Hungary: Economy

Prior to World War II, the Hungarian economy was primarily oriented toward agriculture and small-scale manufacturing. Hungary's strategic position in Europe and its relative lack of natural resources dictated a traditional reliance on foreign trade. In the early 1950s, the communist government forced rapid industrialization following the standard Stalinist pattern in an effort to encourage a more self-sufficient economy. Most economic activity was conducted by state farms and state-owned enterprises or cooperatives. In 1968, Stalinist self-sufficiency was replaced by the "New Economic Mechanism," which gave limited freedom to the workings of the market, reopened Hungary to foreign trade, and allowed a limited number of small businesses to operate in the services sector.

Although Hungary enjoyed one of the most liberal and economically advanced economies of the former Eastern Bloc, both agriculture and industry began to suffer from a lack of investment in the 1970s. Belated reaction to the economic crisis of the early 1970s and deteriorating terms of trade resulted in increasing indebtedness. In response, the Hungarian Government launched a restrictive economic policy in the late 1970s and early 1980s, followed by the “Dynamization Program of 1985,” which increased consumer subsidies and investments--mainly in unprofitable state enterprises--eventually leading to a doubling of foreign debt levels. By 1993, Hungary's net foreign debt rose significantly--from $1 billion in 1973 to $15 billion. Liberalization of the economy continued, however, and in 1988-89 Hungary passed a joint venture law, adopted tax legislation, and joined the International Monetary Fund (IMF) and the World Bank. By 1988, Hungary developed a two-tier banking system and enacted significant corporate legislation which paved the way for the ambitious market-oriented reforms of the post-communist years.

The Antall government of 1990-94 began market reforms with price and trade liberation measures, a revamped tax system, and a nascent market-based banking system. As a result of the collapse of Eastern markets and the inability of state-owned companies to compete with foreign competitors, industrial production fell by 50% between 1989 and 1994, and the country faced high unemployment and inflation rates, as well as a deteriorating trade balance. By 1994, the costs of government overspending and hesitant privatization had become clearly visible. In 1996, austerity measures referred to as the “Bokros package” (for then-Finance Minister Lajos Bokros) improved both the fiscal and external balance situation, and increased investor confidence. Simplified and accelerated privatization led to significant inflow of foreign capital in industry, energy, and telecommunications sectors, and a number of greenfield investments were launched. Hungary's early openness to foreign direct investment (FDI) led to a sustained period of high growth and made Hungary a magnet for FDI in the late 1990s and early parts of this century.

In 1995, Hungary's currency--the forint (HUF)--became convertible for all current account transactions, and subsequent to Organization for Economic Cooperation and Development (OECD) membership in 1996, for almost all capital account transactions as well. In 2001, the Orban government lifted remaining currency controls and broadened the band around the exchange rate, allowing the forint to appreciate by more than 12% in a year. Trade with European Union (EU) and OECD countries now comprises over 75% and 85% of Hungary's total trade, respectively. Germany is Hungary's most important trading partner, followed by Italy and France. The United States has become Hungary's sixth-largest export market, while Hungary is ranked as the 72nd-largest export market for the United States. Bilateral trade between the two countries has increased to more than $1 billion per year.

With more than $60 billion in FDI since 1989, Hungary has been a leading destination for FDI in central and eastern Europe, although this level is beginning to decline. The largest U.S. investors include GE, Alcoa, General Motors, Coca-Cola, Ford, IBM, and PepsiCo, with the overall level of direct U.S. investment estimated at $9 billion. As a result of extensive and continuing liberalization, the private sector produces about 80% of Hungary’s output.

Close relationship with the economies of the EU helped pave the way for Hungary's EU accession in 2004. As part of its EU membership agreement, Hungary agreed to meet the economic criteria necessary to adopt the euro. In 2005 and 2006, however, it became clear that not only was a high budget deficit hurting the economy (nearly surpassing 10% of GDP in 2006), but that Hungary was moving away from meeting euro entry requirements, and would be subject to EU excessive deficit procedures. Against this backdrop, in fall 2006, Prime Minister Gyurcsany launched a program of fiscal consolidation by raising taxes, decreasing subsidies, and streamlining the public sector. Businesses complained, however, that increased taxes, particularly on labor, decreased Hungary's economic competitiveness compared to other countries in the region. Greater fiscal discipline allowed the government to reduce its deficit to 3.4% of GDP by 2008, but decreasing government spending during this period also reduced domestic consumption and contributed to a decrease in Hungary's GDP growth.

In October 2008, the effects of the global financial crisis spilled into Hungary. Despite its success in reducing its fiscal deficit, years of high budget deficits and Hungary’s high external debt levels fueled investor risk aversion, and negatively affected the foreign exchange, government securities, and equity markets in Hungary. The country was hit hard by global de-leveraging, and weak demand for government bonds. A sharp decline in the share of non-resident investors in the government securities market raised concerns that Hungary would be unable to meet its external financing requirements. In order to increase investor confidence and ensure liquidity in domestic financial markets, Hungary concluded a $25 billion financial stabilization package with the IMF, EU, and World Bank in November 2008.

Under this agreement, Hungary committed to further fiscal consolidation, financial sector reforms, and enacting banking sector support measures. Terms also included periodic assessment of macroeconomic and fiscal targets. Taking into consideration the worsening global economic and financial crisis, the IMF and the EU revised their projections of Hungary’s GDP decline in 2009 to -6.7%, and agreed to increase the 2.9% deficit target to 3.9% for 2009. Public debt was expected to increase to 83% of GDP in 2009 before returning to more sustainable levels through fiscal tightening.

To respond to the crisis, the Bajnai government in 2009 enacted a series of economic reforms and spending cuts intended to reduce the tax burden on labor, encourage employment, improve Hungary's economic competitiveness, and offset lost government revenue due to the deeper-than-expected recession. These measures included reforms to the pension and entitlement systems, as well as tax changes to shift the tax burden from labor to wealth and consumption. In addition to cuts in taxes for businesses and employees, tax changes included raising the value added tax (VAT), and a proposal for the introduction of a property tax. In 2009 GDP declined by 6.3%, and the Hungarian Government was able to meet the 3.9% deficit target.

Elected in 2010, the Orban government adopted what Economy Minister Matolcsy described as an "unorthodox economic policy" to help steer Hungary through the economic crisis. This included the introduction of “crisis taxes” targeting banking, energy, telecommunications, and retail sectors. Originally unveiled as 3-year, limited-duration, and extraordinary measures, the crisis taxes were meant to shore up the government budget until more long-term, structural changes were made. In November 2010, the government acknowledged that the “crisis taxes” would exist in some form until 2014, 2 years later than previously discussed. In addition, in 2010 the government discontinued contributions to the voluntary private pillar of the pension system, and imposed financial disincentives on those who chose not to return to the state system. The government intends to use the resulting budgetary windfall to help reduce the country's debt levels and meet its deficit target of less than 3% for 2011 and 2012.

In March 2011, the government launched its Szell Kalman Plan, which outlines structural reform plans in the areas of local government finance, education, healthcare, employment, and public transportation for 2011-2014. The government is now developing more detailed reform implementation plans in each of these areas. Initial market reaction to the plan has been positive, and by May 2011, the country had already met its foreign currency financing requirements for 2011 through two large dollar and euro bond issuances.

Sources: