demand that results in euro area GDP growth falling by ½ percentage point below baseline could imply a cut in the policy rate in Hungary over time by as much as 125 bps.
- Other risks:
  - Further increases in global food and energy prices would boost inflation, potentially affecting inflation expectations and wage pressures.
  - An increase in the risk premium on forint-denominated assets—stemming from tighter global financial conditions or increased political uncertainty—would put downward pressure on the exchange rate and tend to boost inflation.

### Financial stability assessment
- Financial system risks increased over the past year due to global financial market turbulence and continued rapid credit growth.
- Risk assessments published by MNB (Financial Stability Report) and HFSA (Financial Risk Outlook).
- Banking system health:
  - System is well-capitalized and profitable, though indicators deteriorated in 2007.
  - Capital adequacy ratio close to 11 percent, but has fallen every year since 2004.
  - Return on equity fell to 18 percent in 2007, due in part to lower interest margins from increased competition.
  - Nonperforming loan ratio has been stable in part because banks have sold overdue loans to work-out companies.
- Credit risks:
  - Rapid credit growth driven in part by easing lending standards for households (longer maturities, higher loan-to-value ratios for mortgages, new higher-risk products such as yen-based loans).
  - Prudential responses: MNB and HFSA announced guidelines on foreign currency risk management and consumer protection.
  - HFSA published criteria to implement Pillar II assessments.
  - Hungarian banks have no direct exposure to the U.S. subprime market.
- Liquidity and funding risks:
  - Robust credit growth has led to a rise in banks’ loan-to-deposit ratios, a decline in liquid asset ratios, and an increase in external funding to 30 percent of total liabilities.
  - Decline in global risk appetite increased banks’ external funding costs and shortened maturities.
  - External funding from non-parent sources amounts to about half of total external funding and is potentially more volatile than funding from parent banks.
  - Financial strains in mature markets are driving a slowdown in parent banks’ lending growth, likely affecting emerging market countries; magnitude and timing of additional spillovers to Hungary are uncertain.

*Italic: IMF staff report content as provided in the source document.*

### 33.     The authorities are taking additional measures to address these risks. Regarding

### _cr08313 - 33.     The authorities are taking additional measures to address these risks. Regarding

### Authorities' measures on credit risk
- The MNB conducts top-down stress tests.
- The MNB, with the HFSA, is working on the implementation of bottom-up stress-testing.
- A full-list credit registry for corporate borrowers already exists.
- Officials and staff agreed that a mandatory, full-list credit registry for households would:
  - improve banks’ credit risk management;
  - enhance consumer protection by discouraging the build-up of excessive household debt;
  - but officials pointed to privacy concerns.

### Authorities' measures on liquidity risk
- The HFSA is conducting a review of banks’ liquidity management practices to strengthen HFSA’s capacity to supervise liquidity management.
- Staff suggestions and interim recommendations:
  - The HFSA should develop and publish explicit recommendations on banks’ liquidity management as soon as possible.
  - In the meantime, the HFSA should ensure that banks have effective contingency arrangements.

### Financial safety nets and crisis management
- The HFSA has supervisory tools to encourage corrective action, including the authority to:
  - order a cessation of activities;
  - replace management;
  - require an increase in capital.
- Staff suggested consideration of introducing a formal system of early remedial action.
- Domestic crisis management arrangements between the MNB, the HFSA, and the MOF have been established and tested.
- Deposit insurance:
  - The deposit insurance scheme is already in compliance with the relevant EU directive.
  - The authorities are reviewing the co-insurance rules and the procedures to ensure rapid payments to depositors.
- Cross-border coordination:
  - Given important cross-border linkages to parent banks in western Europe and to subsidiary banks in southeastern Europe, the authorities recognize the importance of effective communication and collaboration with foreign financial authorities.
  - Cross-border MOUs are already in place.
  - A crisis simulation exercise is being planned.

### Key statistics cited in the content unit
- Real GDP (change in percent), 2003–2009: 4.2, 4.8, 4.1, 3.9, 1.3, 2.0, 2.8
- Private consumption (change in percent), 2003–2009: 7.8, 2.8, 3.6, 1.9, -1.9, 0.6, 2.2
- CPI (end year), 2003–2009: 5.7, 5.5, 3.3, 6.5, 7.4, 5.5, 3.4
- Unemployment rate (average, in percent), 2003–2009: 5.9, 6.1, 7.2, 7.5, 7.4, 7.8, 7.7
- Overall general government balance (percent of GDP), ESA-95 basis, 2003–2009: -7.2, -6.4, -7.8, -9.2, -5.5, -3.8, -3.3
- Gross public debt (percent of GDP), 2003–2009: 58.0, 59.4, 61.7, 65.6, 66.0, 64.9, 64.2
- Current account (percent of GDP), 2003–2009: -7.9, -8.4, -6.8, -6.1, -5.0, -4.8, -5.4
- Gross external debt (percent of GDP), 2003–2009: 61.6, 67.0, 75.0, 90.5, 96.4, 94.2, 93.3
- Reserves (in billions of US dollars), 2003–2009: 12.8, 16.0, 18.6, 21.6, 24.0, 26.4, 27.6

