Hungary: the facts, tasks and prospects of the transformation process

Dr Peter Medgyessy
Former Minister of Finance, Hungary

It is not by chance that Hungary plays the role of a pioneer in the social and economic transformation process in the Central/Eastern European region. The collapse of the Eastern Bloc that led to this also meant that Hungarian independence was finally regained after many centuries. We could openly declare the values we believed in: that we seek to establish democracy and a competitive economy, we want to show that we are part of the European cultural tradition, and to become an equal participant in the Euro/Atlantic integration process.

Current situation

As early as the mid-1980s Hungary had introduced a Western European-type tax system, a two-level (central and commercial) banking system, and laws on the foundation and operation of economic organisations. As part of the transition, this was shortly followed by the elimination of restrictions in the field of foreign trade, prices and wages. The law on fair competition and the bankruptcy law were passed, modern accounting regulations were introduced and the stock exchange was opened.

Privatisation was mostly carried out through market techniques, with the inclusion of a considerable amount of foreign capital (direct capital investments and contributions worth US$13 billion had been made by the end of 1995), and today two-thirds of GDP is generated by enterprises operating in the form of privately owned businesses. Some 25-30 per cent of Hungary's production is realised in foreign trade; we still have numerous contacts with Central and Eastern European countries, though on a new, market basis (Russia, for instance, is Hungary's second or third largest business partner). Two-thirds of our turnover, however, comes from trade with developed countries. The forint became convertible (according to the criteria set by international organisations) in 1996. Hungary is a member of the IMF, the World Bank, WTO and OECD. On the basis of our agreement as an Associate European Union member, signed in 1994, the process of integration into Europe and phasing out customs duties has begun, and the EU's harmonisation requirements are taken into consideration when doing the wide-range legislative work that accompanies the creation of a market economy. Hungary has announced its intention to become a regular EU member following this Associate EU membership.

The transformation process requires a number of sacrifices. A large amount of capital is required to establish an enterprise structure that is capable of surviving among and adjusting to market conditions, and is able to develop among these conditions. We were handicapped at the very start, as a large amount of debt was accumulated by the former regime, which was aggravated by a considerable loss of capital and drop in output caused by the rapid liquidation of companies and activities that were unable to adapt to market conditions. Between 1989 and 1993 GDP showed a large (some 20 per cent) drop, and has only been increasing by an annual one to two per cent since, while productivity has improved, and labour costs in production have dropped significantly. In the 1980s, one quarter of the total workforce became unemployed (the rate of registered unemployment eventually stabilised at 11 per cent), and real wages decreased, sometimes dramatically. This caused a large differentiation in incomes; the economic position of the middle classes declined considerably, and the bottom 20 and 30 per cent of the income structure consists of very poor people. This occurred during a period when public expenditures needed to be cut dramatically, in order to lay down the foundations for a sufficient amount of resources for the enterprise sector.

The Hungarian Government currently in office has just implemented a stabilisation programme that was accompanied by considerable austerity measures, but which has proved successful. When faced with low output, insufficient investment in capital goods by enterprises and increasing poverty, the previous government sought to launch economic recovery by revitalising domestic demand. This, however, led to Government overspending and an unprecedented acceleration of indebtedness in 1993-94.

The new government, which had won the public's confidence in the elections, passed radical austerity measures early in 1995 in order to slow down the country's tendency toward indebtedness and - so that the stabilisation is a lasting one - in order to restructure resources simultaneously to enhance the competitiveness of enterprises (the forint has been considerably devalued, an import surcharge was introduced, and programmes were launched to make the central budget more economical and to reduce wage costs).

The goal of the 1996 economic and financial programme was to consolidate this process. As a result, the ratio of public finance expenditure to GDP dropped from 60 per cent to 50 per cent, the general government deficit fell from eight per cent to four per cent, the current account deficit dropped from over nine per cent to below four per cent between 1994 and 1996, and Hungary's net debts have started to drop. Although this temporarily slowed down economic growth, raised the rate of inflation - which used to be above 20 per cent anyway - and reduced the standard of living, the process can serve as a solid base for setting the economy on an upward path with a more cautious economic policy and a stricter monetary policy.

Tasks and prospects

The Government's medium-term economic strategy is aimed at the achievement of a lasting, reasonable, accelerating but safely financeable economic growth. The Government seeks to further strengthen the economy's capacity to accumulate and attract capital, to preserve and consolidate the recently achieved improvement in equilibrium, and at the same time gradually but irreversibly to slow down inflation.

