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When György Matolcsy was nominated to the post of governor of the Hungarian National Bank (MNB) in March 2013 by premier Viktor Orbán, the country’s finances remained in a fragile state. Hungary had emerged from the global financial crisis intact, but confidence remained at a low ebb. The national stock of debt remained at perilous levels. Banks were lending too little, particularly to smaller and medium-sized companies. A pre-crisis growth model based on consumption and leverage, having vanished, was still to be replaced.
Orbán’s decision to promote his economy minister to run the central bank was not without its critics. Matolcsy was viewed by some, particularly in consensus-seeking Brussels, as unorthodox, a non-conformist. In a continent clinging (mostly unsuccessfully) to the strictures of austerity, his adherence to Keynesian growth principles swam against the tide.
Yet the appointment proved inspired, showing that bold decisions can pay off. After shrinking in the first three months of 2013, Hungary’s economy returned to growth the following quarter and has never looked back. Gross domestic product is on track to have grown by around 3% in 2014, and by 2% and 2.5% respectively in 2015 and 2016, according to London-based Capital Economics.
New levies on the financial services sector irked some foreign lenders, but allowed the government to cut income and corporate tax rates, underpinning growth, slashing debt and building renewed national confidence and stability. In the third quarter of 2014, the government deficit fell to HUF109 billion ($405 million) or 1.4% of GDP, according to the Central Statistical Office, a level bettered only twice in the past 15 years.
Matolcsy, who is rarely interviewed by the international media, made time in December to talk to Euromoney at the MNB’s headquarters in Budapest. The engaging and driven central bank chief, widely seen as one of the primary architects of Hungary’s financial resurgence, is nonetheless keen to highlight the continuing importance of tough decisions made in the early days of the Orbán administration.
In the months following the 2010 general election, the government made a conscious decision to blaze its own trail, Matolcsy says, launching “a series of statutory reforms, without which we couldn’t have turned the economy around, returned to growth and, crucially, cut the deficit”. Under Orbán, the government “flatly rejected the official orthodox and conventional economic policy mix of the European Commission”, abandoning austerity in favour of a series of structural reforms, resulting in a “stronger economy and political stability”.
While the second of those points may be debatable depending on the definition of political stability (the government has survived the past five years intact, though its popularity has waned, leading to periodic marches across the capital, Budapest) there is little doubting the truth of the former. Or, indeed, the success of the unorthodox measures used to embed growth in a once embattled economy.
| The blend of policies and measures turned out to be very successful, creating room for an unconstrained, independent monetary policy |
György Matolcsy, MNB
Hungary has in recent years shaken up its tax system, slashing taxes levied on households and corporates in a push to accelerate growth, while balancing the books by imposing new or raising existing taxes on industries ranging from banks to mining to telecommunications. Lenders bore the brunt of the changes, hit by a direct tax on profits and a broader financial transactions levy that raised the tax on wire transfers and cash withdrawals. Banks grumbled at the time, but few now doubt the success of this radical (at least in modern European terms) attempt to generate growth while balancing the books. Total net external debt, which peaked at 120% of GDP in 2009, dipped below 70% at end-2014 for the first time since 2006, and continues to fall.
For his part, Matolcsy sees the reforms, designed to create, for the first time in decades, a well-balanced economy with low unemployment and a high rate of economic productivity, as a “successful blend of conventional and unconventional economic policy. On the one hand, we cut both the budget deficit and taxes on labour – both can be regarded as conventional measures,” the central bank chief notes. “On the other hand, we also introduced unconventional measures, such as the bank levy. That blend of policies and measures turned out to be very successful, creating room for an unconstrained, independent monetary policy.”
Another vital facet of the country’s resurgence has been its Funding for Growth (FGS) plan, a low-interest funding scheme based on the Bank of England’s Funding for Lending approach and aimed at boosting lending to local small- and medium-sized enterprises. Despite being the lifeblood of Hungary’s economy, SMEs were suffering from a serious credit crunch by the spring of 2013. Matolcsy remembers bumping into European Central Bank president Mario Draghi in the early days of his job. “He said to me: ‘Oh, you’re the guy from the country with the credit crunch’. The situation was dangerous, critical even.”