### Staff recommendations and considerations (summarized)
- Complete implementation of bottom-up stress-testing alongside existing top-down tests.
- Consider mandatory full-list household credit registry, weighing benefits for credit risk management and consumer protection against privacy concerns.
- HFSA to publish explicit liquidity management recommendations promptly and ensure effective contingency plans for banks.
- Consider formal system of early remedial action for supervisory enforcement.
- Continue to review deposit insurance co-insurance rules and depositor payment procedures to ensure rapid payouts.
- Strengthen cross-border communication and collaboration; follow through with planned crisis simulation exercise.

*Prepared by IMF staff; excerpt from the Staff Report for the 2008 Article IV Consultation informational annex (Hungary).*

### APPENDIX II.  HUNGARY—STATISTICAL ISSUES

### APPENDIX II. HUNGARY—STATISTICAL ISSUES

### A. Real Sector Statistics
- Hungary subscribes to the Special Data Dissemination Standard (SDDS); metadata posted on the Fund’s DSBB.
- Chain-linked volume measures of GDP:
  - Started from the third quarter of 2006 with backward calculations to 2001.
  - Quarterly GDP estimated using production and expenditure approaches.
  - First preliminary estimate of GDP volume indices released 45 days after the reference period.
  - Detailed estimates released 70 days after the end of the reference period.
  - Prior to chain-linking, GDP volume indices based on the production approach were compiled at constant prices of 2000.
  - Since the third quarter of 2006, HCSO has been compiling current price estimations.
- Methodological refinements:
  - As of September 2006, HCSO introduced direct output volume measurement for some government services (education and healthcare).
  - HCSO refined indirect measurement of financial intermediation services by introducing two separate reference rates for transactions in local and in foreign currencies.
  - HCSO started to include illegal activities into the national accounts.
- Consumer Price Index (CPI):
  - Compiled as an annual chained Laspeyres index using for weights the expenditure patterns of two years prior to the current period.
  - Computation of imputed rent for owner-occupied housing is based on the average price changes of different repair items and does not cover all elements of costs to the user.

### B. External Sector Statistics
- Balance of Payments (BOP) and International Investment Position (IIP):
  - MNB launched project in 2005 to replace the international transaction reporting system (ITRS) with direct reporting (DR) of respondents.
  - DR system became effective in January 2008: resident economic entities report directly transactions and positions vis-à-vis nonresident entities.
- Enhanced cooperation between HCSO and MNB:
  - Data sharing expanded: trade in goods (since 2003), FDI (since 2004), travel and business services (since 2005), transportation, insurance, financial and government services (since 2006).
  - Extended cooperation to non-financial accounts (compensation of employees and EU transfers).
  - Full responsibility for compilation and publication of BOP and IIP remains with MNB.
- Special-Purpose Entities (SPEs):
  - MNB changed reporting of stock and flow data of SPEs as of January 1, 2006.
  - Off-shore status of SPEs ceased to exist on December 31, 2005; from January 2006 the MNB compiles BOP including data on SPEs.
  - MNB continues to treat statistics excluding SPEs as readily interpretable; MNB defines SPE range in cooperation with HCSO.
- Errors and omissions in BOP:
  - HCSO, MNB and Ministry of Finance investigating high level of errors and omissions.
  - Joint task force (2007 work program) investigating possible flaws in Foreign Trade Statistics (FTS) including:
    - Possibly wrong attribution in FTS of Hungarian residence to foreign, nonresident companies importing/exporting goods with a Hungarian VAT number.
    - Possible VAT fraud (“carousel fraud”) leading to underestimation of goods imports.
  - VAT resident issue:
    - Task force explored impact on NA and BOP vs FTS concepts.
    - Final conclusion and decision in February 2008: revise trade data back to 2004 in both NA and BOP in a concerted way in September 2008; will respect Eurostat's relevant future recommendations, if any.
  - VAT fraud issue:
    - HCSO and MNB to agree on redesigning tax and customs authorities’ information system to provide necessary details on explored frauds for NA and BOP compilation; on HCSO-MNB 2008 work program.

