CELEX: 51991PC0083
Language: en
Date: 1991-03-26
Title: PROPOSAL FOR A COUNCIL DECISION PROVIDING FURTHER MEDIUM-TERM FINANCIAL ASSISTANCE FOR HUNGARY

COMMISSION OF THE EUROPEAN COMMUNITIES
 i
                                        C0M(91)  83 final
                                        Brussels, 26 March 1991
 U-
                             Proposal for a
                            COUNCIL DECISION
IPC
          providing further medium-term financial assistance
                               for Hungary
                     (presented by the Commission)
m
 ---pagebreak---                                         - 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$200 million World Bank
cofinancing arrangement from Japan and short-term credit and bridge
loan   facilities    from   Germany    and   the  Bank   for   International
Settlements.
Notwithstanding encouraging progress towards adjustment and reform in
1990, Hungary's financial situation remains fragile in 1991 when the
country will be faced with a number of major external shocks including
the reform of trade prices within the COMECON            area, the partial
breakdown of trade relations with other COMECON partners and the impact
of Gulf crisis. As a result, the financing requirement is expected to
increase considerably.
To  meet   the   increase  in   its   financing  requirement,   Hungary  has
requested further assistance from the IMF in the form of an Extended
Fund Arrangement (EFF) as well as access under the oil excess window of
the  Fund's    Compensatory   and   Contingency   Financing   Facility.  The
agreement on the latter was reached in January 1991 and the EFF was
approved by the Fund's Executive Board on 20.2.91.
However, barring any significant increase in net private flows to
Hungary, the envisaged assistance from the Fund will not be sufficient
to cover the financing needs. Although direct investment inflows and
capital market borrowing rose significantly in 1990 and are expected to
                          --       •- .-i«4-<«„ UahiHties to commercial
 ---pagebreak---                                    - 3-
banks make it difficult to envisage any substantial increase in bank
lending. Accordingly, to help cover its overall financing requirement
and enable it to maintain the policy of remaining current on its
external obligations, Hungary has submitted a request for complementary
financial assistance from the Community and the Group of Twenty-Four.
The need for such assistance has been assessed by the Commission
Services   in close cooperation with the      staff  of the    IMF  and  is
estimated at some US$ 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.
 ---pagebreak---                                  - 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.
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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.
 ---pagebreak---                                     - 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                              -1200
         Debt amortisation                                    -2400
         Build up of reserves (- « increase)                  - 700
I.       Total gross financing requirement                    -4300
         Private borrowing                                    +1500
         Borrowing from official sources already committed    + 900
         IMF facilities                                       +1400
II.      Total capital inflows                                +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.
 ---pagebreak---                                  - 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.
 ---pagebreak---                                     - 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;
 ---pagebreak---                                      - 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 :
 ---pagebreak---                                 - 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.
 ---pagebreak---                                     - 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.
 ---pagebreak---                                  - 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
 ---pagebreak---                                    - 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.
 ---pagebreak---                                   - 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.
 ---pagebreak---                                                                                 ISSN 0254-1475
                                                                    COM(91) 83 final
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