Europaudvalget 2016
SWD (2016) 0085
Offentligt
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EUROPEAN
COMMISSION
Brussels, 26.2.2016
SWD(2016) 85 final
COMMISSION STAFF WORKING DOCUMENT
Country Report Hungary 2016
Including an In-Depth Review on the prevention
and correction of macroeconomic imbalances
This document is a European Commission staff working document. It does not
constitute the official position of the Commission, nor does it prejudge any such position.
EN
EN
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CONTENTS
Executive summary
1.
2.
Scene setter: Economic situation and outlook
Imbalances, risks, and adjustment issues
2.1.
2.2.
2.3.
2.4.
External sustainability: Continued adjustment in stock vulnerabilities
Private and banking sector adjustments
Elevating growth potential
MIP assessment matrix
1
4
12
12
22
31
34
3.
Additional structural issues
3.1.
3.2.
3.3.
3.4.
3.5.
Fiscal policy
Labour market and social policy
Education and skills
Business environment
Network industries and environment
36
36
41
47
51
55
A.
B.
C.
Overview Table
MIP Scoreboard indicators
Standard Tables
58
63
64
LIST OF TABLES
1.1.
2.2.1.
2.4.1.
B.1.
C.1.
C.2.
C.3.
C.4.
C.5.
Key economic, financial and social indicators - Hungary
Funding for Growth Scheme
MIP Assessment Matrix (*) - Hungary
The MIP scoreboard for Hungary
Financial market indicators
Labour market and social indicators
Labour market and social indicators (cont.)
Structural policy and business environment indicators
Green growth
11
25
34
63
64
65
66
67
68
LIST OF GRAPHS
1.1.
1.2.
GDP in constant prices (2010 price level)
External and domestic demand contributions to economic growth
4
4
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1.3.
1.4.
2.1.1.
2.1.2.
2.1.3.
2.1.4.
2.1.5.
2.1.6.
2.1.7.
2.1.8.
2.1.9.
2.1.10.
2.1.11.
2.1.12.
2.1.13.
2.1.14.
2.1.15.
2.2.1.
Headline inflation and core inflation
Net lending/borrowing by sector
Components of Net International Investment Position
Key external vulnerability indicators: Hungary and regional peers
Short term external debt
Components of the external position (current and capital account)
Current and capital EU transfers (% of GDP)
Export and import growth in volumes (2008=100)
Evolution of trade balance
Evolution of Hungary's export market share (year-on-year)
Components of export market share change - goods (2008-2014, annual averages)
The evolution of real effective exchange rate (2008=100)
Export deflators (Euro based)
Share of export value by quality category (2009-2014)
Net foreign direct investment: Hungary and regional peers
Corrected and uncorrected net FDI inflows as % of GDP
Greenfield foreign direct investment inflows into Hungary
Private sector debt in relation to GDP - comparing East-Central European countries to
Euro Area
5
7
12
13
13
13
14
17
17
18
18
18
19
19
20
20
21
22
22
23
23
24
25
26
26
26
27
29
29
2.2.2.
2.2.3.
2.2.4.
2.2.5.
2.2.6.
2.2.7.
2.2.8.
2.2.9.
2.2.10.
2.2.11.
2.2.12.
2.2.13.
Non-financial corporations' y-o-y changes in debt-to-GDP
Private debt in relation to GDP, boom and gradual adjustment
Debt service ratio in Hungary, international comparison
Indebtedness of non-financial corporate sector as a proportion of GDP
Banking sector’s total assets and risk-weighted assets (2008 = 100)
Banking sector profitability
Average capital adequacy ratio in the Hungarian banking system
Non-performing loan ratios
5 year credit default swap (CDS) in Hungary and peer countries
Evolution of total assets in Hungary, Poland and the Czech Republic
Evolution of the cost-to-income ratio in Hungary, Poland and the Czech Republic
Fees and commissions as percentage of total assets - comparing Hungary to Poland and
the Czech Republic
30
31
32
32
33
39
40
41
42
44
44
2.3.1.
2.3.2.
2.3.3.
2.3.4.
3.1.1.
3.1.2.
3.2.1.
3.2.2.
3.2.3.
3.2.4.
Investment rate (investment/GDP) in Hungary and regional peers
Potential GDP in the EU
Different estimates of potential growth
Contributions to potential growth in Hungary and in regional peers
Gross government debt ratio: historic data and short term projection
Gross government debt ratio: the baseline scenario and alternative trajectories
Activity, employment and unemployment rates
Unemployment, youth unemployment, NEET and long-term unemployment rates
Enrolment of children up to three years-old in formal childcare in 2014
The severe material deprivation rate in the region (% of the population)
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3.2.5.
3.3.1.
3.3.2.
3.3.3.
3.4.1.
The share of people living in low work intensity households (% of people aged 0-59)
Unemployment rates by educational attainment in Hungary
Employment rates by educational attainment in Hungary
Segregation index 2010-2013
Hungary - evolution of business R&D intensity and public R&D intensity, 2000-2014
44
47
47
48
54
LIST OF BOXES
1.1.
1.2.
2.1.1.
2.2.1.
3.1.1.
Investment Challenges
Contribution of the EU Budget to structural change
How does the MNB's Self-Financing Programme reduce Hungary's external vulnerability?
The 2015 foreign exchange denominated loans conversion schemes
Developments in sector-specific taxes
8
10
15
28
38
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EXECUTIVE SUMMARY
This country report assesses Hungary's economy in
light of the European Commission's Annual
Growth Survey published on 26 November 2015.
The survey recommends three priorities for the
EU's economic and social policy in 2016: re-
launching investment, pursuing structural reforms
to modernise Member States' economies, and
responsible fiscal policies. At the same time, the
Commission published the Alert Mechanism
Report that initiated the fifth annual round of the
macroeconomic imbalance procedure. The Alert
Mechanism Report identified Hungary as
warranting an in-depth review.
Hungary is on a balanced, albeit still relatively
moderate growth path, gradually reducing its
macroeconomic imbalances.
Real GDP has
surpassed its pre-crisis peak and the growth
potential has been gradually recovering.
Nevertheless, Hungary's rate of potential growth
remains a full percentage point lower than before
the crisis, which was already comparatively low.
In 2015, GDP is estimated to have increased by
2¾%, supported by strengthening private
consumption and healthy export growth. A decline
in EU-funded investment is projected to slow
growth in 2016, but continuing support from
private consumption and a gradual recovery in EU-
funded investment will see growth returning to
levels slightly above potential in 2017. As the
impact of lower energy prices fades, inflation is
projected to revert to the central bank’s target rate
by the end of 2017.
Labour market developments have been
favourable, recently also in the private sector.
This drove the unemployment rate below its pre-
crisis level despite a rapidly increasing activity
rate. The long-term unemployment rate followed a
similarly favourable path. Stricter policies on
social transfers, early retirement and increasing
statutory retirement age strengthened labour
supply. On the demand side, job creation in the
private sector picked up starting late 2013,
although emigration and the rapid increase in the
public works scheme have also significantly
contributed to the fall in unemployment. Because
of the increasing activity rate, labour becomes a
positive contributor to the potential growth rate
despite population ageing. Looking forward, the
private sector is expected to increase its share in
job creation, helping to lift productivity growth.
An initially strong pickup in investment,
however, proved temporary.
The considerable
investment growth experienced in 2013-2014 came
to a halt last year and is projected to turn into a
slight decline this year as EU-funded investment
temporarily subsides. Corporate lending continued
to decline despite several policy initiatives of the
central bank to promote SME lending, and the
trend of private investment recently turned
negative again. Private investment is hampered by
a still cautious credit environment, a relatively
high country risk premium that keeps funding
costs high, and an unstable regulatory and tax
environment. These factors particularly hinder
foreign direct investment. Without a healthy
growth of market-driven private sector investment,
the contribution of capital accumulation to
potential growth and productivity growth is
expected to remain moderate, in particular as EU-
funded investment gradually subsides.
The budget deficit has been contained, keeping
the public debt ratio on a gradually declining
path.
The budget deficit declined significantly in
2015, and is expected to decrease further in 2016-
2017, albeit the latter is mostly due to the
improving economic situation. Since its peak in
2011 following the crisis, the public debt ratio has
declined moderately. Sizeable capital transactions
and valuation changes have also contributed to this
decline.
Overall, Hungary has made some progress in
addressing
the
2015
country-specific
recommendations.
It has achieved some progress
in the field of taxation by significantly reducing
the levy on credit institutions. Substantial progress
has been made in putting in place policy measures
to combat tax evasion. At the same time, limited
progress has been made to reduce the high labour
tax burden on low-income earners and to improve
the efficiency of the tax administration. However,
no progress has been made to reorient budgetary
resources from public works to other active labour
market policies and to improve the adequacy and
coverage of social assistance and unemployment
benefits. Moreover, limited progress has been
made to improve the employability of
disadvantaged groups, in particular to increase
their participation in inclusive mainstream
education. Overall, the quality of economic
policies has improved but important challenges
remain in this regard.
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Executive summary
Regarding the progress in reaching the national
targets under the Europe 2020 Strategy, Hungary is
performing well in reducing the greenhouse gases,
increasing renewable energy and tertiary
education, while more effort is needed to increase
the employment rate, R&D expenditure, reduce
early school leaving and poverty. The main
findings of the in-depth review contained in this
country report, and the related policy challenges,
are the following:
External imbalances have been significantly
reduced but several risks remain.
Net
external liabilities declined from 116% of GDP
in 2009 to 73% by 2014. This is still high by
international comparison but it is closer to
levels of other converging economies, and the
rapid pace of decline is projected to continue.
The rebalancing of the economy has been
achieved through maintaining large current and
capital account surpluses, which reflect private
sector deleveraging and a sizeable inflow of
EU funds. The improvement in the external
balance continued despite a pick-up in
domestic demand. This was facilitated by a
partial reversal of previous market share losses
due to the rapid expansion of the automobile
industry and an export-oriented service sector,
benefitting
from
improved
cost
competitiveness. Moreover, recent policy
measures, including the conversion of foreign
exchange-denominated household loans and
the central bank's self-financing programme,
have contributed to a further reduction and
better distribution of foreign exchange risks.
Nevertheless, the still rather high gross external
debt and short-term rollover needs continue to
pose risks to the economy. Hungary’s limited
capacity to attract new foreign direct
investment also remains a challenge.
Internal financial imbalances have been
reduced but challenges remain.
Hungary
entered the crisis burdened with a relatively
high level of private sector debt, mostly
denominated in foreign currencies, but it has
made considerable progress in this area as well.
Private sector debt was reduced from its peak
of 117% of GDP in 2009 to 91% by 2014,
albeit at the inevitable price of a continuous
decline in private sector lending that hindered
investment. In 2015, however, lending to
households showed signs of recovery, albeit a
similar turnaround in corporate lending has yet
to take place. The conversion of household
foreign currency-denominated loans eliminated
one of the largest systemic risks. The
profitability of the banking sector is recovering
helped
by
the
improving
economic
environment and by a moderation in the
previous policies towards taxes on banks.
Nevertheless, banks remain cautious in their
lending even though they are well capitalized
and highly liquid. Going forward, the main
challenges are to reduce the high share of non-
performing loans and promote healthy growth
of market-based private sector lending.
Enhancing the growth potential is crucial to
further reduce the share of external and
internal debt in GDP and avoid depressing
domestic demand.
While labour market
policies helped in this regard, at this juncture
the key challenge facing Hungary is to find
new ways to accelerate total factor productivity
and promote higher investment in productive
assets. Improving financial intermediation and
nurturing innovation will assist in addressing
this issue.
Other key economic issues analysed in this report
which point to particular challenges facing
Hungary's economy are the following:
The public debt ratio has been declining
since the beginning of the decade, but its
level remains high, making public finances
vulnerable.
Medium-term debt sustainability
simulations indicate a steadily declining
trajectory reducing public debt towards 60% of
GDP. Sustained high primary surpluses and
savings from recent pension reforms are the
key factors driving this trend. However, the
debt-reduction path remains fragile. Hence,
maintaining fiscal discipline remains essential
in order to mitigate potential risks.
Despite considerable recent improvements
in tax policies and tax administration,
Hungary's reliance on sector-specific taxes
remains a potential barrier to investment.
These sector specific taxes pose additional
financial and administrative burdens on the
sectors concerned. While new sector-specific
2
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Executive summary
taxes were introduced in 2015, the levy on
credit institutions has been significantly
reduced. On the negative side, several
indicators point to potential weaknesses of the
tax administration. The labour tax wedge for
low-income earners is still high, which may
affect their employability.
The public works scheme has contributed to
a fall in unemployment, but it does not seem
to sufficiently improve the employability of
the participants.
Active labour market policies
rely excessively on the public works scheme,
but the programme does not sufficiently help
participants acquire necessary new skills and
find jobs in the open labour market. This risks
locking participants into the scheme,
particularly low-skilled workers and people in
disadvantaged regions.
The labour market is steadily improving,
but labour, social and education policies face
several challenges.
The duration of
unemployment benefits is the lowest in the EU
and significantly shorter than the average time
necessary to find a job. Social and poverty
indicators have not improved in line with the
economic recovery. Moreover, the social
protection system does not seem to provide
adequate support to the most vulnerable. The
health system also faces major challenges. The
main challenge of the education system is to
reduce socio-economic differences and provide
all pupils with adequate basic skills and key
competences.
Competition in public procurement remains
limited while unpredictable regulatory
changes and administrative burden hamper
private business and investment.
A
comprehensive e-procurement strategy has not
yet been developed and corruption risks remain
high. While the government took steps to
reduce administrative burdens, Hungary's
restrictive regulations in services sectors, such
as retail, and a volatile regulatory environment
remain concerns for businesses.
3
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1.
SCENE SETTER: ECONOMIC SITUATION AND OUTLOOK
Graph 1.2:
External and domestic demand contributions
to economic growth
Macroeconomic developments
In 2015, the Hungarian economy is estimated to
have grown by 2.7 %, down from 3.7 % in
2014.
After a deep double dip recession, a steady
recovery started in early 2013. The rebound was
helped by a modest recovery in Europe and a
strong pick-up in EU-funded investment. More
recently, economic growth was driven by private
consumption and net exports supported by
improved cost competitiveness. Despite a solid
growth performance in the past three years when
Hungary recovered the losses of the double dip
recession, the economy keeps lagging behind the
best performers among its regional peers (Graph
1.1).
GDP growth is forecast to remain relatively
stable in 2016-2017.
It is set to decrease to 2.1%
in 2016 as EU funds disbursement temporarily
dips due to a transition between programming
periods and the slack in the economy diminishes.