### C. Monetary and Financial Statistics
- From January 2003, MNB compiles and publishes monetary statistics consistent with ECB framework using the national residency approach.
  - Coverage extended to include money market funds in addition to the central bank and credit institutions.
- Follow-up to 2001 data ROSC recommendations:
  - Authorities reported addressing all recommendations in monetary and financial statistics.
  - STA recommended market valuation of securities on depository corporations’ balance sheets.
    - From 2004, depository corporations were encouraged to use market valuation for securities in their trading portfolio.
    - From 2005, market valuation made compulsory for depository corporations listed on the stock exchange.

### D. Government Finance Statistics (GFS)
- January 2004 STA substantive update of the GFS dataset using July 2003 Data Quality Assessment Framework.
  - Significant progress on shortcomings of budget execution data and GFS identified in 2001 ROSC Data Module.
  - Improvements mainly in institutional coverage of general government, consolidation of data and reconciliation of deficit and financing.
  - Plans to report monthly expenditures classified on an economic basis had not yet been implemented.
- GFS publication status:
  - Latest data reported for publication in the 2007 GFS Yearbook are for 2006.
  - These data cover consolidated central government and consolidated general government sectors and subsectors.
  - Data for 2000 onwards compiled on an accrual basis and reported in Government Finance Statistics Manual 2001 format.

### Table of Common Indicators (as of July 11, 2008) — selected entries
- Exchange Rates: Date of latest observation 6/25/2008; Date received 6/25/2008; Frequency of Data D and M; Frequency of Reporting D and M; Frequency of Publication D and M.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation May 2008; Date received 6/6/2008; Frequency M (data/reporting/publication).
- Reserve/Base Money: May 2008; received 6/12/2008; Frequency M.
- Broad Money: May 2008; received 6/12/2008; Frequency M.
- Central Bank Balance Sheet: May 2008; received 6/12/2008; Frequency M.
- Consolidated Balance Sheet of the Banking System: May 2008; received 6/30/2008; Frequency M.
- Interest Rates: May 2008; received 6/5/2008; Frequency M.
- Consumer Price Index: Apr 2008; received 5/14/2008; Frequency M.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: latest year 2007; received 4/1/2008; Frequency A.
- Stocks of Central Government and Central Government-Guaranteed Debt: Q4 2007; received 4/1/2008; Frequency Q.
- External Current Account Balance: Q4 2007; received 3/31/2008; Frequency Q.
- GDP/GNP: Q4 2007; received 3/7/2008; Frequency Q.
- Gross External Debt: Q4 2007; received 3/31/2008; Frequency Q.
- International Investment Position: Q4 2007; date received 7/11/2008.

