RaboResearch - Economic Research

Country Report Hungary

Country Report


Thanks to a policy-induced rebound of domestic demand and solid exports, Hungary exited recession last year while keeping its budget deficit below 3% of GDP. Yet, sustainability concerns remain, as unorthodox policies will likely continue beyond the parliamentary elections in April.

Strengths (+) and weaknesses (-)

(+) Favourable geographic position and well-developed infrastructure

Due to its location at the heart of Central Europe and its good infrastructure, Hungary’s economy benefits from short transportation routes to major markets and industrial production centres.     

(+) Commitment to fiscal discipline

Hungary’s government is strongly committed to fiscal discipline, as it strives to reduce the country’s dependency on external financing. Yet, oftentimes populist consolidation depresses private investment and thereby puts potential growth and the sustainability of fiscal policy at risk.

(-) Very high external debt load and FX-denominated debt

Given this year’s foreign debt of about 130% of GDP, a gross external financing requirement of USD 64bn, and considerable amounts of FX-denominated local debt, Hungary is strongly exposed to a deterioration of external funding conditions and a sustained depreciation of its local currency.

(-) Populist unorthodox economic policies undermine business climate

The current government tends to opt for populist unorthodox ad-hoc short-term policy measures that create considerable policy uncertainty. Economic policy favours industrial production at the detriment of services and strives to replace foreign by Hungarian (state) ownership in key sectors.

Key developments

1. A policy-induced economic recovery

Hungary’s economy re-emerged from its 2012 recession last year, as economic growth reached 1.1% in 2013. While net exports still contributed significantly to the recovery, reflecting resilient export growth particularly in the automotive sector as additional production capacity became available, domestic demand strengthened markedly. Yet, the rebound of the latter was primarily driven by policy stimulus, as private consumption and investments were held back by ongoing deleveraging efforts, elevated unemployment levels, the banking sector’s very weak asset quality, and general uncertainty regarding economic policies. In an attempt to boost both domestic demand and its popularity ahead of several elections this year, the government implemented a series of mandatory utilities tariff cuts, raised public spending and increased public investments that were partly financed by the improved absorption of EU funds. Moreover, Hungary’s central bank tried to counter still contracting private credit provision by means of a series of interest rate cuts and its ‘Lending for Growth’ scheme, which provides funding at zero cost to banks for the provision of new loans with a maximum interest rate of 2.5%. However, in spite of these efforts, the economic recovery has been limited so far to the volatile agricultural sector, car manufacturing and construction. Due to further improvement of domestic and external demand, economic growth this year is expected to come in at about 2%. The risks to the outlook are slightly tilted to the downside, as Hungary is not immune to the effects of US Fed tapering and a sustained depreciation of the forint would lead to rising debt servicing costs for the public and private sector.

Figure 1: Growth performance
Figure 1: Growth performanceSource: EIU
Figure 2: External debt and public finances
Figure 2: External debt and public financesSource: European Commission, EIU, MNB

 2. Hungary exits the EU’s excessive deficit procedure, but sustainability concerns remain

The European Commission released Hungary from its excessive deficit procedure (EDP) last year, as the country managed to keep its budget deficits below 3% of GDP since 2011. The EDP exit reduces the risk of cutbacks in EU transfers that proved crucial in boosting both economic growth and the country’s current account surplus. Yet, given the controversial nature of recent deficit reductions, the EU will likely keep a close eye on fiscal developments, as Hungary’s recent strong performance was oftentimes achieved by the ad hoc imposition of additional taxes. This had also been the case last year, when additional levies imposed on the mainly foreign-owned banking sector helped reduce the budget deficit to 2.9% of GDP. Due to the negative impact of the fiscal consolidation strategy on private sector investment and (potential) economic growth, serious doubts about the sustainability of the current approach remain. Still, ongoing commitment to fiscal discipline can be expected, given both the government’s determination to avoid external interference and general awareness of the need to uphold investor confidence as relations with the IMF soured markedly last year. Given reluctance to cut spending, taxation risks will remain high, particularly so following the recent controversial decision to borrow EUR 10bn (10% of GDP) from Russia to finance the expansion of the Páks nuclear power plant, which forces future governments to conduct cautious fiscal policies to avoid a further increase of Hungary’s high public debt ratio.

3. Hungary’s external position remains vulnerable and restricts policy space

While Hungary’s stable current account surpluses have supported investor confidence so far and helped reduce the country’s still very high external debt load, the country remains exposed to a worsening of external financing conditions, as the US Federal reserve gradually reduces its monetary stimulus. While this year’s gross external financing requirement amounts to a very high 50% of GDP, including banks’ FX wholesale funding needs, households and corporations remain susceptible to a sustained depreciation of the forint as 60% of loans are FX-denominated. Given the need to attract sufficient external funding and support the local currency, Hungary’s central bank will probably end its recent easing cycle, while fiscal policy will likely remain relatively tight.

4. Fidesz-KDNP heading for victory at upcoming elections[1]

The Fidesz-KDNP party of prime minister Victor Orbán will likely dominate this year’s elections, as recent mandatory utility tariff cuts and the prospect of another attempt at reducing foreign-currency denominated debt (likely at the cost of foreign-owned banks) boosts the government’s popularity. Consequently, a continuation of the current populist economic policies can be expected, as the country’s opposition still struggles to seriously challenge Fidesz-domination of Hungarian politics. Yet, the recent decision of all opposition parties (excluding the extreme-right Jobbik party) to field a single leading candidate and shared candidate lists could prevent the incumbent from gaining another two-third majority at the April 6 parliamentary elections, which would limit the government’s scope for further constitutional changes.

Foot note
[1] Parliamentary elections (April 6th, 2014), European elections (May 2014), local elections (Autumn 2014)

Factsheet of Hungary
factsheet of HungarySource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Hungary is small open economy in Central Europe with a nominal GDP of USD 129bn (2013) and about 10m inhabitants. Benefitting from its proximity to developed markets in Austria, Germany and Italy, its well-educated low-cost workforce, and the swift transition to a free-market capitalist economy following the end of Communism, it has been a major recipient of foreign direct investment prior to the global economic crisis. Its largely privatized and well-diversified economy is closely integrated into Central and Western European supply chains, which contributes to close business cycle synchronicity with the euro area. Manufacturing, particularly car production (Audi, Mercedes Benz, Opel, Suzuki), and food processing constitute important export industries, as does tourism. Hungary’s rapid economic transition in the last two decades went hand in hand with a considerable increase in corporate and household indebtedness, oftentimes in foreign currencies (mainly Swiss franc), while very lax fiscal management prior to the global economic crisis boosted public debt levels. In spite of strict fiscal consolidation measures initiated since 2006, Hungary was forced to apply for EU/IMF financial assistance in 2008. Considerable public disenchantment with the austerity measures imposed by the previous government brought the centre-right Fidesz-party to power in 2010. Driven by its conviction to reduce foreign involvement in Hungary’s economy and the perceived influence of opposition parties on public institutions, the Fidesz-government has used its two-third parliamentary majority to implement major political and economic changes in recent years, including the introduction of a new constitution. As various policies threatened to undermine the checks and balances of Hungary’s democratic system and populist economic policies tend to target sectors dominated by foreign ownership, Hungary’s relations with the EU deteriorated and its appeal among foreign investors cooled markedly. Given ongoing weak public support for the opposition parties, Fidesz will likely dominate Hungarian politics in the years to come.

Economic indicators of Hungary
Economic indicators of HungarySource: EIU


Fabian Briegel
RaboResearch Global Economics & Markets Rabobank KEO
+31 88 726 7864

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