10 April 2013

Macro-economic Imbalance Procedure in-depth review for Hungary

The in-depth review concludes that though the adjustment process is on-going and there have been improvements most notably in the external imbalances, a number of policies that cannot be considered market-friendly have contributed to losses in the country's growth potential.

Hungary has been experiencing imbalances, in particular as regards  developments related to the net international investment position (NIIP) and  public debt as mentioned in last year's IDR. External imbalances have decreased  as the current account is in surplus for the third year in a row and the NIIP has  been improving steadily (from -117 per cent in 2009 to above -103 per cent in 2012), but it remains significantly more negative than the threshold. This is expected to be the case also in the years to come. The current account turnaround that started in 2009 was mainly the result of a fall in domestic demand amidst a sharp recession; export competitiveness has rather deteriorated somewhat. After a marked decline during the 2009 recession, the deficit in the factor income has started to widen again, though it remains below pre-crisis levels. Both elements suggest that the external correction is partly cyclical.

Public debt, which was reduced from 82 per cent to below 79 per cent in the 2010-2012 period  thanks to one-off capital transfers from the abolition of the mandatory private pension scheme as well as some consolidation measures, is still very high compared to the country's GDP per capita level and regional peers. Given the combination of a weak growth potential, high debt level and financing costs, a very high share of foreign ownership of public debt securities and the relatively high gross financing needs, public sector deleveraging is a vulnerable process.

The combination of high level of debt stocks and low  growth keeps the country vulnerable and exposed to sudden adverse changes in market  sentiment. Therefore, in addition to flashing indicators of the scoreboard such as the highly negative size of the net international investment position, public and private sector debt and high unemployment rate, the business friendliness of the economic environment deserves very close attention so as to reduce the important risks of adverse effects on the functioning of the economy.

While continuing on the path of fiscal consolidation to create the basis for sustainable growth, the policy response could usefully include a revision of the tax system by lowering surtaxes on certain sectors (most notably on the financial sector), and more generally creating a more business friendly environment. These steps should also make the country less vulnerable to changes in market sentiment and restore its attractiveness for foreign direct investment and bank funding which would result in improved lending, investment and economic growth. In addition, structural reforms in both labour and product markets are worth pursuing in order to lift the country's potential growth. These may include steps toward more efficient active labour market policies, including a thorough review of the Public Works Scheme with respect to training elements and by reinforcing the capacity of the Public Employment Service. In addition, a strengthened functioning of competition enforcement, public procurement rules could be suggested. The on-going efforts to implement measures that lower the administrative burden is commendable and could be continued and plans envisaged in the National Reform Programme fully implemented. Improving educational outcomes can also positively affect growth. Finally a reform of the transport and energy systems toward more sustainable levels is necessary from both the point of view of fiscal sustainability and economic efficiency.

Full review

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