F o c u s. Employment Overview 58% 57% 56% 55% 54% 53% 52% thousand people Content

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1 Hungarian Development Bank s monthly report F o c u s Employment Overview October 212 By the end of Summer 212 the percentage of economically active people rose to a record high in Hungary (57.1%), whereas unemployment fell to a two-year low (1.) (see Chart 1). Still, a true turning point in labour market processes has yet to be seen, as the growth in the employment rate is due largely to an upturn in the public work programme. The number of employees, which paints a more accurate picture of the number of people in long-term employment relationships, has continued its sharp downturn (see Chart 2), which is another indication that a turning point in economic trends has yet to arrive. After the upturn in the public work programme, trends in employment figures became detached from trends of the economic cycle. The reintroduction of inactive groups of society to the labour market can be considered a positive process in terms of long-term potential growth (and in many other structural respects as well), but these new actors to the labour market were so far unable to produce any positive effects on economic growth either on the production side or the expenditure side (private consumption) of the GDP. (Continued on page 2) Hungarian economy shrank in the first half of (Page 4) Slowing export growth, improving financing capacity... (Page 5) Despite the start of the Mercedes Plant in Kecskemét external and domestic trends break the recovery in the industrial sector... (Page 6) Decline in investments slowed down in Q2 212, there are risks around future developments... (Page 7) The total amount of corporate credits decreased further, while increasing loan demand is expected... (Page 8) The banks lending willingness is expected to grow, but this can go hand in hand with more careful client selection... (Page 9) The employment growth was driven mainly by the public work programs and only smoothed the decline in the consumption... (Page 1) Tax changes at the start of 212 keep the inflation rate high until the end of the year in Hungary... (Page 11) The movement of HUF/EUR exchange rate had no direction in September... (Page 12) % 5 thousand people Content Chart 1: Unemployment and activity rate trends in Hungary Activity rate (LHS) Unemployment rate (RHS) The general government balance continued to improve in August as a result of rising income and decreasing expenditures... (Page 12) 13% 1 11% 1 Chart 2: Changes in the number of employed people and employees, and GDP growth in Hungary Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Change in the number of employed people (year/year, LHS) Change in the number of employees (year/year, LHS) GDP growth (year/year, RHS) Q4 211 Q1 212 Q Authors: Erzsébet Gém Chief economist Álmos Mikesy (Mikesy.Almos@mfb.hu) Zsolt Szabó (Szabo.Zsolt@mfb.hu) Publisher: MFB Hungarian Development Bank Private Limited Company Editor in chief: Erzsébet Gém Contact: Nádor utca 31. H-151 Budapest Tel.: Web: The views expressed in the analyses published by MFB Plc reflect the authors personal views and do not correspond in any circumstances to the Bank official views. The analyses are based on data obtained from credible sources but the authors do not take responsibilities for their authenticity. MFB Plc and the authors are not responsible for the accuracy of the forecasts.

