15 Jan Hungary’s economic growth rate will continue to be 2-3% higher than the Eurozone average
Mihály Patai, Deputy Governor, Magyar Nemzeti Bank, introduces a strong banking system and central bank initiatives that are supporting the Hungarian economy’s recovery
Hungary’s solid economic performance in the years prior to the kick-off of the new decade culminated in the third quarter of 2019, where it stood out as the second fastest-growing economy in Europe. From the perspective of Magyar Nemzeti Bank (MNB)—the Hungarian central bank—could you give us a snapshot of the different elements that contributed to Hungary’s strong macroeconomic fundamentals, including those resulting from the bank’s monetary policy?
Hungary had an excellent economic cycle between 2013 and 2019: gross domestic product (GDP) growth was very high, unemployment was low and the investment rate was among the highest in Europe at 28-29 percent. It is more important that the macroeconomic balances were in order, including the state budget and the current account. In the last 100 years, Hungary has never had a cycle with such attractive growth coupled with orderly macro balances, but the Hungarian economy has always suffered from the so-called twin deficit, with the state budget and the current account in the red. As far as fiscal policy is concerned, there has been a stop-go situation in the last 100 years. The political elite had overspent and then came the wall and they started to save, time and again. This stop-go policy was true for more than ninety years in our history.
A whole new policy started in 2010 when this government took office. A new economic cycle has been established where we have sustainable growth because the balances are absolutely in order. This was the first time that the political elite was not overspending, but was very disciplined. This is why this pandemic is a tragedy for us because everything was going so well, and it seemed to us that we could continue this because we were very disciplined in fiscal policy.
The last cycle was based on very strong fiscal policy. The deficit was always below 3 percent: the Maastricht criteria. On the other hand, monetary policy was cooperating with fiscal policy. So in the last eight years, the central bank has achieved very important results. The first one was bringing down the price of money, which is the basic interest rate, from 7 percent to below 1 percent. This was one important achievement. The second one was that in 2015 we converted all Swiss franc mortgages into Hungarian currency. This was very dangerous for the financial system because 80 percent of household mortgages were denominated in Swiss francs. This was an inheritance of the previous cycle. €10 billion was the volume of the conversion, which happened on the morning of 2 January 2015, and the central bank was the most important factor achieving that. But definitely, we had to do it, and it was a really great achievement. It had never happened before in European banking that, in one day, you could convert more than a million mortgage contracts with a value of €10 billion. This happened and it was very important for financial stability.
The third one is that MNB has launched its Funding for Growth scheme, which was very successful. In the last eight years, this Funding for Growth scheme helped 60,000 small- and medium-sized enterprises (SMEs). The amount of funding was up to 7 percent of GDP and it provided these SMEs with very cheap loans, so cheap that the level had never been imagined before.
We entered the pandemic with very strong fundamentals. This is why the first quarter of 2020 was still positive in Hungary, but then of course, in the second and the third quarter there were many more problems. But, I do definitely believe that if you have very strong fundamentals or very strong growth you are better prepared for crisis than if you have had balance issues or growth issues. This is why I am optimistic about the future as well.
Prior to joining the central bank as deputy governor, you held several leadership roles in the private sector, as chairman and CEO of Unicredit Hungary, and in the Hungarian Banking Association as well. When combining this experience and knowledge, both from a regulatory standpoint and from that of the private sector, how would you evaluate the health and stability of the Hungarian financial sector?
Today, the financial sector is in a much better shape than it was before. In 2008, the ratio of liquid assets to total assets was 10 percent. In 2019, it was 31 percent. The loan-to-deposit ratio was 150 percent in 2008, because foreign banks were bringing Austrian, Italian and German savings into Hungary and it was originated into loans. Today, the loan-to-deposit ratio is 75 percent, it’s a completely different situation. Capital adequacy was 11 percent in 2008, now it is 21 percent, putting a stronger capital adequacy into the Hungarian banking system. The ratio of net non-performing loans was 16 percent in 2008 and now it is 2 percent. The ratio of foreign currency loans to household loans was 70 percent, now it is practically zero. The corporate credit loan dynamic was 6.5 percent, today it is 14 percent. The Hungarian banking system has more liquidity, a very strong capital base and it has been very active during this pandemic period. It’s a completely different situation to that seen during the previous global financial crisis.
Again, I am optimistic because our banking system today is responding to the COVID-19 crisis with a strong capital base and with very strong liquidity. I don’t want to underestimate the pandemic. But the root cause of this problem is not in economics. We have seen about 25 crises in the last 200 years and know how it was in France, the U.S., Korea, Russia, Germany, Japan and China. We don’t have experience with this pandemic, so I don’t want to underestimate the issue, but definitely the banking system is in a much stronger situation to respond to this problem than it was during the 2008-2009 financial cycle.
