## _cr08361

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---

### I. Background and recent economic challenges
- Hungary experienced intensified financial market stress in mid-October 2008 as global financial turmoil reduced financing access and raised costs.
- Longstanding balance-sheet vulnerabilities:
  - General government deficit averaged more than 8 percent of GDP between 2002 and 2006.
  - General government debt amounted to 66 percent of GDP as of end-2007.
  - External debt about 97 percent of GDP at end-2007.
  - Over half of bank lending to the nonfinancial sector denominated in foreign currency (mostly euro and Swiss francs).
  - Main domestic bank accounts for 21 percent of banking system assets; major foreign-owned banks account for another 52 percent.
- Recent 2008 pressures:
  - Banks had difficulty rolling over maturing foreign currency swaps.
  - Auctions of government securities less than fully successful; secondary market liquidity tightened.
  - Government bond yields and sovereign CDS spreads rose sharply; stock market fell; forint depreciated.
  - Several banks announced slowing growth of lending, particularly foreign currency-denominated lending.
- Key policy developments since 2006:
  - Fiscal consolidation began mid-2006; fiscal deficit fell from 9¼ percent of GDP in 2006 to 5 percent of GDP in 2007.
  - CPI inflation peaked at 9 percent (year-on-year) in early 2007; was 5¾ percent in September 2008.
  - Exchange rate band eliminated in early 2008.

### II. SBA-supported program — objectives, design, and EU cooperation
- Overall objectives:
  - Strengthen Hungary’s economy and foster return of less stressed financial market conditions.
  - Reduce size of the public sector and lower structural risks from financial sector balance-sheet mismatches.
  - Ensure consistency with Hungary’s commitments to the European Union.
- Program pillars:
  - Strong policy program: substantial fiscal adjustment and upfront bank capital enhancement.
  - Large external financing assistance: external buffer to minimize run risk given large external debt stock; encouragement of large private creditors to maintain exposures.
- EU cooperation principles applied:
  - Early consultation and ongoing information exchange between IMF and European Commission/EFC.
  - Final program package contains sizeable contributions from the IMF, the EU, and the World Bank; joint announcement and coordinated press activity.
  - Consistency of design and conditionality between IMF and EU arrangements; regular coordination during monitoring.

### III. Macroeconomic framework and 2009 projections
- Crisis severity and mitigating factors:
  - Expected to follow pattern of previous capital account crises but be less severe due to: entering from low growth rather than overheating; expected EU structural funds; assurances from foreign parent banks; early policy action and external support.
- 2009 key projections and drivers:
  - Output: expected to contract by about 1 percent in 2009.
    - Drivers: sharp reduction in new bank lending, exchange rate depreciation increasing debt servicing on foreign currency loans, no fiscal stimulus due to lack of fiscal space and tight financing conditions.
  - Inflation:
    - Peaked at 9 percent in early 2007; stood at 5¾ percent in September 2008.
    - Expected to reach 4 percent at end-2009.
  - Current account:
    - Projected to drop by more than 4 percentage points of GDP between 2008 and 2009.
    - Adjustment driven primarily by sharp contraction of imports.
  - Capital and financial account:
    - Surplus of €8.2 billion in 2007; expected to fall to €6.4 billion in 2008; expected to be a deficit of €7.5 billion in 2009.
  - Rollover assumptions:
    - Foreign-owned banks account for some 60 percent of banks’ short-term external debt and are assumed to roll over 80 percent of parent funding.
    - Rollover rates for other forms of debt assumed to be 70 percent.
- Medium term:
  - Growth expected to reach estimated potential of 3 percent after 2011.
  - Adjustment expected to follow a U-shaped pattern; current account adjusts slowly due to sluggish investment response and slow improvement in national savings.

### IV. Fiscal consolidation: objectives, measures, and targets
- Recent consolidation achievements and vulnerabilities:
  - Headline deficit reduced from 9¼ percent of GDP in 2006 to an expected 3.4 percent in 2008 (ESA-95).
  - Past fiscal excesses left Hungary vulnerable because of large stock and maturity structure of government debt; growing interest burden limits further adjustment room.
  - Non-residents hold about 30 percent of Hungary’s forint-denominated debt (about 8 percent of treasury bills and 35 percent of treasury bonds).
- 2009 program targets:
  - General government deficit target: 2.5 percent of GDP in 2009.
  - Implies structural fiscal adjustment of 2½ percent of GDP (2 percentage points more than envisaged in the 2008 Article IV staff report).
  - Program incorporates higher interest payments and financing needs connected with the bank-support package.
- Expenditure-side measures (primary government expenditure targeted to fall by 2 percentage points of GDP relative to 2008):
  - Nominal wage freeze and elimination of the 13th monthly salary for all public sector employees (1 percent of GDP).
  - Elimination of the 13th monthly pension for all early retirees and cap of the 13th monthly pension to HUF 80,000 for other pensioners (0.2 percent of GDP).
  - Postponement or elimination of indexation of selected social benefits (0.2 percent of GDP).
  - Across-the-board cuts in other ministry spending allocations (0.5 percent of GDP).
  - Within capital expenditure, priority to EU structural fund cofinanced projects (0.1 percent of GDP).
- Revenue stance:
  - Tax cuts previously envisaged for 2009 postponed until fiscal space created by expenditure restraint.
  - Authorities will not make tax-code changes leading to net revenue loss.
- Fiscal governance reforms:
  - Draft fiscal responsibility law submitted to parliament with rules: public debt cannot increase in real terms; primary balance cannot be negative; rolling three-year expenditure ceilings; creation of a non-partisan fiscal council.
  - Political constraints: lack of two-thirds majority required compromise on local government rules and constitutional enforcement mechanism; cost of violation is reputational.

### V. Banking sector support, Guarantee Fund, and liquidity measures
- Bank-support package — size and structure:
  - Total funding: HUF 600 billion (2.2 percent of GDP) divided evenly between:
    - Capital Base Enhancement Fund (HUF 300 billion).
    - Refinancing Guarantee Fund (HUF 300 billion).
  - Availability: Funds available to all private Hungarian banks of systemic importance with own funds above HUF 200 billion (0.73 percent of GDP) — effectively covering three largest banks; other 33 banks covered via blanket deposit guarantee and widened central bank refinancing access.
  - Any unused Capital Base Enhancement Fund amounts by end-January 2009 will transfer to the Refinancing Guarantee Fund.
- Capital Base Enhancement Fund mechanics:
  - Sized to bring eligible banks’ CAR up to 14 percent.
  - Two largest banks had CARs just below 10 percent as of end-June 2008 and eligible for capital increases of around HUF 200 billion and HUF 100 billion, respectively.
  - Preference shares: dividend equals government cost plus margin of 2 percentage points, increasing by one percentage point annually from 2011; banks may repurchase when consistent with strong capital positions.
  - Stress test: starting from CAR of 14 percent, largest domestic bank would preserve CAR above 8 percent under combined losses of 5 percent on HUF loans, 10 percent on foreign currency loans, and 10 percent on foreign subsidiaries’ assets.
- Refinancing Guarantee Fund and liquidity measures:
  - Guarantee Fund capitalized at HUF 300 billion (1.1 percent of GDP).
  - Invested in euro-denominated government bonds of Euro area countries and managed by the MNB.
  - Guarantees available for rollover of loans and wholesale debt securities initial maturity > 3 months and ≤ 5 years; open for new transactions until end-2009; provided against a fee not to exceed 4% per annum.
  - Additional measures: blanket government deposit guarantee (announced October 8); widened access to central bank refinancing; foreign exchange swap facility; two new MNB forint liquidity facilities (two-week fixed-price refinancing window and six-month tender with no fixed price); expansion of usable collateral for MNB facilities as needed.
- Household foreign-currency loan exposure and borrower relief:
  - Authorities seeking agreement with commercial banks on measures to mitigate household balance-sheet risks, including: loan duration extension with fixed installments at debtor request; conversion of foreign currency loans to forint without extra charges upon debtor request; transitional installment reductions if debtor unable to service existing loan.
  - Private debt resolution strategy to be implemented if asset quality deteriorates (LOI ¶13).
- Supervisory and resolution enhancements:
  - Strengthening HFSA and MNB capacity; mechanism to grant HFSA remedial powers to accelerate bank resolution to be submitted to parliament by end-December 2008 (structural benchmark, LOI ¶15).
  - Introduction of positive credit registry for households and maximum loan-to-value ratio requirements for new mortgage loans.

### VI. External financing, exceptional access, and capacity to repay
- Gross external financing requirements: projected about €39 billion through end-2009.
- Financing gap: €20 billion after expected sources.
- External commitments reducing gap: European Union commitments of €6.5 billion and the World Bank €1 billion.
- Reserve implications: without such financing, gross reserves projected to fall to about €7.8 billion at end-2009, covering only 30 percent of short-term debt by remaining maturity (end-Q2 2008 coverage was 72 percent).
- Exceptional access request and SBA terms:
  - Exceptional access requested: €12.5 billion (SDR 10.5 billion, 1,015 percent of quota).
  - Upfront disbursement proposal: up to €5 billion to be disbursed up front.
  - Staff assesses Hungary meets four exceptional access criteria.
  - Fund exposure by end of arrangement projected to be about 10 percent of GDP and 53.5 percent of gross reserves.
- Risks to capacity to repay:
  - Accelerated capital outflows leading to exchange rate overshooting and sharper GDP slowdown.
  - Sharper depreciation increasing household and corporate debt burdens and hurting bank health.
  - Failure to reach agreement with banks on reducing borrower balance-sheet risks.
  - Rollover rates falling significantly or prolonged below assumptions.
  - Political risk: government lacks majority in parliament.
- Fund financial exposures and implications:
  - Proposed SBA access (SDR, phasing):
    - November 6, 2008: SDR 4,215.0 (405.9 percent of quota).
    - February 15, 2009: SDR 2,107.5 (203.0 percent of quota).
    - May 15, 2009: SDR 1,264.5 (121.8 percent of quota).
    - August 15, 2009: SDR 1,264.5 (121.8 percent of quota).
    - November 15, 2009: SDR 1,264.5 (121.8 percent of quota).
    - February 15, 2010: SDR 421.5 (40.6 percent of quota).
    - Total: SDR 10,537.5 (1,014.8 percent of quota).
  - If fully drawn, Fund credit outstanding to Hungary would reach 1,014.8 percent of quota and represent about 10 percent of Hungary’s GDP.
  - Proposed SBA would reduce the Fund’s one-year FCC by SDR 10.5 billion (about 8 percent of FCC as of end-September).
  - Projected charges on Hungary’s GRA obligations: SDR 355 million in 2009; projected Fund debt service payments shown peaking in later years.
- Mitigants and design features:
  - Program duration 17 months (Nov 2008–Mar 2010) with phasing and quarterly reviews.
  - Upfront policy actions to lock in fiscal and financial measures (e.g., submission of Fiscal Responsibility Law, bank-support legislation).
  - Monitoring includes daily monitoring of banks’ foreign assets, liabilities, and swap positions.