2 However, the number of people in long-term employment is following a different trend altogether, and is far more closely aligned to real economic processes: since the outbreak of the crisis, there has been only a four-quarter period (from Q2 21 to the first three months of 211) where the number of employees increased; since then the number of employees working at least 6 hours a month has once again been on a continuous decline (see Chart 3). The difference is even more pronounced if we compare these figures to pre-crisis levels (Q2 28): the number of workers (who work at least one hour per week) has already exceeded these levels by 7 7, whereas the number of employees is lagging behind by 13 6 (in the competitive sector the difference is 156 8). In 21, manufacturing firms still expanded their human resources capacities primarily by extending the shorter working hours they had introduced during the crisis (i.e. employing part-time employees in full time) rather than by hiring new workforce. From the first half of 211, however, their additional workforce demand was fully present on the labour market, and of all sectors it was the processing industry that had the largest mitigating effect on the consequences of recession on the Hungarian labour market. Manufacturing employment is responding rapidly and in a flexible manner to the shock that the sector suffered. Since due to the structure of Hungarian manufacturing production these shocks are largely of external origin, employment in the sector depends on export trends and, more broadly, on global recovery processes (see Chart 4). The decrease in the number of employees in the first half of the year was similarly a result of the slowdown in external demand, as well as to individual effects. The number of employees rose only in the automobile industry and in the closely related metalworking industry (mainly due to major automotive industry investments); this was counterbalanced by the other sub-sectors. Employment rates fell especially sharply among computer and electronic equipment manufacturing companies (see Chart 5). This, however, was due primarily to an individual factor, namely the closure of the Nokia plant. The weight of such individual effects is a negative consequence of the strongly dual and concentrated structure of the Hungarian economy. thousand people thousand people Chart 3: Contribution to changes in the number of employees in the various sectors (year/year change) Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 *competitive sector excluding manufacturing Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Public sector Manufacturing Competitive sector* Non-profit sector Change in the number of employees (year/year, LHS) Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Q2 212 Q3 212 Q Chart 4: Trends in the number of employees in the manufacturing and in manufacturing production and industrial exports Export industry sales: adv. 1 quarter Manufacturing production: adv. 1 quarter thousand people Change in the number of employees in the manufacturing (year/year, LHS) Industrial export sales (RHS) Manufacturing production (RHS) Chart 5: Trends in the number of employees* in the sub-sectors of the manufacturing in the first half of 212 (year/year) Car manufacture Metalworking Other manufacturing Food processing industry Rubber and plactis production Electric machinery production Wood processing Computer and electronic equipment production Manufacturing *average numbers for the first two quarters Periscope October 212 2

3 Relations between Monetary Policy and Employment Figures The primary objective of the monetary policy of the National Bank of Hungary is to achieve and maintain price stability; the improvement of employment, however, is not among its tasks. The link between interest rate policy and unemployment figures is noticeable in Hungary as well, but is less pronounced than in major global economic centres, and there are several factors (such as the openness and duality of the Hungarian economy, as well as the fiscal shocks that took place) that would make it difficult to influence unemployment by monetary instruments. In examining the links between monetary policy and employment, the following article does not seek to describe the obstacles presented by the adjusted Phillips curve that examines the connections between inflation and unemployment or by the strength of the domestic interest rate channel, but rather to highlight other characteristics of the Hungarian economy. Out of the central bank of