PROPOSAL FOR A COUNCIL DECISION PROVIDING FURTHER MEDIUM-TERM FINANCIAL ASSISTANCE FOR HUNGARY
Date: 1991-03-26
Institutions: European Commission
Subjects: Community loan, Hungary, International Monetary Fund, financial aid, medium-term credit, reflation

COMMISSION OF THE EUROPEAN  COMMUNITIES 

C0M(91)  83  final 

Brussels, 26  March 1991 

i 

U-

Proposal  for a 

COUNCIL  DECISION 

IPC 

providing  further  medium-term  financial  assistance 

for  Hungary 

(presented by the Commission) 

m 

- 2 -

EXPLANATORY  MEMORANDUM 

The request for additional financial support 

During  the  past  two  years  Hungary  made  substantial  progress  in 

implementing  a comprehensive  adjustment  and reform programme  aimed at 

replacing central planning with market based mechanisms. 

In March 1990, in support of this programme the International Monetary 

Fund  agreed  on  a  12-month  stand-by  arrangement.  Following  this,  the 

European  Community  decided  to  grant  Hungary  a medium-term  balance of 

payments  loan of ecu 870 million. The first tranche of this  loan was 

disbursed  in April  1990 and the  second  in February  1991. During  1990 

some members of the Group of Twenty-Four  (G-24) made  commitments  for 

additional  financial  support  including  a  US$200 million  World  Bank 

cofinancing  arrangement  from  Japan  and  short-term  credit  and  bridge 

loan  facilities  from  Germany  and  the  Bank  for  International 

Settlements. 

Notwithstanding  encouraging  progress towards adjustment  and  reform  in 

1990, Hungary's  financial  situation  remains  fragile  in  1991 when the 

country will be faced with a number of major external shocks including 

the  reform  of  trade  prices  within  the  COMECON  area,  the  partial 

breakdown of trade relations with other COMECON partners and the impact 

of Gulf crisis.  As a result, the financing requirement is expected to 

increase considerably. 

To  meet  the  increase  in  its  financing  requirement,  Hungary  has 

requested  further  assistance  from the IMF  in the  form of  an Extended 

Fund Arrangement  (EFF) as well as access under the oil excess window of 

the  Fund's  Compensatory  and  Contingency  Financing  Facility.  The 

agreement  on the  latter was  reached  in January  1991 and  the  EFF was 

approved by the Fund's Executive Board on 20.2.91. 

However,  barring  any  significant  increase  in  net  private  flows  to 

Hungary, the envisaged assistance from the Fund will not be sufficient 

to  cover  the  financing  needs. Although  direct  investment  inflows and 

capital market borrowing rose significantly in 1990 and are expected to 

-- 

•-  .-i«4-<«„  UahiHties  to  commercial 

- 3 -

banks make  it difficult  to envisage  any  substantial  increase  in bank 

lending. Accordingly, to help cover  its overall  financing  requirement 

and  enable  it  to  maintain  the  policy  of  remaining  current  on  its 

external obligations, Hungary has submitted a request for complementary 

financial assistance from the Community  and the Group of Twenty-Four. 

The  need  for  such  assistance  has  been  assessed  by  the  Commission 

Services  in  close  cooperation  with  the  staff  of  the  IMF  and  is 

estimated at some US$ 500 million. 

The Ecofin Council of January 28 agreed in principle on the Community's 

participation, up to an amount of 50% ($250 million) of a G-24 effort 

to  assist  Hungary.  On  this  basis  the  Commission  has  initiated 

discussions with non-EEC G-24 and other third countries with a view to 

ensuring  the  mobilisation  of  the  overall  amount.  Some  non-EEC  G-24 

members  have  already  made  firm  pledges; most  others  have  revealed  a 

positive attitude towards participation in the support scheme, but are 

not yet  in a position to commit themselves. It is expected  that they 

will announce their final commitments during the next few weeks. 