However, as the implementation of EU-funded
projects gathers steam again, growth is projected to
bounce back to 2.5 % in 2017, slightly above
potential (Graph 1.2).
Graph 1.1:
GDP in constant prices (2010 price level)
pp
10
8
6
4
2
0
-2
-4
-6
-8
-10
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
Investment
Consumption
Net exports
GDP growth (2010 prices)
Source:
European Commission
125
120
115
110
2008=100
Private consumption is expected to drive
growth going forward, while the contribution of
net exports is expected to decrease.
Measures
that eased the burden of mortgage loans on
households, low inflation, and high nominal wage
growth boosted real disposable income of
households in 2015, which in turn stimulated
consumption (Graph 1.2). This trend is foreseen to
continue in 2016, further helped by a 1 pp. cut in
the flat personal income tax rate. Investment is
forecast to contract further, mostly driven by the
availability of EU funding. Despite solid export
growth, the contribution of net exports to growth is
projected to gradually decline as domestic demand
strengthens.
Following a sharp decline in recent years,
inflation is projected to gradually return to the
central bank's target.
Inflation rate stabilised
around zero in the past two years, following a
steep fall in 2013 (Graph 1.3). In addition to the
global factors, low food prices, cuts in regulated
energy prices, and a major fiscal tightening in
2012 were the important driving forces of
disinflation in Hungary. Despite low domestic
inflation, GDP deflator remained above 2% in
2015, mainly due to a positive terms-of-trade
effect, helping to maintain a healthy nominal
growth. As a positive output gap is slowly opening
up and oil prices stabilise, inflation is forecast to
pick up to 1.7 % and projected to gradually reach
the central bank's target of 3 % by end-2017.
105
100
95
90
08
09
10
11
12
13
14
15*
CZ
HU
PL
SK
Source:
European Commission
Note: Data is based upon European Commission winter
forecast 2016
4
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1. Scene setter: Economic situation and outlook
Graph 1.3:
Headline inflation and core inflation
10
8
%
6
4
2
0
-2
scheme, which will help increase employment, but
sustained job creation in the medium-term will to a
considerable extent hinge on an improvement of
the private sector employability of the participants
in this scheme. Moreover, while the increase in the
number of frontier workers and people working
abroad helped reduce domestic unemployment, it
also started to create skill mismatches in Hungary.
Furthermore, despite the laudable improvement in
recent years, the activity rate is still below the
levels of regional peers and by some 5 pp. below
the EU average.
Budgetary developments and outlook
Consumer price index
Core inflation excluding indirect taxes
(1) Inflation and core inflation excluding indirect taxes are
based on national definition
Source:
Hungarian Central Bank
Labour market situation
Recent policy initiatives have significantly
improved the labour market situation, albeit
private sector job creation remains limited.
The
unemployment rate declined from about 11 % in
2010-2012 to 6 ¾ % in 2015, while the activity
rate increased from around 63 % in 2010-2012 to
69 % in 2015. On the supply side, a set of policy
measures, such as introducing stricter policies on
social transfers, increasing the retirement age and
tightening the conditions for early retirement
strengthened the incentives for people to enter or
remain in the labour market. On the demand side, a
public works scheme brought inactive or
unemployed people to the labour market, albeit not
to the private segment of it (Section 3.2). In
addition, the number of frontier workers (people
working abroad but maintaining a household in
Hungary) reached 1% of the population and the
number of people leaving the country to work
abroad also seems to have increased. While
employment in the private sector has also
recovered, a considerable part of the improvement
has been attributable to the public work scheme.
Moving forward, these factors will continue to
drive down unemployment, but will also create
new challenges.
As the economy steadily expands,
the unemployment rate is projected to decline to
5 % by 2017. The medium-term budgetary plans
envisage the expansion of the public works
The fiscal deficit declined significantly in 2015
but future improvement is set to be limited.
While structural measures helped to decrease the
deficit, future improvements will be mostly due to
better economic conditions. Based on the
Commission's 2016 winter forecast, the general
government deficit is expected to have declined to
2.1 % of GDP in 2015, from 2.5 % in 2014. The
deficit is projected to decrease further to 1.9 % of
GDP in 2017. The modest decline in the headline
deficit in 2016-2017 is mostly driven by the
cyclical upturn, as savings from pension reforms
and from declining interest costs are planned to be
spent on a new housing support scheme and on
sizable tax cuts. As a result, the structural balance
remains below -2 % of GDP, and thus it will not
reach the medium-term objective of -1.7 % of
GDP.
Government debt is expected to remain on a
declining path.
From its peak level of close to
81 % in 2011, the public debt-to-GDP ratio is
estimated to have declined to slightly below 76 %
in 2015. While relatively low headline deficits and
an improving economy helped reduce the public
debt ratio, the above trend masks sizable below-
the-line capital transactions and sizable negative
valuation changes due the high share of foreign
currency debt. The state took over most of the
assets of the mandatory second-pillar private
pension funds, but it also acquired several private
companies and banks. Moreover, delays in the
receipt of EU transfers in 2015 had a considerable
debt-increasing effect without increasing the
deficit as the latter is on accrual basis. The
relatively high nominal GDP growth and declining
headline deficit are expected to continue driving
down the debt ratio, to around 72�½ % in 2017.
5
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1. Scene setter: Economic situation and outlook
Nevertheless, the level of public debt remains high
compared to regional peers.
Hungary was affected by the recent refugee
influx as a transit country, but apart from a
relatively limited budgetary cost, there was
little impact on the economy.
These refugees
were predominantly transiting through Hungary,
and their inflow was almost completely halted in
mid-October 2015. The associated extra budgetary
costs are estimated to have reached HUF 45 billion
(somewhat more than 0.1% of GDP) in 2015, the
bulk of which was related to expenditure on border
controls.
Financial sector
lending and put pressure on profits. The newly
passed personal insolvency legislation and the two
asset management companies that were set up to
help reduce non-performing loans can help in this
regard (see Section 2.2).
External balances
Private sector indebtedness and foreign
exchange risk exposure declined significantly.
Private debt was reduced to about 90% of GDP in
2015, from its peak of close to 120% of GDP in
2009, albeit at the inevitable price of a decline in
private sector lending that hindered investment.
Moreover, the conversion of 15% of GDP foreign
currency denominated household debt into
domestic currency denominated debt in 2015 fully
eliminated the previously large foreign exchange
risk exposure of households. These changes
together with an improving labour market reignited
new lending to households with a particularly
strong pick up in mortgage lending, albeit from a
low basis. With the introduction of a new
government housing support scheme in 2016, this
trend is expected to continue. However, corporate
lending has not yet begun to grow as there are
factors on both the supply and demand sides that
hinder lending. The central bank launched various
schemes to promote lending to SMEs but so far
they only managed to stabilise the outstanding
stock of loans to SMEs. Moving forward, the
recently announced growth supporting programme
and a new market-based lending scheme of the
central bank will help promote a more organic and
stable investment growth in the private sector.
The banking system's vulnerability declined
over the past year.
The banking sector is showing
better results helped by the improving economic
environment. Nevertheless, banks remain cautious
in their lending to the corporate sector even though
they are strongly capitalised and highly liquid. The
main challenge for banks is to reduce the still high
share of non-performing loans that hinder new
Following the crisis, Hungary's net external
position improved significantly.
With high
external debt and large net external liabilities,
Hungary was particularly vulnerable to external
shocks at the outbreak of the financial crisis.
Following the crisis, however, there has been a
sharp correction on the external side. The
adjustment was particularly strong in the private
sector, reflecting an increase in gross savings and a
fall in the investment rate, which remained below
its pre-crisis level despite an increased inflow of
EU funds. As a result, net external liabilities
declined from 116% of GDP in 2009 to 73% by
2014 and the ratio is estimated to have declined
further in 2015. The rebalancing of the economy
has been achieved through maintaining high
current and capital account surpluses, which reflect
private sector deleveraging and a high inflow of
EU funds. The strong net lending position of the
country remained stable despite the recent pick up
in domestic demand (Graph 1.4). This has been
facilitated by the reversal of previous market share
losses due to the expansion of the automobile
industry and improved cost competitiveness.
Despite a temporary decline in EU funds inflows,
the net lending of the economy is projected to
remain high in 2016 and 2017 (at 6.5% and 7.8%
of GDP, respectively) as domestic demand
continues to be contained compared to the pre-
crisis levels. Notwithstanding these improvements,
the still rather high gross external debt and short-
term rollover needs continue to pose risks to the
economy (Section 2.1).
6
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1. Scene setter: Economic situation and outlook
Graph 1.4:
Net lending/borrowing by sector
Investment challenge and growth potential
15
10
% of GDP
5
0
-5
-10
-15
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15*16*17*
Households and NPISH
Corporations
General government
Total economy
(1) NPISH: Non-profit institutions serving households
Source:
European Commission
Although improving, the growth potential of the
country remains moderate for a catching-up
economy.
The current rate of potential growth is a
full percentage point lower than before the crisis,
which was already comparatively low. The weak
growth potential mainly reflects a low total factor
productivity growth, which in turn is linked to
problems with financial intermediation and to the
low level of innovation in the economy (Section
2.3). The level of investment has not yet reached
its pre-crisis value (Box 1.1). Low corporate
investment – which particularly hinders growth
and job creation – is attributable to deleveraging
needs and to the perceived deterioration in the
business environment. Nevertheless, there have
been some improvements in the contribution of
labour to potential growth, which is linked to the
above-mentioned labour market reforms.
Hungary's floating exchange rate regime helped
facilitate external adjustment, and can do so
even more in the future.
The country recorded
steadily increasing trade surpluses since 2008. The
improvement in trade balance was also supported
by the real depreciation of the forint (by 12% and
19% between 2009 and 2015 in terms of consumer
prices and real unit labour costs, respectively),
which to a large extent resulted from the
deprecation of the nominal exchange rate (by 17%
over the same period). However, the depreciation
simultaneously deteriorated the balance sheet
position of the private sector with adverse
macroeconomic
consequences.
This
was
particularly relevant for the household sector,
which had a considerable amount of foreign
exchange denominated debt and a limited ability to
absorb exchange rate risks. However, the recent
conversion of practically all foreign currency
denominated household loans into local currency
denominated loans has removed this constraint on
the exchange rate policy. Although the net foreign
asset position of the economy has not changed as
the foreign exchange transactions were made
directly with the central bank and thus resulted in a
concomitant reduction in the central bank's foreign
currency reserves, the conversion ensured a better
distribution of exchange rate risks. A similar effect
could be attributed to the central bank's self-
financing programme, which reduces the foreign
exchange exposure of the central government
(Section 2.1)
7
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1. Scene setter: Economic situation and outlook
Box 1.1:
Investment Challenges
Macroeconomic perspective
Total investment as a percentage of GPD had been on a steadily declining trend before the crisis and
declined even further after the crisis.
Between 2000 and 2007, the decline in the private investment ratio
from 21.9% to 19.4% has been partially offset by a slight increase in the public investment ratio from 3.6%
to 4.3%. In the post-crisis period, the private investment ratio reported a sharp drop in 2010 and then
remained fairly stable in the following years. The government investment ratio on the other hand reported a
sharp drop in 2008. The total investment-to-GDP ratio dropped below 20% in 2011 and 2012, compared to
an average of 24% between 2000 and 2007.
In 2013, gross fixed capital formation started to grow again, fuelled by investments stemming from
accelerated absorption of EU funds (mostly in the public sector). In that year gross fixed capital formation
grew by 7.3% year-on-year and contributed do GDP growth with 1.4 pps. In 2014 the pattern continued even
more, the growth of grossed fixed capital formation was an outstanding 11.2% on year-on-year terms and
2.3 pps. contribution to GDP (out of the 3.7% real growth in 2014). This meant that the he investment ratio
propelled to 21.7% of GDP in 2014. The Commission's current forecast predicts a small decrease of the ratio
in 2015 and a significant drop in 2016 before funds from the new programming period of EU funding will
start to positively affect investment again in 2017.
Graph 1:
Investment ratio by sector and component
25
Public and private investment as a % of GDP, 2000-2017, HU and EU
average
Forecast
14
Investment by components as a % of GDP, 2000-2017, HU and EU average
Forecast
20
12
10
15
8
10
6
4
5
2
0
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
15
16
17
0
00
01
02
03
04
05
HU investment in dwelling
HU investment in equipment
HU other investment
06
07
08
09
10
11
12
13
14
15
EU-28 investment in dwelling
EU-28 investment in equipment
16
17
HU government investment
HU private investement
EU-28 government investment
EU-28 private investment
HU investment in other construction
EU-28 investment in other construction
EU-28 investment other investment
Forecasts for 2015-2017 based on a no-policy-change assumption
Source:
European Commission
There was a significant change in the composition of investment activity by type of assets over the last
years: the relative share of manufacturing and public investments increased, largely at the expense of real
estate activities, but the share of market services also declined. For the components of investment, there has
been a steady decrease in the equipment investment ratio in the pre-crisis period, which has been halted in
2010. From this point onwards, the ratio continuously recovered. Dwelling investment on the other hand has
been fairly stable in the pre-crisis period but decreased from 2009 onwards. The same development was
observed for the investment in other construction ratio, which however recovered sharply from 2013
onwards.
The growth of gross fixed capital formation in volume terms was largely driven by the public sector over the
last five years. At the same time, the private sector experienced a negative growth apart from a short revival
in 2013-2014 (Graph 2).
(Continued on the next page)
8
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1. Scene setter: Economic situation and outlook
Box (continued)
Graph 2:
Annualized quarterly trend growth of investment
25
Annualised quarterly growth, %
20
15
10
5
0
-5
-10
Total
Government
Private sector
Source:
Fiscal Responsibility Institute Budapest, Baseline projection of 08.12.2015
Assessment of barriers to investment and ongoing reforms
Overall investment activity is dependent on the absorption of the EU funds. EU funds propel investments
majorly through public investments. Despite recent progress, investment barriers in Hungary remain in key
areas (
1
):
Regarding the financial sector low lending activity and the tax burden on financial institutions cause
problems (section 2.2).
The private sector is still deleveraging, and lending activity is subdued due to
factors on both the supply and the demand sides of the credit market. The financial sector has been
substantially weakened by years of extraordinary tax burden, high non-performing loan ratios and high
regulatory costs, albeit the sector has remained adequately capitalised.
On the front of taxation, the high tax wedge on low skilled labour and the reliance on sector specific
taxes could have a negative impact on investment (section 3.1 and 3.2).
High tax burden on low income
earners can have a negative impact on market employment and thus can hamper investment in an open
economy. The heavy reliance on sector specific taxes is a source of distortion across sectors also by
generally weakening investors' confidence.