the US (the Fed), the European Central Bank (ECB) and the National Bank of Hungary (NBH), keeping unemployment at a low level is only a statutory task and goal of the first; in practice, however, there are varying degrees of correlation between interest rate policy and unemployment rate trends in all three economies. In the United States and the eurozone central bank interest rates and unemployment indicators have been highly correlated since 1999 (see Charts 1-2) which, in numeric terms, is shown by the fact that the correlation between the base rate and the unemployment rate was -.85 between 1999 and 212 in both economies. Moreover, it is not just the correlation between the two that can be considered strong; the curves of both data series has been following the same cycle both in the US and in the eurozone. Periods of strict monetary policy and high employment rates coincided, for example, both around 2 21 and around The length of these cyclical trends roughly fit into the so-called Juglar cycle said to be a commercial cycle which lasts 7 13 years, but has been becoming gradually shorter over time, and which corresponds to the length of one investment cycle. The periodic nature of monetary policy and unemployment is thus the result of real economic reasons in two of the three economies. If we were to examine whether interest rate trends influence or simply follow unemployment statistics, we would find that in the US and in the eurozone the two data series are in synch (that is, the absolute value of the correlation is the highest in a concurrent comparison in both economies). In general, the monetary policies of both the United States and the eurozone can be considered anticyclical, with the minor addendum that in the quarters following interest rate decisions by the Fed there is a somewhat stronger influence on US unemployment rates than in the case of the correspondence between the data series of the ECB base rate and eurozone unemployment rates. In Hungary s case there is a significantly lower correspondence between NBH interest rate trends and unemployment statistics (see Chart 3); the correlation was a mere -.54 between 1999 and 212, which is due to several factors. On the one hand, unlike the Fed, the NBH is not tasked with monitoring employment and unemployment, and on the other hand there are two factors that diminish cyclical trends in interest rate and unemployment figures. Firstly, unlike in the economies of the US and the eurozone, there are no periodic fluctuations in the real economy that would have an impact on the labour market and would influence the direction of monetary policy, as waves of recovery and investment cycles in Hungary follow international economic trends with some delays, whereas another segment of the labour market follows the different cycles of budgetary policy (including the system of housing subsidies, public work programmes, etc.). Secondly, cyclical trends in interest rate policy are influenced by two factors that also restrict the autonomy of the NBH s interest rate policy, namely the high degree of openness of the Hungarian economy and the relatively frequent fiscal policy measures aimed at influencing price levels (changes in VAT rates, excise duties, etc.). 3% 1% 5, 4,5 4, 3,5 3, 2,5 2, 1,5 1,,5, % Chart 1: Fed base rate and unemployment rate trends in the United States Q Q Q1 2 Q3 2 Q1 21 Q3 21 Q1 22 Q3 22 Q1 23 Q3 23 Q1 24 Q3 24 Q1 25 Q3 25 Q1 26 Q3 26 Q1 27 Q3 27 Q1 28 Q3 28 Q1 29 Q3 29 Q1 21 Q3 21 Q1 211 Q3 211 Q1 212 Fed base rate (LHS) ECB base rate (LHS) Unemployment rate (RHS) Sources: Fed, Reuters Unemployment rate (RHS) Chart 2: ECB base rate and unemployment rate trends in the eurozone Sources: ECB, Reuters Q Q Q1 2 Q3 2 Q1 21 Q3 21 Q1 22 Q3 22 Q1 23 Q3 23 Q1 24 Q3 24 Q1 25 Q3 25 Q1 26 Q3 26 Q1 27 Q3 27 Q1 28 Q3 28 Q1 29 Q3 29 Q1 21 Q3 21 Q1 211 Q3 211 Q % 1 7, 7, 8, 8, 9, 9, 1, 1, 11, 11, 12, Chart 3: NBH base rate and unemployment trands in Hungary Sources: NBH, Reuters NBH base rate (LHS) Unemployment rate (RHS) Q Q Q1 2 Q3 2 Q1 21 Q3 21 Q1 22 Q3 22 Q1 23 Q3 23 Q1 24 Q3 24 Q1 25 Q3 25 Q1 26 Q3 26 Q1 27 Q3 27 Q1 28 Q3 28 Q1 29 Q3 29 Q1 21 Q3 21 Q1 211 Q3 211 Q inverted scale inverted scale inverted sscale Periscope October 212 3

4 GDP growth Hungarian economy shrank in the first half of 212 Business confidence indicators show further economic slowdown in Q3 of 212 (Chart 1). The eurozone GDP declined by. (y/y) in Q2, which was mainly driven by the significant set-back in investments (-3. y/y). As a consequence of permanent uncertainty caused by the deepening debt crisis, the outlook of the European economic actors signals a prolonged recession period (Charts 2-3). In the CEE region the Hungarian and the Czech economy decreased by -1.1 and -1. (y/y) in the second quarter, the Romanian GDP growth accelerated to +1., while the Polish and the Slovakian GDP grew by 2.5 and 3. respectively (Chart 4). The Hungarian economy stopped in Q2 of 212 which was a result of unfavourable domestic and external factors. In annual basis the export still increased slowly (+2.1%), the fall in investments continued, and the shrinking household consumption (-1.) was mainly due to declining government transfers. The agriculture could not repeat its last year s excellent performance, the drop in external demand was strongly detected in declining industrial production on yearly comparison, while construction output continued to plummet (Charts 5-6) Chart 1: Business climate* in certain area of the global economy (January 27 = 1) Source: Reuters Eurozone China USA Germany *Eurozone: ESI Index, China: PMI Index, USA: ISM Index, Germany: IFO Index percentage point Q1 27 Chart 2: The GDP main components' contribution to growth in the eurozone Q2 27 Q3 27 Q4 27 Q1 28 Q2 28 Q3 28 Q4 28 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Q2 212 Government consumption exp. Gross fixed capital formation Household consumption exp. GDP growth (RHS) Source: Eurostat Export of goods and services Import of goods and services Changes in inventories* * and statistical discrepancy Chart 3: Economic sentiment in the eurozone Chart 4: GDP growth* in Central and Eastern Europe (y-o-y) Long-term average ( ) Average between 28 and 29 ESI sentiment indicator Source: European Commission * seasonally adjusted data Source: Eurostat Q1 26 Q2 26 Q3 26 Q4 26 Q1 27 Q2 27 Q3 27 Q4 27 Q1 28 Q2 28 Q3 28 Q4 28 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Q Hungary Czech Republic Romania Slovakia Poland percentage point Chart 5: The GDP main components' contribution to growth in Hungary Q1 27 Q2 27 Q3 27 Q4 27 Q1 28 Q2 28 Q3 28 Q4 28 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Q2 212 Final consumption of households Gross fixed capital formation External trade balance Final consumption of government Changes in inventories GDP (RHS) Chart 6: The gross value added of the main sectors (Q2 212) -1. Agriculture Source: HCSO Industry. -.1% Manufacturing. -1. Construction -2.3% -. Services -.1% -1. Trade, hotels, restaurants Transport, storage. 4. ICT sector Financial and insurance activities % Real estate activities -.3% -1.3% GDP growth Year/year* *unadjusted data Quarter/quarter** **seasonally and calendar effect adjusted data Periscope October 212 4

5 Foreign trade, current account Slowing export growth, improving financing capacity In July the export increased by 5.6 and the import by 4. (y/y). The surplus in trade balance was HUF billion in the first seven months of 212, which exceeded by HUF 57.3 HUF the level of the same period of the previous year (Chart 1). Between January and June the export calculated in HUF rose by 1.. Though the export of machinery and transport equipment increased only by 4. (y/y), the vehicle export grew by 15.4 % mainly due to the Mercedes Plant (Chart 2). In terms of GDP growth, it is favourable that the export-import gap (calculated in EUR) was positive in both June and July (Chart 3), but outlook is worsening because in Germany, which is the main export market for the Hungarian products, slowing economic dynamic is increasingly evident (Chart 4). Between April and June 212 the net financing capacity of the Hungarian economy (i.e. the combined surplus on its current and capital accounts) was 3. of the GDP which exceeded by 1.1 percentage points the previous quarter data. After a set-back at the beginning of the year the allocation of EU transfers accelerated in the second quarter of 212 according to accrual-based data (Charts 5-6). billion HUF 25, 2, 15, 1, 5,, -5, -1, -15, percentage points Chart 1: 2: External Extrnal trade volume and trade balance in Hungary Trade balance (LHS) Import volume (y/y, RHS) Export volume (y/y, RHS) Chart 3: Evaluation of export import gap* in Hungary *the export-import gap is positive if the growth rate of export exceeds the growth rate of import **3-month moving average Export import gap** (y/y, volume index) Export import gap** (y/y, data in EUR) Chart 5: Current account, capital account and financing capacity of Hungary percentage points Food, beverages, tobacco Commodity Fuels, electric energy Manufactured products Machinery and transport equipment Export Import Chart 2: Yearly changes of export and import (January - July 212, calculated in HUF) Road vehicle TOTAL IFO-index: adv 3 m % % % Chart 4: The German business expectations and the Hungarian export-outlook IFO-index: business expectations (LHS) Chart 6: EU-transfers Sources: HCSO, CESifo * 3-month rolling average Export volume* (RHS) million million Unadjusted data Seasonally adjusted data million Q1 26 Q2 26 Q3 26 Q4 26 Q1 27 Q2 27 Q3 27 Q4 27 Q1 28 Q2 28 Q3 28 Q4 28 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Q Source: NBH -2 Current account Capital account Net financing capacity**(rhs) Source: NBH *seasonally adjusted data ** as % of GDP Q1 24 Q3 24 Q1 25 Q3 25 Q1 26 Q3 26 Q1 27 Q3 27 Q1 28 Q3 28 Q1 29 Q3 29 Q1 21 Q3 21 Q1 211 Q3 211 Q1 212 Periscope October 212 5

6 Industry Despite the start of Mercedes Plant external and domestic trends break the recovery in the industry By September the expectations of economic actors and analysts of financial sector reached a level, which is below the average value of the period 2-27 in Germany, as a consequence of eurozone s prolonged economic crisis (Chart 1). The CEE countries may not avoid the effect of the German business cycle: manufacturing production slowed down sharply in the Visegrád countries (with the exception of Slovakia) (Chart 2). Hungarian industry production shrunk by 2. (y/y) in July 212, and both domestic and export orders declined (Chart 3). With the start of the Mercedes Plant the production of vehicle rose by 9. (y/y), but it was offset by the set-back of the coke production, and the mainly export-driven manufacturing of vehicles and electronic equipments. In total the manufacturing production decreased by.3% and according to the confidence indicator weak performance of the sector is expected to continue in the coming months (Charts 4-5). In July the performance of construction sector raised by 7.6 % (y/y), due to the low basis, some road and pipeline construction and railway reconstruction. The number of the contracts increased by only. compared to the previous year, which does not promise the boost of the sector (Chart 6) Source: ZEW, CESifo ZEW index (LHS) IFO index (RHS) Chart 1: Sentiment indicators in Germany ZEW index* (LHS) IFO index* (RHS) Chart 3: Industrial production and sales (y/y) *average value between 2 and Chart 2: The German business climate (IFO index) and the manufacturing production* in the Visegrád countries Sources: Eurostat, CESifo * 3-month rolling average Chart 4: Manufacturing production in certain product branches (July 212, y/y) IFO index (LHS) Hungary Poland Czech Republic Slovakia *working day adjusted Manufacturing Transport equipment Electricity, gas, steam supply Food products Rubber and plastic products Metal products Electrical equipment Machinery Coke and refined petroleum products -.3% Domestic sales Export sales Industrial production* Chart 5: Manufacturing sentiment index* and manufacturing production Chart 5: Construction production and orders (y-o-y) ESI - Manufacturing: adv. 1 month ESI - Manufacturing (LHS) Sources: HCSO, European Commission * ESI (European Sentiment Index) ** 3-month rolling average Manufacturing production** (y/y, RHS) Stock of orders at the end of the month (LHS) New orders (LHS) Construction output (RHS) Periscope October 212 6

7 Investment Decline in investments slowed down in Q2 212, there are risks around future developments Between April and June 212 the gross fixed capital formation fell by 4. (y/y) in Hungary, which has been still the poorest performance among the CEE countries, however, it was 2.1 percentage point better than in Q Due to the decrease beginning in 29 the investment rate is the lowest in Hungary regarding the region, in the middle of 212 the gross fixed capital formation to GDP ratio reached 16. (Charts 1-2). In Q2 212 there was increasing investment (y/y) in information and communication owing to network extensions and in whole sale, retail sale due to dynamic extensions and developments of chain stores (Chart 3). The drop of public investments (-27.) exceeded the fall in private investments (-1.) as a consequence of cut in public spending (Chart 4). The investment activity in the future has been shadowed on the one hand by the fact that the capacity utilization in the manufacturing fell from 78.1% in Q2 to 76. in Q3, and on the other hand that the decline in new orders may cause deferment in developments (Charts 5-6). Chart 1: Gross fixed capital formation Central and Eastern European countries (y/y) Chart 2: The gross fixed capital formation to GDP ratio* in Central Eastern Europe Source: Eurostat * 4-quarter rolling average Sources: HCSO, Eurostat * not seasonally adjusted data Q1 28 Q2 28 Q3 28 Q4 28 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Q2 212 Q2 24 Q4 24 Q2 25 Q4 25 Q2 26 Q4 26 Q2 27 Q4 27 Q2 28 Q4 28 Q2 29 Q4 29 Q2 21 Q4 21 Q2 211 Q4 211 Q2 212 Hungary Czech Republic Poland Slovakia Romania Hungary Czech Republic Poland Slovakia Romania Chart 3: Investment outlay of national economy by certain sectors Chart 4: Investment activity in the public and business sector in Hungary ICT sector Wholesale and retail trade Agriculture. Transportation, storage. Real estate activities -4.1% Construction sector -4. Manufacturing -5. Public administration -6. Electricity, gas, steam -44. Total -5. Of which: Construction -8.3% Of which: Machines, vehicles -2. Q1 212 Q Q1 2 Q3 2 Q1 21 Q3 21 Q1 22 Q3 22 Q1 23 Q3 23 Q1 24 Q3 24 Q1 25 Q3 25 Q1 26 Q3 26 Q1 27 Q3 27 Q1 28 Q3 28 Q1 29 Q3 29 Q1 21 Q3 21 Q1 211 Q3 211 Q1 212 Business sector* (y/y) * corporations with more than 49 employees Budgetary institutions (y/y) Chart 5: Capacity utilization in manufacturing Chart 6: New orders and and gross fixed capital formation (y-o-y) Source: Eurostat 5 Q1 28 Q2 28 Q3 28 Q4 28 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 Q2 212 Q3 212 Hungary Czech Republic Poland Romania Slovakia Sources: European Commission, HCSO * 4-quarter rolling average Q Q2 2 Q4 2 Q2 21 Q4 21 Q2 22 Q4 22 Q2 23 Q4 23 Q2 24 Q4 24 Q2 25 Q4 25 Q2 26 Q4 26 Q2 27 Q4 27 Q2 28 Q4 28 Q2 29 Q4 29 Q2 21 Q4 21 Q2 211 Q4 211 Q2 212 Consumer goods* (LHS) Intermediate goods* (LHS) Investment goods* (LHS) Gross fixed capital formation* (RHS) 12, 1, 7, 5, 2,, -2, -5, -7, -1, -12, Periscope October 212 7

8 Corporate demand for external financing The total amount of corporate credits decreased further, while increasing loan demand is expected The non-financial companies financing capacity reached 2. of Q2 GDP and also 2. of GDP in the last four quarters, which means that the sector has had net saving position since the beginning of 29 (Chart 1). In August 212 the outstanding amount of corporate loans decreased by HUF 25.3 billion HUF due to net loan transactions, while in the first eight months dropped by HUF billion (this fall exceeded the previous year data by HUF 1.9 billion). The outstanding stock of HUF credits grew by HUF 2.9 billion in August and by HUF 94.7 billion in the January-August period, while the total amount of FOREX loans decreased by HUF 28.2 billion in August and by HUF billion in the first eight months of 212 due to net loan transactions (Chart 2). In contrast to Hungary there is stagnation in the corporate lending in the Czech Republic, Slovakia and Romania and increase in Poland (Chart 3.) But the negative trend in the Hungarian lending may be stopped during the next six months: according to the lending survey of the National Bank of Hungary growing demand of both the SMEs and large companies is awaited by the Hungarian banks mainly for the short term credits and HUF loans (Charts 4-6). Chart 1: The financing capacity of the main sectors (in % of GDP) * balance of last 4 quarters/gdp of last 4 quarters Chart 3: Change in total amount of outstanding corporate loans (y/y)* HUF billion Chart 2: Change in total amount of outstanding corporate loans through loan transactions Source: NBH HUF loans Loans denominated in foreign currencies Total loans Chart 4: Demand for corporate loans in the next 6 months according to the Hungarian credit institutions' view HUF billion * change in total value converted to euro Czech Republic Hungary Poland Large and medium corporations Small and micro enterprises Source: NBH lending survey -1 Source: ECB Romania Slovakia -2 * net change indicator, positive: increase Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q Chart 5: Demand for corporate loans in the next 6 months by currency according to the credit institutions' view HUF loans FX loans -6-8 * net change indicator, positive: increase Source: NBH lending survey Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q4 21 Q1 211 Q3 211 Q4 211 Q1 212 Q2 211 Q3 211 Q4 211 Q1 212 Q2 212 Chart 6: Demand for corporate loans in the next 6 months by duration according to the credit institutions' view 1 Short term loans Long term loans * net change indicator, positive: increase Source: NBH lending survey Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q1 2 Q3 2 Q1 21 Q3 21 Q1 22 Q3 22 Q1 23 Q3 23 Q1 24 Q3 24 Q1 25 Q3 25 Q1 26 Q3 26 Q1 27 Q3 27 Q1 28 Q3 28 Q1 29 Q3 29 Q1 21 Q3 21 Q1 211 Q3 211 Q1 212 Q3 211 Q4 211 Q1 212 Non-financial companies (LHS) Households (LHS) Financing capacity (RHS) Source: NBH General government (LHS) Rest of the world (LHS) Periscope October 212 8