The success of the FGS scheme convinced the central bank to split it into multiple tranches. The first phase of the plan, FGS I, which lasted for three months in mid-2013, helped disburse $2.8 billion to smaller Hungarian corporates, according to data from independent think-tank Századvég Economic Research Institute. FGS II, which caps the interest rate banks can levy on loans to SMEs at 2.5%, and which was recently extended to end-2015, is expected to boost lending to SMEs by a further $3.7 billion. Péter Virovácz, head of the macroeconomic department at Századvég, says the plan has “really helped boost growth and improve the fortunes of smaller and mid-cap Hungarian corporates. SMEs are Hungary’s future, and are becoming key parts of the global supply chain” in sectors including manufacturing, agriculture, tourism and retail.
Inflation and interest rates have also been targeted during the Matolcsy era, with resounding success. Core inflation fell to 1.2% in November 2014, the lowest rate in more than eight years, and down from 6.3% in August 2012. The central bank chief expects inflation to remain between zero and 1% in 2015, so long as energy prices remain low. Interest rates meanwhile have systematically fallen during the Matolcsy era, from 7% to 2.1% as of the beginning of 2015. Sharply lower oil prices have caused some countries to react by raising or lowering interest rates, but Hungary, so far at least, has avoided the temptation of cutting rates.
While recognizing the impact of a “serious” price shock in the form of lower oil prices, and the expectation of near-term rate rises in the US and UK, Matolcsy highlights the continuing importance of building a stable economic and financial system. Hungary “badly needs stability in order to offer a stable economic environment for SMEs and corporate and financial investors, which is the reason why we think that - if our assumptions hold - our base rate will remain at 2.1% for the next year or so”, he says. Maintaining loose monetary conditions will also, he adds, help meet the central bank’s medium-term inflation target.
Nor is the central bank governor’s work done. Indeed, 2015 may well prove to be the busiest year of his life. A “fair banking” bill recently tabled in parliament will likely be introduced in the first half of the year, designed to place a ceiling on the measure of income banks can generate from lending, and to create a more transparent financial system. The law, notes László Bencsik, chief financial and strategic officer at OTP Bank, the country’s largest commercial lender, is “good for clients but also for the banks as it creates a very responsible banking system”.
Hungary’s parliament in late 2014 also approved legislation to force lenders to convert €9 billion ($10.7 billion) worth of foreign currency loans issued prior to the financial crisis into forints, the local currency, at the most customer-friendly of two exchange rates. That move will cut banks’ income in the short term but, by writing off the spiralling debts of hundreds of thousands of Hungarian households, should ultimately boost domestic consumption.
Finally there is the expected formation of a $1.2 billion bad bank, overseen by the MNB and designed to buy and house failed commercial real estate loans. The banking sector’s non-performing loan (NPL) ratio stood at 18.5% at end-June 2014, one of the highest in Europe, largely due to bad ‘project loans’ made in the years before the financial crisis. Those failed or failing loans remain a “heavy burden” for lenders, says Matolcsy, who is hoping eliminate a third of all corporate NPLs from Hungary’s banking system by the end of 2015.
Hungary’s economic and financial revival has not gone unnoticed. In May 2014, Standard & Poor’s raised its outlook on the long-term sovereign credit rating to stable from negative, citing higher exports and an improved economic environment. The ratings agency affirmed both its outlook and its BB sovereign credit rating in September, and Matolcsy expects the country to enjoy a further upgrade from leading ratings agencies in 2014, in light of the ongoing economic and financial reforms. Notes Zoltán Polyánszky, a senior analyst at Századvég: “Hungary is clearly undervalued in international financial markets, and ratings agencies have failed to acknowledge the country’s fiscal and economic efforts. The country’s rating is predicted to improve in 2015, as a consequence of which risk premiums are expected to decrease.”
Many things have gone right since premier Orbán took office, many of which emanate from the heart of the central bank. Two years ago Hungary remained at a low ebb, depressed by low growth, high unemployment and a still-troubled banking sector. Thanks to the unorthodox and ultimately successful policies of MNB chief Matolcsy, the economy is starting to swell again, boosting growth and creating myriad new opportunities for investors. Hungary was once a country in the gutter, looking at the stars. Now, its economy is starting to shine again.