Insights from Budapest point to resilience in central and eastern Europe

Creative economic policy-making employed to address macro challenges in region hit hard by successive crises

As small, open economies, deeply integrated into international supply chains, the countries of central and eastern Europe were highly vulnerable to the economic difficulties resulting from the pandemic and energy crises. The region suffered nearly double the inflation figures as western Europe, with cumulative inflation nearing 30% in the region between June 2021 and September 2023.

But the region has proved resilient. The labour market has remained strong, foreign direct investment is picking up once again and there are already signs of growth recovery. On 16 November, OMFIF hosted a conference in Budapest, convening around 110 attendees and 30 speakers from all over Europe, to discuss progress and challenges in Hungary and throughout CEE.

Regional optimism despite sticky inflation

The panellists shared a cautiously positive outlook for Hungary and the entire CEE region, which was hit hard by both the pandemic and energy shocks from the Russia-Ukraine war. The primary risk to recovery now is inflation.

Geoff Gottlieb, senior resident representative of the International Monetary Fund’s regional office for central, eastern and southeastern Europe, pointed out that inflation in the region is moving from the supply side – due to exogenous shocks – to a function of core pressure from wages. He noted that it is important that demand remains weak so that firms are not incentivised to pass on these price increases.

Hungary showing signs of modest recovery  

After the pandemic, the Hungarian economy demonstrated resilience by achieving a record-high gross domestic product growth of 7.1%, outpacing the European Union average by 2 percentage points. However, this momentum was halted by a combination of high inflation and depressed growth. Inflation in the country surpassed its regional peers, peaking at just under 25% in January, but has since decreased to 9.9% in October, aligning with the single-digit target. Magyar Nemzeti Bank deputy governor Barnabás Virág stated that he expects inflation to decline to 7% or below by December, with underlying patterns resembling pre-Covid 19 levels.

As presented by finance minister Mihály Varga, Hungary’s labour market has remained robust, with employment rates surpassing EU and fellow Visegrád country averages. Increased participation rates are being driven by targeted programmes benefitting women, young and elderly workers. Geographical investment imbalances improved, particularly in the less-developed, eastern Hungarian region.

The current account deficit, dipping to 8.2% of GDP earlier in the year due to the high cost of energy imports, was rectified this quarter to reach positive territory (0.9% of GDP). Though the government deficit remains high at 5.8% of GDP, policy-makers are pursuing active proactive fiscal consolidation in addition to the postponed recapitalisation of the central bank, to bring the country back in line with the Maastricht criteria. But risks around inflation, geopolitical tensions, EU infighting and the impact of the developed world’s yield environment warrant caution.

Policy-makers leading the way to increase investment

Political risk, inflation and market volatility made foreign investors more cautious about the region over the past two years, leading to outflows from asset classes in 2022 and 2023. Liquidity concerns were raised by asset managers on the investment panel, particularly due to the size of the Hungarian market. But the Hungarian debt management office’s (ÁKK) agility and diversification were noted as key mitigating factors by speakers of the financing and investment panel discussions. Transparent communications from Hungary’s central bank were also highlighted as beneficial for the capital markets. Asset managers on the panel noted that the ÁKK has also done well in this regard, such as publishing all affairs on the website and presenting all information in English. These are simple yet effective measures that go a long way towards making investors’ lives easier. In this respect, other countries in the CEE region are looking to the ÁKK.

Because their bond issuances would be too large for local markets and too small for international markets, some Hungarian companies are unable to reach a benchmark or sub-benchmark size transaction – putting them at a disadvantage. But financing options via international bond markets are growing. The ÁKK has a role to play here. As Zoltán Kurali, head of the ÁKK, explained, ‘For local corporates and government guaranteed names, rightly or wrongly, the spreads are derived from the sovereign. Hence, we have to be very present in the international markets – in euros, dollars, Japanese yen, RMB, so whoever issues in these markets can find a reference point.’

MNB taking active role in green and digital transformation

Hungary has experienced a 33% decarbonisation since 1990, but the pace has slowed in the last five years, explained David Papp, head of sustainable policy at the MNB. There are positive developments in the real economy, such as solar panel construction, but there is a need for broader, more effective market mechanisms, price signals and incentives, especially regarding carbon pricing and taxation.

Corporates are turning to bond markets to finance their transition, issuing green bonds in line with EU taxonomy guidelines. To help facilitate the transition, the MNB has gone further than other central banks on sustainability – it is the only European monetary authority with a green mandate alongside its primary financial stability and inflation mandates. In addition, the central bank has initiated green programmes, including refinancing programmes, green asset purchasing and efforts to integrate climate risk into banks’ prudential supervision.

The MNB is also taking an active approach through a variety of fintech initiatives to help speed up digitalisation and digital transformation in Hungary’s banking sector. Several factors could make Budapest an ideal sandbox for pilot programmes: Hungary’s location in the centre of Europe, an advantageous tax environment for fintechs, proximity to universities and the size of the country. But the current macroeconomic climate of inflation and high interest rates is affecting funding.

The MNB also aims to lead by example for the fintech sector by undertaking various central bank digital currency pilot projects and via the bank’s innovation hub. Together, these programmes are preparing the bank for large-scale CBDC issuance – which attendees of the conference believe that Hungary is bound to achieve before the European Central Bank.

Taylor Pearce is Senior Economist at OMFIF.

The entire conference can be viewed on demand here.




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