### External Debt Sustainability — Key figures and projections (2003–13)
- Baseline: External debt (percent of GDP)
  - 2003: 61.6
  - 2004: 67.0
  - 2005: 75.0
  - 2006: 90.5
  - 2007: 96.4
  - 2008: 94.2
  - 2009: 93.3
  - 2010: 93.4
  - 2011: 93.5
  - 2012: 93.7
  - 2013: 94.0
- Debt-stabilizing non-interest current account: -4.0
- Change in external debt (annual)
  - 2003: 7.1
  - 2004: 5.4
  - 2005: 8.0
  - 2006: 15.5
  - 2007: 5.9
  - 2008: -2.2
  - 2009: -0.9
  - 2010: 0.2
  - 2011: 0.1
  - 2012: 0.3
  - 2013: 0.3
- Identified external debt-creating flows (4+8+9)
  - 2003: 2.6
  - 2004: -2.6
  - 2005: -4.4
  - 2006: -0.6
  - 2007: -6.1
  - 2008: -1.7
  - 2009: -1.3
  - 2010: -0.9
  - 2011: -0.7
  - 2012: 0.0
  - 2013: 0.3
- Current account deficit, excluding interest payments (percent of GDP)
  - 2003: 5.7
  - 2004: 5.8
  - 2005: 3.8
  - 2006: 2.9
  - 2007: 1.3
  - 2008: 0.9
  - 2009: 1.3
  - 2010: 1.7
  - 2011: 1.9
  - 2012: 2.1
  - 2013: 2.3
- Deficit in balance of goods and services (percent of GDP)
  - 2003: 3.8
  - 2004: 2.7
  - 2005: 0.5
  - 2006: -0.4
  - 2007: -2.5
  - 2008: -2.6
  - 2009: -1.9
  - 2010: -1.2
  - 2011: -0.8
  - 2012: -0.4
  - 2013: 0.0
- Exports (euro terms, percent of GDP)
  - 2003: 61.5
  - 2004: 65.0
  - 2005: 67.8
  - 2006: 77.6
  - 2007: 80.0
  - 2008: 84.9
  - 2009: 89.4
  - 2010: 92.1
  - 2011: 96.6
  - 2012: 100.5
  - 2013: 105.1
- Imports (euro terms, percent of GDP)
  - 2003: 65.3
  - 2004: 67.7
  - 2005: 68.3
  - 2006: 77.2
  - 2007: 77.4
  - 2008: 82.4
  - 2009: 87.5
  - 2010: 90.9
  - 2011: 95.8
  - 2012: 100.1
  - 2013: 105.1
- Net non-debt creating capital inflows (negative = net inflows, percent of GDP)
  - 2003: -1.9
  - 2004: -5.4
  - 2005: -6.6
  - 2006: -4.3
  - 2007: -0.5
  - 2008: -4.7
  - 2009: -4.2
  - 2010: -3.5
  - 2011: -3.3
  - 2012: -3.3
  - 2013: -3.2
- Automatic debt dynamics (percent)
  - 2003: -1.3
  - 2004: -3.0
  - 2005: -1.7
  - 2006: 0.8
  - 2007: -7.0
  - 2008: 2.2
  - 2009: 1.6
  - 2010: 1.0
  - 2011: 0.7
  - 2012: 1.2
  - 2013: 1.3
- Contribution from nominal interest rate (percent)
  - 2003: 2.3
  - 2004: 2.6
  - 2005: 2.9
  - 2006: 3.2
  - 2007: 3.6
  - 2008: 4.0
  - 2009: 4.1
  - 2010: 4.2
  - 2011: 4.2
  - 2012: 4.2
  - 2013: 4.2
- Contribution from real GDP growth (percent)
  - 2003: -2.2
  - 2004: -2.7
  - 2005: -2.5
  - 2006: -2.9
  - 2007: -1.0
  - 2008: -1.8
  - 2009: -2.5
  - 2010: -3.2
  - 2011: -3.5
  - 2012: -3.0
  - 2013: -3.0
- Contribution from price and exchange rate changes (percent)
  - 2003: -1.4
  - 2004: -2.9
  - 2005: -2.1
  - 2006: 0.5
  - 2007: -9.5
  - 2008: ...
- Residual, incl. change in gross foreign assets (2-3)
  - 2003: 4.5
  - 2004: 8.0
  - 2005: 12.4
  - 2006: 16.1
  - 2007: 12.1
  - 2008: -0.6
  - 2009: 0.4
  - 2010: 1.0
  - 2011: 0.8
  - 2012: 0.3
  - 2013: 0.0
- External debt-to-exports ratio (percent)
  - 2003: 100.1
  - 2004: 103.1
  - 2005: 110.6
  - 2006: 116.6
  - 2007: 120.6
  - 2008: 110.9
  - 2009: 104.3
  - 2010: 101.4
  - 2011: 96.8
  - 2012: 93.3
  - 2013: 89.4
- Gross external financing need (in billions of euros)
  - 2003: 19.1
  - 2004: 25.7
  - 2005: 27.8
  - 2006: 30.6
  - 2007: 29.5
  - 2008: 37.8
  - 2009: 44.4
  - 2010: 43.2
  - 2011: 47.0
  - 2012: 46.7
  - 2013: 49.4
- Gross external financing need (percent of GDP)
  - 2003: 25.6
  - 2004: 31.2
  - 2005: 31.2
  - 2006: 34.0
  - 2007: 29.2
  - 2008: 35.0
  - 2009: 39.0
  - 2010: 35.9
  - 2011: 36.9
  - 2012: 34.8
  - 2013: 35.0

