OECD Seminar : „20 years after” Panel 2 : Challenges and opportunities

1. OECD Seminar : „20 years after”Panel 2 : Challenges and opportunities Júlia Király Deputy Governor, Magyar Nemzeti Bank

2. „This time it was not us” • The epicentre of the crisis was not in emerging markets • It was originating from developed countries … • Macro imbalances (low interest rates, excess liquidity, housing market boom, saving imbalance...) • Financial market imbalances (yield hunting and greedy risk appetite, originate-to-distribute model and subprime lending, „toxic assets”: highly leveraged, structured products, high leverage, shadow banking system...) • …and spreading towards East through trade and financial markets • Strong financial and trade integration in the CEE region incl. Hungary has led to fast spill-over of the crisis

3. Strong financial and economic integration of the CEE countries Source: EKB, Eurostat.

4. Hungary’s high vulnerability triggered an avalanche High HUF yields Large public debt „Fiscal alcoholism” 1. Government risk External debt High inflation Integrated banking system with developed countries Overoptimistic expectations of the households Lending in foreign currency 150% loan to deposit ratio 2. Banking sector risk Liberalised balance of capital

5. Private sector is responsible for 2/3 of the external debt Source: MNB.

6. The currency mismatch of the private sector amounts to 40% of the GDP Source: MNB.

7. 9th October 2008 • the fx swap interbank market collapsed • the secondary government paper market collapsed • the HUF depreciated hour by hour • the stock exchange trade was suspended because of the price fall

8. Response to the crisis Immediate remedies for the liquidity crisis: MNB: extended collaterals, LOLR in FX!, decreased reserve requirement Foreign parent banks: replacing money market funds Fixing balance sheets: Government: a sizeable and structural fiscal adjustment - pro-cyclical effects (cut in social transfers, tax reshuffling: VAT and real estate tax↑, taxes on labor↓) Households: increase net saving position, decrease credit demand Companies: labor market adjustment, postponing investments Banks: deleverage, decrease L/D ratio and tighten credit conditions Monetary policy: focus on price stability AND financial stability (forced tightening, slow easing)

9. Hungarian banks withstand the shock • Loan loss ratio is expected to triple in 2009 and slightly increase in 2010, while in the stress scenario it would be 5-6 times higher in 2010 than in 2008 • Strong capital position is expected to be kept along the baseline scenario (end-2010 CAR above 11%) • Recapitalisation needs (EUR 400-600 million for the whole banking system) under a severe stress scenario are manageable Source: MNB.

10. Fast adjustment in the private and banking sector Source: MNB.

11. GDP growth rates in new EU countries Necessary adjustment can lead to deeper recession and slower recovery Source: Eurostat, EC.

12. The potential output can be negatively affected by the crisis • Productivity (TFP): • Financing constraints disrupt daily operations • Expenditure on innovation falls • Sluggish reallocation between industries • Labour input: • Long-term unemployment erodes human capital • Capital input: • Capital accumulation slows down • Excess capacities are scrapped • But two country-specific factors reduce these negative effects: • High risk premia fall with fiscal consolidation • Government measures boost labor market participation

13. Financial crises reduce potential growthalthough their long-term impact varies: Lower long-run potential growth rate (Japan)? Full recovery in levels (Sweden)? One-time loss in output level (Finland)? Source: Impact of the current economic and financial crisis on potential output, European Economy, Occasional Papers No 49

14. IMF estimations • Growth regression • Potential growth is 0.6-2.5 pp lower after the crisis • Hungary is mostly affected through its debt burden Source: IMF Regional Outlook Europe, October 2009, Box 5

15. Potential growth and its components in Hungary MNB re-evaluated its projections in August Source: MNB.

16. European Commission estimations for the CEE region Potential growth slows to 2-2.5 per cent No recovery to pre-crisis growth rates (contrary to the euro area) …but Hungary with lower post-crisis potential output growth is not an exception in CEE Source: Impact of the current economic and financial crisis on potential output, European Economy, Occasional Papers No 49 Note: calculations for the EU-8 aggregate (BG, CZ, EE, LT, LV, PL, RO)

17. MAIN LESSON FOR US:THERE IS NO FREE LUNCH!NEVER SUPPORT UNSUSTAINABLE EQUILIBRIUM!