Hungary--Concluding Statement of the 2010 Article IV Mission
IMF News, October 25, 2010
Source details
- Canonical URL
- Hungary--Concluding Statement of the 2010 Article IV Mission
Other formats
Bibliographic details
- Published: October 25, 2010
Macroeconomic outlook and risks
- Recovery status and drivers:
- Hungary has emerged from a severe crisis; recovery is fragile.
- Export-led recovery underway; domestic demand remains sluggish as the private sector continues to adjust balance sheets.
- Output expected to grow slightly less than 1 percent in 2010.
- Inflation expected to decline slowly to 3¾ percent by year-end.
- External current account is temporarily in surplus.
- Near- and medium-term projections:
- Real GDP growth of 2½ percent in 2011.
- Real GDP growth rising to about 3 percent in the medium term.
- Average inflation expected above 3½ percent in 2011.
- Output gap will close only slowly; real exchange rate close to equilibrium.
- Uncertainty and scenarios:
- Upside risks:
- Accommodative monetary policy in advanced economies may spur global growth and stronger capital inflows, potentially compressing Hungary’s borrowing spreads.
- Recent policy package could boost employment and investment more than assumed if supplemented by structural reforms and improvements in the business climate.
- Downside risks:
- Global recovery and increased global risk appetite may prove temporary.
- Change in investor sentiment could compound financing risks as large sovereign redemptions fall due in 2011-14.
- Further strengthening of the Swiss Franc could increase household debt servicing costs and depress domestic demand.
- Failure to restore fiscal sustainability could increase policy uncertainty and depress household and investor behavior.
The policy agenda
- Strategic objective:
- Solidify stability gains, head off downside risks, and create conditions for a permanently higher growth trajectory.
- Articulate a coherent policy framework beyond the 2011 budget with high-quality measures and conservative medium-term assumptions.
- Assessment of government program:
- Recent program elements include adherence to EU fiscal targets and reduction of taxation of labor.
- Reliance on temporary and distortive measures risks medium-term fiscal sustainability, increases uncertainty, and may harm growth.
- Recommendation to spell out additional elements: permanent spending reductions and efficiency improvements in public services.
- Program improvements recommended:
- Include well-specified structural measures to replace recently introduced temporary taxes.
- Reverse distortive measures that disregard Hungary’s dependence on foreign trade and investment.
- Ensure household pension savings are not used as a substitute for structural fiscal adjustment.
- Complete the financial sector reform agenda.
- MNB to continue a cautious monetary policy stance to support efforts.
Fiscal policy: assessment and recommendations
- 2010 fiscal stance:
- Temporary measures appear sufficient to limit the fiscal deficit to 3.8 percent of GDP in 2010.
- Measures include levies on financial institutions, energy, telecommunication, and retailers, and redirection of pension contributions from the second to the first pillar.
- 2011 fiscal requirements:
- Additional measures needed to meet the fiscal deficit target of 2.9 percent of GDP in 2011 agreed with the EU.
- Government tax package submitted October 16 includes phased flat-rate PIT and reduction of CIT rate in 2013; these reforms are expected to substantially reduce revenues.
- Recently announced expenditure cuts (reductions in staff and material costs) assessed as insufficient to bring the headline fiscal deficit below 3 percent of GDP.
- Quality of measures and structural implications:
- PIT reform estimated cost: at least 3 percent of GDP over the medium term.
- Primary fiscal deficit expected to widen by slightly more than 1 percent of GDP in 2010 and to further increase in 2011 (structural deterioration).
- Levies discriminate among sectors and send negative signals to foreign investment; taxes partly passed on to consumers via higher prices.
- Redirection of pension contributions may undermine confidence and raises questions about compensation to contributors.
- Durable expenditure rationalization recommended (implementation starting in 2011 and continuing over the medium term):
- Reduce generosity of social benefits; introduce means-testing to universal transfers (e.g., child benefits).
- Eliminate untargeted price subsidies (e.g., for gas).
- Scale down public works programs (pathway to work).
- Restructure main public transportation companies, notably MAV.
- Administrative reforms, including at local government level, to lower operational expenditures.
- Additional structural revenue and governance measures:
- Introduce a property tax over the medium term.
- Mobilize more EU transfers.
- Strengthen public finance management to avoid spending slippages.
- Improve revenue collection via continued implementation of tax administration’s compliance strategy and planned merger of customs and tax administrations.
- Concerns on pension system changes:
- Winding down the second pillar would allow improvement of headline fiscal indicators without structural fiscal adjustment; recorded assets would be treated as revenue.
- Risks: reduced fiscal transparency, increased fiscal risks, negative impact on domestic capital market liquidity, potential reduction in national savings and investment.
- Consider regulatory measures to address relatively low second pillar pension fund returns.
- PIT reform caveats:
- Reduced taxation of labor improves competitiveness by lowering the tax wedge, but labor supply response may be limited without reductions in generous universal social benefits.
- Short-term consumption impact may be limited because benefits primarily accrue to high income earners with lower propensity to consume.
- Compliance gains likely to materialize only in the medium term and depend on tax administration improvements.
Monetary policy
- MNB stance:
- The MNB’s cautious monetary policy stance remains appropriate.
- Large output gap suggests downward pressure on prices, but inflation forecasts over the policy horizon are above target, limiting scope for monetary stimulus.
- Inflation is highly sensitive to exchange rate developments and exposed to changes in risk premia.
- Credibility of government medium-term adjustment, level of risk premia, and inflation outlook are key considerations before any change in monetary stance.
Safeguarding financial stability
- Banking sector performance and risks:
- Non-performing loans (MNB definition) increased to 8½ percent by end-June 2010 and are now expected to peak in 2011 at around 12 percent.
- Deterioration in credit quality reflects commercial real estate weakness, household defaults amid Swiss franc strength, and moratorium on foreclosures.
- Aggregate pre-tax profitability remains relatively sound; existing capital cushions provide stress-absorbing capacity for most banks.
- MNB stress tests suggest only modest recapitalization needs under further sharp deterioration and large depreciation against the Swiss franc.
- System-wide stress tests indicate banks seem well prepared to meet forthcoming higher Basel III capital standards, though detailed analysis pending.
- Sector generally well placed to meet expected Basel standards for liquidity; lack of quantitative domestic liquidity requirements poses risks if sudden liquidity demands arise from parent companies or subsidiary holdings.
- Measures to assist households and restore mortgage market functioning:
- Support scheme by the Ministry for the National Economy (MfNE) addresses households struggling with mortgage servicing while limiting explicit and contingent fiscal liabilities and minimizing moral hazard.
- Scheme avoids a national asset management company.
- Once the new scheme is introduced, the moratorium on mortgage foreclosures should be ended to restore a functioning mortgage market and support covered bond market development.
- Initiatives to enhance predictability and transparency of loan terms are welcome if they do not violate existing contracts or impose arbitrary penalties on financial institutions.
- HFSA’s new consumer protection responsibilities and MNB’s focus on financial stability considered important.
- Financial sector levy concerns:
- Financial sector levy equals 0.7 percent of GDP—more than three times the largest such tax elsewhere—and serves fiscal purposes.
- For less profitable banks the levy amounts to a de-facto expropriation of capital.
- Design places disproportionate burden on foreign banks.
- Payment obligation fixed for 2010 and 2011; undetermined for 2012 and beyond.
- Risk: uncertainty about future design could lead banks to reduce balance sheets over time, harming credit supply and growth.
- Recommendation: government should signal that the levy will be substantially reduced and/or aligned with emerging EU standards after 2011.
- Institutional and supervisory developments:
- HFSA upgraded to an autonomous institution accountable to Parliament.
- Tri-partite Financial Stability Council (FSC) established, composed of the MfNE, the HFSA, and the MNB, to coordinate macro- and micro-prudential oversight.
- FSC and MNB can make regulatory and legislative proposals on a “comply or explain” basis with 15-day government response requirement; important that this mechanism and FSC regular meetings with published minutes continue.
- HFSA should obtain authority to issue regulations in its own right.
- Continue work on draft legislation to strengthen bank resolution framework; informed by European Commission initiatives on cross-border crisis management and resolution.
- On-site supervision and international cooperation:
- HFSA enhanced on-site inspection capacity; conducted comprehensive inspections of eight largest banking groups with follow-up targeted inspections on credit quality; thematic inspections underway.
- Current legislation requires regular mandatory inspections of all banking groups, credit cooperatives and other financial enterprises.
- Continued close cooperation between on-site and off-site supervisors needed.
- Progress on inspecting foreign subsidiaries of domestically incorporated banks where HFSA is the home state supervisor; HFSA developing relationships with home and host state supervisors.
Concluding statement issued in Budapest, October 25, 2010.