The Organization for Economic Co-operation and Development (OECD) said swift action was needed to stabilize the Hungarian economy and put growth on a sound footing for a durable recovery in its fresh Economic Survey of the country published on Tuesday.
The OECD said its survey shows that the country's fragile and highly-indebted economy has been hard hit by the global slowdown and heightened financial market stress. It added that that controversial domestic measures have added to the uncertainty that is undermining business, household and market confidence.
"Strengthening the credibility and predictability of domestic policies is essential to develop an environment that is conducive to growth and rising incomes," the OECD said.
The OECD's latest projections published last November show Hungary's economy contracting by 0.6% in 2012 but growing by 1.1% in 2013.
The OCED said an agreement on precautionary financial assistance Hungary is seeking from the International Monetary Fund and the European Union would "help restore confidence and support needed fiscal consolidation", lowering the debt burden in foreign currency by stabilizing the exchange rate.
The OECD said that putting growth on a sound footing to allow a durable recovery would require reductions in household debt without damaging banks, to avoid a credit crunch. It added that raising potential growth was of "utmost importance" and suggested boosting labour force participation and health outcomes as two "promising avenues".
The OECD said "credible fiscal consolidation and support for labour demand" would held stabilize the economy. It termed recent changes to Hungary's tax and benefit system "highly regressive", adding that "minimizing negative distributional impacts of consolidation is essential to ensure public acceptance and, thus political sustainability".
The OECD said that making the economy more robust to shocks and promoting a business-friendly environment would put growth on a sounder footing. It said that Hungary is "excessively exposed" to changing investor sentiment because of its high foreign currency indebtedness and suggested state debt rely more on domestic financing in forints.
The OECD welcomed an agreement between banks and the government reached in December, calling it a "step in the right direction", but added that it "is not sufficiently targeted to distressed borrowers". The OECD suggested bank recapitalization to prevent a sharper slowdown in lending and said the bank levy "should be reduced and redesigned".
The OECD said more checks and balances would lead to a more predictable, business-friendly environment, adding that the full powers of the Constitutional Court on economic matters should not be conditional to Hungary's state debt-to GDP ratio. It said that the effective independence of the central bank should be guaranteed, in line with Hungary's international obligations.
The OECD said structural measures were needed to increase labour supply of under-represented groups, such as women, youth, older people and the Roma. It suggested that a reallocation of resources from inpatient services to outpatient services, prevention and health promotion programs and long-term care could improve health outcomes without straining public finances.