### VII. Program monitoring, conditionality, and performance criteria
- Program length: 17 months from November 2008 to March 2010.
- Disbursement phasing and review schedule (SDR amounts and dates as above).
- Quantitative performance criteria and indicative targets include:
  - Floor on central government system primary cash balance (end-December 2008 performance criterion: 215 billion HUF).
  - Band around 12-month CPI inflation (quarterly bands specified; central point and inner/outer band values provided for Dec 2008–Sep 2009).
  - Floor on change in net international reserves (NIR outstanding stock end-September 2008: 15,890.7 million euros; cumulative external program disbursement baseline projections from end-September 2008: end-December 2008: 2,000; end-March 2009: 4,500; end-June 2009: 6,500; end-September 2009: 7,500).
  - Continuous criterion: non-accumulation of external debt arrears (arrear = payment not made within seven days after due).
  - Indicative ceiling on total debt stock of central government system (end-September 2008 actual: 15,973 billion HUF; ceilings for subsequent dates specified: end-December 2008: 16,320; end-March 2009: 16,650; end-June 2009: 16,850; end-September 2009: 16,860).
- Structural conditionality and benchmarks:
  - Structural performance criterion: submission to parliament of draft support package for domestic banks and request initiation of extraordinary procedures for early passage by November 10, 2008.
  - Structural benchmarks:
    - Passage of fiscal responsibility law by end-December 2008.
    - Submission to parliament of draft law granting HFSA special remedial powers to accelerate resolution of failed banks by end-December 2008.
- Safeguards assessment:
  - First-time safeguards assessment of the MNB to be completed no later than first review under the SBA.
  - Audited financial statements published; preliminary findings indicate MNB external audit and financial reporting practices comply with international standards.

### VIII. Key quantitative indicators (selected, preserved exactly as reported)
- Real GDP (annual percent change): 2005: 4.1; 2006: 3.9; 2007: 1.1; 2008: 1.8; 2009 proj.: -1.0.
- CPI (end year): 2005: 3.3; 2006: 6.5; 2007: 7.4; 2008: 5.1; 2009 proj.: 4.2.
- Unemployment rate (average, percent): 2005: 7.2; 2006: 7.5; 2007: 7.4; 2008: 7.8; 2009 proj.: 8.5.
- Gross external debt (percent of GDP): 2005: 75.0; 2006: 90.4; 2007: 97.2; 2008: 106.4; 2009 proj.: 115.8.
- Gross official reserves (billions of euros): 2005: 15.7; 2006: 16.4; 2007: 16.4; 2008: 19.5; 2009 proj.: 19.8.
- General government balance (ESA-95, percent of GDP): 2006: -9.3; 2007: -4.9; 2008 Est.: -3.4; 2009 Staff proj.: -2.9; 2010 Proj.: -2.5; 2011 Proj.: -2.0; 2012 Proj.: -1.5.
- Public sector debt (percent of GDP, baseline): 2008: 67.4; 2009: 70.1; 2010: 68.4; 2011: 66.2; 2012: 62.9; 2013: 59.4.
- External debt (percent of GDP, baseline): 2008: 106.4; 2009: 115.8; 2010: 105.4; 2011: 98.8; 2012: 90.6; 2013: 84.8.
- Program access and phasing (SDR): total SDR 10,537.5 (1,014.8 percent of quota); first disbursement SDR 4,215.0 on November 6, 2008 (405.9 percent of quota).

### IX. Staff appraisal, risks, and priorities
- Staff diagnosis:
  - Hungary’s prior macro adjustment was disrupted by global financial crisis; fiscal adjustment reduced headline deficits but was insufficient amid market stress.
  - Regaining credibility requires financing plus policy discipline.
- Policy priorities emphasized by staff:
  - Lock in fiscal adjustment and structural fiscal reforms (fiscal responsibility law, medium-term framework).
  - Ensure banking sector solidity via capital enhancement and liquidity guarantees, strengthen HFSA and MNB capacities, and implement borrower relief measures.
  - Maintain prudent monetary policy to bring inflation toward the 3 percent target by early 2010 while using liquidity tools consistent with inflation targeting.
- Key risks reiterated:
  - More severe economic deterioration than projected.
  - Slower recovery of global financial markets.
  - Insufficient political support for key measures.
- Program aim:
  - Restore market confidence, provide breathing space for adjustment, and support medium-term fiscal and banking-sector reforms leading toward sustainable growth and eventual euro accession.

*Source: _cr08361 — IMF staff report and Technical Memorandum of Understanding excerpts as provided in the supplied PDF content unit.*

### 1. Main Economic Indicators, 2005–09 ...................................................................................

### _cr08361 - 1. Main Economic Indicators, 2005–09

### I. Background and recent economic challenges
- Hungary was among the first emerging market countries to suffer from the fallout of the current global financial crisis; financing conditions deteriorated sharply in mid-October 2008.
- Balance sheet vulnerabilities accumulated over a long period due to excessive borrowing by public and private sectors and high foreign investor risk appetite (Figure 1).
- Fiscal and debt facts:
  - The general government deficit averaged more than 8 percent of GDP between 2002 and 2006.
  - General government debt amounted to 66 percent of GDP as of end-2007.
- Banking and currency exposure:
  - The main domestic bank accounts for 21 percent of banking system assets and the major foreign-owned banks account for another 52 percent.
  - Over half of bank lending to the nonfinancial sector is denominated in foreign currency (mostly euro and Swiss francs).
  - External debt amounted to about 97 percent of GDP at end-2007.
- Policy developments since 2006:
  - Fiscal consolidation began in mid-2006; the fiscal deficit fell from 9¼ percent of GDP in 2006 to 5 percent of GDP in 2007.
  - CPI inflation fell to 5¾ percent in September 2008 after surging in early 2007.
  - The exchange rate band was eliminated in early 2008.
- Recent developments and pressures (2008):
  - Banks faced difficulties rolling over maturing foreign currency swaps.
  - Auctions of government securities were less than fully successful; secondary market liquidity tightened.
  - Government bond yields and sovereign CDS spreads rose sharply; the stock market fell; the currency depreciated.
  - Several banks announced they would slow growth of lending, particularly foreign currency-denominated lending.
- Key economic challenges:
  - Large stock vulnerabilities imply substantial debt servicing and rollover needs.
  - Large share of foreign currency lending creates exchange rate and rollover risks via foreign exchange swaps.
  - Past policy action was insufficient; fiscal and current account deficits did not come down sufficiently.

### II. The SBA-supported program — objectives and design
- Overall objectives:
  - Strengthen Hungary’s economy and foster a return of less stressed financial market conditions.
  - Reduce the size of the public sector and lower structural risks from financial sector balance sheet mismatches.
  - Ensure program consistency with Hungary’s commitments to the European Union (Box 1).
- Regional and spill-over considerations:
  - Stabilizing a Hungarian financial group that is regionally active will enhance credibility of its subsidiaries and reduce host-country risks.
  - Addressing Hungary’s crisis reduces negative spillovers to home markets of prominent foreign banks active in Hungary.
- Program pillars:
  - Strong policy program:
    - Substantial fiscal adjustment to address large public debt and provide confidence on financing needs.
    - Upfront bank capital enhancement to ensure banks can weather the imminent economic downturn.
  - Large external financing assistance:
    - A very substantial external financial buffer is essential to minimize the risk of a run on Hungary’s debt and currency markets given the large external debt stock.
    - Large private sector creditors—especially foreign parent banks of major Hungarian banks—were encouraged to maintain exposures and have responded favorably.

- EU cooperation (Box 1) — key practical principles used in the Hungary case:
  - Early consultation and ongoing information exchange between the IMF and the European Commission/EFC.
  - The final program package contains sizeable contributions from the IMF, the EU, and the World Bank.
  - Joint announcement and coordinated press activity to underline broad support and front-loaded support to address urgent balance of payments needs.
  - Consistency of program design and conditionality between IMF and EU arrangements.
  - Consultation during program monitoring with regular coordination between institutions.

### III. Macroeconomic framework and projections
- Crisis severity outlook:
  - Hungary’s response is expected to follow the pattern of previous capital account crises but be less severe due to four mitigating factors:
    1. Hungary entered from a period of low growth rather than overheating.
    2. EU structural funds are expected to provide a stable financing source and limit the fall in investment.
    3. Program includes assurances from foreign parent banks that they will maintain their exposures.
    4. Early policy action and external support are in place to prevent negative feedback loops.
- Key projections and quantitative expectations for 2009:
  - Output: expected to contract by about 1 percent in 2009.
    - Drivers: sharp reduction in new bank lending, exchange rate depreciation increasing debt servicing on foreign currency denominated loans, no fiscal stimulus due to lack of fiscal space and tight financing conditions.
  - Inflation:
    - Peaked at 9 percent (year-on-year) in early 2007.
    - Currently stands at 5¾ percent.
    - Expected to reach 4 percent at end-2009 due to a large negative output gap and decline of global food and energy prices outweighing exchange rate depreciation effects.
  - Current account:
    - Projected to drop by more than 4 percentage points of GDP between 2008 and 2009.
    - Adjustment driven primarily by a sharp contraction of imports (partly upheld by imports related to investments related to EU-funds).
  - Capital and financial account:
    - Surplus of €8.2 billion in 2007.
    - Expected to fall to €6.4 billion in 2008 (with a large deterioration in the last quarter).
    - Expected to be a deficit of €7.5 billion in 2009 (with some improvement late in the year as markets regain confidence).
    - Capital account improvement somewhat from absorption of already committed EU funds.
    - Net portfolio flows, external borrowing by the government, and lending to corporates expected to slow sharply.
  - Rollover assumptions:
    - Foreign-owned banks account for some 60 percent of banks’ short-term external debt and are cautiously assumed to roll over 80 percent of their funding from parent banks.
    - Rollover rates for other forms of debt are assumed to be 70 percent.
- Medium-term growth path:
  - Growth is expected to reach its estimated potential of 3 percent after 2011.
  - The adjustment is expected to follow a U-shaped pattern rather than a V-shaped one, reflecting simultaneous GDP slowdown in Hungary’s main trading partners and global deleveraging.
  - After contracting sharply in 2009, the current account is expected to adjust slowly over the medium term due to sluggish investment response and slow improvement in national savings.

*Source: _cr08361 - 1. Main Economic Indicators, 2005–09*

### 13. In recent years, fiscal consolidation has been the cornerstone of the government’s

### 13. In recent years, fiscal consolidation has been the cornerstone of the government’s

### Fiscal consolidation: objectives and vulnerabilities
- Fiscal strategy adopted in mid-2006 after several years of expansionary policies and high fiscal deficits.
- Headline deficit reduced from 9¼ percent of GDP in 2006 to an expected 3.4 percent in 2008.
- Past fiscal excesses have left Hungary vulnerable to a government funding crisis due to the large size and maturity structure of government debt.
- Growing interest burden on outstanding debt will limit room for further fiscal adjustment.
- Fiscal consolidation constrained by expenditure composition: comparatively high government wage bill, and a high share of pensions and social transfers.
- Foreign participants play an important role in the Hungarian treasury bill and government bond markets; non-residents hold about 30 percent of Hungary’s forint-denominated debt (about 8 percent of treasury bills and 35 percent of treasury bonds).

