The actual conditions of Hungarian economic development differ from projected ones in several respects in 1999. The dynamic economic growth even by international comparisons and the considerable curbing of inflation were accompanied by growing disequilibria.

In this report we provide the analysis of changes in external and internal relations influencing economic development and disequilibria. Actual data are available on the first half of 1999 on international and domestic trends. Projections up to the end of 1999 were also published in our latest quarterly report.

The growth of the world economy and international trade is projected to decelerate considerably this year. The slowdown can be observed especially in the European Union with the annual growth rate expected to amount to 1.8-2.0 per cent against the 2.8 per cent figure of 1998.

Source: Economic Survey of Europe 1999. No. 1.

Economic growth tends to slow down in Eastern Europe as well. The average figure of the region is projected to amount to maximum 2 per cent because of the long lasting financial and transformation problems. Growth prospects remain thus below those of 1998 even in this region. The 10 per cent increase of world trade recorded in 1997 declined to 4-5 per cent in 1998 due to the global financial crisis. World Bank projections expect the concomitant figure of 1999 to amount to about 2 per cent.

As regards the European Union, the main problems are observed in agriculture having indicated considerable deterioration of profitability past year. Contraction was attributed basically to the decrease of prices caused by over-production.

The direct and the indirect negative effects of the Balkan war have been significant recently. It is though nearly impossible to measure the economic damage caused by the war to Hungary. A rough estimation may arrive at USD 200-250 million. The indirect effects increase Hungary's deficits further. Let us mention e.g. the deterioration of Hungary's political relations to Russian involving further drastic contraction in bilateral trade. Hungary will suffer the negative consequences of the war in the rest of the year as well. The gross domestic product may drop by 0.5 per cent as a result of the war. The Hungarian economy is expected to participate in the reconstruction works following the war. However, the positive effects of these projections are not to be observed this year.

The individual sectors of the Hungarian economy are affected differently by the changes in the world economy. Exports of industrial customs free zones providing 40 per cent of total exports are not influenced by the deceleration of world economic growth. The markets of the large multinational firms located in these zones are not affected as reflected by the 38 per cent growth of customs free zones' exports measured at current prices in the first four months of 1999 against the few per cent increase of world trade.

However, the dynamic growth of customs free zones' exports (and the positive trade balance) represents only a moderate driving force of the Hungarian economy since there is only 1 per cent of total labor force employed by the concomitant firms and their production is based primarily on imports instead of domestic deliveries.

The customs area providing 60 per cent of all exports was intensively affected by the world economic slow down, the Russian financial crisis and the direct and indirect (political) consequences of the Balkan war. Exports of the area having increased by 4.7 per cent past year contracted by 10 per cent in the first four months of 1999 whereas imports stagnated. Consequently, the trade balance indicated USD 360 million higher deficit in the first four months of the year than in the same period of past year.

The indigenous demand on domestic products decreases because of the continuous increase of imports. This may involve the moderation of economic growth. The increase of incomes was not dynamic, either. In the first quarter of the year real earnings grew by 3.1 per cent remaining below the concomitant figures of 1998 and 1997 by 0.5 and 2 percentage points, respectively. Though there is a rather great gap between real and aggregated earnings, it is apparent that the drop of the rate of growth of real earnings involves the deceleration of the rate of growth of consumption as well.

GDP growth is expected to slow down in 1999 because of the deterioration of demand factors. The projected figure of 3.8-4.3 per cent is considered to be outstanding by European standards (let us mention the 2 per cent growth projection of the EU). The gross national income increases significantly slower, by 2.5-3 per cent at most since growth derives mainly from the exports of customs free zones' firms being in foreign stake and their contribution to the GNI is rather low.

In spite of the moderation of economic growth rate, both external and internal disequilibria of the Hungarian economy deteriorated significantly in the first four months of 1999. The USD 318 million deterioration of the current account came partly from the growth of customs area deficit and partly by the increase of the imports of certain services.

The deterioration of the balance of customs area economy has started in 1990. The total figure amounted to USD 5 billion in the period 1990-1998, one third of recent customs area exports. This trend is related to the crash of Eastern European trade, import liberalization neglecting domestic interests and certain privatization measures. The Hungarian economy has not only lost a considerable part of its foreign markets but it is also superseded from domestic markets more and more. The energetic measures of March 1995 (i.e. devaluation, import fees entering into force) stopped the deterioration of disequilibria only temporarily in the customs area economy. The trend continued more or less dynamically later on. The rapid increase of customs free zones' exports was stabilized though the foreign trade deficit (at USD 2 billion) temporarily, even the total balance started to deteriorate in 1998. The same trend can be observed in the first four months of 1999.

Source: CSO statistical annuals             ME statistical quick reports on foreign trade             ECOSTAT projection

The next main factor of the deterioration of the balance of payments is the drop of services' assets. Building installation services (especially in Germany) and transportation activities contracted significantly in the past period. As regards technical and cultural services, the significant deficit of 1998 (surely deriving from the withdrawal of incomes of several kinds of royalties) was to be observed without any increase this year.

The income repatriation of foreign capital investors dropped considerably in comparison to the previous year, however, uncertainty is furthermore rather significant since income withdrawals are determined by measures of the management of a few great firms.

In the first four months of 1999 the deficit of the balance of payments was financed by the inflow of direct capital investments (indicating a rather decreasing trend anyway) and the (portfolio) investments in securities embodying proprietorship and in bonds.

