1 At its meeting on 1 December 2003, the Monetary Council, considered the latest economic and monetary developments and maintained the central bank base rate at 12.50%.

Reviewing the short period following the 300 basis point increase in the base rate, the market's reaction has been favourable – yields on government bonds with maturities of 3 to 15 years have fallen by 10–50 basis points, and the forint has strengthened.

2 The December 2003 Report on Financial Stability, discussed and approved by the Monetary Council, is available on the MNB’s website.

In the Monetary Council’s judgement, despite improving outlook for the global business cycle, the risks to macroeconomic stability have increased over the past six months – the current account deficit has grown, the volatility of the forint exchange rate and yields has increased considerably and so has the expected interest premium on forint-denominated investments.

As a result of the domestic demand-pull growth in the past two years, the current account deficit is expected to increase significantly in 2003.

Because of a greater availability of subsidised loan facilities and a rapid increase in income over the past two years, households’ propensity to save has declined. In the past decade, households have as a rule contributed to the financing of other sectors, in accordance with international experience and in agreement economic standards; however, in 2003 the increase in household savings has not been sufficient to offset the rise in outstanding debt.

The economy is expected to pass its cyclical trough in 2003, and growth is likely to pick up modestly from 2004. Simultaneously with this, the corporate sector’s borrowing requirement will rise with the position of households recovering extremely slowly, if at all. Consequently, a reduction in the general government borrowing requirement, couple with a fall in household demand for credit and an increase the sector's savings will likely be given the dominant role in improving Hungary's external balance.

The fiscal budget adopted for 2004, the EU regulations, also applicable to Hungary from next year, and the Government’s commitment to the adoption of the euro in 2008 are all indicative of lower borrowing by general government abroad. In the Bank's forecast, the current account deficit declines by a total of 1%–1.2% of GDP in 2005–06. The external borrowing requirement is likely to fall by a larger degree, owing to the transfers from the European Union.

With regard to the stability of the Hungarian financial intermediary system, 2003 H1 was characterised by deepening bank intermediation – the increase in the balance sheet total of the banking sector accelerated, significantly exceeding GDP growth. In line with improving economic prospects, the corporate sector's demand for credit increased. Simultaneously with a slowdown in the rate of household income growth, consumer credit and housing loans continued to grow rapidly. The outstanding increase in indebtedness is fundamentally attributable to an extension of the subsidised housing loan scheme and demand brought forward in anticipation of restrictions on the system of subsidised housing loans. A continuation of rising indebtedness will entail additional risks.

As a result of the expansion in lending, the banking sector’s profitability rose significantly in 2003 H1, even in comparison with last year's outstanding results. The rapid increase in subsidised housing loans has had a major role in the improvement of the banking sector’s profitability in the past 18 months, as such loans have earned banks significant extra profits through high interest margins, disproportionate to risks.

In addition to the pick-up in lending, the quality of outstanding loans has also improved. Banks have continued to be averse to taking exchange rate risks, thus the increased volatility of the forint exchange rate has not been a considerable source of loss for the sector. Increased volatility of yields may add to fluctuation in banks' interest income, but exposure to interest rate risks has recently been reduced by the relatively short average duration of the banking sector's government securities holdings.