### 2008 developments and near-term fiscal projections
- After policy adjustment, primary government expenditures as a share of GDP are expected in 2008 to remain below the level envisaged in the budget, mainly by the government’s decision not to use reserves built into the budget.
- General government deficit projected to fall from 4.9 percent in 2007 to 3.4 percent of GDP in 2008.
- Funding difficulties experienced in March 2008 and more pronounced at the outset of the current crisis in October 2008 indicate continued rollover of the large outstanding stock will require more ambitious fiscal targets.

### 2009 program targets and adjustment magnitude
- Program envisages a general government deficit of 2.5 percent of GDP in 2009.
- Implies a large structural fiscal adjustment of 2½ percent of GDP (2 percentage points of GDP more than envisaged in the 2008 Article IV staff report).
- Program incorporates higher interest payments (reflecting mainly higher interest rates) and financing needs in Q4 2008 and Q1 2009 connected with the bank-support package.
- If macroeconomic outlook further deteriorates, staff will consult with authorities on policy adjustments.

### Measures to achieve fiscal objectives (emphasis on expenditures)
- Program aims at a reduction of primary government expenditure by 2 percentage points of GDP, compared to 2008.
- Measures included in the LOI:
  - Nominal wage freeze and elimination of the 13th monthly salary for all public sector employees (1 percent of GDP).
  - Elimination of the 13th monthly pension for all early retirees and a cap of the 13th monthly pension to HUF 80,000 for other pensioners (0.2 percent of GDP).
  - Postponement or elimination of indexation of selected social benefits (0.2 percent of GDP).
  - Across-the-board cuts in other spending allocations to ministries (0.5 percent of GDP).
  - Within capital expenditure, priority to investment projects cofinanced by EU structural funds (0.1 percent of GDP).
- Revenue-side stance:
  - Tax cuts previously envisaged for 2009 will be postponed until sufficient fiscal space is created through expenditure restraint.
  - Authorities will not make any changes in the tax code that could lead to a net revenue loss.

### Fiscal governance and structural reforms
- Draft fiscal responsibility law submitted to parliament (LOI ¶11) with core elements:
  - Fiscal rules on public debt (which cannot increase in real terms) and the primary balance (which cannot be negative).
  - Strengthening of the medium-term expenditure framework (rolling three-year expenditure ceilings).
  - Creation of a non-partisan fiscal council to provide independent and expert scrutiny.
- Political constraints:
  - Lack of a two-thirds majority forced abandonment of stricter fiscal rules for local governments and enshrinement of an enforcement procedure in the constitution.
  - Cost of violating the fiscal framework is reputational.
- Historical evidence noted: national fiscal rules contributed to permanent improvements in primary balances in the European Union (see IMF Country Report No. 08/314, Chapter I).

### Box 2 — Fiscal adjustment in IMF-supported programs in capital account crises (summary of findings)
- Planned improvements in headline fiscal balances under IMF-supported programs during past crises ranged from 1 percent of GDP (Mexico, Argentina, Korea) to 5 percent of GDP (Turkey); Hungary’s program (1 percent of GDP) is at the low end of this range.
- Targeted primary balances were generally set above medium-term debt-stabilizing primary balances calculated from historical averages for nominal growth and interest rates; exception: Brazil (1999).
- Hungary’s program: required primary balance is 3 percentage points of GDP higher than the medium-term debt-stabilizing primary balance; but below the short-term debt-stabilizing balance by 1.3 percentage point of GDP.
- Fiscal adjustment can influence market confidence variably; evidence suggests fiscal adjustment helped reverse capital flows where public sector vulnerabilities or fiscal credibility issues were well identified (Brazil, Turkey, and to a lesser extent, Argentina and Mexico).
- In emerging markets with debt overhangs, “Keynesian” effects of fiscal adjustment likely outweighed by “non-Keynesian” effects related to expectations and credibility; credible fiscal contraction can be expansionary if it signals improved public sector solvency.

### Financial sector resilience and crisis response
- Hungarian domestic banks entered market stress with strong solvency positions, though liquidity pressures emerged, partly driven by developments in the largest Hungarian bank’s foreign subsidiaries.
- Liquidity pressures strongest for domestic banks lacking support of a strong parent.
- Government announced a blanket guarantee of all banks’ deposits on October 8.
- Program includes a strong bank-support package to buttress credibility and ensure soundness of banks operating in Hungary; submission of necessary legislation by November 10, 2008 is a structural performance criterion (LOI ¶15).

### Bank-support package: size, structure, and rationale
- Total funding of HUF 600 billion (2.2 percent of GDP) divided evenly between:
  - Capital Base Enhancement Fund.
  - Refinancing Guarantee Fund.
- Availability:
  - Funds available to all private Hungarian banks of systemic importance with own funds above HUF 200 billion (0.73 percent of GDP) — effectively covering the three largest banks.
  - Other 33 banks protected through the blanket deposit guarantee and widened access to central bank refinancing.
- Any amount not utilized in the Capital Base Enhancement Fund by end-January 2009 will be transferred to the Refinancing Guarantee Fund.

### Capital Base Enhancement Fund: mechanics and stress testing
- Fund sized to bring eligible banks’ capital adequacy ratio (CAR) up to 14 percent.
- Two largest banks had CARs of just below 10 percent as of end-June 2008 and will be eligible for capital increases of around HUF 200 billion and HUF 100 billion, respectively.
- Preference shares:
  - Capital Fund will acquire preference shares that pay a dividend based on the cost for the government plus a margin of 2 percentage points, which will increase by one percentage point annually from 2011.
  - Banks may repurchase these preference shares whenever compatible with maintaining a strong capital position.
- Stress-test result:
  - Starting from a CAR of 14 percent, the largest domestic bank would be able to preserve a CAR of above 8 percent in the event of combined losses of 5 percent on HUF loans, 10 percent on foreign currency loans, and 10 percent on foreign subsidiaries’ assets.
- Safeguard measures will accompany capital increases.

### Refinancing Guarantee Fund and other liquidity measures
- A Guarantee Fund capitalized at HUF300 billion to guarantee new interbank loans and issuance of new wholesale securities with maturities > 3 months and < 5 years.
- Pre-funded guarantee provided against a fee not to exceed 4% per annum.
- Additional measures:
  - Blanket guarantee of deposits by the government.
  - Widened access to central bank refinancing through recently introduced liquidity facilities.
  - Established a foreign exchange swap facility; two new MNB facilities to inject forint liquidity: a two-week refinancing window at a fixed price and a six-month tender with no fixed price.
  - Expansion of the liquidity toolkit, including expanding the definition of usable collateral for MNB facilities, to be effected as needed.

### Cross-country comparison (Box 3) — alignment with European measures
- Hungary’s package broadly in line with major EU countries: comprises capital injections and bank guarantees.
- Capital injections similar to the United Kingdom’s approach—additional capitalization not aimed only at distressed banks.
- Bank guarantee scheme differs by requiring banks’ qualification for capital injection as a pre-condition for the guarantee.
- Deposit insurance coverage increased in line with EU agreements; government pledged blanket guarantee for all deposits.
- In the event systemic liquidity measures required, the MNB has various tools though not publicized for moral hazard reasons.

*Source: _cr08361 - 13. In recent years, fiscal consolidation has been the cornerstone of the government’s*

### 22. The Guarantee Fund is meant to bring comfort to the providers of wholesale

### 22. The Guarantee Fund is meant to bring comfort to the providers of wholesale funding and secure the refinancing of the eligible banks

### Guarantee Fund design and purpose
- Endowment: HUF 300 billion (1.1 percent of GDP).
- Currency and management: Invested in euro denominated government bonds of Euro area countries and managed by the MNB.
- Availability: Open for new transactions until end-2009.
- Coverage: Will guarantee the rollover of loans and wholesale debt securities with an initial maturity of more than 3 months and up to 5 years.
- Terms: Guarantees provided against a fee and with appropriate safeguards.

### Banking sector resilience initiatives
- Household foreign-currency loan exposure:
  - Government is seeking an agreement with commercial banks to mitigate balance sheet risks of households from their exposure to foreign currency loans.
  - A private debt resolution strategy is to be put in place in the event that asset quality deteriorates significantly (LOI ¶13).
- Supervisory and resolution capacity:
  - Efforts to strengthen HFSA’s and MNB’s capacity to assess and address solvency and liquidity concerns in banks in a timely manner.
  - A mechanism to grant the HFSA the necessary remedial powers for accelerated resolution of any failed bank will be submitted to parliament by end-December 2008 (structural benchmark) (LOI ¶15).
  - These reforms aim to facilitate quicker payout to insured depositors when needed.
- Additional regulatory measures:
  - Introduction of a positive credit registry for households.
  - Introduction of maximum loan-to-value ratio requirements for new mortgage loans.
  - Close monitoring of foreign exchange exposures, among other measures.

### Role and outlook for foreign-owned banks
- Nature of exposure: Foreign banks’ exposure is to a significant extent to their subsidiaries.
- Strategic stakes: Subsidiaries represent sizeable and strategic investments in “brick and mortar” and in the human capital of their employees, and have been major sources of growth and profits for parent banks.
- Parent bank support: Parent banks have issued statements affirming willingness to support their clients’ forint and foreign exchange needs.
- Expected lending: Some decline in lending in Hungary may be expected in line with a more difficult economic environment and some foreign parents’ own funding issues.
- Monitoring: As part of the program, stocks and flows of net foreign assets, as well as foreign exchange swap positions, will be monitored on a daily basis.

### Monetary and exchange rate policy
- Inflation objective:
  - Monetary policy will aim at gradually bringing inflation back to the official target by early 2010.
  - Official target: 3 percent.
  - Progress monitored using a standard consultation clause.
- Exchange rate regime:
  - The exchange rate band was removed in early 2008, allowing the MNB to exclusively focus on its inflation target of 3 percent.
  - Consistent with inflation-targeting, the MNB generally refrains from intervening on the foreign exchange market, except to stabilize disorderly market conditions.
- Policy actions in 2008:
  - Monetary policy was tightened in the first half of 2008 in response to a rise in underlying inflationary pressures.
  - On October 22, 2008 the MNB hiked the policy rate by 300 basis points to fend off a potentially destabilizing swing of the exchange rate.
- Forward guidance and constraints:
  - The MNB will continue to set the policy interest rate to bring inflation back to target at the two-year horizon (quantitative performance criterion, LOI ¶18).
  - Monetary policy should be supported by an agreement between the government and social partners to restrain nominal wage growth.
  - Premature easing will be avoided given the risk that global deleveraging may continue to put downward pressure on the exchange rate, which could have inflationary consequences.
- Liquidity facilities:
  - The MNB will ensure that facilities created to manage domestic currency liquidity are managed within the inflation targeting framework.
  - Liquidity-enhancing measures are intended solely to improve liquidity in market segments, not to influence prices (including bond yields), which should remain market-determined.
  - The MNB should stand ready to expand its toolkit as needed, including by modifying the Central Bank Act to simplify and expand the use of collateral put up by financial institutions to obtain access to its facilities.

