Hungary special report 2015: Untapped economic potential

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Foreign investors are starting to appreciate the opportunities available in an economy that has turned itself around.

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Heinrich Pecina leans back in a chair at the Gresham Palace hotel in Budapest and scratches his head. A senior partner at Vienna Capital Partners (VCP), a leading Austrian private equity player, he’s confused by the sometimes unreceptive attitude to Hungary adopted by the outside world. An influential and prominent investor (VCP’s acquisition of the local media operations of German publishing giant Axel Springer was approved in October 2014, the latest in a long line of successful deals), he is baffled at Hungary’s image among some – though not all - foreign investors and commentators. 

“The country’s economic development story is there, though it isn’t always recognized outside the region, or outside Europe,” Pecina says, warming to his theme. “Hungary boasts a reliable workforce, and low labour and production costs. It’s in the Schengen region, meaning ease of travel around Europe. Real estate prices are rising again, showing that the property market may have bottomed out, and confidence has returned. There is so much untapped potential here.”

There is much in what he says. Hungary was on its uppers in 2009, fast running out of cash and on the verge of calling in the bailout team at the International Monetary Fund. It never quite came to that, though those were distressing days, admits Gyula Pleschinger, a member of the Monetary Council of the Central Bank of Hungary (MNB). “The country was in a very dark place,” he says. “In fact, it was pretty much the worst-performing economy in the region.” Hungary muddled through, but by 2010 a newly installed government, headed by premier Viktor Orbán, knew that structural reforms were needed to get the economy back on track. 

Making it better

To many, the decisions made in the immediate aftermath of those elections were the making – or rather the re-making – of Hungary. New taxes to plug a yawning hole in public finances were imposed on sectors including financial services, telecommunications, utilities and natural resources. Orbán and his council of ministers offset that pain by introducing a series of unorthodox but ultimately successful and business-friendly reforms. 

Pecina VCP
Heinrich Pecina,
Vienna Capital Partners

The government, notes Pecina, was probably the only one in Europe to react to the financial crisis by slashing income tax, creating a new flat rate of 16%. “Income taxes went up across Europe in the wake of the events of late 2008, but not here,” he says. Corporate tax in Hungary stood at 19% at end-2014, according to data from KPMG, on a par with Poland and the Czech Republic, the region’s two other leading economies, but below the levels in Austria (25%) or Germany (29.58%). 

The aim, in the wake of the 2010 elections, was to boost growth and consumption and cut debt at the personal, corporate and national levels, even while creating a wealth of new jobs – no small feat given the depths to which Hungary, over-leveraged and rudderless, had sunk. Given that some European nations have struggled, in the post-crisis era, to meet a single one of those criteria, Hungary’s ensuing success story is nothing short of miraculous.

Unemployment, which last peaked at 12% in late 2012, stood at 7.3% at end-September 2014, according to data from Eurostat, far below Poland (8.5%) and Slovakia (13%). Péter Virovácz, head of the macroeconomic department at Századvég Economic Research Institute, a Budapest-based think-tank, reckons that 400,000 jobs have been created in the private sector since the financial crisis, many in the resurgent manufacturing sector. 

Financial policy minister Gábor Orbán told Euromoney that the key to job creation has been lower taxes, a higher annualized investment rate – which hit 15% in 2014 – and incentives to create new vacancies. “In recent years, we have made every effort to increase labour force participation,” the minister says, notably by slashing corporate taxes while cutting welfare benefits. That made it financially viable for companies to hire - and for individuals to work, rather than living off the state. 

Government debt as a share of gross domestic product (GDP) has also fallen sharply, to 2.4% by end-September, against 4% in Poland, while consumption is tipped by Virovácz to surge in 2015 thanks, he says, to “higher disposable income due to higher wages, rising employment, and consumer-price deflation”. Two further boosts are likely to come from bank refunds, following a late-2014 government ruling on pre-crisis loans issued in foreign currencies, and a fresh influx of development finance from the European Union. 

Other factors point to a country with a bright future. Hungary rose three places year on year in the World Bank’s 2015 Doing Business report, to 54th place, ahead of both Poland (85th) and the Czech Republic (110th). It takes just five days to start a business, beating Poland by nearly a month. Hungary also boasts the highest level of labour market flexibility in Central and Eastern Europe (CEE), according to the Organisation for Economic Cooperation and Development. It ranked 20th in the 2015 World Bank report in terms of enforcing contracts – outstripping its CEE peers and on a par with nations in Western Europe and North America. 

