A decade after accession, Hungary is poised to enjoy significant growth in the short term, but the country must reinforce its competitiveness if it is to achieve sustainable growth in the future, writes István Salgó, country manager Hungary at ING Bank.
About István Salgó
István Salgó is country manager Hungary at ING Bank. He joined ING in 1998 as chief executive officer for ING Investment Management Budapest, following a career at MeesPierson and elsewhere. Between 2002 and 2006, he was deputy state secretary for the Hungarian ministry of Finance. In 2006, he re-joined ING.
In the decade since Hungary joined the European Union, along with seven other first-wave accession countries from Central and Eastern Europe (CEE), its achievements have been significant. Hungary has gained new knowledge, technology, capital and direct funds (from the EU) that have enabled many aspects of its economy to be transformed.
In practical terms, Hungarians can drive on new highways from one end of the country to the other and enjoy a cleaner environment, with better air quality and improved sewage treatment (often as a result of EU grants). Hungarians are better educated and have more opportunities: they can work for global companies, such as Daimler, or in skill-based sectors that barely existed 10 years ago, such as shared services.
A less tangible - but no less important - achievement over the past decade is the increased openness of Hungarian society. Hungarians are now free to travel or relocate across Europe, and have gained access to new opportunities and experiences.
Hungarian attitudes have been changed by increased interaction with other Europeans: an increasingly large number of which are choosing to move to Hungary.
Hungary now has a modern economy with telecoms infrastructure, for example, that matches or surpasses many Western European countries. Moreover, Hungary has consistently demonstrated its commitment to integration in the global economy: it exports more as a percentage of GDP than any other CEE country.
Setting the economy on the right course
Hungary’s public sector finances were in difficulty when it joined the EU in 2004. Its government deficit increased from 6.5% of GDP in 2004 to 9.4% in 2006 - significantly in breach of the Maastricht 3% target.
However, in 2006 a series of measures were introduced to stabilise the government deficit and national debt. These were reinforced in 2010 following a change in government: the restoration of confidence in fiscal policy, and achieving the 3% budget deficit target, were made a priority. And while Hungary required an IMF emergency loan in 2008, sound stewardship of the economy enabled it to be repaid in August 2013, ahead of schedule.
Partly as a result of Hungary’s high public sector debt in the years immediately after accession, economic growth has been lower in the past decade than might have been anticipated when the country joined the EU. However, while average growth has been below the CEE average, it has been well above the EU average.
Hungary’s debt-to-GDP ratio has now been stabilised, following the end of fiscal consolidation in 2013, and growth has returned. The recovery has been also driven by one-off factors, helping to push economic growth to 3.9% in the second quarter of this year: growth for the whole year is expected to be 3.3%. Moreover, Hungary is growing without fuelling inflation: prices are expected to rise just 0.3% this year compared to inflation of 6.8% a decade ago. Price stability is a major achievement of the present government. One-off utility price cuts had a significant spillover effect: inflation expectations, and wage dynamics moderated, breaking the long inflationary cycle that has dogged Hungary. Lower inflation facilitated lower interest rates, benefiting businesses, and spurring investment.
An outward-looking economy
Hungary’s location, low costs, relatively good infrastructure and high education standards ensured that it was one of the largest recipients of foreign direct investment (FDI) in CEE even before 2004.
The Hungarian government encouraged investment in the manufacturing sector by harmonising tax, legal and business rules in line with EU requirements, helping to create an attractive investment climate.
Accession in 2004 reinforced the stability and clarity of Hungary’s legal framework and its suitability as a business location. As a result, FDI continued to be strong between 2004 and 2009. Competition for FDI flows intensified after the financial crisis, and investment flows have slowed worldwide. However, Hungary remains a favourable location for industrial investment, and the positive effects of the past wave of capital formation in the automotive industry are already delivering benefits.
Hungary’s outward-looking approach has resulted in significantly increased exports in the past decade: exports as a percentage of GDP have risen from 63.3% in 2004 to 96.2% in 2014, with only a brief decline in 2009 following the financial crisis1. Exports to the EU have remained fairly constant as a percentage of total exports over the past decade, although the percentage exported to new EU members has increased markedly and in 2013 accounted for 22.8% of Hungary’s total (the pre-2004 EU15 member states accounted for 54.2%).