### Program modalities — Access and financing needs
- Gross external financing requirements: Projected at about €39 billion through end-2009.
- Current account: Projected to decline to 2 percent of GDP in 2009.
- Expected financing sources: Foreign direct investment, net positive capital transfers with the European Union, portfolio flows, and bank and corporate foreign financing.
- Financing gap: €20 billion after expected sources.
- External commitments reducing gap: European Union commitments of €6.5 billion and the World Bank €1 billion.
- Reserve implications: Absent such financing, gross reserves projected to fall to about €7.8 billion at end-2009, covering only 30 percent of short-term debt by remaining maturity.
- Historical reference: At the end of the second quarter of 2008, reserve coverage was 72 percent of short-term debt by remaining maturity.

### Exceptional access assessment and SBA terms
- Exceptional access requested: €12.5 billion (SDR 10.5 billion, 1015 percent of quota).
- Upfront disbursement proposal: Up to €5 billion to be disbursed up front.
- Rationale: Staff assesses Hungary meets the four criteria for exceptional access (see Box 4).
- SBA terms appropriateness: SBA terms considered appropriate given uncertainty about speed of investor return and risk that balance of payments difficulties may require a longer time to resolve than the SRF maturity.
- Box 4 summary of exceptional access criteria findings:
  - Criterion 1: Exceptional balance of payments pressure in the capital account due to global deleveraging, increased capital outflows, forint depreciation, sharp increase in sovereign spreads, and restricted market access.
  - Criterion 2: Sustainable debt position conditional on further fiscal consolidation; government debt-to-GDP ratio was 66 percent of GDP at end-2007; external debt projected to increase from 97 percent of GDP at end-2007 to 116 percent of GDP at end-2009 in the baseline, with vulnerability to depreciation shocks.
  - Criterion 3: Good prospects of regaining access to private capital markets given Hungary’s track record in servicing external debt and likely restoration of access.
  - Criterion 4: Policy program provides reasonably strong prospect of success based on recent policy implementation and political agreement.

### Capacity to repay the Fund and risks
- Fund exposure projection: By end of the arrangement, Fund exposure projected to be about 10 percent of GDP and 53.5 percent of gross reserves.
- Public and external debt projections: Public sector projected at 66 percent of GDP and external debt at 105 percent of GDP at end-2010.
- Capacity to repay: Hungary’s record of timely servicing obligations and likely improvement in global financing conditions support capacity to discharge Fund obligations.
- Key risks to repayment and program success:
  - Accelerated capital outflows leading to exchange rate overshooting and a sharper GDP growth slowdown than envisaged.
  - Sharper exchange rate adjustment increasing pressures on household and corporate balance sheets, hurting banking sector health.
  - Failure to reach agreement with banks on reducing balance sheet risks to borrowers (LOI ¶13).
  - Rollover rates falling significantly or for prolonged periods below assumed levels.
  - Political risk: Government does not have a majority in parliament; despite efforts to build consensus, political risk remains a concern.
- Overall assessment: The proposed arrangement entails significant risks to the Fund.

### Risk mitigation and program design features
- Program duration and phasing: Intended to capture macroeconomic framework and budget for 2010.
- Upfront policy action: Aims at locking in fiscal performance (notably submission of the Fiscal Responsibility Law).
- Conditionality: Ensures strengthening of the banking sector (framework for additional capital and guarantees for interbank lending).
- Monitoring: Daily monitoring of banks’ foreign assets, liabilities, and swap positions to enable early policy discussions if pressures emerge.

### Program monitoring and conditionality specifics
- Program length: 17 months from November 2008 to March 2010.
- Disbursement phasing (Box 5):
  - Access: SDR 10.5 billion.
  - SDR 4.2 billion to be made available upon the Board’s approval of the arrangement.
  - The eight subsequent tranches equal SDR 6.3 billion.
  - Next two tranches could be made available in February and May 2009, and quarterly thereafter.
- Review frequency: Quarterly reviews; first review set for February 2009, based on end-December targets.
- Quantitative performance criteria and targets:
  - A floor on the central government system primary cash balance.
  - A band around the 12-month rate of inflation of consumer prices.
  - A floor on the change in net international reserves.
  - Non-accumulation of external debt arrears (continuous criterion).
  - Indicative target: Ceiling on the total debt stock of the central government system.
- Structural conditionality:
  - Structural performance criterion: Submission to parliament of a draft support package for domestic banks and request of initiation of extraordinary procedures for early passage by November 10, 2008.
  - Structural benchmarks:
    - Passage of the fiscal responsibility law by end-December 2008.
    - Submission to parliament of a draft law granting the HFSA special remedial powers to accelerate the resolution of any failed bank by end-December 2008.
- Safeguards assessment:
  - Staff initiated a first-time safeguards assessment of the MNB to be completed no later than the first review under the SBA.
  - Audited financial statements are published on the central bank's website and preliminary findings indicate MNB’s external audit and financial reporting practices comply with international standards.

### Staff appraisal — diagnosis and policy priorities
- Disruption: Hungary’s successful macroeconomic adjustment was disrupted by the global financial crisis; fiscal adjustment had reduced headline deficits but proved insufficient amid market stress.
- Credibility requirements:
  - Regaining credibility requires both financing and a high degree of policy discipline.
  - A large financing package can reassure markets that short-term obligations can be met without unsustainable policies.
  - Strong fiscal and financial sector policies are needed to ensure stocks of debt and debt service burdens decline over the medium term.
- Medium-term goals: Exit from the episode of financial stress as soon as possible and continue focusing on medium term structural development and growth goals, including accession to the euro.

*Source: _cr08361 - 22. The Guarantee Fund is meant to bring comfort to the providers of wholesale (excerpt).*

### 37. The authorities’ program—which is supported by the proposed SBA—delivers a

### 37. The authorities’ program—which is supported by the proposed SBA—delivers a strong policy anchor, but risks remain.

### Program effects and risks
- The program accelerates the path of fiscal adjustment.
- Liquidity provision to financial markets is being strengthened.
- A system is being put in place to ensure that high levels of capital of the banking system are maintained.
- The program includes elements to strengthen financial sector surveillance.
- These measures address areas that have proven to be among the most serious vulnerabilities in the crisis and should go far in turning around market expectations.
- Identified risks to the program include:
  - a more serious economic deterioration than underlying the macroeconomic framework projections;
  - a slower recovery of global financial markets;
  - lack of necessary political support for key measures.
- To minimize risks, the authorities recognize the need for:
  - continued and careful program monitoring;
  - ongoing policy dialogue with the Fund;
  - commitment to make policy adjustments that may become necessary.

### Fiscal policy and political consensus
- A broad political consensus around medium-term goals is needed to support the fiscal policy package.
- The authorities’ program aims for consistency between current measures and established longer term reform needs.
- Key policy choice: not only to contain overall spending but to uphold the goal of reducing the (comparatively large) size of the government sector in Hungary.
- Adjustment includes a broad set of expenditure cuts, including in wages and pensions.
- Expected longer term benefits cited:
  - bringing Hungary closer to wage and pension levels in neighboring countries;
  - allowing for a more growth oriented and sustainable level of total spending.
- It remains critical to engage the public and build consensus on retaining reform momentum.

### Banking sector measures
- Hungary’s banking sector includes subsidiaries of foreign banks and domestic banks, one of which has subsidiaries in a number of neighboring countries.
- In light of the global financial crisis, many advanced countries have taken pre-emptive measures to shore up bank capital and other steps to support their banking systems.
- Hungary’s banking sector package will re-establish a level playing field by ensuring that key banks, including domestic banks, have access to a well-defined capital support framework.
- Supporting improvements in supervision and central bank liquidity management will help enhance the stability of the banking sector and support its continued access to global financial markets.

### Other macroeconomic policies
- Other macroeconomic policies need to remain prudent to support the overall policy package.
- Hungary has a successful track record of implementing an inflation targeting framework.
- Under the program, keeping inflation low and predictable will support exchange rate stability and be critical for the sustainability of the reform package.

*Source: _cr08361 - 37. The authorities’ program—which is supported by the proposed SBA—delivers a*

### 41. With the consistent implementation of the program, staff expects that the

### _cr08361 - 41. With the consistent implementation of the program, staff expects that the

### Program support and IMF arrangement
- Staff supports the authorities request for a 17-month SBA arrangement.
- Schedule of reviews and purchases (amounts in SDRs):
  - November 6, 2008: 4,215.0 (405.9 percent of quota) — Approval of arrangement
  - February 15, 2009: 2,107.5 (203.0 percent of quota) — First review and end-December 2008 performance criteria
  - May 15, 2009: 1,264.5 (121.8 percent of quota) — Second review and end-March 2009 performance criteria
  - August 15, 2009: 1,264.5 (121.8 percent of quota) — Third review and end-June 2009 performance criteria
  - November 15, 2009: 1,264.5 (121.8 percent of quota) — Fourth review and end-September 2009 performance criteria
  - February 15, 2010: 421.5 (40.6 percent of quota) — Fifth review and end-December 2009 performance criteria
  - Total: 10,537.5 (1,014.8 percent of quota)

### Fiscal stance, consolidation, and general government
- Consolidated general government (ESA-95, percent of GDP):
  - Total revenues: 2008 Est.: 42.6; 2009 Program Proj.: 44.9; 2010 Proj.: 45.3; 2011 Proj.: 45.6; 2012 Proj.: 44.6; 2013 Proj.: 44.8; 2014 Proj.: 45.1
  - Total expenditures: 2008 Est.: 51.9; 2009 Program Proj.: 49.8; 2010 Proj.: 48.7; 2011 Proj.: 48.5; 2012 Proj.: 47.1; 2013 Proj.: 46.8; 2014 Proj.: 46.6
  - General government balance: 2006: -9.3; 2007: -4.9; 2008 Est.: -3.4; 2009 Staff proj.: -2.9; 2010 Proj.: -2.5; 2011 Proj.: -2.0; 2012 Proj.: -1.5
  - Primary balance: 2006: -5.4; 2007: -0.9; 2008 Est.: 0.6; 2009 Staff proj.: 1.3; 2010 Proj.: 1.9; 2011 Proj.: 2.6; 2012 Proj.: 3.2
- Key fiscal composition (percent of GDP, 2008 Est. and projections where shown):
  - Tax revenues: 2008 Est.: 37.0; 2009 Proj.: 39.5; 2010 Proj.: 39.8; 2011 Proj.: 39.9; 2012 Proj.: 38.7; 2013 Proj.: 38.8; 2014 Proj.: 39.1
  - Taxes on income, profits and capital gains: 2008 Est.: 9.4; 2009 Proj.: 10.2; 2010 Proj.: 10.5; 2011 Proj.: 10.8; 2012 Proj.: 10.2; 2013 Proj.: 10.3; 2014 Proj.: 10.4
  - Taxes on payroll and workforce and Social Security contributions: 2008 Est.: 12.6; 2009 Proj.: 13.6; 2010 Proj.: 13.8; 2011 Proj.: 13.8; 2012 Proj.: 13.5; 2013 Proj.: 13.5; 2014 Proj.: 13.6
  - Taxes on goods and services: 2008 Est.: 15.0; 2009 Proj.: 15.6; 2010 Proj.: 15.5; 2011 Proj.: 15.3; 2012–2014 Proj.: 15.0