Assuming no changes of recent trends, the deficit of the balance of payments is expected to amount to USD 2.5-2.9 billion this year. USD 1.5-2.0 billion direct capital investments and USD 1.-1.5 billion portfolio investments enable the financing of this figure without the increase of debt.

The deficit of the balance of payments seems to be manageable both on short and medium term by the well known measures having been applied recently. On the long term, however, the high ratio of liabilities is thought to involve permanent stagnation and further indebtedness.

The 1998 figure of GNI amounting to about USD 46 billion is expected to grow by 2.5-3 per cent this year reflecting an increase of USD 1.4 billion namely. However, the annual profit or yield of direct capital investments and portfolio investments (amounting to USD 30 billion as a whole) total 5-6 per cent, USD 1.5-1.8 billion. Profit is totally used up by interest and allowance payments indicating a negative spiral in the economy.

The deficit of the state budget is the second factor of the economic disequilibria. Considerable deterioration was observed here in the first five months of the year. The preliminary consolidated deficit of the budget (local governments excluded) amounted to HUF 380 billion at the end of May, 86.8 per cent of the figure envisaged for the whole year. Considering the average revenue and disbursement items of the past three years (1996-98), 1999 figures indicate HUF 75 billion drop on the revenue side and HUF 66 billion increase at the disbursement side. Namely, the deficit of the first five months 1999 exceeded the figure expected according to the past three years' trend by HUF 140 billion. This was partly caused by several financial processes since the effect of certain special financing items expected for this year has not been counterbalanced yet.

The drop of revenues exceeding the figure expected by reason of former trends derived mainly (HUF 40 of the 70 billion) from the default in central bank payments and payments related to debt service. Disbursements exceed the figure projected by the trends of 1996-1998 by HUF 66 billion though they remain below the time-rated level. The increment is related to three areas, the assistance of economic organizations, the disbursements of central budgetary organizations and debt service liabilities. Expenses related to debt service exceed the time-rated level by HUF 44 billion.

60 per cent of the increase of the deficit compared to past three years' trends derived thus from non-real-economic financial processes expected to be counterbalanced on the annual level.

Economic organizations' payments and consumption related taxes remain below optimistic expectations in spite of their increase exceeding far the growth of GDP. As regards the disbursement side, subsidies paid to economic organizations are also expected to exceed projections mainly because of agricultural demands. Consequently, the deficit of the state budget may exceed the envisaged figure by HUF 50-70 billion.

The deficit of social security funds connected mainly to the unadvised timing of the pension reform also contributes to the deficit of the state budget. Several experts pointed to a problematic aspect of the preferred solution at the reform preparation debate. Namely, it was thought to burden the budget on the long term since recent pensions are paid by the state whereas those entering private pension saving banks and those just starting their carrier pay a part of their payments to private saving banks. The deficit of this state budgetary sub-system is expected thus to exceed projection by HUF 30-40 billion. We have to mention an other problem as well. Namely, the social security deficit was underprojected in the previous years (the actual deficit exceeded projections by HUF 30-50 billion from year to year).

Considering even the deficit of social security funds, the deficit of the state budget is expected to exceed projection by HUF 70-100 billion this year. Consequently, the deficit is thought to amount 4.5 percent of the GDP in contrary to the 3.7 percent projection. As regards international comparisons, the above figure meets the early nineties’ indicators of the most developed countries. Exceeding the budgetary projection by HUF 100 billion may increase inflation by 1 percentage point at most or may promote economic growth in a favorable situation.

Analyzing external balance problems we find the following conditions of improving the balance of payments under recent Hungarian relations:

• more intensive protection of domestic companies at domestic markets,
• more intensive subsidy of exporting sectors in order to improve their market activities and the technical level of their products,
• drop of the past years’ considerable foreign trade deficit against Eastern European countries, even in the form of barter trade.

Consequently, in order to solve recent balance problems the structure and competitivity of economy has to be improved first instead of further decrease of budgetary disbursements.

Source: ECOSTAT, CSO estimation

The formation of disinflation measure is one of the most important topics of the economic development path besides balance problems. Inflation was curbed significantly, by about 5 per cent annually in Hungary in the past three years (from 28.2 per cent to 14.3 per cent in the period 1995-1998). This measure considered to be a positive result exceeds far that of South European countries. However, international experiences indicate that countries struggling against balance problems curb though inflation rapidly from time to time, it recovers again later on (as seen in Turkey). Our Institute evaluates thus the results and consequences of the disinflation path rather cautiously.

The curbing of inflation is expected to slow down. In the first five months of the year the consumer price index amounted to 9.4 per cent because of the slight increase of foodstuff prices. The decreasing trend of inflation having been rather intensive until recently may slow down for several reasons in the second half of the year. International energy prices are expected to increase slowly followed by domestic prices a bit later. The formation of foodstuff prices is rather doubtful since the price level forced down recently may involve an awkward situation for the agrarian economy. Income outflow increases because of the settlement of wage debates and the consumer demand may grow parallel contributing also to the increase of inflationary pressure probably. The growth of the deficit of the budget is thought to contribute to the increase of inflationary pressure as well. On the other side, the projected moderation of the monthly rate of HUF devaluation (0.2 percentage point) and government efforts aiming at reducing the growth of prices being susceptible on authorities' influence, are expected to curb inflation. All these imply that the consumer price index of 1999 is projected to.