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IMF commends Hungarian recovery but says fiscal sustainability still main challenge

The Executive Board of the International Monetary Fund (IMF) commended the ongoing recovery of the Hungarian economy but said the country's main challenge will be to establish a sustainable fiscal stance over the medium term in an assessment published on Thursday.

The assessment was part of the IMF board's summary of a staff report concluded under Article IV consultation and post-program monitoring with Hungary.

The IMF led a €20 billion financial support package for the Hungary in the autumn of 2008, after the country's bond markets locked up. Hungary stopped drawing on the loan in the autumn of 2009. The loan expired last autumn.

The board said recent tax cuts could improve competitiveness but also entail a substantial fiscal cost. Measures to offset the revenue loss, including levies on select industries, are "in large part temporary and distortionary", the board added.

Hungary's new government, which took office late last spring, introduced an extraordinary financial sector levy and "crisis taxes" on the telecommunications, energy and retail sectors in 2010. The bank levy brought in about HUF 182 billion to the budget in 2010 and the crisis taxes generated some HUF 152 billion. The 2011 Budget Act targets HUF 187 billion in revenue from the bank levy and HUF 161 billion from the crisis taxes.

The government's unwinding of the private pension fund pillar is "a source of concern as it increases medium-term fiscal risks while reducing transparency," the IMF board said.

Recent government measures gave private pension fund members the choice to move to the state pension pillar, with their pension assets, but created a strong counter-incentive for opting out of the move and remaining with the private pension funds. The move, which undid some pension reforms launched in 1998, was intended to shore up Hungary's fiscal gap.

The board said there was a need for "durable expenditure rationalization" in the near term, notably better targeting of social benefits and restructuring of state-owned transportation companies. The board added that it welcomed the government's plans to unveil a reform package in February.

The government reform package, to be finalized on February 28, is expected to reduce unemployment benefits and drug subsidies, and restructure the public transport system.

The IMF board welcomed efforts to support distressed retail borrowers suffering the effect of the strong Swiss franc, but said moral hazard and fiscal costs should be contained. Beside the ongoing rise in credit losses, bank earnings in Hungary are already under pressure from a "disproportionately large levy" that could dampen credit growth and undermine the economic recovery. the board noted.

A moratorium on evictions by lenders introduced by Hungary's previous government last winter is set to end on April 15, 2011. The moratorium has been extended several times before. Some experts say the end of the moratorium could affect as many as 100,000 properties.

The board welcomed action to strengthen the legal authority of financial market regulator PSzÁF, but said the weakening of the Financial Stability Council "reduces the capacity to monitor and control systemic risk."

The Fiscal Stability Council was established after the crisis to survey the financial sector and identify risks, and is made up of the head of the central bank, the head of the financial market watchdog PSZAF and the Finance Minister (the National Economy Minister).

The board said the National Bank of Hungary's recent tightening cycle helped anchor inflation expectations and protect the financial sector but added that there is still substantial slack in the economy as evidenced in particular by high unemployment, they added. "A sound medium-term fiscal framework would create room for monetary easing," the board said.

The NBH started a tightening cycle in November, its first since October 2008. The National Economy Ministry said after each of the three decisions to raise rates in November-January that they were unjustified.

The board expressed concern over the weakening of economic governance, noting that steps to lessen the independence of both the Fiscal Council and the central bank's Monetary Council as well as the reduced role of the Constitutional Court in assessing budgetary matters undermine key checks and balances. "These steps run counter to the authorities' stated goal of restoring investor confidence and lowering borrowing costs," the board said.

A government-supported amendment has eliminated the staff and most of the budget of the Fiscal Council, an independent body established by the previous government to issue opinions on fiscal policy. Another amendment will take the power to pick the central bank's external rate-setters from the central bank governor and the prime minister and given it to Parliament. (Econews)