### Macroeconomic developments and short-term outlook
- Real economy (annual percent change, selected years):
  - Real GDP: 2005: 4.1; 2006: 3.9; 2007: 1.1; 2008: 1.8; 2009 proj.: -1.0
  - Private consumption: 2005: 3.6; 2006: 1.9; 2007: -1.9; 2008: 0.9; 2009 proj.: -3.9
  - Gross fixed investment: 2005: 5.3; 2006: -2.5; 2007: 0.1; 2008: 1.0; 2009 proj.: -0.9
  - Exports: 2005: 11.5; 2006: 19.0; 2007: 14.2; 2008: 7.6; 2009 proj.: 2.1
  - Imports: 2005: 6.8; 2006: 14.7; 2007: 12.0; 2008: 8.1; 2009 proj.: 0.7
- Inflation and labor market:
  - CPI (end year): 2005: 3.3; 2006: 6.5; 2007: 7.4; 2008: 5.1; 2009 proj.: 4.2
  - CPI (average): 2005: 3.6; 2006: 3.9; 2007: 7.9; 2008: 6.3; 2009 proj.: 4.5
  - Unemployment rate (average, percent): 2005: 7.2; 2006: 7.5; 2007: 7.4; 2008: 7.8; 2009 proj.: 8.5
- National accounts ratios:
  - Gross domestic investment (percent of GDP): 2005: 23.6; 2006: 23.1; 2007: 23.0; 2008: 22.8; 2009 proj.: 20.0
  - Gross national saving (percent of GDP, from BOP): 2005: 16.1; 2006: 15.6; 2007: 16.6; 2008: 16.5; 2009 proj.: 18.0

### Balance of payments and external financing
- Balance of payments (millions of euros, selected items and quarters):
  - Current Account (2007 Sep.–Dec. yearly): -6,510; -1,934; -1,214; -6,632; quarterly 2008 Mar.: -581; Jun.: -396; Sep.: -543; Dec.: -395
  - Goods and services, net (2007 Sep.–Dec. yearly): 1,370; 258; 951; 1,956; quarterly 2008 Mar.: 1,473; Jun.: 1,982; Sep.: 1,796; Dec.: 2,021
  - Exports (2007 Sep.–Dec. yearly): 80,824; 20,093; 21,560; 85,209; 2008 quarterly: 19,761; 21,428; 21,967; 23,549
  - Imports (2007 Sep.–Dec. yearly): -79,454; -20,068; -20,666; -83,253; 2008 quarterly: -18,288; -19,446; -20,171; -21,529
  - Income, net (2007 Sep.–Dec. yearly): -7,386; -1,726; -2,169; -7,810; 2008 quarterly income net: -1,922; -2,246; -2,207; -2,283
- Gross external debt and reserves:
  - Gross external debt (percent of GDP): 2005: 75.0; 2006: 90.4; 2007: 97.2; 2008: 106.4; 2009 proj.: 115.8
  - Gross official reserves (billions of euros): 2005: 15.7; 2006: 16.4; 2007: 16.4; 2008: 19.5; 2009 proj.: 19.8
  - Current account (percent of GDP): 2005: -7.5; 2006: -7.5; 2007: -6.4; 2008: -6.2; 2009 proj.: -2.0

### Program financing, prospective Fund credits, and financing gap
- Program financing table highlights (millions of euros, projection 2008–09):
  - Prospective financing (2008–09): European Union: multiple tranches totaling projected support; World Bank: projected €500 million and additional lines in later periods
  - Financing gap (2008 Dec.–2009 projections): cumulative financing gap shown as -6,034; -2,500; -1,500; -1,500; -1,500; total -13,034 (table totals)
  - Prospective Fund credits (projection note): A €500 million Fund disbursement is projected for the first quarter of 2010, bringing total prospective Fund credit to €12.5 billion.
  - Bank Guarantee Fund item: -1,034 appearing in financing assumptions for specific quarters
- Central government borrowing requirement (in billion forints, 2008 and 2008–09 projections):
  - Net borrowing requirement examples: Q1 2008: 510.0; Q2 2008: 209.8; Q3 2008: 6.5; Q4 2008: 802.6; Total 2008: 1,528.9
  - Redemptions in Hungarian forints (2008 totals): 5,914.3; 2009 (projected totals by quarter): 1,299.4; 2,112.6; 2,085.0; 1,651.0; Total 2009: 7,148.1
  - Gross issuance (actual and planned, HUF, 2008 totals): 6,281.1; 2009 planned HUF issuance: 7,852.7
  - Constrained borrowing assumptions include scenarios with limited FX issuance and specified rollover rates

### Debt sustainability: public and external debt vulnerability tests
- Public debt (public sector debt in percent of GDP, Table 10 baseline and projections):
  - Baseline public sector debt: 2003: 58.0; 2004: 59.4; 2005: 61.7; 2006: 65.6; 2007: 65.9; 2008: 67.4; 2009: 70.1; 2010: 68.4; 2011: 66.2; 2012: 62.9; 2013: 59.4
  - Change in public sector debt (percent of GDP): 2008: 1.5; 2009: 2.8; 2010: -1.7; 2011: -2.2; 2012: -3.3; 2013: -3.5
  - Identified debt-creating flows (4+7+12): 2008: 1.3; 2009: 0.2; 2010: -0.3; 2011: -1.7; 2012: -3.3; 2013: -3.7
  - Gross financing need (percent of GDP): 2003: 19.1; 2004: 23.2; 2005: 24.6; 2006: 24.3; 2007: 18.7; 2008: 23.8; 2009: 18.4; 2010: 17.1; 2011: 13.3; 2012: 12.4; 2013: 11.1
- External debt (external debt in percent of GDP, Table 11 baseline and projections):
  - Baseline external debt: 2003: 61.6; 2004: 67.0; 2005: 75.0; 2006: 90.4; 2007: 97.2; 2008: 106.4; 2009: 115.8; 2010: 105.4; 2011: 98.8; 2012: 90.6; 2013: 84.8
  - Change in external debt (percent of GDP): 2008: 9.3; 2009: 9.3; 2010: -10.4; 2011: -6.6; 2012: -8.2; 2013: -5.9
  - Gross external financing need (in billions of euros): 2003: 19.1; 2004: 25.7; 2005: 28.4; 2006: 32.4; 2007: 30.9; 2008: 39.1; 2009: 47.2; 2010: 37.1; 2011: 38.5; 2012: 43.9; 2013: 45.7
- Stress scenarios and bound tests summarized graphically (figures reported):
  - Public Debt: baseline average projection in boxes: baseline 59; scenario averages shown (e.g., growth shock, interest rate shock, primary balance shock, combined shock, real depreciation and contingent liabilities shocks) with scenario projections such as 65, 63, 68, 66, 69 depending on shock description in figures.
  - External Debt: baseline average projection in boxes: baseline 85 (historical 78); scenario projections include growth shock, interest rate shock, combined shock, current account shock, real depreciation shock with values indicated in figures (e.g., 88, 113 for 30% depreciation scenario)
  - Notes indicate individual shocks are permanent one-half standard deviation shocks, combined shock uses permanent 1/4 standard deviation shocks, and one-time real depreciation of 30 percent and contingent liabilities shocks described in figure notes.

### Financial markets and banking sector indicators
- Interest rates and yields:
  - Policy rate and overnight interbank rate series shown (policy rate and overnight interbank rate in percent, 2005–08 series).
  - Government bond yield (5-year maturity, in percent): time series plotted Jul-07 through Oct-08 with values rising through 2008 (figure).
- Market pressures and spreads (selected indicators):
  - Euro-denominated EMBI Spreads (basis points) for regional peers shown with dates 6/29/2007 and 10/28/2008
  - Budapest Stock Exchange Index (January 2, 2005=100) plotted Jan-05 through Jan-08 with declines in 2008
  - Exchange rate (forints per euro) series Jan-05 to Jan-08 for Hungary, Poland, Czech Republic plotted (forints per euro series decline/appreciation dynamics shown)
- Banking sector indicators and vulnerabilities:
  - Share of foreign currency liabilities in total liabilities: 2005: 34.4; 2006: 39.3; 2007: 42.4; 2008 proj.: 42.0
  - Share of foreign currency loans in total credit to households: 2005: 9.5; 2006: 14.8; 2007: 19.3; 2008 proj.: 23.0
  - Non-performing loans to gross loans: 2005: 2.5; 2006: 2.5; 2007: 2.4; 2008 proj.: 2.8
  - Household debt service burden (principal and interest payments as percent of disposable income) series plotted 2003Q1–2008Q1 with components principal payment and interest payment (figure).
  - Sharpe Ratios of parents of major banks in Hungary plotted Jan-07 to Nov-08 for OTP, Erste, KBC, Unicredit (figure).

### Key macro-financial indicators and vulnerabilities (selected table entries)
- Table 1 highlights (2005–09):
  - Gross external debt (percent of GDP): 2005: 75.0; 2006: 90.4; 2007: 97.2; 2008: 106.4; 2009 proj.: 115.8
  - Reserves (in billions of euros): 2005: 15.7; 2006: 16.4; 2007: 16.4; 2008: 19.5; 2009 proj.: 19.8
  - General government debt (percent of GDP): 2005: 61.6; 2006: 65.5; 2007: 65.8; 2008: 67.4; 2009 proj.: 70.1
  - Overall balance (general government percent of GDP, ESA-95): 2005: -7.8; 2006: -9.3; 2007: -4.9; 2008: -3.4; 2009 proj.: -2.5
- Indicators of external vulnerability (Table 12, 2005–08):
  - Exports of goods and services, annual percent change: 2005: 12.9; 2006: 15.0; 2007: 17.1; 2008 proj.: 5.4
  - Gross official reserves (billions of euros): 2005: 15.7; 2006: 16.4; 2007: 16.4; 2008 (observation as of end-September 2008): 19.5
  - In percent of short-term debt at remaining maturity: 2005: 108.3; 2006: 116.2; 2007: 86.6; 2008 obs.: 67.2
  - Total external debt (billions of euros): 2005: 66,608; 2006: 81,428; 2007: 98,266; 2008 obs.: 112,951

### Staff assessment and outlook language
- "With the consistent implementation of the program, staff expects that the Hungarian economy will weather the current difficulties."

