IMF welcomes smaller deficits, but warns Hungary

Ratings

The International Monetary Fund (IMF) welcomed reductions in Hungary's fiscal and current account deficits in 2007, but warned that the country still remains highly vulnerable.

The IMF noted that Hungary's government debt and net external liabilities, relative to GDP, are by far the largest among new EU member states. This places it in a vulnerable position, considering the decline in global investors' appetite for risk - which has caused government securities yields to rise - as well as increased financial system risks.

To reduce its vulnerability, the IMF said Hungary must continue its fiscal consolidation program and make tax and spending reforms that preserve stability and promote growth; keep monetary policy firmly anchored by the 3pc inflation target at the two-year horizon; and make improvements to banks' risk management practices as well as review financial safety nets.

The IMF projected GDP growth would pick up to 2% in 2008 and around 2.7% in 2009 from a sluggish 1.3% in 2007 as private consumption slowly picks up and export growth and EU development funding support an acceleration in investments. It put mid-term potential GDP growth at 3.0%-3.5%, though it would be higher if the size of Hungary's government and the corresponding tax burden were reduced, and the administrative burden on companies were lowered.

The IMF said the current account deficit is expected to narrow in 2008-2009, as export growth improves the trade balance and EU transfers grow, but widen again in the mid-term as the pick up in domestic demand reduces the trade balance. The IMF noted that the forint's real effective exchange rate is estimated to be slightly above the value implied by fundamentals, but conceded that large uncertainties surround such assessments.

Hungary's large external liabilities - net external liabilities come to about 100% of GDP - present an important vulnerability, the IMF said. Bank borrowing from sources other than parent banks presents a special risk, and a related vulnerability is households' exposure due to foreign currency-denominated borrowing.

Assessing the outlook for 2008-2009, the IMF said better-than-projected farm sector output could spur a faster pick up in growth. On the downside, a worsening of external financing conditions, caused by global or domestic developments could raise the cost of borrowing and dampen investments.

A large depreciation of the forint could temporarily improve competitiveness but would hurt household balance sheets, given their large foreign currency-denominated liabilities.

The IMF said Hungary's fiscal deficit target of 4% of GDP is attainable, but added that a further reduction to 3.2% of GDP in 2009 is essential. Given the uncertainties surrounding the economic outlook, the IMF said the 2009 should include sizable contingency reserves. The IMF said there is no room for tax cuts unless they are offset by a reduction in spending.

The IMF said a draft fiscal responsibility law (requiring a two-thirds majority in Parliament) would help a further consolidation and lower the state's borrowing costs.

The IMF said it sees Hungary's inflation rate falling to the 3% target by H1 2010, but said further increases in global food and energy prices present upside risk. (MTI – Econews)

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