### Key Macroeconomic Assumptions Underlying Baseline
- Real GDP growth (percent)
  - 2003: 4.2
  - 2004: 4.8
  - 2005: 4.1
  - 2006: 3.9
  - 2007: 1.3
  - 2008: 2.0
  - 2009: 2.8
  - 2010: 3.6
  - 2011: 4.0
  - 2012: 3.4
  - 2013: 3.4
- GDP deflator in euros (change in percent)
  - 2003: 1.4
  - 2004: 5.1
  - 2005: 3.7
  - 2006: -2.5
  - 2007: 13.5
  - 2008: 4.7
  - 2009: 2.6
  - 2010: 1.9
  - 2011: 1.9
  - 2012: 1.9
  - 2013: 1.8
- Nominal external interest rate (percent)
  - 2003: 4.4
  - 2004: 4.7
  - 2005: 4.7
  - 2006: 4.3
  - 2007: 4.5
  - 2008: 4.4
  - 2009: 4.6
  - 2010: 4.7
  - 2011: 4.8
  - 2012: 4.8
  - 2013: 4.8
- Growth of exports (euro terms, percent)
  - 2003: 3.3
  - 2004: 16.3
  - 2005: 12.6
  - 2006: 16.0
  - 2007: 15.7
  - 2008: 13.4
  - 2009: 11.0
  - 2010: 8.7
  - 2011: 11.1
  - 2012: 9.5
  - 2013: 10.1
- Growth of imports (euro terms, percent)
  - 2003: 5.9
  - 2004: 14.1
  - 2005: 8.9
  - 2006: 14.6
  - 2007: 12.6
  - 2008: 13.6
  - 2009: 12.1
  - 2010: 9.6
  - 2011: 11.7
  - 2012: 10.0
  - 2013: 10.5
- Current account balance, excluding interest payments (percent of GDP) — repeats table values above.
- Net non-debt creating capital inflows (percent of GDP) — repeats table values above.

*Source: APPENDIX II. HUNGARY—STATISTICAL ISSUES (IMF staff report content).*

### APPENDIX IV

### APPENDIX IV

### Debt projections (Public sector debt, percent of GDP)
- Baseline: Public sector debt 1/
  - 2003: 58.0
  - 2004: 59.4
  - 2005: 61.7
  - 2006: 65.6
  - 2007: 66.0
  - 2008: 64.9
  - 2009: 64.2
  - 2010: 63.3
  - 2011: 62.4
  - 2012: 61.8
  - 2013: 61.0
- o/w foreign-currency denominated (percent of GDP)
  - 2003: 14.1
  - 2004: 15.3
  - 2005: 17.4
  - 2006: 18.5
  - 2007: 18.6
  - 2008: 18.3
  - 2009: 18.1
  - 2010: 17.8
  - 2011: 17.6
  - 2012: 17.4
  - 2013: 17.2
- Change in public sector debt (percentage points of GDP)
  - 2003: 2.4
  - 2004: 1.4
  - 2005: 2.3
  - 2006: 3.9
  - 2007: 0.4
  - 2008: -1.0
  - 2009: -0.7
  - 2010: -0.9
  - 2011: -0.9
  - 2012: -0.6
  - 2013: -0.8

### Identified debt-creating flows (percent of GDP)
- Identified debt-creating flows (4+7+12)
  - 2003: 0.8
  - 2004: -1.2
  - 2005: 5.1
  - 2006: 1.7
  - 2007: -2.0
  - 2008: -1.3
  - 2009: -1.0
  - 2010: -1.1
  - 2011: -1.1
  - 2012: -0.8
  - 2013: -0.8
- Primary deficit (percent of GDP)
  - 2003: 3.1
  - 2004: 2.0
  - 2005: 3.7
  - 2006: 5.3
  - 2007: 1.4
  - 2008: -0.3
  - 2009: -0.8
  - 2010: -0.7
  - 2011: -0.7
  - 2012: -0.8
  - 2013: -0.9
- Revenue and grants (percent of GDP)
  - 2003: 41.9
  - 2004: 42.6
  - 2005: 42.2
  - 2006: 42.6
  - 2007: 44.6
  - 2008: 44.7
  - 2009: 44.2
  - 2010: 44.2
  - 2011: 44.2
  - 2012: 44.2
  - 2013: 44.2
- Primary (noninterest) expenditure (percent of GDP)
  - 2003: 45.0
  - 2004: 44.5
  - 2005: 45.9
  - 2006: 47.9
  - 2007: 46.0
  - 2008: 44.4
  - 2009: 43.3
  - 2010: 43.5
  - 2011: 43.4
  - 2012: 43.4
  - 2013: 43.3