The Hungarian reform process 

In  September  1990  the  government  issued  its  "Economic  Programme  of 

National Renewal". This programme, which outlines the broad  framework 

of the medium-term  economic and administrative reform process, is now 

in the process of implementation. 

In particular, greater  fiscal discipline  and  new  tax  rules  are being 

introduced.  The  tax  base  and  tax  rate  have  been  modified  in  the 

framework  of the  revised  budgetary  policy  in vigor  since mid-1990 to 

help meet requirements under last year's stand-by arrangement with the 

IMF. The budget proposed by the government for 1991 foresees a deficit 

corresponding  to  1.5  percent  of  GDP  as  compared  with  an  estimated 

outcome  of  0.7  percent  of  GPD  in  1990. To  achieve  this  target  the 

government  is  committed  to  cutting  subsidies  and  reducing  government 

transfers for tourism, regional development and social organisations. A 

system  of  monitoring  to  better  control  developments  in  public 

expenditure an revenues will be set up in 1991. 

-  4-

As  regards  price  regime  as  of  January  1991  almost  90  percent  of 

consumer goods will be fully liberalised as compared with 80 percent in 

January  1990.  A tight monetary  and credit policy will continue to be 

pursued  to  contain  the  potential  inflationary  consequences  of  price 

reform. 

Further steps towards current account convertibility for the forint are 

being  considered  (in practice the forint  is already  quasi-convertible 

for most commercial transactions). A restructuring of the international 

currency  basket  to which the  forint  is pegged  is under  discussion  in 

order  to  better  reflect  the  growing  role  of  European  currencies  in 

Hungary's international transactions. 

Hungary  still maintains  some  degree  of  restriction  on  foreign trade. 

Imports of some goods continue to require joint import/foreign exchange 

licenses.  The  availability  of  foreign  exchange  for  services  and 

transfers  is  also  subject  to  restrictions;  a  87  percent  tranche 

liberalisation  target  for  1991 was recently  approved  in the  framework 

of the three year Economic Programme. 

Reform  in  banking  will  proceed  in  1991. About  thirty  new  commercial 

banks  have  been  granted  permission  to  be  established  so  far.  Some 

foreign banks have also been authorised to start up joint ventures in 

Hungary.  A  bill  on  the  new  role  of  National  Bank  of  Hungary  as  an 

autonomous body accountable only to the Parliament  is being discussed 

for adoption in 1991. 

At  enterprise  level  privatisation  programme  involving  20  large  state 

companies was completed in 1990. At the end of the year a second phase 

of the programme was initiated concerning another 20 medium-sized state 

companies with plans to process another  100 in five programmes during 

1991  with  an  estimated  book  volume  of  about  100  bn  forints.  In 

addition, a programme to transfer  the ownership  of  a  large  number of 

retail and service outlets is under way. The privatisation programme is 

managed by the State Property Agency, which has the goal of cutting the 

public sector's share of the economy to 40 percent by 1995 from around 

85 percent at present. 

- 5 -

In addition some 5000 new joint ventures have been established  so far, 

many of them fully owned by non residents. Their total  capitalisation 

is about 1 bn US$. Incentives are offered to non residents include full 

repatriation of profits. 

The need for additional financial support 

Notwithstanding  a  projected  further  increase  in  exports  to  Western 

markets, the current account is expected to deteriorate sharply in 1991 

due to the exceptional combination of negative shocks mentioned above. 

The  IMF's  latest  estimates  point  to  a  (consolidated)  current  account 

deficit of $1200 million in 1991. This projection incorporates measures 

under  the  government's  current  policy  programme  aimed  at  offsetting 

roughly half  of the balance of payments  impact of the  new  shocks, in 

addition to maintaining the adjustment achieved already in 1990. 

Hungary  continues  also  to  face  a  large  debt  servicing  burden  and  a 

considerable  need  for  refinancing.  Thus, with  scheduled  amortisation 

payments amounting to $2.4 billion  in 1991 and allowing  for a minimum 

build up of foreign exchange reserves and a need to increase Hungary's 

export credits, the total gross financing requirements for 1991 amount 

to $4.3 billion. 