There are several challenges for public administration and it is likely that the investment activity
would benefit mostly from a better business environment (section 3.4).
Overall the high administrative
burden, also for start-ups, could negatively affect investment decisions. The volatile regulatory framework,
with frequent and unpredictable regulatory changes, creates uncertainty for investors. Overall, the perceived
low effectiveness and efficiency of public administration can affect the business climate and weight on
investment. Increasing entry barriers in previously open markets in certain sectors could have undermined
sunk-cost investments contributing to a general sense of policy-induced uncertainty regarding the security of
intangible assets.
Other areas where challenges for investment can be identified include research, development and
innovation and sector specific regulation (sections 3.4 and 3.5).
The resources devoted to science and
technology are comparatively low. In addition, there is a lack of spill-over effects from multinational
companies. Financing of new innovative companies through venture/seed capital and newer initiatives such
as crowdfunding remains marginal. High administrative and tax burden as well as entry barriers the retail
sector, hamper investment. Below-cost regulated end-user prices for household consumers in the retail
electricity and gas utility sector brought rates of return in the electricity and gas regulated business segments
to zero during the past few years, leaving limited funds for investment.
(
1
) See
"Challenges
to
Member
States'
Investment
Environments",
SWD
(2015)
(http://ec.europa.eu/europe2020/challenges-to-member-states-investment-environments/index_en.htm).
400
final
9
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1604551_0014.png
1. Scene setter: Economic situation and outlook
Box 1.2:
Contribution of the EU Budget to structural change
Hungary is a major beneficiary of the European Structural and Investment Funds (ESIF) and can receive up to EUR
25 billion for the period 2014-2020. This is equivalent to 3,1% of GDP annually and 62.3% of the expected national
public investment in areas supported by the ESI funds.
A number of reforms were passed as ex-ante conditionalities in areas to benefit from the Funds to ensure successful
investments. Reforms in areas such as public procurement, capacity building in public administration, employment
services, vocational and higher education, early school leaving and social inclusion are still pending and to be
completed by end-2016. Where ex-ante conditionalities are not fulfilled by end 2016, the Commission may suspend
interim payment to the priorities of the programme concerned.
The Funds will contribute to the Europe 2020 objectives and focus on priorities and challenges identified in recent
years in the context of the European Semester and under the Europe 2020 strategy. Hungary's ESIF allocation is
concentrated on key issues such as: enhancing innovation and competitiveness of businesses, supporting ICT
development, supporting the shift towards a low-carbon economy contributing to the development of the labour
market, improving the skills of the labour force, improving efficiency of public administrations, contributing to the
reduction and prevention of poverty, supporting equal access to mainstream education, increasing tertiary attainment .
Combating early school leaving and supporting youth employment is also addressed through the specific Youth
Employment Initiative allocation. Regular monitoring of implementation includes reporting in mid-2017 on the
contribution of the Funds to Europe 2020 objectives and progress in addressing relevant structural reforms to
maximise the use of EU financing.
Financing under the new European Fund for Strategic Investments (EFSI), Horizon 2020, the Connecting Europe
Facility and other directly managed EU funds would be additional to the ESI Funds. Following the first rounds of
calls for projects under the Connecting Europe Facility, Hungary has signed agreements for EUR 270 million for
transport
projects.
For
more
information
on
the
use
of
ESIF
in
Hungary,
see:
https://cohesiondata.ec.europa.eu/countries/HU.
10
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1604551_0015.png
1. Scene setter: Economic situation and outlook
Table 1.1:
Key economic, financial and social indicators - Hungary
2003-2007
3.5
4.8
1.0
3.5
14.6
12.8
2.6
3.0
2.8
-0.1
0.8
-0.5
1.4
2.1
-7.5
-1.8
-0.6
0.4
-87.1
-31.3
69.1
47.5
5.2
-2.1
4.1
13.6
79.1
23.3
55.8
-1.1
23.5
0.4
.
4.5
4.4
5.4
8.0
3.6
4.2
-0.2
2.8
2.9
35.0
19.4*
19.2
.
.
.
6.8
3.0
17.1
61.1
31.0
11.3
-7.1
37.6
.
61.4
2008
0.8
-1.2
3.1
1.0
6.9
6.0
2.3
1.2
0.3
-0.2
0.7
-1.4
1.3
1.4
-7.0
0.4
-1.2
1.1
-102.3
-54.7
99.5
39.4
3.3
-1.1
1.5
12.7
105.6
36.5
69.1
-1.4
24.1
-0.7
-3.1
4.1
5.0
6.0
7.3
2.9
4.3
-0.6
0.7
2.7
38.3
23.4
28.1
13.5
19.2
3.7
7.8
3.6
19.5
61.2
28.2
12.0
-3.6
39.7
.
71.6
2009
-6.6
-6.7
1.4
-8.3
-11.4
-14.7
-4.5
0.1
-5.2
-4.0
2.6
-1.9
0.8
1.2
-0.8
4.1
1.3
1.7
-115.7
-56.1
111.5
22.4
-3.3
-0.5
3.6
6.0
117.1
37.7
79.4
4.8
23.9
0.7
-9.0
4.2
3.9
4.0
-1.3
-4.2
3.0
-0.9
-9.7
-5.3
37.8
23.8
-0.8
13.1
16.3
7.7
10.0
4.2
26.4
61.2
29.6
11.3
-4.6
39.2
.
78.0
2010
0.7
-2.8
-0.4
-9.5
11.3
10.1
-3.4
-0.4
-3.7
3.2
1.3
-1.8
0.4
1.1
0.3
5.4
0.1
1.8
-108.9
-54.2
113.9
11.8
-8.0
-3.0
3.6
-4.2
115.6
39.7
75.9
5.0
24.6
1.6
-5.8
3.1
2.3
4.7
-0.3
1.0
-1.3
-3.5
-1.3
1.6
31.2
23.8
-0.3
14.1
3.7
10.9
11.2
5.5
26.4
61.9
29.9
11.9
-4.5
37.5
-3.5
80.6
2011
1.8
0.8
0.2
-1.3
6.6
4.5
-1.5
-0.2
0.2
-0.4
2.0
-1.4
0.3
0.9
0.8
6.1
-1.4
2.4
-106.4
-51.4
117.1
6.6
-3.7
-1.6
4.1
-4.6
114.9
37.6
77.3
5.1
25.3
3.5
-6.9
2.2
2.2
3.9
3.1
1.7
1.4
-0.8
0.0
-0.4
35.0
26.8
7.1
13.8
8.0
12.8
11.0
5.2
26.0
62.4
31.5
12.8
-5.5
36.9
-4.5
80.8
2012
-1.7
-2.2
-1.5
-4.4
-1.8
-3.5
-3.2
0.0
-2.3
-0.6
1.3
-0.8
0.1
0.7
1.8
6.8
-1.0
2.5
-94.2
-45.8
100.6
-11.9
-10.7
-2.1
2.6
-6.1
102.0
31.8
70.2
3.4
24.4
3.0
-9.3
2.0
3.5
5.7
2.1
-1.8
4.0
0.5
-3.0
-2.2
35.1
34.5
-6.7
16.0
7.3
14.1
11.0
5.0
28.2
63.7
32.4
12.8
-2.3
38.6
-1.4
78.3
2013
1.9
0.3
2.4
7.3
6.4
6.3
-2.3
0.9
2.1
-0.7
0.5
-0.1
0.4
0.6
3.9
7.3
0.5
3.6
-83.5
-37.2
89.0
-13.6
4.0
0.1
3.9
-1.1
95.3
28.2
67.1
7.2
25.6
2.9
-4.6
1.4
3.1
1.7
1.8
0.9
0.9
-2.2
-1.6
-1.4
34.5
34.5
-4.0
17.0
7.1
14.0
10.2
4.9
26.6
64.7
34.8
13.6
-2.5
38.2
-1.5
76.8
2014
3.7
1.8
2.9
11.2
7.6
8.5
-0.5
1.8
3.8
0.0
-0.2
0.5
0.7
0.6
2.2
7.4
0.7
3.8
-73.2
-33.7
86.3
-9.12
3.5
-2.6
4.9
-0.5
91.3
25.9
65.4
5.1
26.3
3.4
3.1
1.6
3.2
0.0
0.9
-0.9
0.3
-2.9
-4.2
-3.5
34.5
34.5
8.2
14.6
-15.3
14.2
7.7
3.7
20.4
67.0
31.1
12.2
-2.5
38.4
-2.5
76.2
2015
2.7
3.0
0.3
0.0
8.5
7.3
0.2
2.0
1.6
-0.4
1.6
0.6
0.7
0.7
.
.
1.0
.
.
.
.
.
.
.
.
.
.
.
.
7.0
26.2
3.3
.
.
2.3
0.1
3.5
.
2.8
0.5
-0.4
-2.0
.
.
.
.
.
.
6.7
.
.
.
.
.
-2.1
39.1
-2.2
75.8
forecast
2016
2.1
3.2
0.2
-2.0
6.2
5.8
0.3
2.0
1.2
0.0
0.9
0.7
0.5
0.9
.
.
0.5
.
.
.
.
.
.
.
.
.
.
.
.
7.5
27.0
2.4
.
.
2.4
1.7
3.5
.
2.7
0.3
-0.2
0.5
.
.
.
.
.
.
6.0
.
.
.
.
.
-2.0
37.8
-2.5
74.3
2017
2.5
2.5
0.5
3.6
6.4
6.6
0.6
2.2
2.1
0.0
0.5
0.6
0.6
1.0
.
.
0.0
.
.
.
.
.
.
.
.
.
.
.
.
8.4
27.7
1.8
.
.
2.8
2.5
3.5
.
2.2
-0.6
.
0.4
.
.
.
.
.
.
5.2
.
.
.
.
.
-1.9
37.4
-2.2
72.4
Real GDP (y-o-y)
Private consumption (y-o-y)
Public consumption (y-o-y)
Gross fixed capital formation (y-o-y)
Exports of goods and services (y-o-y)
Imports of goods and services (y-o-y)
Output gap
Potential growth (y-o-y)
Contribution to GDP growth:
Domestic demand (y-o-y)
Inventories (y-o-y)
Net exports (y-o-y)
Contribution to potential GDP growth:
Total Labour (hours) (y-o-y)
Capital accumulation (y-o-y)
Total factor productivity (y-o-y)
Current account balance (% of GDP), balance of payments
Trade balance (% of GDP), balance of payments
Terms of trade of goods and services (y-o-y)
Capital account balance (% of GDP)
Net international investment position (% of GDP)
Net marketable external debt (% of GDP) (1)
Gross marketable external debt (% of GDP) (1)
Export performance vs. advanced countries (% change over 5
years)
Export market share, goods and services (y-o-y)
Net FDI flows (% of GDP)
Savings rate of households (net saving as percentage of net
disposable income)
Private credit flow (consolidated, % of GDP)
Private sector debt, consolidated (% of GDP)
of which household debt, consolidated (% of GDP)
of which non-financial corporate debt, consolidated (% of GDP)
Corporations, net lending (+) or net borrowing (-) (% of GDP)
Corporations, gross operating surplus (% of GDP)
Households, net lending (+) or net borrowing (-) (% of GDP)
Deflated house price index (y-o-y)
Residential investment (% of GDP)
GDP deflator (y-o-y)
Harmonised index of consumer prices (HICP, y-o-y)
Nominal compensation per employee (y-o-y)
Labour productivity (real, person employed, y-o-y)
Unit labour costs (ULC, whole economy, y-o-y)
Real unit labour costs (y-o-y)
Real effective exchange rate (ULC, y-o-y)
Real effective exchange rate (HICP, y-o-y)
Tax wedge on labour for a single person earning the average wage
(%)
Taxe wedge on labour for a single person earning 50% of the
average wage (%)
Total Financial Sector Liabilities, non-consolidated (y-o-y)
Tier 1 ratio (%) (2)
Return on equity (%) (3)
Gross non-performing debt (% of total debt instruments and total
loans and advances) (4)
Unemployment rate
Long-term unemployment rate (% of active population)
Youth unemployment rate (% of active population in the same age
group)
Activity rate (15-64 year-olds)
People at-risk poverty or social exclusion (% total population)
Persons living in households with very low work intensity (% of
total population aged below 60)
General government balance (% of GDP)
Tax-to-GDP ratio (%)
Structural budget balance (% of GDP)
General government gross debt (% of GDP)
(1) Sum of portfolio debt instruments, other investment and reserve assets.
(2, 3) Domestic banking groups and stand-alone banks.
(4) Domestic banking groups and stand-alone banks, foreign (EU and non-EU) controlled subsidiaries and foreign (EU and
non-EU) controlled branches.
Source:
European Commission, winter forecast 2016; European Central Bank.
11
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1604551_0016.png
2.
IMBALANCES, RISKS, AND ADJUSTMENT ISSUES
This section provides the in-depth review foreseen under the macroeconomic imbalances procedure
(MIP) (
1
). It focuses on the risks and vulnerabilities flagged in the Alert Mechanism Report 2016. The
section firstly analyses the reasons behind the significant decline of the net external liabilities, the
drivers of large surpluses on the external balance and the impact on the ongoing stock adjustment. The
focus is on export performance, competitiveness and the role of foreign direct investment. Secondly, the
section focuses on the ongoing adjustment in the banking sector. Deleveraging pressures are easing but
continue to constrain investment and economic growth. Financial risks have significantly decreased.
Thirdly, the section analyses possible ways to enhance potential growth. While labour market policies
helped in this regard, it appears crucial to find new ways to accelerate total factor productivity and
promote higher investment in productive assets. The section concludes with the MIP assessment matrix,
which summarises the main findings.
2.1. EXTERNAL SUSTAINABILITY: CONTINUED ADJUSTMENT IN
STOCK VULNERABILITIES
Adjustment in external indebtedness
Graph 2.1.1:
Components of Net International Investment
Position
20
0
Net external liabilities declined from 116% of
GDP in 2009 to 73% by 2014
(Graph 2.1.1). This
is still high by international comparison but it is
closer to levels of regional peers and the rapid pace
of decline is projected to continue. The rebalancing
of the economy has been achieved through
maintaining high current and capital account
surpluses (reaching 6-9% of GDP in recent years),
which reflect private sector deleveraging and a
high inflow of EU funds. While the crisis resulted
in sharply increased net savings of households and
corporations, the general government deficit also
decreased after 2011. The high surplus position
remained stable despite the recent take up of
domestic demand. Regarding liabilities by sectors,
the improvement in the net external liabilities is
primarily attributable to a declining external debt
of the banking sector accounting for more than
two-thirds of the total change. Roughly half of the
net external liabilities consist of debt securities and
the other half is represented by FDI or portfolio
investments.