The Hungarian government has launched several stimulus packages and other incentives to help keep businesses afloat. What strides have been made by MNB in facilitating new funds for commercial banks to help refinance the economy and how else is it helping to propel growth?
I would mention four issues that I believe are pioneering. The first one, which is obvious, is that we had to convince the government to announce an immediate moratorium on all loans, corporate and household alike. The second one is that we started to increase our commitment to the state budget, so we are buying state bonds, government bonds. With this policy, the central bank is contributing to a healthy government bond market.
The third one is the Funding for Growth scheme. It was relaunched during this pandemic and it’s much more attractive than it was before. We provide funding at a zero-percent interest rate to the banking system. We cap the margin that they can charge; it is 2.5 percent maximum. The banks that are using this cheap money and originating loans for SMEs can place the same amount with the central bank at a very favorable interest rate. We make sure that the bank is profitable because we sterilize the liquidity, which means that we pay good interest on deposits that are placed with the same amount that was originated with the loan. We make sure that the banking system is profitable and we make sure that the customer receives a good loan because we maximize the margin for them. We take care of the client and we take care of the banking system as well.
There is a fourth initiative that is quite new. The central bank started to buy corporate bonds as well. Just to give you a hint: in 2019 in the Eurozone, the corporate bond market was approximately 20 percent of GDP: in France it’s 25 percent, in Italy it’s approximately slightly more than 20 percent and in the U.S. it’s even higher because the bond market plays a different role. In Hungary, it was 1 percent. The corporate bond market was practically non-existent until last year. In one year, we doubled the ratio of the corporate bond market to GDP. We are deliberately pushing those businesses. This corporate bond buying provides very long-term and very cheap liquidity for those corporates that are capable of getting a good rating from Standard & Poor’s, Fitch, Moody’s, Scope or Euler Hermes. We try to provide very favorable liquidity through the Funding for Growth Scheme and then we are giving additional liquidity for the very long term—a 10 to 15 or 20 years’ liquidity—to businesses directly when we buy the bonds.
These are very strong instruments. In your opinion, which other key elements will help speed up the recovery and help Hungary return to its pre-crisis levels of growth?
From the central bank’s point of view, the most important decision will be about how the balance sheet of the central bank will grow in the future. In the past, in the previous cycle, we tried to reduce the balance sheet of the Hungarian central bank. Today, if you compare the balance sheets of other central banks, in just one year there have been very important changes. For example, the balance sheet total of the European Central Bank to the Eurozone in February this year was 39 percent; in seven months, in September, it had changed to 57 percent. This is the result of quantitative easing. The same happened in the U.S., where the Federal Reserve’s balance sheet was increasing.
So we have decided that we will use the chance to increase the balance sheet of the Hungarian central bank. It goes back to your previous question, because if we are participating in the corporate bond market, if we are participating in the government bond market, as buyers, and we are giving funding for growth to the banking system, that means that our balance sheet should increase. We do believe that MNB’s most important weapon, for the next two or three years, is to increase the balance sheet, which is only 37 percent compared to GDP for Hungary today. If you take the Japanese central bank, it’s far above 100 percent. Definitely there are examples for us. We do not shy away from continuing with bond purchases, government and corporate bonds alike, and engaging ourselves even more actively in the Funding for Growth scheme.
How would you say innovation and sustainability, two key economic drivers in Hungary, are playing a role in the transformation of the industry toward more responsible banking practices?
The Hungarian banking system lags behind in terms of digitalization. We are forcing the Hungarian banking system to develop in this regard and we have made great achievements. In March 2020, we introduced the instant payment system in Hungary that is really unique in the world. This is the first time that it has been obligatory for all participants of the payment system. In other countries, like the U.S. for instance, there are only some big banks that are participating in the instant payment system. According to international standards, instant payment is where you have access to the money in five seconds. So five seconds is the international threshold for achieving an instant payment system. Singapore has it and Denmark has it. But in Denmark, only 70 percent of the market is using it, while in Singapore, 90 percent of the market is using it because smaller banks don’t have the capacity.
Hungary has the first banking system in the world that introduced an obligatory instant payment system. It’s working and it’s very successful. This immediately opens the door for digitalization and, as an illustration, we have four banks that have introduced new mobile banking applications based on that. The other banks are also introducing this kind of initiative. For example, if I transfer money to you, in the traditional way I have to write your name and your bank account number. There is an initiative in Hungary—and already 10 percent of the market is using it—that it’s enough if I just put in your mobile phone number or if I put in your email address, if you have previously registered them with your bank.