It  is  assumed  that  Hungary's  private  borrowing  ($1.5  billion)  will 

continue to be largely based on borrowing  from capital markets, which 

are  expected  to  remain  a  more  important  source  of  new  credit  than 

commercial  banks.  Official  lending  already  committed  includes  the 

second  tranche of  the Community's medium  term  loan approved  in early 

1990  (and  disbursed  in  February  1991),  a  World  Bank  structural 

adjustment  loan,  Japan's  cofinancing  of  the  World  Bank  and  project 

financing from the European Investment Bank. Direct investment inflows 

are also expected to increase somewhat. In addition, it is assumed that 

Hungary will be able to draw on some of its outstanding claims on the 

Soviet  Union  (may  be  as  much  as  200  million  US$)  stemming  from 

accumulated  transferable  ruble surpluses  from recent  years, as payment 

for imports of oil and raw materials. 

- 6 -

With  the  IMF's  assistance  to  Hungary  expected  to  reach  some 

US$ 1.4 billion  in 1991  (about  300 million under the Compensatory  and 

Contingency Facility and about 1.1 billion under a new 3-year Extended 

Fund Arrangement  approved by the Executive Board on 20 February  1991) 

the remaining financing gap to be covered through new official lending 

amounts to some $500 million  (see table below). 

Hungary  : External financing requirement in 1991 

(estimates in US$ million) 

Current account deficit 

Debt amortisation 

Build up of reserves  (- « increase) 

-1200 

-2400 

- 700 

I. 

Total gross financing requirement 

-4300 

Private borrowing 

+1500 

Borrowing from official sources already committed  + 900 

IMF facilities 

II. 

Total capital inflows 

+1400 

+3800 

III. 

Residual financing gap (I + II) 

- 500 

Given the significant degree of adjustment already achieved in 1990 and 

the  additional  adjustment  envisaged  by  Hungary  under  the  new  Policy 

Programme the Commission  considers any further import  compression that 

would  be  required  to  close  the  financing  gap  in  the  absence  of 

Community  and G-24 support could seriously  jeopardize the achievements 

of the policy objectives underlying the government's reform effort. 

- 7 -

This  further  and  additional  financial  assistance  in  1991  from  the 

Commission  and  the  Group  of  Twenty  Four  is  specifically  aimed  at 

helping Hungary to overcome in 1991 the negative impact on its Balance 

of Payments of some exceptional external shocks largely unforeseen only 

few months  ago.  In this  respect  this  loan,  which  has  the  nature  and 

takes the form of a Balance of Payment  support, has a different nature 

from the previous one approved by the Commission in early 1990 with the 

aim  to  overcome  the  difficulties  of  structural  adjustment  of  the 

Hungarian  economy.  Therefore  these  two  forms  of  financial  support 

should be seen as complementary and not as substitutes. 

Main features of the loan 

The Commission  is proposing that the Community  should  grant  Hungary a 

new medium-term loan for 1991 at a maximum amount of ecu 180 million to 

help the country face a number of adverse external shocks that were not 

taken  into  account  when  the  Community's  ecu  870  million  medium-term 

loan was approved in early 1990. 

The  loan the Commission  is envisaging  would  be closely  linked  to the 

IMF Extended  Financing  Facility Arrangement  and would  be disbursed  in 

two tranches, the  first  tranche being  subject  to approval  of  the IMF 

Arrangement, the second one —  which is to be disbursed in the third or 

fourth  quarter  of the  year  -  subject  to  compliance  with  a  number  of 

performance  criteria  which  are  to  be  discussed  with  the  Hungarian 

government in consultation with the Monetary Committee. 

The Community  would provide the funds through market  borrowing  with a 

guarantee  by  the  Community  budget;  Hungary  would  subsequently  borrow 

from  the  Community.  The  borrowing  and  lending  operations  will  be 

perfectly matched and without any commercial risk for the Community. 

