In the last decade, Hungary has undergone a comprehensive and successful political and economic transformation from a centrally planned to a market economy. Fundamental changes in the institutions and the structure of the economy have gradually created the conditions for sustainable economic growth. The success of the Hungarian transformation is reflected in the country's gradual integration into the developed world. Hungary is a member state of the Organisation for Economic Co-operation and Development (OECD) and has just become a North Atlantic Treaty Organisation (NATO) member this March; it has an Association Agreement with the European Union (EU) and has started negotiations with the EU on the conditions of membership. After a period of austere measures, Hungarian citizens now have the prospect of a gradual improvement in social well being.

Hungary is an open market economy where the private sector accounts for 80 per cent of its total output. Hungary's potential growth rate and economic output depends on the competitiveness of Hungarian companies. A key element of the Government's economic policy is to create a transparent economic regulatory system which encourages innovation and elaboration of a long term strategy with firms.

Priorities

The new economic leadership, which entered into office in 1998, puts the emphasis on sustainable economic growth. Accordingly, it projects to realise a substantial economic growth while diminishing the public sector deficit in the Gross Domestic Product (GDP).

The new Government concentrated the management of economic strategy to a single ministry. Multi-year projects were launched at the Ministry of Economic Affairs, including that of developing the economic strategy to be followed: the development of small and medium-sized enterprises (SMEs), a project for tourism, the elaboration of a new proposal for energy strategy, and the development of a new system of social dialogue, all of which are expected to reap rewards in the future.

The Hungarian economy in 1998

The rapid development of the Hungarian economy in 1998 occurred along a growth path which ensured equilibrium and a cutback in inflation. An approximate five per cent GDP growth went hand-in-hand with a 20 per cent rise in export revenues (which approximately equals 17 per cent in volume terms), more than a 13 per cent increase in investments and as much as a three to four per cent rise in consumption. The growth in export demand continued to be decisive, although mid-year processes in 1998 already reflected the impact of a slackening upturn in the country's major markets.

Expansion of domestic demand in general, and the rise in investments in particular, contributed to this growth. Competitiveness in the corporate sector improved, the companies' own resources increased faster than GDP, while growth in real wages was in line with the rise in productivity.

Industrial production increased by 12.6 per cent while a particularly fast growth was registered in the machinery sector. The upturn in the construction industry continued. The performance of the agricultural sector declined slightly.

Nevertheless, the current account deficit turned out to be higher than expected (US$2.3 billion), which was linked to a deterioration in the balance of trade and an increasing profit repatriation. The latter, however, was limited to certain large companies and does not represent a long term trend. In addition to the export and investment-led growth, the deficit remained 'financeable' primarily due to the inflow of foreign direct investments (FDIs) and improvement in the terms of trade.

The crisis of the international money and capital markets did not shake the Hungarian financial system; the exchange rate of the forint continued to improve, interest rates returned to an earlier declining trend, propensity to save could be maintained and an expanding net borrowing position could be guaranteed for undertakings.

The slowdown in the pace of inflation continued; the price index was close to 14 per cent in an annual average, while the December/December 12-month price index was only 10.3 per cent, for which diminishing world market prices and fiscal policy set the conditions. Based on the data available, the process of disinflation will be rapid in 1999 (prices are expected to rise by nine per cent only) and, according to forecasts, inflation may drop to four per cent by 2002.

Based on processes at the end of 1998 and at the beginning of 1999, further restructuring is required in some sectors of the economy, particularly those with links to the Russian economy. Primarily, this affects some sectors of the food, pharmaceutical and vehicle industries. There are certain signs of excessive demand in the economy, therefore, reserves have been built into this year's budget, which are capable of mitigating excessive demand together with an increasingly stringent monetary policy.

Although the assessment of the external environment is uncertain, the approximate two per cent growth in 1999 projected for the EU, which is the most important region for Hungary, indicates that there is no need to reckon with a long term slowdown in the country's major export market. Expectations of some specialists concur that the slowdown in the growth of world production bottomed out in 1998 and recovery may begin this year or probably in the year 2000. Although restructuring and fundamental reforms may be necessary in significant areas of the world economy, it is hoped that Hungary is linked to a stable region which guarantees sustained development.

