Hungary: Staff Concluding Statement of the 2022 Article IV Mission

IMF News, November 18, 2022

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Canonical URL: Hungary: Staff Concluding Statement of the 2022 Article IV Mission

As the recovery from the COVID-crisis was taking hold, supply-chain disruptions, rising energy and commodity prices amplified by Russia’s war in Ukraine, and a drought hit the economy.
Loose fiscal policy in 2021 (with a deficit of 7.1 percent of GDP) and early 2022 intensified inflation—now above 20 percent—and turned the current account into a large deficit.
The exchange rate depreciated and funding costs increased, both by more than for peer countries.
Price caps contributed to widening imbalances by creating artificially low prices that can lead to shortages, divert inflation to other goods, erode suppliers’ margins, and disproportionately benefit higher income groups.

Growth remained very strong in the first half of 2022 and is expected close to 5 percent for the year.
A sharp deceleration is expected in 2023 as: high inflation erodes households’ real income; domestic policy tightens; external demand weakens; funding costs rise; and uncertainty weighs on investment.
Baseline outlook: as international energy prices are anticipated to ease and domestic demand moderates, the current account deficit is expected to improve significantly and inflation to decelerate to single digits by the end of 2023.
Downside risks that could significantly worsen the outlook include:
- untimely or incomplete delivery of expected EU funds;
- higher-than-expected global funding costs;
- higher-than-expected commodity prices;
- an EU-wide shut-off of Russian gas.

The government expects a deficit of 6.1 percent of GDP this year and the 2023 budget aims to reduce it to 3.5 percent of GDP.
The planned fiscal adjustment in the 2023 budget is appropriate to keep debt on a downward path and to complement monetary policy in dampening demand and inflation.
Rebuilding fiscal buffers is advisable given significant risks.
Composition recommendations:
- End temporary windfall taxes on the energy and banking sectors upon expiration; ex-post taxes risk discouraging investment and extensions could erode tax policy credibility.
- The recently-increased financial transaction tax is distortive and may incentivize informality.
- Prioritize delayed investment projects carefully to preserve the most productivity-enhancing capital spending.
- Reduce operational (goods and services) spending where feasible through efficiency gains while preserving basic public services.

Price caps should be avoided: they have widened imbalances and are ineffective in fighting inflation.
- Motor fuels price cap led to a surge in demand for fuels and increased imports.
- Price cap on selected food products was ineffective in controlling food inflation—distributors raised prices on other foods.
- Longstanding household utility price cap benefits richer households more, disincentivizes energy savings, contributes to deteriorating the trade balance, and pressures the exchange rate and domestic inflation.
The relaxation in August of the household utility price cap for above-average consumption was a step in the right direction, but more is needed as domestic prices remain among the lowest in the EU while costs are still high.
Direct support to the vulnerable is recommended:
- Refine the new block utility tariffs by lowering the threshold for the subsidized rate to a basic consumption amount per household to improve targeting.
- Prefer targeted transfers through existing social safety nets or lump-sum payments to vulnerable households to shield them from the cost-of-living crisis while containing fiscal cost and preserving price signals.

The central bank significantly tightened monetary policy since June 2021; the recently introduced overnight one-day deposit tender has become the de facto policy rate at 18 percent.
Given still-rapid core inflation (among the highest in Europe) and risks of a wage-inflation spiral in a tight labor market, tight monetary policy remains needed until inflationary pressures clearly and sustainably ease.
Monetary policy ahead should remain data dependent and focused on driving inflation towards the target.
Continued exchange rate flexibility is advised to serve as a shock absorber amid external risks.
The MNB’s shift toward more conventional liquidity-absorbing tools is welcome to strengthen monetary policy transmission.
Caps on mortgage and SMEs interest rates should not be extended beyond their current expiration as they:
- hamper the transmission of monetary tightening;
- discourage prudent credit demand;
- are an untargeted way to support borrowers.

Overall banking sector buffers appear adequate, but supervisory vigilance and timely provisioning are warranted in a deteriorating environment.
Credit risks are expected to rise as growth slows, costs rise—particularly for energy-intensive industries—and higher interest rates test real estate market imbalances.
Bank profitability may come under pressure if higher net-interest margins do not fully offset costs of additional windfall and indirect taxes, and caps on variable interest rates.
The impact of rising interest rates on nonbank financial institutions requires close monitoring.

Hungary has taken emergency measures to avoid gas shortages this coming winter, including filling gas storages to a high level, which now covers more than half of annual consumption, and contracting additional imports from Gazprom.
Hungary’s ability to diversify away from Russian gas and oil is limited by its geography as a landlocked country and by limited capacity to significantly reduce the share of gas in the total energy mix.
Risks exist for the 2023-24 winter and measures to foster demand adjustment are important.
Diversification away from gas will require significant investment over several years, primarily in:
- projects shifting households from gas-powered to electricity-powered heating;
- projects reducing the share of gas in power production;
- strengthening the electricity grid to handle alternative energy sources, including solar.
Securing financing for these large-scale investments is critical.

Strengthening transparency and the anticorruption framework will improve the business environment and the efficiency of public spending.
In consultation with the EU, the government has launched regulatory and institutional reforms to strengthen the rule of law, judicial independence, and the anti-corruption framework.
The central bank is continuing to strengthen the anti-money laundering framework in line with international FATF standards.
Continued progress will help strengthen the business environment, long-term growth prospects, and public spending efficiency.

IMF Staff Concluding Statement of the 2022 Article IV Mission — November 18, 2022