Economic growth is expected to accelerate in 1997 and even more in 1998, and annual growth may eventually reach four to five per cent if investments in capital goods are reinvigorated and remain strong (such investments are expected to expand by more than ten per cent annually). This will further enhance the competitiveness of our economy and will also increase exports, which have so far been growing by a two-digit figure annually, and will allow these trends to continue. If this is achieved, we do not anticipate the need to reduce real personal wages any further, and the standard of living can begin to rise slowly and gradually. As far as the economic equilibrium is concerned, Hungary seeks to come closer to the requirements set by the Maastricht agreement. As for the criteria set for current deficits (in trade and public finance), we will be able to comply with them within a reasonable period of time. The requirements set for reducing the rate of inflation and public debts, however, are only expected to be met by the turn of the century.

The government intends to lay down the foundations for these objectives through pursuing a consistent, predictable and transparent policy of adjustment (income and financial policy) that is void of abrupt changes, but which is at the same time ready to implement major changes and radical reforms although in a thoughtful and transparent way. The latter includes primarily the overall reform of the public finance system, as well as the development of the financial and capital markets.

As a result of the reform of the public finance system, the remnants of the patronising, so-called 'early welfare state' typical of the socialist system will be eliminated, and the model of the 'service state' will be pursued. We seek to reduce the operating costs of public administration in the financial sense, public redistribution, and - after the reduction of deficit - related public burdens, thereby improving the country's external equilibrium and simultaneously making an increasing amount of resources available to the enterprise sector for accumulation. (Domestic savings may only be used up by the public finance system deficit to an extent that leaves an increasing amount of resources on the domestic financial market for the enterprise sector, and so that the deficit in the balance of payments is kept within limits covered by the influx of direct capital investments.)

To achieve this end, public duties, and the legitimacy and requirements of state intervention must be re-defined in the entire public finance system, and new requirements must be set in order to establish and efficiently operate a slimmed-down system of public institutions. Public distribution of burdens and the social welfare system must be reasonably adjusted to the country's capacity. The transformation of the pension system, healthcare, education, public administration and local councils' finances, as well as the adjustment of the tax system will greatly affect both those running economic organisations (especially in the public finance sector) and private individuals, that is, the entire society.

As a result of the reforms, economic interests will be more clear-cut; the relationship between prices and costs and efficiency and output will appear more transparent. The reforms will serve as a firm ground for the individual in career planning and financing, personal activity and self-support. As a result of the reform, the state's functions will be restricted to those which have proved to be the most useful in developed market economies, and public welfare will be limited to those most in need of it.

The achievement of the transformation process, which is a stable economy, and the Government's economic policy, that has clearly set objectives and employs transparent techniques, is creating a favourable climate for investment and the development of the financial and capital markets. Privatisation is about to come to an end, but still offers a good opportunity for foreign investors to acquire stakes, primarily in the banking sector and the infrastructure.

In line with our international commitments, foreign banks will be able to set up branches in Hungary in 1998. Foreign enterprises can take part in the development of the infrastructure through concessions or by other means. Current laws guarantee free transfer of capital invested by foreign enterprises and the acquired profit. Under the law, foreign companies are assured the same treatment as Hungarian companies. When founding a company, it only needs to be registered with the court of registration, except for some specific types of enterprises and activities (permits are required in the case of companies whose headquarters are located in duty free zones, and offshore companies must be kept on record).

Our tax system contains general and special preferences for investments (the basic corporation tax rate has been 18 per cent since 1995, and dividend tax will be 20 per cent starting in 1997, which may be reduced by conventions eliminating dual taxation; preferences in the corporate tax are related to investments aimed at exports, infrastructure development and those investments made in certain priority regions (the personal income tax system favours savings). Investments in certain fields are supported by subsidies from the Fund for Regional Development and the Fund for Economic Development.

Hungary wishes to offer peace and prosperity to its citizens, and hospitality and fair co-operation with a reasonable profit to its business partners. With its choice of values and diligent work, our country wishes to enter fully into the world's circulation, and to contribute to the creation of a new tradition of an integrated Europe.

Dr Peter Medgyessy was President and Chief Executive of Magyar Paribas, a member of the Paribas bank group, and from September 1994 to March 1996 he was Chairman and Chief Executive of the Hungarian Bank for Investment and Development before taking up his present post as Hungarian Minister of Finance

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