Public Information Notice: IMF Concludes Article IV Consultation with Hungary

March 4, 1999

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On February 22, the Executive Board concluded the Article IV consultation with Hungary1.


Economic performance was robust in 1998. Activity picked up and inflation fell steeply, though there was an increase in the external current account deficit.

Output growth, close to 5 percent in 1998, was led by exports and investment, but consumption also accelerated. After 26 percent export volume growth in 1997, a further rise of 20 percent is estimated in 1998 as earlier investments, including substantial green field FDI, continued to come on stream. Many of these activities, however, rely on imported intermediate and investment goods, so import volumes also increased pari passu. Fixed investment growth remained robust, at an estimated 10 percent, boosted by a strong macroeconomic framework, friendly tax policies, and ready access to EU markets. Real wages rose almost 4 percent, and 1998 saw the first increase in recorded employment since the beginning of the transition. Rising household incomes underpinned stronger private consumption, which according to staff estimates may have risen as much as 5 percent in 1998, compared with 2 percent in 1997.

External developments in 1998 reflect the rebound in domestic demand, but also a surge in profit remittances by foreign-owned enterprises. The current account deficit fell from 3¾ percent of GDP in 1996 to 2¼ percent of GDP in 1997 (including some temporary effects), but is estimated at 4¾ percent of GDP in 1998. This weakening is explained by the acceleration of domestic demand (cost competitiveness continued improving), weakening activity in the European Union, and by an increase in profit remittances—by 1 percent of GDP—which may partly be of a one-off nature. Net external debt (including intercompany loans and nonresident holdings of forint-denominated securities), after years of decline, rose slightly in 1998, owing to the higher external deficit and a slowdown in FDI inflows. However, this rise was due to growing nonresident holdings of forint-denominated bonds. The component of net external debt denominated in foreign currencies continued to decline.

Inflation dropped rapidly. 12-month CPI inflation fell by 8 percentage points through 1998 (to 10.3 percent), overperforming bold inflation targets, and reaching single-digit levels in January 1999. This drop was assisted by the sharp deceleration in food and administered prices (the latter reflecting weak international energy prices, and the more limited adjustment needed in domestic profit margins on services provided by public utilities). Nevertheless, these results mark a clear break in inflation inertia that had held inflation in the 20–35 percent range during most of the 1990s. Private sector gross wages rose by 13 percent in the 12 months through December 1998, decelerating from 22 percent in 1997, indicating the credibility of falling inflation.

The favorable results of 1998 benefitted from a somewhat better-than-budgeted fiscal out-turn, as automatic stabilizers were allowed to operate. At a preliminary 4.6 percent of GDP, the deficit of general government is estimated to be 0.2 percent of GDP stronger than budgeted. While GDP and fiscal revenue growth overperformed, expenditures remained on target, with a few exceptions. The strength of VAT reflected not only the buoyancy of consumption, but also a change in its composition towards goods subject to higher VAT rates and new tax-compliant shopping centers. On the spending side, outlays by social security funds exceeded projections, as in previous years, as did investment expenditure by local governments ahead of the October 1998 local elections.

Monetary policy successfully faced the challenges posed by the turmoil in international financial markets. During the first quarter of the year, the National Bank of Hungary (NBH) continued its sterilization policy aimed at containing the effect on domestic interest rates of strong capital inflows. Shocks to investor sentiment led first to a slowing down in these inflows and then to pressures in the opposite direction. Thus, despite large sales of foreign exchange by the NBH, the forint dropped to the bottom of the ±2¼ percent crawling band in August-September 1998. The NBH responded by lifting the repo rate and by announcing a cut in rate of crawl earlier than had been expected, signaling its commitment to the exchange rate band. Since early October, the pressures have eased, the forint has moved into the top portion of the band, and nominal interest rates have been lowered. The monthly rate of crawl has been cut steadily from 1 percent in August 1997 to 0.6 percent in January 1999.

The pace of structural reform slowed in the run-up to the 1998 elections, but afterward significant reforms were implemented. After the pension reform of 1997, no substantial progress has been made to prepare the reform of disability benefits or health care. Nevertheless, in support of the 1999 budget, the social security funds were brought formally under government control, there were significant cuts in the high burden of payroll taxes, andthe integration of tax and social security contribution collection was initiated. Moreover, further privatization operations amounting to some 1 percent of GDP were completed in 1998.

Executive Board Assessment

Executive Directors commended the authorities for their steadfast implementation of fiscal and monetary policies, which had led to a significant decline in inflation in 1998 and facilitated strong growth, in the context of a manageable external current account position. They noted that the authorities’ prompt policy reaction had also ensured that the impact of unsettled international investor sentiment on Hungary during 1998 had been relatively muted. However, given the strong pace of domestic demand and the still uncertain external environment, most Directors called for further tightening of fiscal policy in 1999 and a renewed effort to carry forward the agenda of structural fiscal reform so as to strengthen the external position, continue the disinflation strategy, and sustain economic growth over the medium term.

