Macroeconomic overview

The National Bank of Hungary (NBH), Hungary’s central bank, was established in 1924. Its primary responsibility is to maintain the internal and external purchasing power of the Hungarian currency. The NBH is regulated by the Central Bank Act of 1991 and since the start of the reforms has gradually been divested of its non-central-bank functions and granted an increased level of independence. The most recent amendment to the Central Bank Act, in force since January 1 1997, has brought the regulation of the NBH into line with the principles laid down in the Maastricht Treaty. This amendment prohibits the NBH from financing the central government. Determining the exchange rate system remains the responsibility of the government in agreement with the NBH. As a consequence of a comprehensive stabilization-cum-reform policy programme launched in March 1995, the Hungarian economy has moved decisively towards macroeconomic balance and sustainable economic growth. The growth rate is expected to reach 3% in 1997, led by exports and private investment. From $3.9 billion in 1994, the current account deficit had fallen to $1.7 billion in 1996 and is projected to stay around that figure in 1997, a level more than offset by foreign investment. As a result, the net foreign debt of the country has declined by $6 billion since the end of 1994.

In order to build on these developments, monetary policy is focused on maintaining a stable environment for economic activity. Inflation has been falling since mid-1995 and is forecast to decline to 17% by the end of 1997. The NBH’s goal is a reduction of inflation to single digits within the next few years while maintaining the momentum for growth. One important objective of the monetary authorities is to break through the public’s inertia towards inflationary expectations by improving the credibility of their policies. To this end, since March 1995, a pre-announced crawling band exchange rate regime has been adopted to serve as a nominal anchor. The rate of crawl has been 1% per month since August 15 1997. The market rate can fluctuate within a +-2.25% band around the central rate, but with the exception of very short periods the exchange rate has remained at the lowest edge of the band since the introduction of the system. This is an indication of the confidence of the markets in the economic policy.

Close coordination of fiscal and monetary policies is a precondition for the sustainability of such an exchange rate regime. The NBH has implemented a cautious interest rate policy, with the aim of guiding the market to establish a level of domestic interest rates which stimulates private savings and channels the funds to the most productive investments without encouraging an excessive inflow of speculative capital. The NBH intends to maintain this prudent policy in order to provide a stable and predictable environment conducive to sustained economic growth.

The NBH has played a dominant role in establishing and developing the financial markets during the years of transition. These markets have achieved a remarkable level of development ­ allowing the NBH to use indirect instruments of monetary control and providing policy-makers with information previously not available. The monetary policy instruments used by the NBH are very similar to those which will be used by the future European central bank. The most important instruments are open-market operations, repo and reverse repo transactions, short-term swaps and reserve requirements. The NBH focuses on the short-term market, but the fight against inflation and the need to develop the longer-term market have made it necessary for the NBH to intervene here as well. Thus, reverse repo is available for one month and ­ due to a lack of marketable government securities in its portfolio ­ the NBH issued its own one-year bond in June 1997.

The improving performance of the Hungarian economy has been recognized internationally. In 1996 credit-rating institutions upgraded Hungarian foreign bonds to investment category and two of them have already improved the rating further from BBB- to BBB. As a result of this improving country rating and the strong performance of Hungarian enterprises, the Budapest stock exchange (BSE) is considered the most stable exchange in the region. The Budapest Stock Index (BUX) has had one of the highest growth rates in the world during the last one-and-a-half years.

Dr György Suranyi, President of the National Bank of Hungary

Towards a balanced economy

Over the last 10 years, Hungary has created the major economic conditions and institutions necessary for the operation of a modern market economy.

Since the late 1980s Hungary has had a two-tier banking system (consisting of an independent central bank and several dozen commercial banks) and a western European style tax system. Laws have been enacted to western European standards to regulate accounting, competition, bankruptcy procedures, customs duties, foreign exchange transactions and the formation and operation of companies. The national currency has been convertible for two years in compliance with Article VIII of the IMF criteria, while very few restrictions have been placed on commerce and, more recently, capital transfers. International relations have been transformed and Hungary is a member of the IMF, World Bank, WTO and OECD, and its efforts at Euro-atlantic integration (NATO and the EU) have so far met with a positive response.

The privatization of state-owned assets is drawing to a close. The Hungarian economy has now overcome the massive shocks and declines in output and living standards involved in the conversion to a market economy. It became clear during the term of the first government after the change of regime that the contradiction between the county’s growing indebtedness and the major capital demands caused by its transformation could not be resolved by forcing economic growth. The drastic increase in foreign debt which this caused was halted by the present government in 1995/1996 with an extremely stringent stabilization programme.

This programme also contains a radical new feature, which represents a sharp break with the “stop-go” economic policy of the previous one-and-a-half decades. The new economic policy regime – which began as a correction programme – aimed not only to improve the internal and external balance indicators as soon as possible, but also to strengthen the competitiveness of the economy and domestic companies in the long term. To encourage the latter, the inevitable restrictions were applied to limit consumer-type demand from the state budget and private households, while a free rein – and indeed encouragement – was given to saving, capital formation, capital consolidation and exports. This adjustment has brought about big improvements in the Hungarian economy.

The decline in demand from the government and households – together with the growing savings rate – led to a radical improvement in the balance of payments, expressed in a reduced budget deficit and foreign debt. The growing profitability and competitiveness of businesses was evident from the consistently-high export rate and then, after a transitional slump, from the renewed pace of investment. In parallel with the permanent structural change in demand, improved competitiveness made the supply sector more able to react, and the initial inflationary effects involved in some of the stabilization measures (currency devaluation and the use of transitional customs surcharges) could then be reduced and eliminated. Economic growth slowed temporarily, but is now steadily increasing, while a balance has been retained and inflation is continuously falling, and this is naturally extending to all sectors of production and consumption.

By continuing successful economic policy, the current situation promises to create an accelerating growth rate, combined with a balanced economy and slowing inflation.

A review of the priorities of the government’s economic policy was carried out in a joint assessment with DG2 of the European Commission, and most domestic and foreign analysts agreed that Hungary can attain economic growth accelerating to between 4% and 5% by the millennium, as long as development remains export-orientated and relies on the expansion of investment. The funds for this process are already available, while the proportion of net foreign debt will remain at the same level compared with growing GDP (if Hungary also continues to reduce the proportion of the budget debt to around 60%, the corporate sector will have ample resources available on the money market). The ongoing improvement of the investment climate, competitiveness and productivity will allow household consumption to increase slowly. It is also possible for inflation to be gradually reduced to single figures over the next two years.

There is a good chance that soon it will be possible to refocus Hungarian development and economic policy away from everyday necessities and towards growth, fulfilment of reforms and Euro-atlantic integration.

Dr Péter Medgyessy, Minister of Finance