Bank trading desk in Budapest, Hungary: loan program aims to maintain liquidity, capital in national banking system (photo: Laszlo Balogh/Reuters)
GLOBAL FINANCIAL CRISIS
Key measures concentrate on the areas of greatest stress—government finances and the banking sector. The measures are designed to be compatible with longer-run economic goals of reforming government finances and ensuring continued high levels of capital in the banking sector.
The 17-month Stand-By Arrangement for Hungary from the IMF is part of a $25 billion financing package to which the European Union has committed €6.5 billion ($8.4 billion) and the World Bank $1.3 billion.
Apart from Hungary, the IMF has been discussing with a number of other countries about loans to help them fend off the impact of the global financial crisis, which has triggered a worldwide economic downturn. The IMF approved a $16.4 billion loan for Ukraine on November 5.
The IMF approval makes $6.3 billion immediately available and the remainder in five installments subject to quarterly reviews. The Stand-By Arrangement entails exceptional access to IMF resources, amounting to 1,015 percent of Hungary's IMF quota, and was approved under the Fund's fast-track Emergency Financing Mechanism.
Two key objectives
Specifically, the IMF-supported economic program is based on two key objectives: to implement a substantial fiscal adjustment to ensure that the government's debt-financing needs will decline; and to maintain adequate liquidity and strong levels of capital in the banking system. Ultimately, the program should help restore stability in the financial sector and create the conditions for an economic recovery.
"The economic program rightly focuses on the fiscal and the banking sectors, which were the two key areas of vulnerability at the outset of the difficulties," said Anne-Marie Gulde, the IMF's mission chief for Hungary who was involved in discussions on the financing package.
"In the fiscal sector, a necessary reduction in the size of the public sector through lower expenditures will ease the country's short-term financing pressures and bring down the high levels of debt," she said.
"In the short-term, the rollover of debt will become easier and debt will become more sustainable in the medium term. The fiscal measures are also in line with the country's goal to slowly reduce the large size of its public sector and to provide more room for private activities to grow," she added.
Given the structure of the Hungarian budget, among other areas, adjustment will need to include revisions of wages and pensions. Under the authorities' program, expenditure restraint will be achieved in part through reductions in the overall government wage and pension bill. Nominal wage adjustments will be postponed and pension bonuses suspended.
While painful, the authorities have chosen this path, noting that a failure to achieve credible budget goals could have led to a government financing crisis with more severe consequences for the entire economy. In designing the measures, low-income pensioners were excluded from benefit reductions. Furthermore, Hungary's comparatively good social benefits will also help to buffer the social effects of these measures.
Hungary, a country of around 10 million people, became a member of the European Union in 2004. It successfully transformed from a centrally planned to a market economy, but the government deficit and the size of the public sector are still relatively large compared to other countries at similar income levels.
Fallout from global crisis
The second pillar of the program is decisive measures in the banking sector. They include a preemptive recapitalization of eligible banks and a strengthening of the supervisory and crisis management abilities of the Hungarian Supervisory agency. Those steps will ensure that banks' capital remains high and that the supervisory authorities are well prepared to recognize risks and take necessary early measures should vulnerabilities occur."
Hungary was among the first emerging market countries to suffer from the fallout of the current global financial crisis. As financial difficulties in advanced economies led to a decline in global liquidity and an increase in risk aversion, investors increasingly started differentiating among emerging markets.
Hungary's high external debt levels, which amounted to 97 percent of GDP at end-2007, and significant balance sheet mismatches, negatively affected investor appetite for Hungarian assets. Even though macroeconomic and financial policies had been strengthened since 2006, with substantial fiscal consolidation and tax administration improvements, Hungary was hit hard by the global deleveraging. Financial markets in Hungary have come under significant stress in recent weeks, reflecting the rise in perceptions of counterparty risk.
Gradual economic recovery
The IMF estimates that growth in Hungary is expected to contract to -1 percent in 2009 from around 1¾ percent in 2008. Already weak private consumption and investment will be negatively affected by both a sharp reduction in new bank lending and the depreciation of the exchange rate. Inflation, which peaked at 9 percent in early 2007, is projected to continue a downward trend and reach 4 percent at end-2009.
In a difficult global environment and with low domestic demand, the economy is projected to recover only gradually due to the fact that the slowdown is simultaneously occurring in Hungary's main trading partners and the global deleveraging process that will leave less foreign capital available to quickly return to Hungary. Growth is not expected to resume until 2010 and converge towards its estimated potential of 3 percent until after 2011.
Key elements of the program
The authorities' economic program is designed to foster a rapid return of less stressed financial market conditions, while supporting longer-run structural goals. The main pressure points in Hungary are in public finances and the banking sector.
In response, the program is based on the following key elements:
Given Hungary's large public debt, substantial fiscal adjustment is required to provide confidence that the government's financing need can be met in the short and medium run. The program envisages a large structural fiscal adjustment of 2½ percent of GDP with emphasis on expenditure measures, consistent with the need to reduce the country's large public sector. To put fiscal sustainability on a permanent footing, a rules-based fiscal framework will also be introduced.
Upfront bank capital enhancement is needed to ensure that banks are sufficiently strong to weather the imminent economic downturn, both in Hungary and in the region. The banking sector support package in the program contains provisions for added capital and resources to finance a guarantee fund for interbank lending.
Large external financing assistance is needed to minimize the risk of a run on Hungary's debt and currency markets, given its large stock of external debt.
Comments on this article should be sent to imfsurvey@imf.org