(
1
) According to Article 5 of Regulation (EU) No. 1176/2011.
-20
-40
% of GDP
-60
-80
-100
-120
-140
-160
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15*
Net portfolio invest., equity and investment fund shares/units
Net portfolio invest., debt securities
Other invest. (net)
Net direct invest.
Net financial derivatives and employee stock options
Net int'l investment position
Marketable debt (portfolio debt instr., other invest. and res. assets, net)
(1) * indicates estimated figure using quarterly data
(2) invest. = investment; instr. = instrument; res. assets =
reserve assets
Source:
Eurostat
The rapid improvement in the net external
liabilities seems to have continued in 2015.
By
mid-2015, net external liabilities declined further
to around 68% of GDP backed by a record high
level of net lending. Following this trend, net
external debt (without intercompany loans)
declined to around 30% of GDP, while gross
external debt decreased below 85% GDP (from
their peak levels of 56% and 111%, respectively).
Overall, Hungary is improving fast towards its
regional peers regarding the key external
vulnerability
indicators
(Graph
2.1.2).
Nevertheless, Hungary's gross external debt
remains relatively high, accompanied by
considerable rollover needs. Although short term
12
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1604551_0017.png
2.1. External sustainability: Continued adjustment in stock vulnerabilities
external debt has also declined by some EUR 15
billion (15% of GDP) since 2011, it still exceeds
EUR 20 billion (above 20% of GDP) and thus
remains a source of vulnerability (Graph 2.1.3).
Graph 2.1.2:
Key external vulnerability indicators: Hungary
and regional peers
140
120
100
80
% of GDP
60
40
20
0
-20
-40
2004
2009
2012
2015*
2004
2009
2012
2015*
2004
2011
2012
2015*
Net external liabilities (-NIIP) as %
of GDP
Net debt as % of GDP
HU
CZ
PL
SK
Gross debt as % of GDP
* The value for 2015 is the latest available quarterly data (Q2 2015)
Source:
Eurostat and own calculations
debt by around 8% of GDP as banks gradually
repay their associated foreign currency liabilities
(see subsection 2.2). Second, the central bank's
self-financing programme aims to increase the role
of domestic sources in financing government debt
by providing incentives for local banks to channel
their excess liquidity from central bank accounts to
the sovereign market (Box 2.1.1). Coupled with
the stepped-up retail securities scheme, the share
of foreign exchange–denominated component in
the public debt has decreased from around 40% to
33% (or by some 5% of GDP) since the
announcement of the programme in spring 2014.
Given that both measures result in a simultaneous
reduction in foreign assets as well (mainly the
central bank reserves), the country's net external
position is not affected. Nevertheless, lower gross
external debt leads to lower external refinancing
needs, diminishing external rollover risks, and may
also help reducing the sovereign risk premium.
Graph 2.1.4:
Components of the external position (current
and capital account)
Graph 2.1.3:
Short term external debt
45
40
35
bn Euro
15
10
5
% of GDP
30
25
20
15
10
5
0
0
-5
-10
04
Corporate sector
General government
Banking sector
Short-term external debt
05
06
07
08
09
10
11
12
13
14 15*
Transfer balance
Income balance
Trade balance
Net lending/borrowing (CA+KA)
Current account balance (CA)
(1)Foreign debt with a maturity shorter than one year
(excluding intercompany loans)
Source:
Hungarian Central Bank
Recent policy developments contributed to a
reduction in external vulnerabilities.
First, the
conversion of almost all foreign exchange-
denominated retail loans decreased the share of
such household loans from 70% to close to zero
since early 2015. It was a two-step conversion
process, which started with mortgages in spring
2015 and was followed by the remaining part,
mainly car-financing loans in the autumn of 2015.
By the end of 2017, the household loan conversion
is expected to lead to a reduction in gross external
(1) Value for 2015 is based on latest available quarterly
data (q2 2015). Income balance: labour income, income
on equity and income on debt. Transfer balance: sum of
the capital account, other primary income and secondary
income.
Source:
European Commission
All key components of the balance of payments
have significantly improved since 2008.
Following a sharp reduction of the deficit in 2009,
the current account gradually improved and
recorded a surplus of 4% of GDP by 2013 (Graph
2.1.4). Although the surplus moderated in 2014 to
2.3% of GDP, largely due to increased reinvested
13
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1604551_0018.png
2.1. External sustainability: Continued adjustment in stock vulnerabilities
earnings of foreign-owned companies, it is
expected to reach around 4% of GDP again in
2015. The sustained surplus position of the current
account in the post-crisis years reflects a steadily
rising trade balance. The latter increased from a
slightly positive level in 2008 to 7.4% of GDP by
2014, and improved further to above 8% in 2015.
The trade balance thus was a key factor driving the
correction of external imbalances since the
outbreak of the crisis in 2008, but not the only one.
Starting from a level of around -7% of GDP, net
primary incomes increased by some 1�½ pps.
between 2009 and 2015. Initially, this was a result
of declining income of foreign equity. However,
more recently the recovery in equity income is
largely counterbalanced by decreasing interest
payments as well as the increasing earnings of
domestic residents working abroad. In addition, net
transfer receipts improved the external balance by
some 3�½ pps. since 2008 (within this the capital
account balance increased from 1% to around 4-
5% of GDP in recent years). This primarily reflects
the growing absorption of EU funds.
EU financial flows made an increasing
contribution to the improvement in the net
external financing, one of the highest in Europe.
Hungary has recently become the largest net
beneficiary of the EU budget among Member
States as measured by the operating budgetary
balances. Net transfers to the country stood at
5.5% and 5.3% of GDP in 2013 and 2014,
respectively (Graph 2.1.5). Current EU transfers –
reflecting direct agricultural supports and the
current expenditure component of structural funds
net of the national contribution to the EU budget –
improved the current account by around 1.5-2% of
GDP in recent years. Meanwhile, EU structural
fund disbursements financing investment activities
(recorded in the capital account) reached around
4% of GDP. According to the 2015 convergence
programme, EU transfers are expected to stay
above 5% of GDP in 2015, and continuously
decline to around 3% of GDP by 2019, before
rising again. However, this pattern may change as
the government has announced an ambitious plan
to accelerate the disbursement of EU funds in the
new programming period.
Graph 2.1.5:
Current and capital EU transfers (% of GDP)
6
5
4
3
% of GDP
2
1
0
-1
04
05
06
07
08
09
10
11
12
13
14
Current transfer
Capital transfer
Source:
Hungarian Central Bank and Hungarian Central
Statistical Office
14
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2.1. External sustainability: Continued adjustment in stock vulnerabilities
Box 2.1.1:
How does the MNB's Self-Financing Programme reduce Hungary's
external vulnerability?
The Hungarian Central Bank (MNB) launched the Self-Financing Programme (SFP) in April 2014 with the
objective to reduce Hungary's external vulnerability primarily via a reduction in its gross external debt.
The level of gross external indebtedness of a country is a source of vulnerability and it is seen as such by
investors and international institutions, including credit rating agencies. Foreign portfolio investment in
emerging markets is notoriously unreliable in a market stress situation, as experienced by Hungary in the
wake of the 2008 global financial crisis. Less gross external debt results in lower external refinancing needs
and a diminishing external rollover risk. Therefore, it can help Hungary to regain its investment grade
sovereign credit rating, which in turn could mitigate risks related to future swings in global risk aversion.
The SFP operates primarily via the transformation of the MNB's key policy instrument in order to channel
commercial banks' excess liquidity from the central bank to collaterizable assets, i.e. – due to the low level
of securitization of the Hungarian financial market – mainly to government bonds. Accordingly, the MNB
converted its two-week bill into a deposit facility in August 2014, no longer accepting funds directly from
non-residents and not providing overnight liquidity to banks against it. As further elements of the SFP, the
MNB introduced a forint interest rate swap (IRS) facility and announced the possibility of other forint
liquidity-providing measures to encourage banks to invest in securities. The IRSs of 3-, 5- and 10-years
maturity reduce banks' interest rate risk and are offered on auctions at a below-market rate price in exchange
for a commitment to hold additional securities. From September 2015, the MNB made it less attractive to
keep excess liquidity in the central bank by introducing a three-month policy instrument (not eligible as
collateral) and putting a quantitative limitation on the usage of the two-week deposit (allocated in tenders). It
also lowered the interest rate corridor to discourage placing funds in one-day deposits and to make it more
favourable for banks to access liquidity.
The increased demand by domestic banks for government securities allows the Treasury to refinance
maturing foreign currency denominated debt with HUF-issuance. The increase in government bond holdings
of domestic banks amounted to about EUR 5.3bn between March 2014 and September 2015, which partly
also crowded out foreign investors from the secondary market and covered the net issuance of the Treasury
(together with the household sector). The shift to forint issuance improves the currency structure of
government debt and reduces the sensitivity of debt ratios to the exchange rate.
The SFP reduces Hungary's gross external debt in various ways. This impact of the transformation of the
MNB's key instrument to exclude foreigners from holding central bank liabilities, the increased secondary
market government security purchases of domestic banks replacing non-residents and the Treasury's
refinancing of maturing foreign debt from HUF-issuance reduce Hungary's gross external debt. The latter
directly reduces the MNB's FX reserves as well (the Treasury converts HUF with the MNB for repaying
foreign debt). Therefore in all these cases, the 'direct' impact of the SFP on Hungary's net international
investment position is neutral (though net external debt decreases if the foreign investor buys equity to stay
in Hungary). On the other hand, over time lower gross external debt will reduce interest payments to abroad
(possibly also due to the ensuing lower risk premium) Hungary's net external lending position, thereby
contributing to a decrease in net external debt.
The SFP lowers the MNB's foreign exchange reserves, but it goes against the trend of increasing reserves
due to EU fund absorption. International reserve coverage of short-term external debt stood at 146% at end-
Q2 2015 and it is projected to remain above the commonly used 100% benchmark in the coming years.
However, a lower foreign exchange reserve represents external vulnerability in itself. Long-term debt can
quickly turn into short-term during a crisis. Furthermore, the level of foreign exchange reserves can be
important not only to preserve the confidence of foreigners, but also that of domestic players (foreign
exchange reserves covered 53% of M3 in October 2015).
(Continued on the next page)
15
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2.1. External sustainability: Continued adjustment in stock vulnerabilities
Box (continued)
Moreover, the SFP strengthens the sovereign-banking sector nexus, which is against the current policy drive
in the euro area and represents risks. Hungary's banks have already a relatively high exposure to government
securities (Graph 1). If doubts about the government's solvency emerge, banks' access to external funding
would deteriorate, thereby the public finance problems could spread to the private sector.
Graph 1:
The share of general government in domestic bank assets (% of balance sheet total of MFIs)
%
25
20
15
10
5
0
Sep 15
BG
CZ
HU
Loans
PL
Debt securities
RO
HR
EA
Source:
ECB
Current projections suggest that Hungary’s net
external liabilities position will continue to
improve in the coming period, despite the
scheduled decrease in EU transfers.
According
to the Commission 2016 winter forecast, net
lending will remain above 6% of GDP over the
forecast horizon leading the next external liabilities
to decline to below 45% of GDP by 2017. Building
on this, the Commission's medium-term baseline
scenario indicates this ratio will decline below
35% by the end of this decade (
2
). Moreover, the
illustrative medium-term scenarios modelled by
the Commission show that Hungary would need to
achieve a current account surplus of only 1.1% of
GDP on average over the next 10 years in order to
halve its net external liabilities by 2025 (to reach
around 35% of GDP) even without a positive
contribution from the capital account. This
condition is most likely to be ensured as the
cyclically adjusted current account balance is
estimated at 3% of GDP on average in 2013-2014,
and it is forecast to reach even higher levels in the
subsequent years.
(
2
) In the baseline scenario, the nominal GDP is projected to
grow at an average rate of 4% over 2016-2026; which is
based on the t+10 methodology, the capital account balance
is assumed to stay at 1.5% of GDP, while the nominal
effective domestic yields are assumed to remain broadly
stable at around 4.6%.
Drivers of trade performance
While until 2012 the improvement in the trade
balance had been mainly driven by the
compressions of import demand, the positive
trend has been maintained alongside the
subsequent recovery of domestic demand.
This
was made possible by export market share gains
and favourable terms of trade effects, creating the
room for the growth in import volumes (Graph
2.1.6). Following a sharp correction from -0.8% to
2.9% of GDP in 2009, the balance of goods
remained broadly stable during the post-crisis
years hovering around 3% of GDP (with a
temporary fall in 2014 reflecting increased imports
with the surge in investment). Thus the increases
in the trade surplus occurred mostly on account of
an uninterrupted improvement of the balance of
services (altogether 4 pps. in terms of GDP
between 2008 and 2015, see Graph 2.1.7).
At around 5% of GDP, the trade surplus in
services already exceeded the positive balance
of goods by 2 pps. in 2015.
This is the result of
expanding service exports, while the value of
service imports has remained broadly stable
relative to GDP since 2008. Nevertheless service
exports are much smaller (around one-fifth) than
the country's exports of goods. While tourism has
16
Sep 15
Sep 15
Sep 15
Sep 15
Sep 15
Sep 15
2009
2012
2009
2012
2009
2012
2009
2012
2009
2012
2009
2012
2009
2012
swd (2016) 0085 - Ingen titel
1604551_0021.png
2.1. External sustainability: Continued adjustment in stock vulnerabilities
the highest share in the balance of services, the
more recent gains were mainly linked to the
growing exports in transportation, manufacturing
services on physical inputs owned by others as
well as in other business services (such as legal
and accounting services).
Graph 2.1.6:
Export and import growth in volumes
(2008=100)
140
130
120
110
100
Index,
2008=100
90
80
70
60
50
04
05
06
07
08
09
10
11
12
13
14 15*
Exports
Imports
* Based on European Commission 2016 winter forecast
Source:
European Commission
Graph 2.1.7:
Evolution of trade balance
more recently there has been a turnaround.
Following a cumulative decline in market share of
23% between 2008 and 2012, Hungary recorded a
cumulative growth of 7.5% in 2013 and 2014
(Graph 2.1.8). This positive trend is expected to
continue. The recovery in export performance has
resulted from an expansion in services and goods
markets with a relatively stronger contribution by
the latter segment. As far as the goods market is
concerned, previous market share losses mainly
occurred in the machinery and electronic
equipment subsectors (accounting for 70% of the
total decline between 2008 and 2012). On the other
hand, recent export market gains have
predominantly been driven by the increased
production capacity in the automobile industry
(with an estimated contribution of around 150% by
the vehicle manufacturing sector to the total
market share growth between 2012 and 2014(
3
)).
