The fast growth of domestic credit, the declining share of FDI in capital inflows, the high current account deficit and turmoil in Asia since mid-1997, however, prompted the government to tighten banking sector prudential regulations and supervision in late 1997. The latter was aimed at curbing fast credit growth and, only indirectly, at curbing portfolio inflows (since banks were funding domestic credit with Eurobond issues). The creation of a stabilization fund - whereby budget surpluses and public sector deposits were invested in foreign assets abroad - and a number of other measures aimed at tightening monetary policy and regulations were announced in early October 1997. These other measures included the raising of the capital adequacy ratio from 8% to 10%; certain curbs on local government's borrowing; the extension of reserve requirements for the banks to include net borrowing from abroad; and increases in the daily liquidity requirement for banks.

The announcement of these measures, combined with some indications from the government that it would remove public sector deposits frcm commercial banks to create the stabilization fund, and previously un-anticipated delays in the funding abroad of several domestic banks, led to a liquidity crisis in the banking sector on October 20, 1997. Interest rates jumped over 300 basis points and between October 20 and the end of November the stock market price index lost over 60% of its value. To restore confidence, the central bank decided to bring forward the implementation of the previously announced measures and announced new measures to tighten banking regulations, including a further increase in capital adequacy requirements to 12<sup>0</sup> /%-to be implemented at a later (unspecified) stage, and increases in the liquidity ratios of banks. The firm stance of banking regulators and the tightening of fiscal policy were conducive to a significant slowdown of credit growth and to improved liquidity in financial markets.

# _HungarylI_

As reward for its early reform efforts and continuous servicing of its foreign debt, Hungary received large capital inflows (including FDI) from the early 1990s on. Lack of fiscal discipline in 1993-94, however, led to a large surge in its current account deficit, reaching almost 10% of GDP in 1994), and created an unsustainable situation. The foreign exchange crisis in 1994 led to an economic downturn, and large debt financing to the public sector was necessary. Following fiscal adjustment and a devaluation in early 1995, there was a new surge in FDI closely linked to an ambitious privatization program (including the privatization of banks and some utilities). A sharp fiscal adjustment along with an intensification of structural reforms led to a rapid contraction in the current account deficit. Capital inflows declined as the path of fast privatization could not be sustained after 1995.

Sterilized intervention was extensively pursued during the periods in which capital inflows threatened the monetary program. To a lesser extent:, capital account liberalization also helped as it led to capital outflows. Exchange rate flexibility, i.e. a devaluation, was used when capital outflow pressures dominated (1994-95). The sharp fiscal adjustment and monetary tightening helped to keep the current account deficit subsequently under control. Strong

-11 Based in part on Oblath, 1997.

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