Confidence returns

Growth, which tentatively returned in early 2013, is now back in force. One need only wander around the streets of central Budapest, packed with buzzing restaurants and bustling designer outlets, to see clear signs of consumer confidence. Economic output expanded at an annualized rate of 3.7% and 3.9% respectively in the first and second quarters of 2014, slowing marginally in the third. Capital Economics tips GDP to have grown by 3.3% in 2014, the third-highest rate in Europe, and by 2% and 2.5% respectively in 2015 and 2016. The London-based consultancy believes the country is capable of delivering long-term growth rates of around 3%, so long as investment rates remain high, and the still-fragile banking sector can resolve its debt overhang. 

Századvég tips growth to come in at 2.8% in each of the next two full calendar years. “Hungary’s macroeconomic position is very sound right now,” notes Virovácz. “We are in the top three in Europe in terms of our real growth rate, and our economy is structurally very sound. Growth in gross fixed capital formation is improving, and the government and the central bank have a lot to do with it.”

In its latest Hungary Quarterly Outlook, published in December 2014, Barclays points to “solid fundamentals”, led by regular current account surpluses, a fiscal deficit below 3% and a high level of growth. “Although some of the improvements have been orchestrated by unorthodox government policies,” the UK bank adds – another nod towards Budapest’s decision to blaze its own trail – “they appear to be durable.” 

Virovácz believes that Hungary, by accident or design, has woven together a “special” economic model. “It’s been a bumpy ride at times but from an economic standpoint, it’s clearly working,” he says. “The economy is growing, wages are rising and unemployment is at its lowest rate in a decade.” Exports, which rose by 5.9% year on year in 2013, are set to grow by 7.9% in 2014 and 6.4% in 2015, reckons Századvég. Premier Orbán’s ambitions are to create a regional manufacturing powerhouse bonded tightly to the global automotive, chemicals, and pharmaceuticals sectors. Research and design investment budgets are rising, boosted by generous government subsidies, while EU funding is being channelled into improving the country’s physical infrastructure. 

Bumps in the road

There may yet be a few more bumps in the road ahead. Hungary’s overall stock of debt remains high while the banking sector, despite being cleaned up in recent years, is still regaining momentum. A new wave of consolidation is expected over the coming year or two, injecting fresh competition into the sector. And while boosting its productivity rate admirably since the financial crisis, the country still ranks 60th in terms of the world’s most competitive economies, according to the World Economic Forum. That places Hungary close to the regional CEE average but below the likes of the Czech Republic. 

Global economic conditions are also both helping and hindering an economy that remains competitive, vibrant and, most important, open to business. On the one hand, notes VCP’s Pecina, “sanctions levied on Russia are hurting Hungary”, particularly its thriving agricultural sector. But, on the other, the sharp fall in oil prices in late 2014 further benefits a resource-scarce economy. 

Much will depend on whether the economies of Germany and Austria, both heavily wired to Hungary’s manufacturing sector, can find a higher gear. “If they do well or badly, so does Hungary,” notes Pecina. The MNB’s Pleschinger believes much will depend on whether the eurozone can extricate itself from its ongoing malaise, and prevent a lost five years becoming a lost decade. “More than three-quarters of our trade is with the region, so we are very concerned about what is happening there,” he says. 

But all open economies are, particularly in this globalized era, to some extent dependent on the success of trading partners, whether near neighbours or distant lands. These days, everyone connects. Hungary’s great success has been both simple and, in its way, old-fashioned: to take responsibility for its problems, fix them and then focus on boosting trade with economies around the world. Its economic model may be unorthodox but its success, based on higher growth, lower debts and unemployment, and a balanced budget, is undisputed. It’s time for the world to recognize, appreciate and profit from Hungary’s economic success story.

Hungary economic outlook by year
YearGross domestic production expansion (%)Private consumption change (% change, year-on-year)Net export growth (% change, year-on-year)Gross external debt ($ bilion)
20131.6-0.15.9164.2
20143.31.58.1148
2015*2.81.84.6131.2
2016*2.82.34.1124.6
*Predictions
Source: Hungarian National Bank, Central Statistical Office