Furthermore, the favourable developments in the
goods market are attributable to market share gains
in individual country and product markets rather
than simply to the initial geographical or product
distribution of exports (Graph 2.1.9). Market share
gains in the geographical dimension are linked to
intra EU trade. Meanwhile, the government's
recent efforts in trade policy aim at facilitating the
entry of Hungarian companies to new markets
outside the EU as well (under the heading of
"Eastern and Southern opening").
(
3
) The contribution is above 100 per cent as other subsectors
where incurring market share losses in the same period.
10
% of GDP
8
6
4
2
0
-2
-4
-6
04 05 06 07 08 09 10 11 12 13 14 15*
Balance of goods
Balance of services
Trade balance
* The value for 2015 is based on quarterly figures
Source:
Hungarian Central Bank
The improvement in the trade balance in the
aftermath of the crisis went in parallel with a
considerable fall of export market shares, but
17
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1604551_0022.png
2.1. External sustainability: Continued adjustment in stock vulnerabilities
Graph 2.1.8:
Evolution of Hungary's export market share
(year-on-year)
15
10
5
0
-5
-10
-15
01 02 03 04 05 06 07 08 09 10 11 12 13 14
Contribution to EMS: goods
Contribution to EMS: services
Export market share growth yoy
Source:
Eurostat
Graph 2.1.9:
Components of export market share change
- goods (2008-2014, annual averages)
the unit labour cost based real effective exchange
rate (REER) of the country depreciated altogether
by around 12% and 19%, respectively (Graph
2.1.10). This was mainly driven by the nominal
depreciation of the forint, but the moderation of
unit labour costs also contributed to this
development. The REER is forecast to remain
broadly stable in the coming years. Nevertheless,
the positive effects of the REER depreciation are
likely to be attenuated by two important factors.
First, given the initially high volume of foreign
currency debt in the corporate sector (above 50%
in 2009), the deterioration in firms’ balance sheet
position due to nominal depreciation could have
resulted in an offsetting effect. Second, the import
share of Hungarian exports is traditionally one of
the highest in the EU (at around 45-50%),
implying that the impact of the exchange rate on
exports is proportionally weaker. In this respect,
the increased cost and price competitiveness could
have had a significantly stronger impact on the
trade surplus of services as the correlation between
exports and imports is typically much weaker for
services than for goods.
Graph 2.1.10:
The evolution of real effective exchange rate
(2008=100)
Rate of change y-o-y (%)
6
4
2
0
-2
-4
-6
-8
-10
%
Initial geograhical
specialisation
Market share gain in
geogr. destinations
Initial product
specialisation
Market share gain in
product markets
Sum
105
100
95
90
85
80
75
70
65
60
Index,
2008=100
2008-12
2012-14
2008-14
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15*
Real effective exchange rates, based on HICP
Real effective exchange rates, based on unit labour costs
(total economy)
(1) The graph shows the role of market share gains as
opposed to the impact of initial export market distribution
on market share growth by adding together the
components of average market share change for the
product and geographical dimensions. Thus the sum of
these components is the double of the average annual
market share change in a period.
Source:
European Commission
* 2015 based on European Commission 2016 winter
forecast
Source:
European Commission
Breaking a trend of real appreciation,
Hungary’s price and cost competiveness has
markedly improved since the onset of the crisis.
Between 2008 and 2015, the consumer price and
However, there seems to be little improvement
in
Hungary’
non-cost
competitiveness.
Hungary’s export deflators in euro terms have
remained broadly unchanged since the beginning
of the last decade. By contrast, other converging
18
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1604551_0023.png
2.1. External sustainability: Continued adjustment in stock vulnerabilities
economies in the region managed to increase their
export prices by around 30 to 60% percent (Graph
2.1.11). This phenomenon may be linked to
Hungary's inability to improve the quality of its
products, albeit from a comparatively high initial
level. The traditionally significant weight of high-
technology products in the Hungarian export sector
has been declining since the last decade. The share
of high and top quality products in export value
decreased from around 30% in 2009 to 23% by
2014, while the quality distribution shifted towards
the middle with a potentially greater exposure to
cost competition (Graph 2.1.12).
Graph 2.1.11:
Export deflators (Euro based)
Graph 2.1.12:
Share of export value by quality category
(2009-2014)
0.4
0.3
0.2
0.1
0.0
150
140
130
120
Index,
2005=100
bottom
low
middle
high
top quality
(0.0 - 0.2) (0.2 - 0.4) (0.4 - 0.6) (0.6 - 0.8) (0.8 - 1.0)
2009
2014
Source:
European Commission
110
100
90
80
70
60
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
CZ
HU
PL
SK
Trends in foreign direct investment
Source:
Eurostat
Following the crisis, the level of foreign direct
investments (FDI) remained at historic lows,
but more recent developments show some signs
of a recovery.
Attracting foreign direct investment
is an important source of technology transfer and
productivity growth for the catching-up EU
Member States. Moreover, foreign investment is a
source of non-debt financing of the external
position and thus enhances the shock absorption
capacity of the country. Following years of very
high inflows, annual net foreign direct investment
in Hungary got below the levels seen in other
countries in the region already before EU
accession. Since the crisis, net FDI inflows
remained low in Hungary, yet in line with its
regional peers relative to GDP ( Graph 2.1.13).
19
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1604551_0024.png
2.1. External sustainability: Continued adjustment in stock vulnerabilities
Graph 2.1.13:
Net foreign direct investment: Hungary and
regional peers
Graph 2.1.14:
Corrected and uncorrected net FDI inflows as
% of GDP
10
% of GDP
6
% of GDP
8
5
4
6
3
2
1
0
4
2
0
-1
-2
-2
04
05
CZ
06
07
08
HU
09
10
11
PL
12
13
14
SK
04
05
06
07
08
09
10
11
12
13
14
Net FDI inflow -corrected
Net FDI - uncorrected
(1) The corrected net FDI filters out the effect of special
purpose entities, capital injections in the financial sector,
mergers and acquisitions and capital-in-transit.
Source:
Hungarian Central Bank
Source:
Hungarian Central Bank
Estimates for the underlying trend in net FDI
inflows also show a decline since the beginning
of the last decade and low levels after the crisis.
Several confounding factors could distort the
assessment of FDI including the effects of capital
in transit and acquisitions as well as capital
injections by parent banks to offset the capital
shortfalls of their subsidiaries. After adjusting for
these effects using calculations by the Hungarian
Central Bank, the decrease in net inflows after
2008 becomes somewhat more pronounced (1.5%
of GDP on average compared with the 2004-2008
period; Graph 2.1.14). At the same time, the
estimates on underlying FDI suggest that the
upturn seen in 2014 is not attributable simply to
transactions affecting financial flows. However, in
the light of the incoming data from the first three
quarters of 2015, which show a weakening in net
FDI again, it would be premature to draw any firm
conclusion regarding an evolving trend yet.
The developments in greenfield FDI inflows to
the country paint a less favourable picture.
Until the crisis, greenfield FDI (linked to the
establishment or expansion of production base) in
Hungary averaged 5-7% of GDP, but has declined
sharply since to around 2% of GDP in recent years
(Graph 2.1.15). While greenfield FDI in the EU
also declined, the fall in Hungary was more
significant. Greenfield investment has numerous
benefits for Hungary as it increases the country's
production capacity, therefore exerting a positive
impact on economic growth and job creation.
20
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1604551_0025.png
2.1. External sustainability: Continued adjustment in stock vulnerabilities
Graph 2.1.15:
Greenfield foreign direct investment inflows
into Hungary
9
8
7
6
% of GDP
2.7
1.7
3.5
1.3
2.2
2.7
5
4
3
4.9
2
3.1
1
5.4
3.8
4.5
1.4
3.1
1.6
0.9
0.9
1.0
1.1
1.4 1.1
10
11
12
0
04
05
06
07
08
09
0.6
13
1.1
14
Total Intra EU inflows
Total Extra EU inflows
Source:
Financial Times FDI Markets database, European
Commission
A better business environment could help
Hungary to attract more FDI.
Among the
Member States in the region, the OECD PMR (
4
)
indicators show Hungary as having one of the
highest legal barriers to entry. In addition, recent
international competitiveness surveys rank the
country as having one of the least transparent
policy-making compared to regional peers.
According to the latest World Economic Forum
Competitiveness Report, Hungary did not perform
well regarding institutions and business
sophistication.(
5
)
(
4
) OECD
PMR
indicators.
OECD,
http://www.oecd.org/eco/growth/indicatorsofproductmarke
tregulationhomepage.htm
(
5
) The Global Competitiveness Report 2015-16, World
Economic Forum,
http://www.weforum.org/reports/global-
competitiveness-report-2015-2016
21
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1604551_0026.png
2.2. PRIVATE AND BANKING SECTOR ADJUSTMENTS
Private sector deleveraging
Hungary's private sector debt has been
significantly reduced.
The country entered the
financial crisis with a moderately high level of
private sector debt, mostly denominated in foreign
currencies. The financial sector that was profitable,
but heavily dependent on wholesale funding. Since
then an important adjustment took place.
Non-financial
corporations
(NFCs)
and
households deleveraged considerably since the
crisis.
NFCs reduced their debt from the peak of
over 80% of GDP in 2009 to 62.7 % of GDP by
mid-2015. This level is significantly below the EU
average but somewhat above the average of
regional peers (Graph 2.2.1). The funding for
growth scheme (FGS) – run by the central bank –
stabilised lending to non-financial corporations.
Further deleveraging needs of the NFCs are
estimated below 10 %. (
6
) Hungarian firms do not
point out "access to finance" as the single most
pressing issue in doing business. (
7
) On average,
business environment, responsiveness of the
administration, and workforce skills are causing
more concern than business financing. As to
households, they reduced their debt from the peak
of 40 % of GDP in 2010 to 30 % of GDP in
2014/2015 and have one of the lowest debt-to-
GDP ratio in the EU. Nevertheless, for some
households, the repayment burden remains
significant and impacts both new lending and
consumption trends. Household sector lending
resumed growth in 2015 following five years of
deleveraging.
Hungary's deleveraging has been supported by
growing GDP.
The change in the debt-to-GDP
ratio can be attributed to four main drivers: net
credit flows, real GDP growth, inflation through
the GDP deflator and other changes such as
valuation changes or write-offs (Graph 2.2.2 and
Graph 2.2.3). Since the peak of indebtedness in
2009, Hungary's corporations actively reduce their
debt, resulting in negative credit flows. In addition,
Hungary has benefited from a positive contribution
from nominal GDP growth. This has gradually
eliminated the need to actively deleverage, while
(
6
)http://ec.europa.eu/economy_finance/publications/european_
economy/2014/pdf/ee7_en.pdf
(
7
) SAFE Survey 2015 edition, ECB and European
Commission
continuing to decrease the debt-to-GDP ratio
"passively" through the denominator effect.
Graph 2.2.1:
Private sector debt in relation to GDP -
comparing East-Central European countries
to Euro Area
150
140
% of GDP
130
120
110
100
90
80
70
60
08
EA-18
09
10
CZ
11
HU
12
13
PL
14
SK
Source:
Eurostat
Graph 2.2.2:
Non-financial corporations' y-o-y changes in
debt-to-GDP
15
10
y-o-y change
5
0
-5
-10
02 03 04 05 06 07 08 09 10 11 12 13 14
Credit flow
Other changes
Real growth
D/GDP, change
Inflation
Source:
Eurostat
22
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1604551_0027.png
2.2. Private and banking sector adjustments
Graph 2.2.3:
Private debt in relation to GDP, boom and
gradual adjustment
140
120
100
80
60
% of GDP
Nevertheless, the debt service ratio (
10
) assessing
the debt repayment burden of Hungarian
households remains very heterogeneous and on
average still high in international comparison
(Graph 2.2.4). An average Hungarian has to spend
18% of his or her monthly income on debt
repayment.
Graph 2.2.4:
Debt service ratio in Hungary, international
comparison
20
%
40
20
18
16
14
0
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Non-financial corporations
Households
12
10
8
Source:
Eurostat
6
4
Households' outstanding loan stock dropped in
2015 but new lending resumed growth.
The drop
in stocks is attributed to the conversion of
essentially all foreign currency denominated
mortgages, in Q1 2015. As a result of the
conversion and also of the settlement introducing
new, fair banking principles, households' loans
declined by HUF 947 billion (on a transaction
basis)(
8
). Nonetheless, the gross volume of
combined new household lending amounted to
HUF 286 billion in the first half of 2015, a 19%
expansion y-o-y and as much as 50% y-o-y growth
in the mortgage segment of the market.
Households' demand for credit is forecast to
grow.
Several factors explain the pick-up in
demand for new household loans. The loans
settlement and the resetting of lending interest
rates had a major impact on the debt servicing
burden of households (
9
) (a drop by about 20-25%
on average), which in turn boosted household
consumption. Households’ real incomes have been
increasing for the past four years and income taxes
will decrease in 2016. The economy is expanding
and the outlook is positive creating a better
environment
for
household
spending.
(
8
) Over 70% of this figure is explained by the impact of the
settlement arising from nullification of the exchange rate
spread and unilateral contract modification.
9
( ) According to the MNB, Financial Stability Report
November 2015.
2
0
(1) Based on end-Q1 2015 data.
Source:
Hungarian Central Bank
The corporate sector's deleveraging is
bottoming out.
The Hungarian NFCs debt-to-GDP
ratio was 62.7% in mid-2015 and just 25.9% if
only domestic lending is taken into account (Graph
2.2.5). The y-o-y decline was on average -3.4%.
However, this aggregate figure masks two trends.
Credit to the SME sector increased as a result of
the FGS. A major drop was observed in
outstanding loans to large corporations in 2015, in
part attributable to some one-off effects (
11
).
Overall, in a context of record low interest rates,
corporate sector's deleveraging is bottoming out,
which trend is also confirmed by recent central
bank's lending surveys (
12
). In December 2015
60% of banks claimed to have eased supply
(
10
) The indicator captures household indebtedness as
proportion of households’ net income spent on servicing
principal and interest repayment.
(
11
) The concentration level in the Hungarian corporate credit
market is very high with over 50% of the corporate loan
stock belonging to less than 1% of loan contracts according
to the MNB.
(
12
) MNB Lending Survey, December 2015 and previous
editions.
23
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1604551_0028.png
2.2. Private and banking sector adjustments
constraints. In parallel banks see a 50%
improvement in perceived demand for corporate
loans. The SME sector is expected to remain
shielded from potential unfavourable credit
conditions through a targeted growth supporting
programme (GSP) initiated by the central bank,
which aims to promote an increase in total
corporate lending of up to 10%.