*Italic: Source — IMF staff report content as provided in the supplied PDF content unit.*

### 1.      Financial market stress in Hungary has intensified in past weeks as a result of events

### 1.      Financial market stress in Hungary has intensified in past weeks as a result of events

### Overview and program request
- Financial market stress in Hungary has intensified in past weeks as a result of events in global financial markets.
- The government and the central bank of Hungary (Magyar Nemzeti Bank, MNB) have developed a comprehensive strategy to firmly anchor macroeconomic policies and reduce financial market stress.
- Request to the Fund: Stand-By Arrangement (SBA) for a period of 17 months in the amount of SDR10.5 billion (€12.5 billion).
- Complementary support: €6.5 billion under the EU’s balance of payment financing facility and other multilateral and bilateral commitments.
- Program monitoring: quantitative performance criteria and indicative targets, structural performance criteria and structural benchmarks, and regular reviews.
- Legislative and timing commitments:
  - Amended fiscal responsibility law submitted to parliament before IMF Executive Board consideration.
  - Support package for domestic banks to be submitted to parliament before November 10, 2008.
  - Law to strengthen emergency powers of the Hungarian Financial Supervision Authority (HFSA) and passage of the fiscal responsibility law by end-2008.
  - First review by February 15, 2009 and second review by May 15, 2009.

### Recent economic performance and macroeconomic framework for 2008–09
- Fiscal consolidation results:
  - General government deficit narrowed from 9¼ percent of GDP in 2006 to a projected 3.4 percent of GDP in 2008 (ESA95 classification).
  - For 2008, the projected outcome is markedly better than planned in the budget.
- Current account:
  - Current account deficit projected at 6¼ percent of GDP in 2008.
- Inflation and monetary policy:
  - Inflation fell from 9 percent in early 2007 to 5¾ percent in September 2008.
  - Official inflation target: 3 percent at the two years horizon.
- Growth:
  - GDP growth expected to recover to just under 2 percent on an annual basis in 2008.
- Baseline scenario for 2009:
  - Global financial market stress will gradually abate.
  - Global deleveraging expected to reduce net capital inflows and sharply slow credit growth in Hungary.
  - Fiscal consolidation will dampen domestic demand.
  - Export growth restrained by slowdown among main trading partners.
  - Projected outcomes: output will likely fall by around 1 percent; CPI inflation will decline to about 4 percent at year-end; current account deficit will narrow to some 2 percent of GDP.
  - Risks: mostly on the downside, reflecting uncertainty about stabilization of financial markets and depth of global slowdown.
- External financing:
  - Gross external financing needs will decline over the course of 2009 due to smaller fiscal and current account deficits.
  - Stable sources: EU structural funds and already committed foreign direct investment inflows.
  - Assumptions: net outflows from the non-financial private sector and reduction in government’s net issuance of external debt.
  - Foreign banks expected to largely maintain exposure in Hungary.
  - Aim to gradually increase MNB’s foreign reserves as a precaution.
  - Resulting external financing need of some €20 billion can be covered by IMF resources, EU balance of payment facility, and other official creditors.
  - Any additional international financial institution support will be used to further augment foreign reserves.

### Fiscal policy — objectives and measures
- Recent fiscal consolidation:
  - Primary government expenditures in 2008 reduced to below budget levels, mainly by not using contingency reserves.
  - General government deficit projected to fall to 3.4 percent of GDP (or 2.9 percent of GDP, adjusted for the EU’s Excessive Deficit Procedure purposes).
- 2009 budget and targets:
  - Revised 2009 budget envisages a general government deficit of 2½ percent of GDP.
  - Implies a structural fiscal adjustment of about 2½ percent of GDP.
  - Revenues expected to decline somewhat as a percentage of GDP due to slower tax base growth and spending measures.
  - Tax cuts previously envisaged for 2009 will be cancelled; no tax code changes that could lower net revenues.
- Expenditure-side adjustment measures (primary government expenditure to be reduced by 2 percentage points of GDP compared to 2008):
  - Keep nominal wages in the public sector constant throughout 2009.
  - Eliminate the 13th monthly salary for all public servants.
  - Cap the 13th monthly pension payment for pensioners at HUF 80,000 and eliminate the 13th monthly pension payment for all early retirees.
  - Postpone the indexation of selected social benefits.
  - Trim operating expenditure allocations to all ministries across the board.
  - Prioritize investment projects cofinanced by EU funds and programs designed to support small and medium-sized enterprises.
  - Government will take corrective measures to prevent accumulation of spending arrears if needed.
- Monitoring and contingency:
  - Program primarily monitored through the primary cash balance of the central government including social security and other extrabudgetary funds (a quarterly performance criterion).
  - Consult IMF staff on adjustments to the primary balance target and corrective measures if:
    - larger-than-expected shortfall in government financing occurs;
    - level of public debt exceeds its indicative target path by more than 300 billion HUF;
    - further significant deterioration of the macroeconomic outlook.
  - Close monitoring of local government finances and consultation with IMF staff if aggregate local government deficit exceeds expectations.
- Medium-term commitment:
  - Continue budget consolidation in the 2010 budget and beyond; new medium-term fiscal targets to be contained in forthcoming convergence program and medium-term fiscal framework.
  - Draft fiscal responsibility law submitted to parliament establishing fiscal rules on public debt and primary deficit, strengthening the medium-term expenditure framework (rolling three-year expenditure ceilings), and creating a fiscal council.
  - Plan to enact fiscal responsibility law by end-December 2008 (structural benchmark).

### Financial sector policies — stability, liquidity, and bank support
- Banking system fundamentals:
  - Hungarian banking system complies with regulatory capital requirements and has been profitable.
  - Liquidity risk increased due to drop in global risk appetite, higher funding costs, and shorter maturities.
  - Most external funding comes from parent banks in the euro area, which have access to ECB liquidity facilities and have pledged continuous support to Hungarian subsidiaries (joint statement of MNB and leading banks of October 17, 2008).
  - MNB and HFSA to monitor parental support closely and provide summary information daily to IMF staff.
  - Domestic funding has not shown stress; any stress would be contained by liquidity facilities described below.
  - Deposit insurance: coverage increased from HUF 6 million to HUF 13 million (in line with EU agreements); government pledged a blanket guarantee on all deposits.
  - Government stands ready to take further measures to ensure stability of bank funding if needed.
- Private debt resolution strategy — proposed agreement with commercial banks (three components):
  - (i) At the request of the debtor, banks will allow the duration of the loan to be extended with fixed monthly installments.
  - (ii) Debtors who deem exchange rate fluctuations carry excessive risks will be allowed to convert their foreign currency-based loan to a forint loan, without extra charges.
  - (iii) If a debtor is unable to service the existing loan, banks will be amenable to transitionally reducing the installments at the debtor’s request.
  - Additional resolution mechanisms to be considered if these strategies prove ineffective.
- Strengthening HFSA and MNB capacities:
  - Step up efforts to strengthen HFSA’s and MNB’s capacity to assess and address solvency and liquidity concerns in banks timely.
  - Mechanism for early remedial actions, including well-defined triggers and emergency powers for the HFSA, to be submitted to parliament by end-December 2008 (structural benchmark).
  - Improve efficiency of bank resolution regime to facilitate quick payouts to depositors if needed.
- Comprehensive banking support package (in consultation with IMF staff):
  - Available to all qualified domestic banks; aims to buttress credibility and preserve key role of banks.
  - Total funding: HUF 600 billion divided evenly between the Capital Base Enhancement Fund and the Refinancing Guarantee Fund.
  - Capital Base Enhancement Fund sized to bring eligible banks’ capital adequacy ratio (CAR) up to 14 percent.
  - Guarantee Fund endowment: HUF 300 billion, to be invested in euro denominated government bonds of Euro area countries and managed by the MNB.
  - Guarantee Fund features:
    - Open for new transactions until end-2009.
    - Will guarantee the rollover of loans and wholesale debt securities with an initial maturity of more than 3 months and up to 5 years.
    - Guarantees provided against a fee and with appropriate safeguards.
  - Package available to private Hungarian banks of systemic importance.
  - Submission to parliament: bill to be submitted by November 10 and request for extraordinary procedure to pass bill as soon as possible (structural performance criterion).
  - Monitor impact of potential deterioration in borrowers’ repayment capacity as the economy slows.
  - Recent pressures on banks’ funding are being addressed by management in coordination with HFSA and MNB.
  - EBRD involvement welcomed to further strengthen the Hungarian banking system.
- Regulatory and supervisory enhancements over program period:
  - Introduction of a positive credit registry for households.
  - Modification of the Central Bank Act to allow the MNB to request individual but unidentifiable data to analyze credit risk.
  - Enhanced regulation of insurance and credit brokers and their products.
  - Introduction of maximum loan-to-value ratio requirements for new mortgage loans.
  - Close monitoring of banks’ foreign exchange exposures.
  - Strengthened communication with financial authorities in home and host countries regarding risk assessments and liquidity contingency plans.

### Monetary and exchange rate policy and liquidity facilities
- Exchange rate regime and monetary focus:
  - Exchange rate band removed in early 2008; Hungary moved to a floating exchange rate regime.
  - Monetary policy can focus exclusively on the inflation target; exchange rate movements are factored into policy interest rate when they affect the inflation outlook.
  - Elimination of the exchange rate band largely removed the possibility of a one-way bet against the forint.
- Inflation objective:
  - MNB determined to gradually bring inflation down to the official target of 3 percent.
  - Progress toward target to be monitored using a standard consultation clause.
  - Monetary policy tightened in first half of 2008 and again recently to fend off potentially destabilizing exchange rate swings.
  - Outlook: economic slowdown likely to put downward pressure on inflation, but further depreciation of the exchange rate could boost inflation.
  - Interest rate policy: remain vigilant; does not respond to short-term exchange rate fluctuations unless they affect long-term inflation outlook.
  - MNB intervention policy applied consistently with target for net international reserves under the program.
  - Government intends to facilitate agreement among social partners to restrain nominal wage growth to support disinflation.
- Recent liquidity measures (weeks prior to letter):
  - Foreign exchange swap facility established, supported by a repo facility with the ECB amounting to €5 bn.
  - Auction facility to purchase government bonds from market makers to improve liquidity in the secondary market.
  - Two new forint liquidity facilities:
    - Two-week refinancing window at a fixed price.
    - Six-month tender with no fixed price.
  - Purpose: improve liquidity in various market segments, not to influence prices (including bond yields), which should remain market-determined.
  - MNB stands ready to further expand its toolkit as needed.