Initiatives are limitless. The main point is that, as far as digitalization is concerned, we have achieved something this year with the instant payment system, and there is definitely no turning back on digitalization. It’s a one-way street; you should be as digital as possible. The Hungarian banking system is not in the forefront. I cannot compare it with Singapore or Sweden, but we are working on this. So the first issue we are working on is digitalization.
The second issue we are working on is a green, sustainable economy, and how the banking system can help with that. Green business and digitalization are the two most important factors that should be followed by central banks. And the Hungarian central bank is in line to follow this agenda. MNB has introduced several green initiatives. We are putting money aside for green sustainable growth. We are supporting those banks, insurance companies and brokerage firms that are initiating and originating green credits or green insurance policies. Definitely, these issues are the future and I am sure that Christine Lagarde will be speaking much more about green business than Greta Thunberg going forward.
When it comes to attracting foreign direct investment (FDI), Hungary has stood out as a country to watch in recent years. FDI grew by 24 percent in 2019, when there were over 100 large investments in 21 different sectors coming from 20 different source countries. Where do you see the biggest investment opportunities in Hungary today?
The results speak for themselves. As far as FDI is concerned, 2019 was the best year in the last 20 years. If I compare it to the 1990s, when Central and Eastern Europe was the favorite target of FDI because the big privatization projects were going on after the communist regime collapsed and a market economy was introduced. So, the mid-’90s was a period of the strongest FDI flow into Central Eastern Europe and Hungary as well, of course. And again, in the last three or four years, this has been repeated and the last year was particularly successful with one important change, because in the ’90s, Western European nations and Western European capital were the driving force of FDI. In 2019, South Korea and China were the two most important investors in Hungary. It doesn’t mean that German investors are less important, because the stock of German investments is much higher, of course. And the most important thing for Hungary is what Germany, Austria, Holland, England or Italy are investing here and I’m sure that this will continue.
Hungary is part of the Schengen area and has very good fundamentals. We have a tax system that is very favorable for businesses. Our corporate tax is 9 percent, one of the lowest in Europe, if not the lowest. We also have a very strong welcoming environment. We can build on this. For example, South Koreans came to Hungary with new initiatives and the biggest bulk of Korean investment went into the electric car business. We have a huge auto industry in Hungary, driven by the Germans: Audi, Mercedes, Volkswagen and Opel are the most important pillar of the manufacturing industry in Hungary. The South Koreans came and they are establishing the biggest electric accumulator companies and production capacities in Hungary. The renewal of the auto industry is already on the agenda in Hungary. This is why, again, I am optimistic that, as we participated over the last 30 years in the German auto industry, we will participate in the renewal of the auto industry as well.
How do you see the way forward for Hungary over the next year or so?
Unfortunately, this year we will have negative growth. We simply cannot escape it. According to MNB’s estimates, GDP growth could be around -6 percent. Next year, we could recover the bulk of that; we expect a 4-4.5 percent increase in 2021, which means that by around the middle of 2022, we would reach the volume of GDP that we produced in 2019. I hope that by the middle of 2022 we will be on ground zero again and we can continue our growth from there. It won’t be as attractive as in the last cycle when quarterly growth was 4.5-5.5 percent. In the previous growth cycle, not just overall growth was important, but it was also important that we were catching up with Western Europe, because Hungary’s growth rate was 2.5-3 percent higher than the Eurozone’s growth rate.
For us, the Eurozone is, of course, the example we want to follow and we want to catch up. I don’t believe that from 2021 we will have such an attractive growth rate as we had in the last cycle. There will be 3.5-4 percent growth. But definitely, the difference between the Hungarian growth rate and the Eurozone’s growth rate will be there: the 2-3 percent difference will be there. And this is very important for the Hungarian economy and the Hungarian way of thinking, because we are catching up with Western Europe.
This year and next year, state budgets and fiscal policy will be in deficit everywhere in Europe. I am convinced that in 2022, when growth is back, we have to return to those times when fiscal deficit is under control. For me, it’s under control if it’s less than 3 percent of GDP. That would be our second biggest achievement again. I hope that, in two to three years, the Hungarian economy will be back to normal: that we have growth and we have the two most important macroeconomic balances, the state budget under control and the current account positive. My aspiration, my hope and my conviction are that we will return to high growth and, additionally, that we will produce high growth with the fiscal budget and the current account in equilibrium.