### Automatic debt dynamics and contributions (percent of GDP)
- Automatic debt dynamics 2/
  - 2003: -2.1
  - 2004: -2.4
  - 2005: 3.3
  - 2006: -2.3
  - 2007: -3.4
  - 2008: -1.0
  - 2009: -0.2
  - 2010: -0.4
  - 2011: -0.3
  - 2012: 0.0
  - 2013: 0.1
- Contribution from interest rate/growth differential 3/
  - 2003: -1.1
  - 2004: -0.6
  - 2005: 0.5
  - 2006: -0.6
  - 2007: -1.6
  - 2008: -1.0
  - 2009: -0.2
  - 2010: -0.4
  - 2011: -0.3
  - 2012: 0.0
  - 2013: 0.1
- Of which contribution from real interest rate (percent)
  - 2003: 1.0
  - 2004: 2.0
  - 2005: 2.8
  - 2006: 1.6
  - 2007: -0.8
  - 2008: 0.2
  - 2009: 1.5
  - 2010: 1.7
  - 2011: 2.0
  - 2012: 2.0
  - 2013: 2.0
- Of which contribution from real GDP growth (percent)
  - 2003: -2.1
  - 2004: -2.6
  - 2005: -2.3
  - 2006: -2.2
  - 2007: -0.8
  - 2008: -1.2
  - 2009: -1.7
  - 2010: -2.2
  - 2011: -2.4
  - 2012: -2.0
  - 2013: -1.9
- Contribution from exchange rate depreciation 4/
  - 2003: -1.0
  - 2004: -1.8
  - 2005: 2.8
  - 2006: -1.7
  - 2007: -1.8
  - 2008: ...

### Other identified debt-creating flows and residual (percent of GDP)
- Other identified debt-creating flows
  - 2003: -0.2
  - 2004: -0.8
  - 2005: -1.9
  - 2006: -1.2
  - 2007: 0.0
  - 2008: 0.0
  - 2009: 0.0
  - 2010: 0.0
  - 2011: 0.0
  - 2012: 0.0
  - 2013: 0.0
- Privatization receipts (negative)
  - 2003: -0.2
  - 2004: -0.8
  - 2005: -1.9
  - 2006: -1.2
  - 2007: 0.0
  - 2008: 0.0
  - 2009: 0.0
  - 2010: 0.0
  - 2011: 0.0
  - 2012: 0.0
  - 2013: 0.0
- Recognition of implicit or contingent liabilities
  - 2003–2013: 0.0 (each year)
- Other (specify, e.g. bank recapitalization)
  - 2003–2013: 0.0 (each year)
- Residual, including asset changes (2-3) 5/
  - 2003: 1.6
  - 2004: 2.6
  - 2005: -2.8
  - 2006: 2.2
  - 2007: 2.3
  - 2008: 0.3
  - 2009: 0.3
  - 2010: 0.2
  - 2011: 0.2
  - 2012: 0.2
  - 2013: 0.1

### Debt ratios and financing needs
- Public sector debt-to-revenue ratio 1/
  - 2003: 138.3
  - 2004: 139.5
  - 2005: 146.2
  - 2006: 153.8
  - 2007: 147.9
  - 2008: 145.1
  - 2009: 145.4
  - 2010: 143.3
  - 2011: 141.3
  - 2012: 139.9
  - 2013: 138.2
- Gross financing need 6/ (percent of GDP)
  - 2003: 19.1
  - 2004: 23.2
  - 2005: 24.6
  - 2006: 24.2
  - 2007: 19.2
  - 2008: 24.0
  - 2009: 18.6
  - 2010: 17.0
  - 2011: 13.7
  - 2012: 13.3
  - 2013: 12.6
- Gross financing need in billions of U.S. dollars
  - 2003: 16.1
  - 2004: 23.7
  - 2005: 27.2
  - 2006: 27.4
  - 2007: 26.6
  - 2008: 39.9
  - 2009: 32.9
  - 2010: 31.9
  - 2011: 27.3
  - 2012: 28.2
  - 2013: 28.1

### Scenarios
- Scenario with key variables at their historical averages 7/
  - 2003: 64.9
  - 2004: 64.9
  - 2005: 64.8
  - 2006: 64.7
  - 2007: 64.6
  - 2008: 64.4
  - 2009: -1.2
- Scenario with no policy change (constant primary balance) in 2008-2013
  - 2008: 64.9
  - 2009: 63.6
  - 2010: 63.1
  - 2011: 62.7
  - 2012: 62.6
  - 2013: 62.5
  - Debt-stabilizing primary balance 10/: 0.2