New sectors driving growth
Some aspects of Hungary’s economy have changed beyond recognition in the past decade. One of the most notable is auto production. Hungary had significant truck and bus production before 1990 and international producers, such as Suzuki and Audi, established production facilities during the 1990s. Since 2004, production has increased further and in 2012 Daimler opened a € 800 million plant in Hungary - the largest greenfield investment in the country’s history.
The growth of auto production in Hungary has spurred numerous suppliers to set up in the country: Daimler, for example, employs around 3,000 new employees directly but has also created an estimated 10,000 indirect jobs among its suppliers. Some estimates suggest that the Daimler facility could add 0.5 percentage points to GDP: including suppliers, the boost to GDP could be as much as one percentage point.
The growth of domestic small and medium-sized enterprises (SMEs) acting as suppliers in the auto sector is mirrored in other sectors, such as retail. While many of Hungary’s largest retailers are foreign-owned companies, they are eager to work with local suppliers.
A second high value sector that has enjoyed tremendous growth in the past 10 years is shared services, including IT, telecom, administration, support and professional services, for regional and global corporates and financial institutions. Hungary is now the 10th most important country for shared services in CEE and Western Europe2.
Shared services providers are attracted to Hungary because of its low costs, familiarity with foreign languages and high skills base. In addition, Hungary offers a convenient location for Western European companies. While wage costs are rising, increasing productivity and innovation should ensure that Hungary remains an attractive location for shared services. Hungary is also an increasingly popular location for logistics and distribution.
Producing national champions
Agriculture continues to represent a higher proportion of GDP - around 3.5%3 - than the EU average. Increased investment by both Hungarian and international investors has helped to increase productivity and improve logistics and move Hungarian producers up the value chain.
Similarly, increased investment has helped to transform Hungary’s pharmaceutical industry and enabled companies such as Gedeon Richter to become internationally successful. Hungary is a strong regional player in energy, through MOL, and banking, through OTP Bank. Tourism is growing in Hungary, with Budapest an attractive destination for global travellers while Hungary is also an important centre for healthcare tourism.
The EU: at the heart of Hungary’s success
EU funding has been essential to Hungary’s success. In the period from 2007-2013 alone, Hungary’s allocation from Cohesion Policy funding was € 25.3 billion. These funds created more than 75,000 jobs, helped to set up 1,250 businesses and provided direct investment for more than 32,000 SME projects. Over 400 km of new roads were built and 1,700 km of roads reconstructed; almost four million people benefit from improvements in urban transport completed during this period.
The EU has also helped Hungary to improve its relationships with its CEE neighbours. Hungary participates in 10 territorial cooperation programmes: four bilateral cross-border cooperation programmes with other member states (Austria, Romania, Slovakia and Slovenia) and two transnational cooperation programmes: the Central Europe programme and the South-East Europe’ programme, for which Hungary has management responsibility.
However, Hungary’s relationship with the EU has not always been smooth. Enthusiasm for the EU has waned: immediately after joining the EU, a record 92% of Hungarians said that they felt attached to Europe4; now just 44% of Hungarian trust the EU5. This seemingly sharp change in public opinion is understandable. Many people had overly high expectations of the speed with which Hungary would converge with the EU in terms of living standards and opportunities. There have been huge improvements in its citizens’ prosperity and life chances. But over time people inevitably become accustomed to new ways of living and discount the scale of change.
A prosperous future as part of the EU
Hungary has achieved much for itself over the past decade but its journey has not always been straightforward: the country experienced economic turbulence during the early part of its EU membership resulting from internal political challenges that pre-dated the financial crisis of 2008.
To create conditions for sustainable growth, Hungary must improve the transparency of policy making, the stability of its legal environment, and competition in the sectors related to the government (such as education and healthcare). Such moves would increase competitiveness and boost Hungary’s growth potential, resulting in faster convergence with Western-European countries.
Hungary’s future clearly lies within the EU. It has an open economy that is fully integrated with the EU and its laws are closely aligned with those of other member states. Most importantly, while there may be disillusionment with the EU among its people - as there is in many EU countries - Hungary’s citizens are EU citizens: they value the freedoms and the opportunities that EU membership has delivered and no-one wishes to wind the clock back 10 years.
2014 A.T. Kearney Global Services Location Index, A.T. Kearney, September 15, 2014 (2)
World Bank, 2010 quoted at www.tradingeconomics.com/hungary/agriculture-value-added-percent-of-gdp-wb-data.html (3)
Eurobarometer 63.4, European Commission, Spring 2005 (4)
Eurobarometer 81, European Commission, Spring 2014 (5)
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