of that we, central bankers are interested in limiting currency mismatches in the balance sheet of domestic market participants. one can also look at fx borrowing of the unhedged domestic agents as the mirror image of the well - known convergence play, when foreigners invest in assets denominated in local currency. the only constraint of this convergence play is the risk absorption capacity of the borrowers. magyar nemzeti bank supports responsible lending and borrowing behavior that targets to increase the risk absorption capacity of borrowers. i am sure we still have to discuss the role of fx loans in more detail in the future. however, i am convinced that an overly simplified view, emphasizing only type of risks, would not lead us towards a consensus view and would help little in guiding future policy measures. finally let me say a few words about the events of the most recent months and touch briefly on future challenges we are facing. summer brought favourable developments in various dimensions. global risk aversion eased significantly, thanks mainly to the well coordinated fiscal and monetary measures of developed countries. this was obviously a very welcome phenomenon for hungary. it helped the currency to appreciate by more than 10 % compared to the levels in spring, and also contributed to the significant drop of domestic bond yields, even at longer maturity. i consider the functioning of the government securities market to be a key indicator of market perception on fiscal sustainability. in this regard, it was particularly favorable that, following a long pause, the government was also able to issue long maturity bonds in forints. while the imf / eu package provides reliable source of financing, the ultimate goal is obviously to return to market financing, preferably in forints. therefore we not only have to present sound and credible fiscal consolidation measures to the international institutions for approval, we also have to make sure that market participants find the fiscal path credible. last, but not least, the return of market confidence gave the magyar nemzeti bank the room to start reducing the key interest rates. further positive news was coming from price developments. ex ante there were wellgrounded concerns about the inflation impact of the large vat hike, a crucial part of the fiscal tightening measures. central banks never welcome any administrative increase in the price level, there is always the risk that a part of the one - off increase will lead to more permanent inflation pressure. this was especially a pronounced concern in hungary given our less than satisfying track record of meeting the inflation targets. while it

we had just introduced inflation targeting which showed some early success in breaking inflation inertia. in the eurozone itself, there were no signs of divergence, either. all this suggested that a quick eurozone entry was doable and worth pursuing. the future looked rosy. however, things turned out to be quite different. an unprecedented fiscal expansion in 20022006 shed a cruel light on the structural and institutional weaknesses of the hungarian public finances and slowed down the disinflation process. the country was drifting away from meeting the maastricht criteria and the expected date of entering the eurozone was moving further and further out in the future. at the same time, news from the euro area caused some discomfort too, as growth in some less developed member countries slowed down so much that their real convergence stopped or even reversed. having had this experience, it is not surprising that when we did our review of the costs and benefits of the euro this year we were a bit more cautious than seven years ago. although our basic conclusion remained the same, that is, we still think that hungary should join the eurozone as soon as possible, clearly we had become more aware of some risks involved in the quick euro adoption strategy. let me elaborate on two of these risks. the first is entering the eurozone without sufficient progress in structural reforms ; the second is the problems caused by potentially large capital inflows after the common currency is introduced. it is a commonly shared view that efficient labour and product markets, which help a country ’ s dynamic adjustment to asymmetric shocks, are essential for success within a monetary union. in terms of labour and product market reforms hungary still has a lot to do. although nominal and real wages are more flexible than in the core eurozone, the employment rate is one of the lowest in the eu. our analysis suggests that this may be related to wrong incentives hindering labour supply, such as generous early retirement and maternity leave schemes and a very high tax wedge. these are in turn manifestations of a bigger problem, “ the premature welfare state ”, which is weighing heavily on potential growth on the one hand, and is a source of a chronic fiscal imbalance on the other. our fiscal and labour market weaknesses are deeply interconnected and we have to address them together in a wide - ranging structural reform. scaling back the overly generous welfare state is painful and the political willingness to do so is not so strong, so when this structural reform will take place is rather uncertain