At its extraordinary meeting on 28 November 2003, the Monetary Council, having disussed economic and monetary developments, decided to increase the central bank base rate by 300 basis points, from 9.50% to 12.50% with immediate effect.
Over the past weeks, the forint’s exchange rate has weakened considerably, with yields on government securities increasing significantly. The cause of uncertainty among foreign investors is that, due to the high general government deficit and the rapid expansion of household borrowing, the current account deficit has risen rapidly over the past year. Spending overrun in general government and the household sector can only be financed through the inclusion of external sources of massive funds. Rising yields on government securities and enhanced expectations of the forint’s depreciation suggest that foreign investors are only willing to secure the funds needed for financing the spending overrun at a higher price.
The MNB projects that the country’s external borrowing requirement will fall significantly in 2004. This is further corroborated by the fact that, as a result of the measures approved by the Parliament, fiscal consolidation is an on-going process, and that the restrictions placed on the housing loan subsidy system are expected to put a brake on the expansion of household borrowing. In addition, with an upturn in the global business cycle, the corporate sector is likely to rely on external sources of funds more heavily. As a result, the borrowing structure of the current account deficit is expected to be more favourable than in 2003. Overall, in 2004, approximately EUR 700 million less portfolio capital will be needed than in 2003.
In the Monetary Council’s judgement, the depreciation of the forint’s exchange rate offers no solution to the problem of how the current account deficit should be reduced. Such depreciation would only increase inflation, which in turn would slow down economic growth and cause several years’ delay in the adoption of the euro in Hungary. The costs of the depreciation would be far too high relative to the advantages that reduction in external deficit through the loss in value of household income and government deficit caused by inflation, and through a short spell of increased competitiveness boosted by a weaker exchange rate could bring.
With respect to medium-term economic growth, it is much more beneficial if reduction in external borrowing requirement occurs through reduction in government deficit and an increase in household savings, with the achievements of the disinflationary process upheld. Therefore, until the positive effects of budgetary tightening and an increase in household savings emerge, the MNB will seek, by maintaining a higher interest rate, to stabilise the forint’s exchange rate at a level needed for the delivery of the 2005 inflation target.