### Key macroeconomic and fiscal assumptions underlying baseline
- Real GDP growth (in percent)
  - 2003: 4.2
  - 2004: 4.8
  - 2005: 4.1
  - 2006: 3.9
  - 2007: 1.3
  - 2008: 2.0
  - 2009: 2.8
  - 2010: 3.6
  - 2011: 4.0
  - 2012: 3.4
  - 2013: 3.4
- Average nominal interest rate on public debt (in percent) 9/
  - 2003: 8.1
  - 2004: 8.3
  - 2005: 7.3
  - 2006: 6.9
  - 2007: 6.7
  - 2008: 6.8
  - 2009: 6.9
  - 2010: 6.5
  - 2011: 6.5
  - 2012: 6.5
  - 2013: 6.5
- Average real interest rate (nominal rate minus change in GDP deflator, in percent)
  - 2003: 2.3
  - 2004: 3.9
  - 2005: 5.1
  - 2006: 3.0
  - 2007: -1.3
  - 2008: 0.5
  - 2009: 2.7
  - 2010: 3.0
  - 2011: 3.5
  - 2012: 3.5
  - 2013: 3.5
- Nominal appreciation (increase in US dollar value of local currency, in percent)
  - 2003: 8.3
  - 2004: 15.3
  - 2005: -15.6
  - 2006: 11.5
  - 2007: 11.0
  - 2008: ...
- Inflation rate (GDP deflator, in percent)
  - 2003: 5.8
  - 2004: 4.4
  - 2005: 2.2
  - 2006: 3.9
  - 2007: 7.9
  - 2008: 6.3
  - 2009: 4.2
  - 2010: 3.5
  - 2011: 3.0
  - 2012: 3.0
  - 2013: 3.0
- Growth of real primary spending (deflated by GDP deflator, in percent)
  - 2003: -0.7
  - 2004: 3.7
  - 2005: 7.3
  - 2006: 8.4
  - 2007: -5.0
  - 2008: -1.4
  - 2009: 0.2
  - 2010: 3.9
  - 2011: 3.9
  - 2012: 3.3
  - 2013: 3.1
- Primary deficit (percent of GDP) (repeated for emphasis)
  - 2003: 3.1
  - 2004: 2.0
  - 2005: 3.7
  - 2006: 5.3
  - 2007: 1.4
  - 2008: -0.3
  - 2009: -0.8
  - 2010: -0.7
  - 2011: -0.7
  - 2012: -0.8
  - 2013: -0.9

### Debt sustainability stress tests (Public Debt in percent of GDP)
- Hungary: Public Debt Sustainability: Bound Tests 1/
  - Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks.
  - Ten-year historical average for the variable is also shown.
- Growth shock (in percent per year) — charted comparisons:
  - Baseline and shock box averages reported (figures shown in source charts; example values visible: 66, 61, 40, 45, 50, 55, 60, 65, 70, 75, 80, 85, 90 across years 2003–2013)
- Primary balance shock (in percent of GDP) and no policy change scenario
  - No policy change after 2008: Baseline assumption: 0.8; Scenario assumption: -0.9; Historical average: -1.0
  - Baseline assumption: 3.4; Scenario assumption: 2.9; Historical average: 4.1
  - Baseline assumption: 3.2; Scenario assumption: 4.5; Historical average: 2.1
- Combined shock 2/ and Real depreciation and contingent liabilities shocks 3/ — scenario descriptions included in source:
  - Combined shock: example box value 68 (baseline 61) in figure
  - Real depreciation and contingent liabilities shocks: one-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2009 (as defined in footnote 3/)

### Supplementary information and Executive Board assessment (selected findings and recommendations)
- Supplementary developments (September 10, 2008)
  - The government proposed a package of tax measures which—if enacted—would likely increase the fiscal deficit and could increase the fiscal deficit by up to ½ percentage point of GDP.
  - Prospects for enactment were uncertain because the government did not have a majority in parliament (as reported).
- Impact of Proposed Tax Package on Fiscal Balance, 2009 (In percent of GDP)
  - Revenue losses: 0.9
    - Social security contributions: 0.5
    - Personal income tax: 0.3
    - Corporate income tax (net): 0.1
    - Taxes on fringe benefits: 0.2
  - Revenue increases and spending cuts: 0.9
    - Excise taxes: 0.1
    - Contributions to rehabilitation fund: 0.1
    - Unspecified expenditure cuts: 0.5
- Recent macro developments (as reported)
  - GDP growth accelerated from 1 percent year-on-year in 2008Q1 to 2 percent year-on-year in 2008Q2.
  - CPI inflation in July was unchanged at 6¾ percent.
  - Private sector wage growth (excluding bonuses) in June was 9 percent.
  - Central bank left the policy interest rate unchanged in August.
  - Government and central bank agreed to keep the inflation target at 3 percent (with a +/- 1 percent tolerance band) for the next three years (or until ERM2 entry).
- IMF Executive Board Assessment (summary of selected points)
  - Commended substantial fiscal consolidation since mid-2006 and narrowing of the current account deficit.
  - Noted risks to external stability: high level of government debt, large net external liability position, and financial system risks amid global financial market conditions.
  - Recommended continued efforts to reduce vulnerabilities: put government debt-to-GDP ratio on a downward path, preserve domestic stability and confidence in the currency, and strengthen financial sector resilience.
  - Urged further fiscal consolidation in 2009 in line with the Convergence Program; advised that tax cuts should be avoided unless offset by specific spending cuts and that the 2009 budget should include sizable contingency reserves.
  - Supported planned introduction of a rules-based fiscal framework if underpinned by credible policies.
  - Recommended monetary policy aim to reduce inflation to the 3 percent target over two years and be prepared to react quickly to inflationary shocks.
  - Financial sector recommendations: establish a credit registry for households; strengthen stress testing including households’ foreign currency exposures; ensure adequate bank capitalization; expedite review of banks’ liquidity management practices and develop liquidity management guidelines; accelerate review of financial safety nets; enhance collaboration with foreign supervisory authorities.