- 8 -

Proposal  for a 

COUNCIL DECISION 

providing further medium-tern financial assistance 

for Hungary 

THE COUNCIL OF THE EUROPEAN COMMUNITIES, 

Having  regard  to  the  Treaty  establishing  the  European  Economic 

Community, and  in particular Article 235 thereof, 

Having  regard  to the proposal  from the Commission1  submitted  following 

consultation with the Monetary Committee, 

Having regard to the opinion of the European Parliament2, 

Whereas  Hungary  is  undertaking  fundamental  political  and  economic 

reforms and has decided to adopt a market economy model; 

Whereas  the  said  reforms  are  already  under  implementation  with  the 

financial  support  from  the  Community  and  will  strengthen  mutual 

confidence and bring Hungary closer to the Community; 

Whereas  Hungary  and  the Community  have entered  into negotiations  for 

the  conclusion  of  Europe  Agreements  establishing  a  relationship  of 

association; 

Whereas by Decision 90/83/EEC3 the Council decided  to grant  to Hungary 

a medium-term  loan facility of a maximum  amount of 870 million ecu in 

order to permit that country to overcome the difficulties of structural 

adjustment of  its economy; 

-  9 -

Whereas,  however,  following  the  changes 

in  the  international 

environment,  Hungary,  like  other  Central  and  Eastern  European 

countries,  is  now  facing  additional  external  shocks  which  might 

Jeopardise  its financial  stability  and  cause  its balance of  payments  to 

deteriorate  sharply; 

Whereas  the  Hungarian  authorities  have  requested  financial  assistance 

from  the  International  Monetary  Fund  (IMF),  the  G-24  and  the  European 

Community,  and  whereas,  over  and  above  the  estimated  financing  which 

could  be  provided  by  the  IMF,  the  World  Bank  and  official  bilateral 

creditors,  a  financial  gap  of  some  360  million  ecu  remains  to  be 

covered  in  1991,  in  order  to  prevent  a  further  erosion  of  Hungary's 

reserve  position  and  avoid  an  additional  degree  of  import  compression 

which  could  seriously  Jeopardise  the  achievement  of  the  policy 

objectives underlying  the government's  reform  effort; 

Whereas  the  Commission  as  coordinator  of  assistance  from  the  Group  of 

24  industrial  countries  has  invited  them  and  other  third  countries  to 

provide  medium-term  financial  assistance  to  Hungary  as  an  appropriate 

mesure  to  support  the  balance  of  payments  and  to  strengthen  the 

country's  reserve  position; 

Whereas  the Community  loan should  be managed  by  the  Commission; 

Whereas  the Treaty  does not  provide,  for  the adoption of  this  Decision, 

powers other  than  those of Article 235, 

HAS DECIDED AS  FOLLOWS  : 

- 10 -

Article 1 

1.  The Community shall grant to Hungary a medium-term  loan facility of 

a maximum amount of  180 million ecus  in principal, with  a maximum 

average  duration  of  seven  years,  with  a  view  to  ensuring  a 

sustainable  balance-of-payments  situation  and  strengthening  the 

reserve position. 

2.  To this end the Commission  is empowered to borrow, on behalf of the 

European Economic  Community, the necessary  resources  that will  be 

placed at the disposal of Hungary  in the form of a loan. 

3.  This  loan  will  be managed  by  the Commission  in full  consultation 

with  the  Monetary  Committee  and  in a  manner  consistent  with  any 

Agreement reached between the IMF and Hungary. 

Article 2 

1.  The  Commission  is  empowered  to  negotiate  with  the  Hungarian 

authorities,  after  consultation  with  the  Monetary  Committee, the 

economic  policy  conditions attached  to the  loan. These  conditions 

shall  be consistent  with  the agreements  referred  to  in the third 

paragraph of Article 1 and with arrangements made by the G-24. 

2.  The Commission shall verify at regular  intervals, in collaboration 

with the Monetary Committee and  in close coordination with G-24 and 

the  IMF, that the economic policy  in Hungary  is in accordance with 

the  objectives  of  this  loan  and  that  its  conditions  are  being 

fulfilled. 