Directors welcomed many of the measures introduced with the 1999 budget, noting that the cuts in social security contributions, together with the measures to slow down pension and wage expenditures, would bolster the public finances, spur job creation, and facilitate disinflation. However most Directors cautioned that the forecast for nominal GDP growth underlying the authorities’ revenue projections in the 1999 budget appeared to be on the optimistic side, and could result in a shortfall in budgetary revenue. In this connection, they welcomed the government’s decision not to spend the contingency expenditure reserve that had been included in the budget. Nevertheless, most Directors believed that additional fiscal tightening measures would be preferable to help slow domestic demand and protect the authorities’ balance of payments objective, particularly in the context of a weakening external environment. Directors also supported more determined actions to address some of the remaining structural weaknesses in the Hungarian public finances, particularly in the areas of agricultural and housing subsidies, labor taxation, and health and disability pension expenditure.

Directors welcomed the decline in the 12-month inflation rate to single-digit levels in January 1999. This had been aided by the announcement of ambitious inflation targets in late 1997, the sizeable cuts in the rate of crawl of the exchange rate, the better-than-budgeted fiscal outturn for 1998, and a slower growth in nominal wages. Directors noted that, to the extent made possible by reduced capital inflows, interest rate policy could be a helpful complement to fiscal policy in containing domestic demand pressures.

Directors observed that Hungary’s crawling peg exchange regime had shown resilience during the recent period of international financial turmoil, and most Directors welcomed its continuation. However, a few Directors cautioned that the narrow intervention bands would constrain monetary policy and expose Hungary to speculative pressures, particularly as capital controls were liberalized over time. Those Directors also noted that in these circumstances the authorities should consider widening the band. In this connection a few Directors also supported the staff recommendation that the authorities consider the adoption of explicit medium-term inflation targets. However, most Directors were of the view that an early formalannouncement of inflation targeting may prove premature. Nonetheless, they endorsed the need for a more explicit medium-term inflation approach, which would facilitate a continuing decline in inflation expectations and underpin the deepening perception of Hungary as an economy converging toward the European Union. Directors urged the authorities to adopt medium term fiscal targets, which would strengthen the credibility of the overall economic policy framework. In this connection they also expressed support for the change in budgetary procedures under which Parliament would set key fiscal parameters well ahead of the budget discussions.

Although Hungary has implemented substantial structural reforms, especially in the enterprise and financial sectors, Directors noted that further steps were needed, particularly in the public sector. The introduction of further labor income tax cuts would be important to increase the long-term efficiency of the economy, but would require deep reforms of public expenditures, including in health and public employment. Directors regretted the further delay in disability pension reform, and urged the authorities to expedite legislation in this area. They also recommended early reform of the health care sector to improve its effectiveness and contain its cost for the budget. Finally, Directors welcomed the decisive steps taken to restore the health of a major retail bank, and re-emphasized the need to ensure the continued strengthening of the financial sector.

Hungary: Selected Economic Indicators

1992 1993 1994 1995 1996 1997 19981

Change in percent
Real Economy
Real GDP -3.1 -0.6 2.9 1.5 1.3 4.6 5.0
Domestic demand -2.6 8.3 1.7 -4.1 0.8 4.4 6.6
Of which: Private consumption 0.0 1.9 -0.2 -7.1 -2.7 2.0 5.3
Gross fixed investment -2.6 2.0 12.5 -4.3 6.7 8.8 10.2
Exports (real)2 2.1 -10.1 13.7 12.4 8.4 26.4 20.0
Imports (real)2 0.2 20.2 8.8 -1.6 6.6 25.5 22.0
Employment -9.8 -6.3 -2.0 -1.9 -0.8 0.0 1.4
Unemployment rate, percent 10.2 11.5 10.3 9.9 9.2 7.7 7.0
CPI (end year) 21.6 21.1 21.2 28.3 19.8 18.4 10.3
Percent of GDP
Public Finance3
Balance (excluding privatization receipts) -7.6 -8.9 -8.6 -6.2 -3.1 -4.9 -4.6
Primary balance4 -2.8 -4.8 -2.7 2.1 4.3 2.9 1.8
Public debt5 77.6 87.9 85.2 84.3 71.5 62.9 60.3
End of year, percent change
Money and Credit
M3 27.6 15.3 13.0 20.2 22.1 19.7 15.5
Credit to nongovernment 0.8 2.5 14.2 9.7 19.9 35.2 17.5
Interest rate (3-month T-bill, average) 22.7 17.2 26.9 32.0 24.0 20.1 17.8
In percent of GDP
Balance of Payments
Current account 0.9 -8.9 -9.3 -5.6 -3.7 -2.2 -4.8
Net external debt6 35.0 38.7 45.4 36.6 31.4 24.4 25.8
Official reserves
(In billions of U.S. dollars) 4.4 6.7 6.8 12.0 9.8 8.4 9.3
(In months of merchandise imports) 4.3 7.1 5.3 8.6 5.5 4.0 4.0
Exchange Rates
Exchange regime Crawling peg against a currency basket, since January 1, 1999 defined by the euro (70 percent) and U.S. dollar (30 percent)
Nominal effective rate (1990=100) 84.9 81.3 72.0 56.1 48.1 44.7 39.8
Real effective rate, CPI basis (1990=100) 120.5 131.3 130.3 125.2 128.2 132.3 133.1

Sources: Data provided by the authorities; International Financial Statistics; and IMF staff estimates.

1IMF staff estimates.
2National accounts basis.
3Consists of the central budget, social security funds, extrabudgetary funds, and local governments.
4This excludes net interest payments from the government balance.
5Includes the effect of bank recapitalization operations of 2.1 percent of GDP in 1998.
6Including intercompany loans, and nonresident holdings of forint denominated assets.

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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