### Hungary: Main Economic Indicators, 2004–08 (selected series)
- Real economy (change in percent)
  - Real GDP: 2004: 4.8; 2005: 4.1; 2006: 3.9; 2007: 1.3; 2008 (Proj.): 2.0
  - CPI (end year): 2004: 5.5; 2005: 3.3; 2006: 6.5; 2007: 7.4; 2008 (Proj.): 5.5
  - CPI (average): 2004: 6.8; 2005: 3.6; 2006: 3.9; 2007: 7.9; 2008 (Proj.): 6.3
  - Unemployment rate (average, in percent): 2004: 6.1; 2005: 7.2; 2006: 7.5; 2007: 7.4; 2008 (Proj.): 7.8
  - Gross domestic investment (percent of GDP) 1/: 2004: 25.9; 2005: 23.6; 2006: 23.1; 2007: 23.0; 2008 (Proj.): 23.8
  - Gross national saving (percent of GDP, from BOP): 2004: 17.5; 2005: 16.8; 2006: 17.0; 2007: 18.0; 2008 (Proj.): 19.0
- General government (percent of GDP), ESA-95 basis 2/
  - Overall balance: 2004: -6.4; 2005: -7.8; 2006: -9.2; 2007: -5.5; 2008 (Proj.): -3.8
  - Primary balance: 2004: -2.3; 2005: -3.9; 2006: -5.5; 2007: -1.7; 2008 (Proj.): 0.2
  - Debt: 2004: 59.4; 2005: 61.7; 2006: 65.6; 2007: 66.0; 2008 (Proj.): 64.9
- Money and credit (end-of-period, percent change)
  - M3: 2004: 11.6; 2005: 14.6; 2006: 13.7; 2007: 11.1; 2008: ...
  - Credit to nongovernment: 2004: 19.2; 2005: 18.9; 2006: 17.1; 2007: 17.3; 2008: ...
- Interest rates (percent)
  - T-bill (90-day, average): 2004: 11.1; 2005: 6.8; 2006: 7.0; 2007: 7.6; 2008: ...
  - Government bond yield (5-year, average): 2004: 9.7; 2005: 8.0; 2006: 6.9; 2007: 7.0; 2008: ...
- Balance of payments
  - Goods and services trade balance (percent of GDP): 2004: -2.7; 2005: -0.5; 2006: 0.4; 2007: 2.5; 2008 (Proj.): 2.6
  - Current account (percent of GDP): 2004: -8.4; 2005: -6.8; 2006: -6.1; 2007: -5.0; 2008 (Proj.): -4.8
  - Reserves (in billions of US dollars): 2004: 16.0; 2005: 18.6; 2006: 21.6; 2007: 24.0; 2008 (Proj.): 26.4
  - Gross external debt (percent of GDP) 3/: 2004: 67.0; 2005: 75.0; 2006: 90.5; 2007: 96.4; 2008 (Proj.): 94.2
  - Net international investment position (in percent of GDP): 2004: 83.5; 2005: 92.4; 2006: 100.9; 2007: 100.5; 2008 (Proj.): 99.5
- Exchange rate
  - Exchange regime: Floating
  - Present rate (September 17, 2008): Ft 169.9 = US$1
  - Nominal effective rate (2000=100): 2004: 110.7; 2005: 111.6; 2006: 105.1; 2007: 111.8; 2008: ...
  - Real effective rate, CPI basis (2000=100): 2004: 130.0; 2005: 132.6; 2006: 127.0; 2007: 142.5; 2008: ...

*Source: International Monetary Fund staff report supplement and Appendix IV tables and figures.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08313.pdf_