*Source: Letter from the Minister of Finance and the Governor of the MNB describing the SBA request and program measures (attachments and table references omitted).*

### 2. Cumulative change in net international reserves (floor, in millions of euros) 2/ 3/

### 2. Cumulative change in net international reserves (floor, in millions of euros) 2/ 3/

### Net International Reserves (NIR) floor
- Outstanding stock: End-September 2008: 15,890.7
- Note: The end-September 2008 NIR figure is a stock. The cumulative change in NIR for subsequent quarters is from September 2008.
- Definition: NIR of the central bank of Hungary (MNB) are defined as the euro value of gross foreign assets of the MNB minus gross foreign liabilities with maturity of less than one year. Non-euro denominated foreign assets and liabilities will be converted into euro at the program exchange rates.
- Coverage: Gross foreign assets include the MNB’s holdings of monetary gold, SDRs, foreign currency cash, foreign currency securities, deposits abroad, and the country's reserve position at the Fund. Excluded from reserve assets are any assets that are pledged, collateralized, or otherwise encumbered, claims on residents, claims in foreign exchange arising from derivatives in foreign currencies vis-à-vis domestic currency (such as futures, forwards, swaps, and options), precious metals other than gold, assets in nonconvertible currencies, and illiquid assets.
- Gross foreign liabilities include all foreign exchange liabilities to residents and nonresidents, including commitments to sell foreign exchange arising from derivatives (such as futures, forwards, swaps, and options), banks foreign currency deposits against reserve requirements, and all credit outstanding from the Fund.
- Adjustment for program disbursements: NIR targets will be adjusted upward (downward) by the surplus (shortfall) in program disbursements relative to the baseline projection. Program disbursements are defined as external disbursements from official creditors that are usable for the financing of the overall central government budget.

### External program disbursements (baseline projection) — cumulative flows from end-September 2008 (in millions of euros)
- End-December 2008 (program projection): 2,000
- End-March 2009 (program projection): 4,500
- End-June 2009 (program projection): 6,500
- End-September 2009 (program projection): 7,500

### Inflation consultation (12-month rate of inflation in consumer prices — CPI)
- Measurement: Headline CPI published by the Hungarian Central Statistical Office.
- Consultation bands (quarterly projections; end-December 2008 and end-March 2009 are performance criteria; end-June 2009 and end-September 2009 are indicative targets):
  - December 2008 / March 2009 / June 2009 / September 2009
  - Outer band (upper limit): 7.1 / 6.8 / 6.5 / 6.3
  - Inner band (upper limit): 6.1 / 5.8 / 5.5 / 5.3
  - Central point: 5.1 / 4.8 / 4.5 / 4.3
  - Inner band (lower limit): 4.1 / 3.8 / 3.5 / 3.3
  - Outer band (lower limit): 3.1 / 2.8 / 2.5 / 2.3
- Consultation commitments:
  - If observed year-on-year CPI inflation falls outside the outer bands, the authorities will complete a consultation with the Fund on their proposed policy response before requesting further purchases under the program and will report publicly the reasons for any breach of the outer bands and their policy response.
  - The MNB will conduct discussions with Fund staff should observed year-on-year CPI inflation fall outside the inner bands specified for the end of each quarter.

### Cash primary balance of the central government system (in billions of forints)
- End-of-the-year primary balance:
  - End-December 2008 (performance criterion): 215
- Cumulative primary balance from January 1, 2009:
  - End-March 2009 (performance criterion): -280
  - End-June 2009 (indicative target): -55
  - End-September 2009 (indicative target): 255
- Definition: Primary balance of a budgetary institution = total revenues − non-interest expenditures. The CGS primary balance is monitored above the line on a cash basis. Primary expenditure excludes any cash payment related to bank recapitalization (to establish the Capital Enhancement Fund) and transfers to the Bank Guarantee Fund. Net lending of any CGS component is treated as non-interest expenditure; negative net lending is treated as revenue.

### Indicative ceiling on the total debt stock of the central government system (in billions of forints)
- Outstanding stock: End-September 2008 (actual): 15,973
- Indicative ceilings:
  - End-December 2008 (indicative ceiling): 16,320
  - End-March 2009 (indicative ceiling): 16,650
  - End-June 2009 (indicative ceiling): 16,850
  - End-September 2009 (indicative ceiling): 16,860
- Scope and exclusions:
  - Applies to the HUF value of total stock of debt contracted by the central government system.
  - Excluded: credits from the IMF, external program financing, normal trade-related credits, reserve and long-term liabilities of the MNB, mark-to-market deposits at or placed by ÁKK, and liabilities related to the bank support package.
  - The program exchange rate will apply to all non-HUF denominated debt.
- Adjustments to the ceiling:
  - Upward (downward) adjustment for shortfall (surplus) in net EU transfers relative to baseline projection.
  - Upward (downward) adjustment for increase (decrease) of ÁKK’s cash reserves in the Single Treasury Account at the MNB relative to the baseline projection.

### Net EU transfers (baseline projections, in billions of forints)
- End-December 2008 (program projection): -269.32
- End-March 2009 (program projection): 334.43
- End-June 2009 (program projection): 25.39
- End-September 2009 (program projection): 1.01

### Cash reserves at the Single Treasury Account (baseline projections, in billions of forints)
- End-December 2008 (program projection): 162.00
- End-March 2009 (program projection): 287.01
- End-June 2009 (program projection): 405.24
- End-September 2009 (program projection): 305.11

### Continuous performance criterion: Non-accumulation of external debt arrears
- Requirement: The central government system will accumulate no new external debt arrears during the program period.
- Definition of arrear: An external debt payment arrear = a payment by the central government system which has not been made within seven days after falling due.
- Reporting: The stock of external arrears will be calculated based on ÁKK’s schedule of external payment obligations and reconciled with creditors. ÁKK will provide final data on the stock of external arrears to the Fund with a lag of not more than seven days after the test date. This performance criterion does not cover trade credits.

### Program exchange rates (as of September 30, 2008, from MNB website)
- HUF 243.17 = €1
- HUF 169.15 = $1
- HUF 154.01 = CHF 1

*Source: Technical Memorandum of Understanding, Hungary — Request for Stand-By Arrangement, November 4, 2008.*

### 5.      In 2005, the Magyar Nemzeti Bank (MNB) launched a project to set up a new data

### In 2005, the Magyar Nemzeti Bank (MNB) launched a project to set up a new data collection system for balance of payments (BOP) and international investment position (IIP) statistics, with a view to replace the international transaction reporting system (ITRS) with direct reporting (DR) of respondents.

### BOP/IIP data collection reform and institutional cooperation
- Reform:
  - The move from ITRS to DR became effective in January 2008.
  - Under DR, resident economic entities report directly their transactions and positions vis-à-vis nonresident entities.
  - The change is in line with recent trends in other EU Member States.
- Institutional roles:
  - Full responsibility for compilation and publication of BOP and IIP statistics remains with the MNB.
  - Cooperation between the HCSO and the MNB has been significantly enhanced for production of external statistics (“Rest of the World” in National Accounts vs BOP and IIP).
  - Existing data sharing prior to 2008 included:
    - trade in goods (since 2003)
    - FDI (since 2004)
    - travel and business services (since 2005)
    - other services such as transportation, insurance, financial and government services (since 2006)
  - Cooperation extended to new areas of non-financial accounts (compensation of employees and EU transfers).
- Special-purpose entities (SPEs):
  - MNB changed reporting of stock and flow data of SPEs as of January 1, 2006.
  - Offshore firm residency follows international statistical standards: resident where registered.
  - Off-shore status of SPEs ceased to exist on December 31, 2005; from January 2006 MNB compiles BOP including SPEs.
  - MNB continues to treat statistics that exclude SPEs’ flow and stock data as readily interpretable in economic terms.
  - In defining range of SPEs, MNB cooperates with HCSO.

### Errors and omissions in BOP; VAT-resident and VAT-fraud investigations
- Joint task force:
  - Established within the General Framework of Cooperation between HCSO and MNB (effective since 2002) and included in the 2007 annual work program.
  - Investigates possible flaws in Foreign Trade Statistics (FTS).
- Issues under investigation:
  - Possibly wrong attribution in FTS of Hungarian residence to foreign, nonresident companies importing and exporting goods to/from Hungary with a Hungarian VAT number.
  - Possible VAT fraud (so-called “carousel fraud”), which has led to underestimation of goods imports in other EU countries (e.g., the UK).
- Outcomes and planned actions:
  - VAT resident issue: final conclusion and decision of interested parties in February 2008 was to address the issue by revising the trade data back to 2004 in both NA and BOP statistics in a concerted way in September 2008; Eurostat relevant future recommendations, if any, will be respected.
  - VAT fraud issue: HCSO and MNB need to agree on a proposal to redesign the information system of tax and customs authorities to facilitate better provision of necessary details on explored frauds that can be used to compile NA and BOP statistics; this task is on the HCSO-MNB 2008 work program.

### Monetary and financial statistics developments
- From January 2003, MNB compiled and published data based on a new methodology consistent with the European Central Bank’s framework for monetary statistics using the national residency approach.
- Monetary statistics coverage expanded to include money market funds in addition to central bank and credit institutions.
- Responses to 2001 data ROSC recommendations:
  - Authorities reported they have addressed all recommendations in monetary and financial statistics made in the 2001 data ROSC.
  - STA recommendation: value securities on balance sheets of depository corporations at market prices.
    - From 2004, depository corporations were encouraged to use market valuation for securities in trading portfolio.
    - From 2005, market valuation requirement made compulsory for depository corporations listed on the stock exchange.

### Government Finance Statistics (GFS)
- January 2004: STA conducted substantive update of GFS dataset using July 2003 Data Quality Assessment Framework.
  - Reported significant progress addressing 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 have not been implemented.
- Publication coverage:
  - Latest data reported for publication in the 2007 GFS Yearbook are for 2006.
  - Data now cover operations of 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 October 28, 2008) — selected metadata
- Exchange Rates: Date of latest observation 10/28/2008; Date received 10/28/2008; 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 Sep 2008; Date received 10/20/2008; Frequency M for data, reporting, publication.
- Reserve/Base Money; Broad Money; Central Bank Balance Sheet: Date of latest observation Sep 2008; Date received 10/13/2008; Frequency M.
- Consolidated Balance Sheet of the Banking System: Date of latest observation Aug 2008; Date received 9/30/2008; Frequency M.
- Consumer Price Index: Date of latest observation Sep 2008; Date received 10/14/2008; Frequency M.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: Date of latest observation 2007; Date received 4/1/2008; Frequency A.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Date of latest observation Aug 2008; Date received 10/21/2008; Frequency M.
- Stocks of Central Government and Central Government-Guaranteed Debt: Date of latest observation Q4 2007; Date received 4/1/2008; Frequency Q.
- External Current Account Balance; Exports and Imports of Goods and Services; GDP/GNP; Gross External Debt; International investment Position: latest observations Q2 2008 with various received dates (e.g., External Current Account Balance received 9/30/2008).
- Notes on data quality indicators and frequency definitions are provided in the table.

