Hungarian economy in for weakness, IMF concludes

The economy is in the midst of a second recession in four years with consumption and investment falling and unemployment remaining stubbornly high. While the fiscal deficit was reduced significantly in 2012, partly to offset an earlier loosening, policies to achieve this worsened the investment climate. A new policy course is needed to deliver the required medium-term fiscal adjustment in a sustainable way to support growth and confidence, repair the financial sector, and promote structural reforms to boost the potential of the Hungarian economy.

The Hungarian economy is in recession and prospects for a quick recovery have weakened, the weak performance being due partly to structural factors, but also to specific domestic policies, the IMF said.

The current favorable external market conditions provide a propitious moment for corrective action, and Hungary needs to urgently address three interconnected challenges: sustain fiscal consolidation to decrease public debt, but with measures that strengthen incentives to invest and work; repair the financial system to ensure that savings are effectively intermediated to the economy; and advance structural reforms to raise potential growth.

In 2012 the government demonstrated a strong commitment to fiscal consolidation, but based on current policies, the general government deficit is expected to increase in 2013-15, the IMF said. After several consecutive policy rate cuts, further monetary easing should be considered very cautiously.

The banking system is facing great challenges as it seeks to redefine its role in an uncertain environment, and a turnaround of bank lending requires improving the banking system's operational environment. In this respect, the IMF said key steps would include increasing the predictability of government policies, scaling down the tax burden, including the retroactive levies, and facilitating conditions to help banks clean up their asset portfolio, including by removing tax, legal, and regulatory obstacles.

The IMF estimates potential GDP growth to be currently close to zero and projected to remain around 1-1.5% in the medium term. The decline of Hungary's productive capacity in recent years has been deeper than in peer countries, Hungary's ranking has deteriorated in the Global Competitiveness Report, investment is at record lows, and labor participation, although improving as a result of recent government measures, remains low by regional standards. Increased policy predictability, a level playing field for all business, and structural reforms are critically needed to generate higher growth and raise living-standards, the IMF said.

After some important steps were taken during 2009-11, including the adoption of more flexible labour market regulations and parametric pension reform, the reform process has lost momentum recently and policies have been directed at piecemeal solutions.

Efforts to stimulate growth through isolated measures (including by temporarily raising disposable income through utility tariff cuts and minimum wage hikes) are unlikely to provide the boost the economy needs as, while supporting consumption in the short-term, they undermine competitiveness and investment.

The job protection plan is a step in the right direction and the public works program has provided some temporary reprieve, but unemployment cannot be durably reduced without a robust private sector recovery. Policies should therefore focus on facilitating the expansion of private activity and raising productivity. In this regard, efforts are needed to increase competition in the product markets, address the persistent weak condition of state-owned enterprises, especially in the transportation sector, further encourage labor participation, and improve the business climate, including through a more balanced and sustainable composition of fiscal adjustment, the IMF concluded.