FDI: a pillar of Hungarian economy

FDIs in Hungary have been a highly important pillar of the economy, playing a key role in industrial restructuring, exports, regional development and financing the deficit of the current account. The inflow of FDIs continued in 1998. Thirty-five of 50 of the world's biggest multinationals have recently been present in Hungary. Since 1990 till the end of last year, the stock of FDI flowed into the country totalling more than $19 billion. Of this, foreign businesses invested about $1.8 billion in the year in question. This value, which was slightly lower than in the preceding year, cannot be interpreted as a sign of foreign investors turning away. Instead, it was a consequence of lower privatisation revenue, as privatisation is coming close.

Investment promotion

It is in Hungary's vested interest that the economy continue to be given additional capital injections for modernisation and restructuring. It is the country' strategic objective to effectively co-operate with foreign investors and local businessmen. That is why the Government attaches special importance to promoting foreign direct investment, giving special support to Hungarian SMEs and to the development of the local suppliers' program and industrial parks.

Consequently, the continuous maintenance of a set of conditions conducive to promoting local investment and FDI is one of the priorities of the Hungarian Government's economic policy. With a view to the different levels of economic development in the various regions of the country, the current regional distribution of FDIs, the value of which exceeded $19 billion at the end of 1998, and the dynamising role of SDI in the economy, the Government makes efforts to ensure that such investments perceptibly increase in the economically depressed areas of the country. To that end, the Government relies on the following key instruments:

• efforts are made to develop the transport infrastructure, as 'just-in-time' delivery is an extremely important consideration for processing companies operating in Hungary. In this respect, the availability of highways has outstanding significance in influencing foreigners' investment decisions. Development of the highway network continues in order to facilitate faster access to the eastern part of the country as well as to the south-eastern and south-western regions. In addition to considerations for promoting direct investments, these investment projects are highly significant for exploiting the transit role of the country due to its geographical position;
• as regards the preferences in line with the Government's international commitments, foreign investors are also eligible for the 18 per cent corporate profit tax rate, which is considered to be singularly low compared to European standards. In addition, a 50 per cent tax preference is also available for a period of five years, in case the value of investment amounts to at least HUF 1 billion (US 1 = HUF 232, March 1999), which will increase to a 100 per cent tax preference granted for a period of ten years in the case of investments with a minimum value of HUF 10 billion. Investors are also eligible for a 100 per cent tax relief for a period of five years if they invest in priority regions, and they become eligible for a 100 per cent tax relief for a period of ten years if they make an investment of at least HUF 3 billion in the so-called disadvantaged regions;
• Hungarian and foreign investors may receive support from separate Government funds as well. Applications can be submitted to the Ministry of Economic Affairs for support from the Earmarked Scheme for Economic Development, for the construction of production capacities capable of turning out up-to-date products, the development of the productive infrastructure, the enhancement of subcontracting relationships and the creation of industrial parks. Business associations establishing themselves in specific regions of Hungary may receive support for their investments from the Earmarked Scheme for Regional Development through applications submitted to the Ministry of Agriculture and Regional Development. Its objective is to mitigate regional economic and social equality. In addition to the above, support may be obtained from the Environment Protection Fund for environment protection investments and the production of environmentally friendly products. Support may also be obtained from the Labour Market Fund to help retain jobs and create up-to-date employment.

Hungary has been taking resolute efforts to build up its market economy, to modernise its economy, and to strengthen its Euro-Atlantic economic and political ties. Parliamentary democracy functions well in the country as political freedoms and human rights are respected. The fact that the country is one of the founding members of the World Trade Organisation (WTO), is admitted to the OECD and NATO, and that the largest multinational companies are present in the country, constitute international guarantees of it being a calculable, reliable economic partner with which it is worthwhile to forge long term economic ties - all the more so as Hungary rightfully hopes to be a member of the EU within the foreseeable future, in the optimal case, by the year 2002.