- 11 -

Article 3 

1.  The loan shall be made available to Hungary  in two instalments. The 

first  instalment  shall  be  released  as  soon  as  an  Extended 

Arrangement  has been concluded between Hungary and the  IMF and the 

second  instalment  after a period of at  least two quarters subject 

to the provisions of Article 2(2). 

2.  The funds shall be paid to the National Bank of Hungary. 

Article  4 

1.  The borrowing and  lending operations referred to in Article 1 shall 

be carried out using  the same value date and must  not  involve the 

Community  in the transformation of maturities,  in any exchange or 

interest-rate risk, or  in any other commercial  risk. 

2.  The  Commission  shall  take  the  necessary  steps,  if  Hungary  so 

decides, to  include  in the  loan conditions, and also to exercise, 

an early repayment clause. 

3.  At  the  request  of  Hungary,  and  where  circumstances  permit  an 

improvement  in the  interest  rate on  the  loans, the Commission may 

refinance all or part of  its initial  borrowings or  restructure the 

corresponding  financial  conditions.  Refinancing  or  restructuring 

operations shall  be carried out  in accordance with  the conditions 

set out  in paragraph  1 and shall  not have the effect of extending 

the average duration of  the borrowing  concerned or  increasing  the 

amount,  expressed  at  the  current  exchange  rate,  of  capital 

outstanding at the date of the refinancing or restructuring. 

4.  All  related  costs  incurred  by  the  Community  in  concluding  and 

carrying  out  the operation  under  this Decision  shall  be  borne by 

Hungary. 

5.  The Monetary  Committee  shall  be  kept  informed  of  developments  in 

the operations  referred  to  in paragraphs  2 and  3 at  least once a 

year. 

- 12 -

Article 5 

At  least once a year  the Commission  shall  address to the European 

Parliament  and  to  the  Council  a  report,  which  will  include  an 

evaluation, on the implementation of this Decision. 

Done at Brussels, 

For the Council 

The President 

- 13 -

FINANCIAL RECORD 

1.  Budget line concerned 

Article  (BO-2102) loan guarantee for aid to Hungary  (to be created 
through an amending and/or supplementary Budget). 

2.  References  (legal base) 

Article 235 of the Treaty 

3.  Classification of the Expenditure 

Obligatory 

4.  Description and Justification for the action 

a)  Description of the action 

Provision  of  a  guarantee  from  the  Community  for  a  loan  to 
Hungary  in  view  of  supporting  its  balance  of  payments  and 
strengthening the country's reserve position. 

b)  Justification for the action 

The  G24  and  the  Council  of  the  EEC  have  endorsed  the 
principle of providing assistance  in response to a request 
from Hungary. 

-  The budget entry is intended to provide a budgetary support 
for guarantee offered by the European Community  to cover a 
loan extended to Hungary. 

5.  Nature of the expenditure and method of calculation 

a)  Nature of the expenditure 

A guarantee to a loan to Hungary. 

b)  Method of calculation 

A token entry  is proposed  given that the amount  and timing of 
any  call on  this budget  line  cannot  be  calculated  in  advance 
and because it is expected that this budget guarantee will not 
be called. 

6.  Effect of the action on intervention credits 

Only in the case of an effective call on the guarantee. 

- 14-

7.  Financing of intervention expenditure 

Endowment  of  the  line  by  transfer,  by  reutilisation  of 
reimbursed  amounts  (Article 27(3) of the  Financial  Regulation 
of 1977), or by amended and/or supplementary budget. 

In  order  to  fulfill  its  obligations,  the  Commission  can 
provisionally  ensure  the  debt  service  with  funds  from  its 
treasury.  In that  case, Article  12 of the  Council  Regulation 
(EEC, Euratom) no. 1522/89 of 29.5.1989 will apply. 

ISSN 0254-1475 

COM(91) 83 final 

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