29 July 2013

ECFIN Country Focus: Private sector deleveraging in Hungary - Economic costs amplified by government policies in the banking sector

Summary

Hungary was among the first EU countries to face severe market stress at the start of the financial crisis. The combination of high external and government debt levels and a weak growth performance made the country vulnerable to external shocks. Since late 2008, helped by financial assistance from the EU (Balance of Payments programme) and the IMF (Stand-by arrangement), a considerable adjustment has been taking place. This is evident primarily in the private sector but also to some extent in the government sector and is contributing to an improving negative net international investment position (NIIP), which has been going hand in hand with a decreasing external and government debt.

Private sector adjustment was necessary particularly in view of the high level of external funding in the banking sector. Both credit demand and credit supply factors were important in this respect. Household and corporate sector debt was not particularly high from a European perspective, but higher than in regional peers. In addition, the high repayment burden and the structure of debt with a high share of foreign-currency-denominated debt justified household and corporate sector deleveraging. Supply pressures have also been important due to decreased risk tolerance, increased funding costs, a deteriorating loan portfolio, and repeated government intervention in the sector.

Based on composite indicators of loan demand and supply pressures, Hungary seems to have experienced the highest supply pressure among European countries in the past year, while demand pressure stands around the EU average. Deleveraging has resulted in high economic costs in Hungary, with the falls in both credit and GDP being among the largest in Europe compared to pre-crisis levels. Overall, the interventionist policies targeted at the banking sector affected the pace of the deleveraging and therefore had a non-negligible cost in terms of growth performance.

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