Graph 2.2.5:
Indebtedness of non-financial corporate
sector as a proportion of GDP
% of GDP
90
80
70
60
50
40
30
20
not large enough to boost market-based corporate
lending. Governmental support programmes
including the guarantee schemes also had a rather
limited effect on loan growth. (
15
) Altogether,
loans with preferential conditions account at
present for about a half of the SME loan stock. As
the second phase of the FGS ended in December
2015, the central bank announced the launch of a
new GSP designed to help domestic banks return
to market-based financing. This is expected to be
achieved by gradually phasing out the FGS and by
announcing a new market-based lending scheme –
an incentive for banks to boost their lending
business. The extended programmes encourage
lending to new projects, as opposed to refinancing,
and widen the scope of eligible SMEs.
Banking sector adjustment
10
0
01 02 02 03 04 05 06 07 07 08 09 10 11 12 12 13 14 15
Domestic loans
Loans from abroad
Source:
Hungarian Central Bank
The Funding for Growth Scheme allowed SMEs
to have access to affordable credit.
According to
the survey of access to finance of enterprises
(SAFE) (
13
), Hungary has better access to finance
than the EU average. The FGS (Table 2.2.1) was
initiated by the central bank in June 2013 as a way
of extending credit to small and medium-size
businesses. As in many Member States, Hungarian
SMEs, and in particular micro-SMEs, which
account for 94.3% of all companies in Hungary,
have struggled with the recession over the past
years. Under the FGS scheme, the central bank
provided credit to commercial banks at zero
interest for the banks to lend onward to SMEs at a
maximum annual interest rate of 2.5%. The
scheme radically improved access to affordable
credit by small businesses (
14
) but its effect was
(
13
) The Survey on the Access to Finance of Enterprises is
being published jointly by the European Commission and
the European Central Bank (ECB) since 2008 and covers
all Member States.
(
14
) According to the central bank, about 28,000 micro, small
and medium-sized enterprises accessed FGS funding
The banking system's vulnerability declined
over the past year.
The conversion of households'
foreign currency loans was a major change. It
eliminated the most important systemic risk
stemming from foreign currency exposures. The
sector is showing better results driven by a
stabilisation of the operating environment. There
have been improvements in the country’s
economic performance and moderation in the
policies and taxation towards the banking system.
Nevertheless, in 2015, banks were on average,
highly cautious and had low risk appetite,
hindering the recovery of market-based corporate
lending. This cautiousness was present despite
high capital ratios and abundant liquidity. Non-
performing credit remains a pressing issue, driven
by low profitability in the corporate segment. The
key concerns at this stage are: (i) re-engaging
market lending, (ii) resolving the bad debt issue
and (iii) putting banks' profitability levels at par
with regional averages. Addressing these concerns
would help reignite growth and the catching up
potential of the Hungarian economy
increasing domestic output by some 1–1.5 percentage
points in the 2013-2015 timeframe.
(
15
) Anecdotal evidence and the banking community point to
the excessive amount of administration involved in
guarantee schemes and the need to revise the
administrative burden in order to make guarantees easier
and more efficient.
24
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2.2. Private and banking sector adjustments
Table 2.2.1:
Funding for Growth Scheme
Funding for Growth Phase
First
Second
Third (Growth Supporting Program)
Source:
Hungarian Central Bank
Timeframe
June - September 2013
Total Funds Contracted (in HUF bn)
HUF 701
October 2013 - December 2015 HUF 1183 (until November 2015)
2016
Both HUF and foreign currency denominated loans pillars with a target
amount of HUF 300 billion
Domestic banks have significantly reduced their
size and business volumes.
Hungarian credit
institutions have been in adjustment mode for far
longer than the two-year period (2008-2009) when
Hungary struggled with its debt crisis and
benefited from the EU/IMF financial assistance
programme. The banking sector's deleveraging and
de-risking continued until 2014, the year with
lowest net result for the Hungarian banking sector
as whole. (
16
) The downsizing of the banking
business was severe, going well beyond the drop in
general economic activity. Total assets of
Hungarian banks decreased by over EUR 20
billion between 2010 and 2015 (Graph 2.2.6). At
the same time, the drop in lending to the economy
by nearly a third of the total outstanding loans was
even more pronounced. It is to some extent the
result of a correction from the pre-crisis boom
years when banks' lent abundantly to Hungarian
borrowers –heavily exposing them to foreign
currency risk – and when credit risk standards
were loose because of ample liquidity in the
market. Nevertheless, credit institutions also
reacted to the unfavourable and often
unpredictable operational environment, very high
taxation and the lack of proper dialogue between
the government and the local credit institutions.
Local banks' lack of risk appetite reached
unprecedented levels resulting in a credit crunch
on the one hand and in rapid deleveraging of
foreign banks on the other hand.
(
16
) In 2014 banks heavily provisioned their lending book
following the "fair banking" legislation.
Graph 2.2.6:
Banking sector’s total assets and risk-
weighted assets (2008 = 100)
105%
100%
95%
90%
85%
80%
75%
70%
65%
60%
08
09
10
11
12
13
14
15 Q2
Change in total assets
Change in risk-weighted total assets
Source:
Hungarian Central Bank
In terms of profitability, 2015 was a
turnaround-year for the Hungarian banking
sector.
The aggregated Q1-Q3 2015 income
figures suggest that the sector is on track to close
2015 with a profit (Graph 2.2.7). Also, the positive
changes in the government’s unfavourable policies
towards the banking system help the banks to
return to profitability. From the financial stability
standpoint vulnerabilities of the banking sector
declined. The system is at present adequately
capitalised - with a Tier 1 capital ratio of 20.5% -
and liquid (Graph 2.2.8). At the height of the
crisis, beginning 2009, banks' capital adequacy
was only at 10%.
25
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1604551_0030.png
2.2. Private and banking sector adjustments
Graph 2.2.7:
Banking sector profitability
80
60
per cent
40
20
0
- 20
- 40
- 60
- 80
05
06
07
08
09
10
11
12
13
14 15 H1
Other income
Loan loss provisioning
Dividend income
Net fee and commission income
ROE
Bank levy
Operating costs
Trading income
Net interest income
Source:
Hungarian Central Bank
Graph 2.2.8:
Average capital adequacy ratio in the
Hungarian banking system
per cent
30
25
comparison is average to high. The restructuring
and work-out of non-performing loans remain high
on the agenda of Hungarian authorities but
improvements in this area are not yet detectable in
aggregate data. In the case of mortgage loans a
recent adjustment of the personal bankruptcy
legislation and the expansion of the National Asset
Management Agency for mortgage loans may
facilitate the resolution of some of the bad
mortgage loans. Nevertheless, there still is the
need for further incentives that would promote
market solutions, in particular a more intense effort
regarding mortgage loan restructuring. The quality
of the corporate portfolio remains an unresolved
issue with high impact on new lending. The
activities of MARK (
17
) may be one of the steps in
a complex solution that could, similarly to the
household segment, entail work on debt
restructuring.
Graph 2.2.9:
Non-performing loan ratios
per cent
30
25
20
18
per cent
20
15
20
15
16
14
12
10
5
0
10
5
0
10
8
6
08 Q4
09 Q1
Q2
Q3
Q4
10 Q1
Q2
Q3
Q4
11 Q1
Q2
Q3
Q4
12 Q1
Q2
Q3
Q4
13 Q1
Q2
Q3
Q4
14 Q2
Q3
Q4
15 Q1
Q2
4
2
0
Tier 2 Capital
Additional Tier 1
10 Q2
11 Q2
12 Q2
13 Q2
14 Q2
15 Q2
Common Equity Tier 1 (CET1)
Total Capital Adequancy Ratio
Non-performing loan ratio: Corporations
Non-performing loan ratio: Households
(1) CDR IV CRR as of 2014 Q2
(2) Capital ratios measure the financial strength of a bank.
The regulatory capital ratios in the EU are based on a
directive (Capital Requirements Directive, CRD IV) and a
regulation (Capital Requirements Regulation, CRR), which
apply as of 1 January 2014.
Source:
Hungarian Central Bank
Source:
Hungarian Central Bank
Systemic risks decreased but the quality of the
loan portfolio remains low.
A considerable
amount of loans denominated in foreign currencies
(mainly Swiss franc) was converted into forints.
This significantly decreased financial systemic
risks. However, asset quality remains a major
concern with non-performing loans ratios of over
18% and 13% in the retail and corporate sectors
respectively (Graph 2.2.9); the coverage ratio in
both segments is about 60%, which in international
The operating environment of the Hungarian
financial system remains challenging.
Overall,
Hungarian banks continue to function in a difficult
business environment that remains characterised
by a high tax burden on financial institutions and
poor investment prospects as shown by the
negative year-to-date investment figures (down
3.4% y-o-y in Q3 2015) (
18
). Nevertheless, foreign
(
17
) MARK is a debt management agency, which was set up by
the Hungarian central bank to purchase and deal with
project loans.
18
( ) A recent survey published by one of the leading Hungarian
lenders estimates the 2016 investment outlook for some
500 companies as weak. Only about a third of the 500
26
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2.2. Private and banking sector adjustments
financial groups operating in Hungary stayed
committed to support their subsidiaries and to
develop their local franchise. This was confirmed
by the very sizeable equity capital injections over
the recent years (some EUR 4.5 billion in total), in
2014 alone over EUR 1 billion. This additional
capital buffer helped Hungarian lenders to face
losses stemming from the fair banking legislation
that limits fees, commissions and interest rates on
lending contracts. The boosted capital base and
liquidity levels are in line with local supervisory
recommendations and the CRD IV and CRR rules
(Graph 2.2.8). The recently published European
Investment Bank's (EIB) quarterly bank lending
survey (
19
) - a gauge of parent banks views on their
CESEE business activities - points to an improving
perception of Hungary from the parent banks
perspective. This improved market sentiment
explains why the speed of steady reduction in
exposure to Hungary (observed over the past
years), as reported by international lenders to the
Bank for International Settlements (BIS), started to
increase in the first quarter of 2015.
The change in market sentiment is reflected in
the further decrease of Hungarian sovereign
risk spreads,
which moved significantly closer to
the level of regional peers (Graph 2.2.10).
Nonetheless, even though the recent EIB survey
for the second quarter of 2015 developments
shows more optimism than the previous first
quarter edition, the prospects for the Hungarian
market are described as being worse compared to
the other countries in the region. About 33% of the
surveyed respondents still believe that the potential
of the Hungarian market is low. Parent banks also
stress that the profitability of the Hungarian
operations is still below the regional standards,
with roughly 50% of the banks reporting risk-
adjusted returns on equity in Hungary as being
significantly lower than the overall group level.
Graph 2.2.10:
5 year credit default swap (CDS) in Hungary
and regional peers
250
bps
200
150
100
50
0
Czech Republic
Hungary
Slovakia
Poland
Source:
Thomson Reuters
companies surveyed plans some investment in the next 12
months. This percentage is even lower when focusing on
large companies – in that segment only 26% intend to
launch some type of higher investment in 2016. The
Commission notes that the 2016 survey strongly resembles
the 2015 edition in which only 30% of Hungarian
companies mentioned they did plan investments for 2015
while 61% responded they did not foresee to change the
level of capital investment in 2015. Some 9% planned to
decrease capital investments in 2015.
(
19
)
http://www.eib.org/attachments/efs/economics_cese
e_bls_2015_h2_en.pdf
The State plays an important role in financial
intermediation.
Since the outbreak of the
financial crisis much of the debate around the
banking system in Hungary focused on two key
matters: foreign exchange (FX) loans, which grew
exponentially with the appreciation of the Swiss
franc and the recession and on boosting lending,
mainly to the small and medium sized enterprises.
Since market based lending continued to contract
and the FX loans problem would take decades to
be resolved (most FX loans were long term
mortgage contracts), the Hungarian authorities
took an increasingly active role in repairing the
financial system that had been perceived as not
supporting economic growth and burdening
households with currency risk (Box 2.2.1). The
authorities focused their policies on "right-sizing"
through consolidation, refocusing on national
currency lending, boosting the efficiency of banks
and promoting the development of a domestically
owned banking sector with a soft target of up to
60% of domestic ownership. Based on recent
calculations the share of financial institutions
owned by domestic actors is now close to the 60%
target (
20
) and the state was over the past year the
most active investor in the financial sector. This
activity entails a contingent liability element for
the Hungarian state budget.
(
20
) MNB, Financial Stability Report, November 2015.
27
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2.2. Private and banking sector adjustments
Box 2.2.1:
The 2015 foreign exchange denominated loans conversion schemes
The foreign exchange (FX) debt settlement schemes affected in total some 730 000 contracts, inluding. some
500 000 mortgage contracts and an additional 230 000 consumer and leasing contracts. As a result of the
conversion, one of the highest household foreign currency-denominated exposures in the EU dropped to one
of the lowest, from 15% of GDP down to essentially nil. The conversion of foreign currency-denominated
household debt took place in two stages. The initial flagship programme of the government initiated in
November 2014 covered only mortgage loans and came into effect with the fixing of the exchange rate for
instalments - as of January 2015. Following an agreement between the authorities and the banking sector it
was the central bank that provided the required foreign exchange funds (in total EUR 9 billion) to the
counterparty institutions, in order to enable them to close their open FX position at market rates and avoid
impacting the market exchange rate of the forint. The timing of the first FX debt conversion scheme
covering ultimately some HUF 3,000 billion in mortgages was matched with the start of the law on "fair
banking", which defined stricter conditions for unilateral changes in interest rates, charges and fees. As a
result of the settlement and the resetting of the lending rates, the debt servicing burden of a typical
Hungarian household decreased by about 20% on average. The conversion of the households' foreign
currency debt – over half of all household debt in Hungary – coincidentally, took place just a few weeks
before the Swiss central bank announcement of unpegging the Swiss franc. With hindsight, the conversion
of households' FX debt was definitely the most successful move by the Hungarian authorities to foster
financial stability over the past few years. The pledge to free Hungarian households from FX debt was made
complete with the second debt settlement scheme that focused on converting foreign-currency car and
personal loans into forint debt at the rates in effect on August 19. The scheme was the outcome of a deal
negotiated between the authorities and the banking association. Similarly to the first FX conversion scheme,
the required funds to close the FX open positions worth some EUR 1 billion were provided by the central
bank, whereas the costs of a rebate compensating borrowers for the weakening of the national currency were
jointly shouldered by the banks and the Hungarian state. Consequently, lenders are allowed to reduce their
2016 and 2017 tax bills by the corresponding amount.