### IMF Stand-By Arrangement (SBA) request and Fund risk assessment — key figures and phasing
- Arrangement request:
  - Authorities requested a 17-month SBA with access of SDR 10.5 billion (1,015 percent of quota).
  - Proposed access is front-loaded: SDR 4.2 billion (406 percent of quota) available upon approval, and SDR 2.1 billion (203 percent of quota) available in February 2009.
  - Remaining access phased in three quarterly purchases of SDR 1.3 billion (122 percent of quota), and a final purchase of SDR 0.4 billion (41 percent of quota) scheduled for February 2010.
- Table 1 (proposed SBA — Access and Phasing) (values as presented):
  - 2008 November (Approval): 4,215.0 SDR million; 405.9 percent of quota; cumulative 405.9.
  - 2009 February: 2,107.5 SDR million; 203.0 percent of quota; cumulative 608.9.
  - 2009 May: 1,264.5 SDR million; 121.8 percent of quota; cumulative 730.6.
  - 2009 August: 1,264.5 SDR million; 121.8 percent of quota; cumulative 852.4.
  - 2009 November: 1,264.5 SDR million; 121.8 percent of quota; cumulative 974.2.
  - 2010 February: 421.5 SDR million; 40.6 percent of quota; cumulative 1,014.8.
  - Total: 10,537.5 SDR million; 1,014.8 percent of quota.
- Implementation note:
  - 1/ Starting from February 2009, purchases will depend on the completion of a review.
- Risk characterization:
  - Hungary’s proposed access is relatively high and front-loaded compared with recent exceptional access cases.
  - Hungary’s outstanding use of Fund GRA resources would reach 406 percent of quota upon approval and rise to 1,015 percent of quota in February 2010.
  - If drawn in full, Hungary’s total outstanding use of Fund resources would represent 10 percent of GDP.
  - From first purchase, outstanding use would be 4.2 percent of GDP.
  - Fund would account for a significant share of Hungary’s public external debt and debt service if SBA is fully drawn:
    - By end-2008, outstanding use of Fund resources would account for 11 percent of public external debt, rising to 22 percent by end-2009.
    - Projected service under the proposed SBA peaking in 2013 at SDR 5.5 billion, accounting for 34 percent of public external debt service (5 percent of exports of goods and services).

### Hungary external debt and related indicators (selected tables and comparisons)
- Table 3. Hungary: External Debt, 2005–2008 (In millions of euros)
  - Total External Debt: 2005: 66,608; 2006: 81,428; 2007: 98,266; 2008 1/: 112,951.
  - Public: 2005: 26,440; 2006: 30,376; 2007: 33,415; 2008 1/: 39,894.
  - Private: 2005: 40,168; 2006: 51,052; 2007: 64,851; 2008 1/: 73,057.
  - Net External Debt: 2005: 30,372; 2006: 38,280; 2007: 48,756; 2008 1/: 54,696.
  - (In percent of GDP)
    - Total External Debt: 2005: 75.0; 2006: 90.4; 2007: 97.2; 2008 1/: 106.4.
    - Public: 2005: 29.8; 2006: 33.7; 2007: 33.0; 2008 1/: 37.6.
    - Private: 2005: 45.2; 2006: 56.7; 2007: 64.1; 2008 1/: 68.8.
    - Net External Debt: 2005: 34.2; 2006: 42.5; 2007: 48.2; 2008 1/: 51.5.
  - Sources: Hungarian authorities and IMF staff estimates.
  - 1/ Projected to end-2008.
- Table 4. Debt Ratios in Recent Exceptional Access Cases (In percent of GDP)
  - Argentina (2003): 129.0 total external debt; 82.5 public external debt; 12.2 debt to IMF.
  - Brazil (2003): 38.6; 21.5; 5.1.
  - Turkey (2005): 35.0; 17.8; 3.0.
  - Uruguay (2005): 82.0; 60.8; 13.8.
  - Georgia (2008) 2/: 34.6; 21.0; 2.8.
  - Hungary (2008) 3/: 106.4; 37.6; 4.2.
  - Notes: 3/ Projected for end-2008, assuming first drawing under proposed SBA.
- Additional context:
  - Total external debt projected to be 106 percent of GDP at end-2008 (Table 3).
  - Total external debt service in 2008 estimated at 28 percent of GDP (€ 29 billion), with public debt accounting for about one-sixth of external debt service.
  - Hungary’s external debt includes intercompany loans for FDI, projected to account for 20 percent of total external debt at end-2008.
  - Public external debt comprises foreign-currency and domestic-currency denominated debt to non-residents, with foreign-currency denominated debt projected to represent 18.5 percent of GDP at end-2008, equivalent to one-half of total public external debt.

### Fund exposures and comparative GRA metrics
- Table 5. Fund GRA Exposures — selected entries (SDR Millions and percent metrics as presented)
  - Panel A — Top five borrowers as of end-September 2008 (Fund credit outstanding as of September 30, 2008):
    - Turkey: 5,898.7 SDR million.
    - Dominican Republic: 350.2 SDR million.
    - Liberia: 342.8 SDR million.
    - Sudan: 220.9 SDR million.
    - Georgia: 161.7 SDR million.
  - Panel B — Forthcoming exceptional access cases (Fund credit outstanding after first purchases of the proposed SBA):
    - Iceland 2/: 560.0 SDR million (476.2 after first purchase).
    - Hungary 2/: 4,215.0 SDR million (405.9 percent of quota after first purchase).
    - Ukraine 2/: 3,073.1 SDR million (224.0 percent of quota after first purchase).
  - Note: For Hungary, Fund credit outstanding after approval shown as 4,215.0 SDR million (405.9 percent of quota).
  - Additional notes clarify denominators and staff projections to end-2008.

*Source: IMF staff report, Approved November 4, 2008.*

### 7.      Moreover, there are considerable risks to Hungary’s capacity to repay the Fund.

### _cr08361 - 7.      Moreover, there are considerable risks to Hungary’s capacity to repay the Fund.

### Risks to Hungary’s capacity to repay the Fund
- Accelerated capital outflows:
  - Program depends on certain rollover rates for funding of foreign-owned banks and other debts (including domestic banks); failure to realize these rollover rates could lead to exchange rate overshooting, exacerbating pressures on households, corporates, and banks, and causing a sharper-than-envisaged slowdown in growth.
  - Resulting deterioration in private sector balance sheets would undermine prospects for rebuilding foreign reserves.
- The process of global deleveraging:
  - Uncertainty about the impact of developments in international financial markets on investor exposure to emerging markets in the medium-term.
  - The depth and pace of recovery from global deleveraging will affect Hungary's ability to mobilize resources from international capital markets.
- Inadequate program implementation:
  - Despite recent progress in fiscal consolidation and improvement in the external current account, sustaining the envisaged fiscal adjustment will be challenging in the context of a sharp slowing in growth and given the government’s lack of a parliamentary majority.

### Impact on Fund finances (summary of Table 6 and related analysis)
- Exposure and liquidity impacts:
  - Fund GRA credit outstanding to Hungary (end-period figures listed in Table 6): 4,215.0; 10,116.0; 10,537.5; 10,537.5; 7,165.5; 1,949.4; 52.7; 0.0 (2008–2015 series as presented).
  - Fund GRA credit outstanding to Hungary (percent of quota): 405.9; 974.2; 1,014.8; 1,014.8; 690.1; 187.7; 5.1; 0.0.
  - One-year Forward Commitment Capacity (FCC) as of end-September: 127,615.8.
  - Hungary's impact on FCC (single-country negative impact): (10,537.5).
  - The proposed SBA would reduce the one-year FCC by SDR 10.5 billion, about 8 percent of the FCC of SDR 127.6 billion as of end-September.
  - Excluding Hungary from the forthcoming Financial Transactions Plan would reduce the FCC by an additional SDR 0.8 billion.
- Concentration and precautionary balance metrics:
  - Hungary’s share of total Fund credit outstanding would be about 27 percent after first purchases under proposed arrangements for Iceland and Ukraine, making Hungary the second largest exposure (second only to Turkey).
  - Share of total credit extended to the top-five borrowers was 92 percent as of end-September 2008.
  - After the first purchase, GRA credit to Hungary would be equivalent to 61 percent of the Fund’s precautionary balances as of end-April 2008; if the proposed SBA is fully drawn this exposure would rise to about 150 percent of current precautionary balances.
- Burden-sharing and charges risk:
  - Charges on Hungary’s GRA obligations are projected at SDR 355 million in 2009.
  - Projected payment of charges to the Fund on GRA credit outstanding (years shown in Table 6): 21.1; 355.0; 538.5; 542.4; 486.0; 244.5; 36.8; 0.5.
  - Projected debt service payments to the Fund on GRA credit outstanding (years shown in Table 6): 21.1; 355.0; 538.5; 542.4; 3,858.0; 5,460.5; 1,933.5; 53.2.
  - If Hungary incurred arrears on charges, the Fund’s burden-sharing capacity could be exceeded; projected 2009 charges (SDR 355 million) are well in excess of estimates of the Fund’s residual burden-sharing capacity assuming first purchases for Iceland and Ukraine.
  - The impact on burden-sharing capacity of overdue charges would decline if the Fund’s loan portfolio were to expand.

### Assessment of the proposed arrangement
- Financial risks to the Fund:
  - The proposed access is large, represents a significant share of the Fund’s liquidity, is at the high end of recent exceptional access cases, and is relatively front-loaded.
  - A range of factors could impair Hungary’s capacity to repay the Fund, including accelerated capital outflows from lower-than-expected rollover rates, difficulties in securing adequate capital market access given Hungary's high debt burden, and a gradual pace of recovery from global deleveraging.
  - Continued integration of Hungary’s economy into the European Union may moderate some repayment difficulties.
- Mitigating factors and conditionality:
  - The Hungarian authorities’ adherence to policies in the proposed arrangement, commitment to long-term fiscal discipline, and readiness to take additional measures as appropriate are key to mitigating risks and safeguarding Fund resources.

### Program objectives and policy elements (from Press Release and Annex)
- Program objectives:
  - Strengthen Hungary’s reserve position to provide breathing space for macroeconomic adjustment and minimize risk of a run on Hungary's debt and currency markets.
  - Facilitate rapid reduction of financial market stress while supporting longer-run structural goals (government finances and banking sector reforms).
- Key program elements:
  - Substantial fiscal adjustment:
    - A large structural fiscal adjustment of 2½ percent of GDP with emphasis on expenditure measures.
    - Introduction of a rules-based fiscal framework.
    - Low-income pensioners exempt from elimination of pension bonuses.
  - Upfront bank capital enhancement:
    - Provisions for added capital and resources to finance a guarantee fund for interbank lending; maintain high levels of capital in the banking system.
  - Large external financing assistance:
    - IMF Stand-By Arrangement: 17-month SDR 10.5 billion (about €12.3 billion or US$15.7 billion); immediate availability SDR 4.2 billion (about €4.9 billion or US$6.3 billion); remainder available in five installments subject to quarterly reviews.
    - Contributions from the European Union (€6.5 billion or about US$8.4 billion) and the World Bank (€1 billion or about US$1.3 billion), totaling €20 billion (about US$25.8 billion) in financial support.
- Expected macroeconomic outcomes (projections reported):
  - Growth: projected to contract in 2009 to -1 percent from around 1¾ percent in 2008; growth not expected to reach estimated potential of 3 percent until after 2011.
  - Inflation: projected to reach 4 percent at end-2009 (peaked at 9 percent in early 2007).
  - Program designed to restore investor confidence through accelerated fiscal adjustment, liquidity provision, bank capital measures, and strengthened financial sector surveillance.

*Source: IMF staff report and Press Release text as provided in the content unit.*

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