In 2015 the Hungarian authorities announced
their plans to reduce burden on banks.
This was
emphasised in a memorandum of understanding
(MoU), signed on 9 February with the European
Bank for Reconstruction and Development
(EBRD) in which the government committed to
reducing bank taxes, to disposing of two lenders
recently acquired by the Hungarian state, assisting
in solving the issue of non-performing credit and
refraining from implementing new laws or
measures that may have a negative impact on the
profitability of the banking sector. A further
commitment was made to ensure that there is fair
competition between and equal treatment of all
financial institutions in Hungary, irrespective of
size or nationality of ownership. A lower rate for
the bank tax was announced in late 2015. The levy
is projected to decrease from 0.53 % in 2015 to
0.24 % in 2016 and be capped at 45% of the 2015
tax obligations. The base for the tax, however,
remains anchored in the end-2009 balance sheet of
banks. For the years 2017 and 2018 the Hungarian
legislator announced plans to further reduce the tax
rate to 0.21 %. The new bill announced in
December stipulates that banks' 2017 and 2018 tax
payments cannot exceed their 2016 payments.
Nevertheless, Hungarian banks continue to
deleverage.
The loan-to-deposit (LTD) ratio
peaked in 2009 at 160%. It dropped below 100%
by the end of 2014 and estimated to decline further
to 94% by mid-2015.
The adjustment of banks' business models to
the new operating conditions
The "rightsizing" of the banking system in
Hungary helped improve profitability but
further efforts are needed to improve the cost
structure of banks.
Comparing the cost base of
the Hungarian banking sector to regional peers
shows the extent of the adjustment of the sector
over the past six years. The 2014 total operating
expenses of Hungarian banks show a 20% decline
compared to the 2008 figures. Banks operating
expenses in Poland and the Czech Republic
increased during the same period by 12% and 9%,
respectively. This is partly explained by the
decrease in employment in the Hungarian banking
28
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2.2. Private and banking sector adjustments
sector, from 34 500 employees in 2008 down to 30
000 at the end-2014 and the closing of some 300
branches across the country (from almost to 1700
outlets to 1400) in the same period. Nevertheless,
the efficiency of the banking sector has not
improved unlike in Poland and in the Czech
Republic. The increase in the total operating
expenses to total assets ratio (2.6% and 3.5% in
2008 and 2014 respectively) points to the fact that
total assets diminished faster than operating
expenses (Graph 2.2.11). Likewise, the cost to
income ratio is very high in Hungary, at 65% in
2014 (59% in 2008), whereas both Poland (53%)
and Czech Republic (48%) managed to lower their
respective cost base (Graph 2.2.12). These
developments reflect the fact that the other
countries in the region did not have such deep and
prolonged recessionary periods as Hungary.
Moreover, the income generating capacity of
Hungarian banks was heavily affected by
government policies including various schemes to
assist FX borrowers.
Graph 2.2.11:
Evolution of total assets in Hungary, Poland
and the Czech Republic
Graph 2.2.12:
Evolution of the cost-to-income ratio in
Hungary, Poland and the Czech Republic
80
70
60
50
40
%
30
20
10
0
08
09
10
CZ
11
HU
PL
12
13
14
Source:
European Central Bank
150
140
130
120
Index,
2008=100
Banks' resilience was strengthened and
sensitivity to shocks decreased.
Banks managed
to correct some of their imbalances through
eliminating much of the reliance on wholesale
funding and by lowering the aggregated cost base
and somewhat increasing their income from fees
and commissions (
21
) (Graph 2.2.13), against the
backdrop of low net interest margin.
(
21
) Both in nominal terms and relative to total assets,
according to ECB data.
110
100
90
80
70
60
08
09
10
CZ
11
HU
12
PL
13
14
Source:
European Central Bank
29
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2.2. Private and banking sector adjustments
Graph 2.2.13:
Fees and commissions as percentage of total
assets - comparing Hungary to Poland and
the Czech Republic
2.0
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
07
08
09
CZ
10
HU
11
12
PL
13
14
Source:
European Central Bank
30
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2.3. ELEVATING GROWTH POTENTIAL
Graph 2.3.1:
Investment rate (investment/GDP) in Hungary
and regional peers
A faster decline of Hungary's accumulated
imbalances
hinges
on
the
successful
implementation of growth enhancing reforms.
The Commission examined in a dedicated chapter
the issue of potential growth three years ago in an
IDR section (
22
). This chapter presents the latest
results of the potential output calculation of the
Commission, based on the commonly agreed
methodology (
23
). In addition, it makes a
comparison with other countries and draws policy
implications on how to enhance potential growth.
Hungary's growth potential has been
recovering since 2010
(see Graph 2.3.4 at the end
of the section). Data suggest that the Hungarian
economy had been overheating until 2008,
characterised by high capacity utilisation and
massive net borrower position. During the crisis,
capacity utilisation fell below its historical
average, while weak domestic demand led the
economy to become a net lender. However, the
economy is projected to return to its potential level
over the forecast horizon, yet with a lower
contribution of total factor productivity (TFP) and
capital accumulation than before the crisis.
While total factor productivity growth and
capital accumulation have not fully recovered,
labour contribution has improved.
The
deceleration in TFP growth is likely linked to
weaknesses of financial intermediation, relatively
low productive investment and a low level of
innovation. Capital accumulation also remains
below the pre-crisis level reflecting lower
investment growth. Deleveraging inherently
reduced investment rates (see Graph 2.3.1), but the
slowdown also partly stems from the perceived
deterioration in the business environment (see box
1.1). However, contribution of labour to potential
growth has considerably improved. This is linked
to structural reforms, namely the extension of the
retirement age, the tightening of the eligibility for
unemployment benefits and disability pensions.
(
22
) Macroeconomic Imbalances - Hungary 2013, European
Economy. Occasional Papers 137. March 2013.
(
23
) Economic Papers nr. 535. (November 2014) "The
Production Function Methodology for Calculating Potential
Growth Rates & Output Gaps" – Throughout the section
this is referred to as the "commonly agreed methodology"
(methodology of the Output Gap Working Group).
% of GDP
30
27
24
21
18
15
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
HU
CZ
PL
SK
Source:
Eurostat
The estimated labour contribution to potential
growth reflects several opposing trends.
Demographic trends are similar to those of other
ageing European countries. The working-age
population has been decreasing by more than
0.3 % year by year since 2012, and is foreseen to
keep declining until 2020. This is partly
compensated by an increasing participation rate.
The participation rate reached 59% in 2014, which
is a record high for Hungary, even if it is still low
in international comparison. It is projected to
increase gradually to 63% by 2020. In parallel,
overall employment is at its long term high.
Average hours worked per employee have been
decreasing due to an increase in part-time
employment. (
24
) The unemployment rate has
decreased substantially and is at its all-time low,
moving smoothly together with the non-
accelerating wage rate of unemployment.
Hungarian potential GDP growth is estimated
above the EU average but below those of the
best performing regional peers.
The almost 2 %
average potential GDP growth estimation between
2013 and 2017 is higher than the EU average
(1.1%). Outperformers among peers are Latvia,
Slovakia, Lithuania, Romania, Estonia and Poland
(Graph 2.3.2). The Czech Republic and Slovakia
(
24
) The considerable fall in the average hours of work per
employee recorded in 2010 reflects a methodological
change (Graph 2.3.4, fourth row, right side).
31
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2.3. Elevating growth potential
display a similar rate of growth, which is mostly
driven by fast TFP growth, making it more
sustainable in the medium term (Graph 2.3.4).
Since its EU accession, Hungary has been lagging
behind in convergence relative to regional peers.
Graph 2.3.2:
Potential GDP in the EU
Graph 2.3.3:
Different estimates of potential growth
3
%
2
1
5
4
3
2
1
0
-1
-2
-3
FR
IE
IT
RO
MT
FI
%
0
-1
10
11
12
13
14
15
16
17
Hungarian Central Bank
Ministry of National Economy
DE
CZ
CY
DK
HR
UK
HU
BG
ES
BE
SE
EE
SK
LU
NL
PT
AT
LV
EL
LT
PL
SI
European Commission
2013-2017 average
HU 2013-2017 average
EU 2013-2017 average
Source:
MNB, MoNE, European Commission
Source:
European Commission
The estimates by the Hungarian Central Bank
and the Ministry of National Economy are
similar to those of the Commission's
(Graph
2.3.3). It seems that Hungary's potential growth
returned to the positive territory around 2010-
2011. After a steady increase, potential growth
slowed down, reaching 2% in 2015. On the
forecast horizon, it is estimated to remain around
this value. According to the Commission's
forecast, potential growth slightly increases in the
short term and then returns to 2% for the outer
years of the forecast period.
There is some consensus across institutions
regarding Hungary's potential GDP and the
policies that could enhance it.
Hungary's
potential GDP is currently estimated at around 2%.
It is mainly the TFP that makes the country lag
behind some of its regional peers. The most
important factor of future potential growth may be
linked to TFP, while labour and capital may
support potential GDP as well. There is a
significant
catch-up
potential
in
labour
productivity, mainly in the subsectors of
manufacturing and among SMEs. There is
potential in human capital accumulation through
reforms in education as well, with the main
focuses such as raising the share of tertiary
education graduates; the reduction of the
proportion of early school leavers. Incentives for
higher R&D activity in the private sector; and
more competitive product markets would
definitely be beneficial (see section 3.4). In
parallel with qualitative factors, quantitative
factors such as the increase in participation rate
may have a significant contribution to potential
growth. Employment among the low-skilled and
the elderly (over 50 years) could be elevated by the
further decrease in labour taxes and contributions.
High technology investments (related mostly to
German automotive producers) that were realized
in the recent years could also have a positive spill
over effect to the overall economy, however recent
data has not yet maintained this hypothesis. The
integration of domestic SMEs in the global value
32
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2.3. Elevating growth potential
chain would be a key development in this regard.
The government has conducted reforms in the
public administration too, although there is still
room for improvement (see box 1.1).
Graph 2.3.4:
Contributions to potential growth in Hungary and in regional peers
7.0
%
6.0
5.0
4.0
3.0
2.0
1.0
0.0
HU
7.0
6.0
5.0
PL
%
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
labour
capital
TFP
POT GDP
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
-1.0
-2.0
-3.0
labour
capital
TFP
POT GDP
7.0
%
6.0
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
CZ
7.0
%
6.0
5.0
4.0
3.0
2.0
1.0
0.0
SK
-1.0
-2.0
-3.0
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
labour
capital
TFP
POT GDP
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
labour
capital
TFP
POT GDP
Source:
European Commission
33
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2.4. MIP ASSESSMENT MATRIX
This MIP assessment matrix summarises the main findings of the in-depth review in this report. It focuses
on imbalances and adjustment issues relevant for the MIP.
Table 2.4.1:
MIP Assessment Matrix (*) - Hungary
Gravity of the challenge
Evolution and prospects
Policy response
Imbalances (unsustainable trends, vulnerabilities and associated risks)
External balance
The NIIP improved from -116% of
GDP to -73% by 2014. However,
gross external debt remains
relatively high (around 80% of
GDP) and the associated rollover
needs still pose risks to the
economy (pp. 14-15)
The improvement in the trade
balance in the aftermath of the
crisis went in parallel with a
considerable fall in export market
shares. Between 2008 and 2012, the
cumulative loss amounted to 23%,
reflecting structural weaknesses
(pp.18-19).
The country has been experiencing
a slowdown in FDI since the last
decade, which limited an important
source of non-debt financing for the
economy (pp.20-21).
The improvement in the NIIP has recently
continued, altogether by some 15 pps. over
2014-2015. High net lending (6-9% of GDP)
has been maintained (pp.13-14). All key
components of the balance of payments
contributed to the adjustment. EU transfers
(increasing to 5-6% of GDP) have played an
important role (p. 17.). The NIIP is likely to
decrease below -35% over the next 10 years
(pp. 17-18.)
Previous export market losses have been
partially reversed with a combined 7.5 pps.
growth in 2014 and 2015, and this trend is
expected to continue. (pp. 18-19.). Cost
competitiveness has improved (the ULC
based REER depreciated by 19% since 2008),
but there has been a little improvement in
non-cost competitiveness (pp. 19-20).
Net FDI inflows have overall declined further
in the post-crisis years (by 1.5% of GDP on
average). More recent balance of payment
data may point to a recovery, but statistics on
greenfield foreign invest paint a less
favourable picture (pp.21-22).
The reduction of general government deficit has
supported the maintenance of the stable net lending
position of the economy. (p.13)
The conversion of foreign exchange denominated
loans and the reduction of foreign exchange
denominated debt reduce external rollover risks
(pp.14-15. and Box 2.1.1).
Recent trade policies aim at opening the country's
export markets outside the EU. Wage and exchange
rate policies overall have facilitated the
improvements in cost competitiveness. (p. 19)
A more stable business environment would improve
the country's capacity to attract FDI. (p.20)
Financial sector
The country entered the financial
crisis with a relatively high level of
private debt (close to 120% of GDP
in 2009). This was accompanied by
a high share of foreign currency
denominated loans both in the
corporate and household sectors
(55% and 70%, respectively),
resulting in a considerable currency
mismatch in the economy (pp. 23)
Uncertainties related to the
regulatory and tax environment
keep both country risk and banks'
risks at elevated levels. In parallel,
the aggregated capital base
remained adequate for most credit
institutions and liquidity conditions
were favourable, but net lending
declined. The banking sector has
been affected by low profitability
and limited capacity to generate
capital (p.26).
Asset quality remains a major
concern with non-performing loan
(NPL) ratios of over 18% and 13%
in retail and corporate sectors
respectively. (p.27).
Private debt-to-GDP ratio has been reduced
to 90% of GDP by 2014. Deleveraging has
been supported by growing nominal GDP
(p.23)
The banking systems vulnerability declined
over the past year with an improved
profitability outlook (pp.25-26) (The systemic
risks generated by the considerable stock of
loans denominated in foreign currencies on
the banks' balance sheets have been
moderated through converting foreign
currency denominated credit into forints (Box
2.2.1)
New lending to households started to grow
again (19% y-o-y growth in 2015). The
repayment burden on households is still high.
Household's demand for credit is expected to
grow While credit to the SME sector
increased in recent years, overall corporate
lending has not saw a revival yet reflecting
uncertainty (pp.24-28).
The adjustment of bank's business models
helped to improve profitability conditions,
but further efforts are needed to improve their
cost structure (pp.30-31).
The authorities have announced their readiness to
improve relations with the banking community and to
discuss any future measures that could affect banks'
profitability (p. 29).
The authorities stepped in with a set of measures –
the key initiative being the launch of the Funding for
Growth Scheme – to increase lending to the economy
(p.25).
A lower bank tax was announced and the government
insists on the compliance with key commitments as
agreed with the European Bank for Reconstruction
and Development (EBRD) in a Memorandum of
Understanding signed in February 2015. The
authorities have also committed to lower the bank tax
in 2016 and further in 2017. (p.29)
Asset quality of banks' balance sheet is being
addressed in various initiatives but results are not yet
visible. New personal insolvency legislation is now in
place The National Asset Management Company has
more capacity (35 000 dwellings) and MARK
(dedicated to purchasing bad debt in the commercial
real estate segment) will start operations soon. (p. 27)
Moving towards a lower bank tax could boost the
sluggish returns on equity. Increased state ownership
in the banking sector is a source of a contingent
liability risk (p. 29).
(Continued on the next page)
34
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2.4. MIP assessment matrix
Table (continued)
Potential growth
Given the large stock of external
liabilities and public debt, subpar
potential growth may pose a
problem
of
macro-financial
stability as the resources needed to
finance debt may be insufficient.
The growth potential of the country
remains moderate (p.32).
Weak real convergence has been
driven by weak productivity growth
(Chart 2.3.4).
The main factor responsible for low
growth potential is total factor
productivity (contribution of 0.7
pps. in 2015) which might be
linked to problems with financial
intermediation as well as to the low
level of innovation in the economy
in general. (p.32).
Hungary's potential output growth has been
negative after the crisis, having returned to
positive territory around 2012 according to
estimates. After a steady increase potential
growth stabilised at around 2% in 2015.
Forecasts points to potential growth around
this value. (p.36)
Hungary's relatively low grow potential could be
addressed with appropriate financial market policies,
including the restoration of market-based lending in
the economy (e.g. implanting the policy
commitments made in the recent Memorandum of
Understanding) and accelerating portfolio cleaning.
The Funding for Growth Scheme also helped the
lending activity of SMEs.
Structural reforms have been made, namely the
extension of the retirement age, the tightening of
unemployment benefits eligibility and disability
pensions. These elevated the contribution of labour to
potential growth.(p.32)
On the other hand the expansion of the number of
enrolees in the Public Works Scheme has a limited
contribution because of the low productivity of these
workers. The continued reliance on extra sector
specific taxes and the unstable business environment
hinder investment. (Box 1.1)
There is a scope for improving factor productivity
through education reforms as well. Reducing the
number of early school leavers would also help.
Enhancing incentives for increased R&D activity in
the private sector; and more competitive product
markets can lead to higher growth potential. (p.37)
Conclusions from IDR analysis
Hungary is on a balanced albeit still relatively moderate growth path, gradually working off its macroeconomic imbalances. Both external and internal financial
imbalances seen at the outset of the crisis have been significantly reduced, but important risks and challenges remain, including the relatively high external debt
rollover needs and the still high share of non-performing loans in the banking sector.
A marked reduction in net external liabilities is on-going, driven by high current and capital account surpluses, supported in particular by recent export market
share gains. The banking sector's outlook is improving and non-performing loans, although elevated, are declining. Credit flows to the private corporate sector
remain subdued in a context of low bank profitability. The banking sector is showing better results helped by the improving economic environment and by a
moderation in the previously harsh policies towards the sector. The main challenges are to reduce the high share of NPLs and to promote the growth of market-
based private lending.
Policy measures have been taken in order to make the regulatory environment more predictable in the financial sector, lower the tax burden on banks, reduce
the proportion of debt held in foreign currency and introduce subsidised lending schemes. The impact of these measures has yet to translate into sustained bank
lending. Moreover, policy gaps remain in the area of non-cost competitiveness, productivity and the overall business environment. Enhancing the growth
potential is crucial to further reduce the share of external and internal debt in GDP and thus escape polices that would achieve the latter by depressing domestic
demand.
(*) The first column summarises "gravity" issues which aim at providing an order of magnitude of the level of imbalances. The
second column reports findings concerning the "evolution and prospects" of imbalances. The third column reports recent
and planned relevant measures. Findings are reported for each source of imbalance and adjustment issue. The final three
paragraphs of the matrix summarise the overall challenges, in terms of their gravity, developments and prospects, policy
response.
Source:
European Commission
35
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3.
ADDITIONAL STRUCTURAL ISSUES
In addition to the macroeconomic imbalances and adjustments issues addressed in section 2, this section
provides an analysis of other structural macroeconomic and social challenges for Hungary. Focusing on
the policy areas covered in the 2015 country-specific recommendations, this section analyses issues
related to firstly the tax system, the tax wedge of labour and tax compliance as well as the improvement
of public debt and the lagging implementation of the medium-term budgetary framework. Second, it
analyses the challenges of labour market, social and health policy. The public works scheme is not
adequately targeted and does not appear to be effective in leading participants back to regular
employment. Education policy is also examined, reflecting on the increasing educational inequalities
and its possible negative social and economic consequences. In addition, the quality of the regulatory
framework and deficiencies in public procurement are evaluated in the business environment part.
Finally, the section reviews network industries policy.
3.1. FISCAL POLICY
Taxation
Hungary's reliance on sector-specific taxes
continues to put an additional burden on the
sectors concerned.
Since 2009, Hungary has
increasingly relied on revenues from sector-
specific taxes. Sector-specific taxes have been
identified as a factor for businesses deferring
investment decisions (
25
), and weakening investor
confidence in general. Such taxes have been
criticised as causing distortions across sectors
given the selectiveness of their design. In addition,
many of the sector-specific taxes in Hungary have
been introduced without proper stakeholder
consultation or an impact assessment as to their
potential adverse effects. The taxable base for
sector-specific taxes has often been established
based on retroactive sales revenue figures, causing
disruptive effects for businesses. While new
sector-specific taxes were introduced in 2015, the
levy on credit institutions is to be significantly
reduced from 2016 pursuant to an agreement with
the European Bank for Reconstruction and
Development (Box 3.1.1).
The labour tax wedge is still high, in particular
for low-income earners, which may affect their
employability.
The tax wedge for low earners was
the highest in the EU in 2014. (
26
) For average
(
25
) OECD Stat, FDI flows by industry, Hungary.
http://stats.oecd.org/Index.aspx?DatasetCode=FDI_FLOW
_INDUSTRY
(
26
) Defined for a single person without children earning 50 %
of the average wage. he tax wedge for a person earning the
average wage was the 4th highest. All data in this
paragraph from European Commission, ECFIN, Tax and
benefits
indicators
database
earners (singles or couples without children) it was
one of the highest. While the family tax credit
reduces the tax wedge for earners with children,
the effect is substantial only for those with at least
three children. The tax wedge for a two-earner
couple with two children (both earning the average
wage) is above the EU average. The 2013 Job
Protection Act introduced targeted reductions in
social contributions paid by employers for specific
groups (low-skilled, young and elderly employees,
the long-term unemployed and women returning
from maternity leave), reducing their tax wedge.
Yet for those earning low incomes, the tax wedge
remains above the EU average. From 2016, the
personal income tax rate has been reduced from
16% to 15%. Furthermore, a further extension of
the family tax credit benefiting families with two
children has also been adopted. While these
measures will also benefit those with lower
incomes, no targeted measures are foreseen for this
specific group.
There is a potential to shift tax away from
labour.
Hungary is heavily reliant on consumption
taxes, with revenues from consumption taxes the
second highest in the EU according to the latest
figures. Revenues from recurrent property taxes
are however relatively low at 0.6% of GDP
compared to an EU average of 1.6%.While
revenues from environmental taxes as a percentage
of GDP are around EU average, the implicit tax
rate on energy is relatively low. A recent study (
27
)
http://ec.europa.eu/economy_finance/db_indicators/tax_be
nefits_indicators/index_en.htm
(
27
) Study on Assessing the Environmental Fiscal Reform
Potential for the EU28 (forthcoming 2016), draft final
report 10.11.15, Eunomia Research and Consulting, IIEP.
36
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3.1. Fiscal policy
suggests considerable revenue potential from
environmental taxes. However, despite persistently
low energy market prices, Hungary does not levy
excise duties on the supply of gas and electricity to
non-business customers. The respective excise
rates on unleaded petrol and gas oil are among the
lowest in the EU (
28
). Environmentally-harmful tax
allowances (including the low taxation of company
cars) persist in Hungary.
Tax compliance costs remain high.
In particular,
the administrative burden in terms of hours needed
to prepare, file and pay taxes (especially labour
taxes) is relatively high compared to the EU
average. (
29
) An OECD study also finds that
Hungarian SMEs are particularly adversely
affected by tax compliance costs. (
30
) Despite
recent efforts to ease the administrative burden on
businesses, no major improvements have been
reported by businesses in this field.
Despite improvements in recent years, Hungary
still faces challenges regarding the efficiency of
tax collection.
VAT compliance remains relatively
low. Cross-country comparable data put the VAT
gap as a percentage of the theoretical liability at
24.4% in 2013 compared to an EU average of
14.5%.(
31
) Recent measures put in place to combat
VAT avoidance seem to have produced significant
revenue yields over the last two years (estimated at
around 0.5-0.7% of GDP). Several indicators point
to potential weaknesses in the efficiency of the tax
administration. The administrative cost to net
revenue ratio in 2013 was relatively high (1.15)
compared to the EU average (1.09). (
32
)
Undisputed tax debt, at 21.1% in 2013 was
significantly higher than EU average (4.4%). An
investigation by the State Audit Office into the
(
28
) European Commission, Taxud, excise duty tables as of July
2015.
http://ec.europa.eu/taxation_customs/resources/documents/
taxation/excise_duties/energy_products/rates/excise_duties
-part_ii_energy_products_en.pdf
(
29
) World
Bank
2015,
Doing
business,
http://www.doingbusiness.org/data/exploretopics/paying-
taxes
(
30
) OECD, 2015, Hungary, Towards a Strategic State
Approach.
(
31
) Case, CPB, 2015, Study to quantify and analyse the VAT
gap
in
EU
Member
States.
-
http://ec.europa.eu/taxation_customs/resources/documents/
common/publications/studies/vat_gap2013.pdf.
(
32
) OECD,
Tax
administration
2015.
http://www.oecd.org/tax/forum-on-tax-
administration/database
activities of the National Tax Authority revealed a
number of shortcomings in the period from 2009 to
2013 regarding adherence to internal regulations in
particular in the fields of risk assessment and debt
collection. (
33
)
Several measures have been taken to improve
compliance and reduce compliance costs.
An
online cash register system was introduced and is
scheduled to be extended to further sectors.
Businesses classified as ‘reliable’ under a new
classification system of tax compliance risks, are
expected to be granted shorter VAT refunds and
tax inspection periods as a benefit. A real time
cargo monitoring system for public road shipments
was introduced in 2015. The Hungarian
government announced a major institutional
reform, to be launched in 2016, targeting tax
administration with a view of promoting
administrative efficiency.
(
33
)
http://www.aszhirportal.hu/hu/hirek/
37
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3.1. Fiscal policy
Box 3.1.1:
Developments in sector-specific taxes
Increased reliance on sector-specific taxes started in 2009 with the introduction of the tax on
energy providers. The tax on financial institutions came into force in September 2010. Additional
taxes were introduced in the following years with the special tax on the retail, telecommunications
and energy sectors, applicable between 2011 and 2013, the telecommunication tax (since July
2012), the public utilities tax (since 2013), the financial transaction duty (since 2013) the insurance
tax (since 2013) and the advertisement tax (since 2014). The extension of sector-specific taxes
continued in 2015, which brought the introduction of steeply progressive rates in the food
inspection fee (
1
) as well as the introduction of a tax on tobacco manufacturers and distributors. (
2
)
However, the European Commission suspended the collection of these levies on the claim that
they give unfair competitive advantage to certain companies. In response to another action by the
Commission, the Hungarian government abolished the progressive design of the advertisement tax
as of July 2015. (
3
) Finally, pursuant to an agreement with the European Bank for Reconstruction
and Development, the rate of the financial tax imposed on credit institutions has been significantly
reduced from 2016. The measure is expected to lower the levy by almost a half.
The revenues collected from sector specific taxes reached a peak in 2013 at somewhat above 2%
of GDP and also in terms of their contribution to total revenues (Graph 1) (
4
). Apart from the
relatively low elasticity of these taxes, the subsequent decline reflects the effect of measures,
including the phasing out of a one-off component of the financial transaction duty in 2014, the
elimination of the duty paid by the State Debt Management Agency (which was levied within the
central government) in 2015, and reduction of the tax on financial institutions in 2016. At same
time, the revenues from sector-specific levies would still exceed corporate income tax receipts.
Graph 1:
Sectorial tax revenues
Revenue collected from sectorial taxes for the
central budget (% of GDP)
2.5
6
Revenue from sectorial taxes to total revenue
collected for the central budget (% of total
revenues)
2.0
5
1.5
4
3
1.0
2
0.5
1
0.0
09
10
11
12
13
14
15
16
0
09
10
11
12
13
14
15
(1) The data are based on the cash returns of the central government and the budgetary appropriations for 2016
Source:
Hungarian Central Statistical Office
(
1
) The flat rate of 0.1% calculated on sales revenue was replaced by progressive rates going up to 6%.
(
2
) For the highest tax band (applicable to sales revenue over HUF 20 billion), the tax rate was set at 40%.
(
3
) The previous progressive rates were replaced by a dual system in which no tax is applied on taxable base between
HUF 0-100 million and a rate of 5.3% applies of the taxable base in excess.
(
4
) These include: the levy on credit institutions, tax on energy providers, tax on the retail, telecommunications and
energy sectors, sectorial tax on financial institutions, public utilities tax, advertisement tax, telecommunication tax,
financial transaction duty and the insurance tax.
38
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3.1. Fiscal policy
Public debt
Graph 3.1.1:
Gross government debt ratio: historic data
and short term projection
Hungary's general government debt, while
declining remains a source of vulnerability to
the economy.
Hungary's short-term sovereign
financing needs are among the highest within the
group of emerging and middle-income economies.
The public debt-to-GDP ratio fell below 76% of
GDP in 2015 from a peak value of close to 81% in
2011. The reduction of debt has been largely
facilitated by the takeover of private pension
assets, the effect of which was partly offset by
negative revaluation effects. In addition, the
primary balance moved to a surplus position since
2012 (Graph 3.1.1).
The European Commission 2016 winter
forecast projects the debt ratio to decrease
further to around 72�½% of GDP by 2017.
Adverse stock flow adjustment effects (most
notably the delays in the receipt of EU funds) are
expected to result in a moderate decline in 2015,