9 Banking sector s credit supply The banks lending willingness is expected to grow, but this can go hand in hand with more careful client selection The lending capacity of Hungarian financial institutions is reduced by the decreasing amount of domestic deposits and total direct foreign liabilities in H1 212, while the lending willingness has been blocked by the still high but falling loan-to-deposit rate and the increase in NPL rate (Charts 1-2). In contrast to the aforementioned facts the relative majority of the Hungarian banks plan to expand their lending activity in 212, but the expected tightening in lending conditions indicates that the financial institutions will select their partners carefully (Charts 3-4). The price of HUF loans was influenced positively in August by the improved global investment climate and the 25 bs base rate cut at the end of the month. The average interest rate on 1 to 5 year corporate loans decreased from 1.3 in July to 1.2 in August, while the interest rates on credits with longer term sank from 1.13% to 1.. In spite of the moderate fall in interest rates on corporate loans the interest rates are still the highest in Hungary after Romania among the Central Eastern European countries, which fact weakens the competitiveness of the Hungarian companies (Charts 5-6). Chart 1: Domestic deposits and total direct foreign liabilities of Hungarian credit institutions* Chart 2: The loan-to-deposit ratio and the proportion of non-performing loans HUF billion Domestic deposits Total direct foreign liabilities *without MFB, EXIM, KELER Source: Hungarian Financial Supervisory Authority HUF billion % , Loan-to-deposit ratio (LHS) 144, Chart 3: Estimation of change in the credit supply in the following 6 months according to the Hungarian credit institutions* Chart 4: Planned changes in credit standards* by the size of the borrower 1 * net change indicator, positive: increase Source: NBH lending survey 6 * net change indicator, positive: tightening Source: NBH lending survey Large and medium corporations Small and micro enterprises -4 Large and medium corporations Small and micro enterprises Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q Q2 211 Q3 211 Q4 211 Q1 212 Q1 29 Q2 29 Q3 29 Q4 29 Q1 21 Q2 21 Q3 21 Q4 21 Q1 211 Q2 211 Q3 211 Q4 211 Q1 212 NPL rate (RHS) Source:Hungarian Financial Supervisory Authority Chart 5: Interbank interest rates*, and interest rates on corporate loans** Chart 6: Interest rates on corporate loans* in Central and Eastern European countries Sources: ECB, NBH * 3-month interbank rates ** annualised interest rates weighted by month-end values BUBOR EURIBOR HUF loans - over 5 years HUF loans years EUR loans in Hungary - over 5 years EUR loans in Hungary years Sources: ECB, NBH * annualised interest rates over 5 year maturity, weighted by month-end values, in national currency Hungary Czech Republic Poland Slovakia Bulgaria Romania Periscope October 212 9

10 Consumption and employment Employment growth driven by the public work programs only smoothed the decline in the consumption The Hungarian consumer confidence has slightly improved since May, but remained the file-closer in the region (Chart 1-2). The retail trade volume shows set-back since April 212, the rate of decrease was 2. in July on a yearly basis, while. on monthly comparison (Chart 3). The decrease of unemployment rate to 1.4 % in June-August 212 and growth of employment only smoothed the rate of decline in retail trade. The number of employed people rose by 75.5 and 77.4 thousands in July and August compared to a one year earlier data (Chart 4), nevertheless the weak consumption data in Q2 (-1. y/y) can be explained by the fact that the 71. of new workplaces created within the last 12 months linked to the public work program. In the second quarter of 212 employment increased mainly in the public administration and agriculture due to the public work program, and in the vehicle industry owing to the accelerating automobile industry production, while in the construction sector lay-offs continued (Chart 5). According to the employment plans of domestic firms with unchanged economic outlook, further dismissals can be expected (Chart 6). Chart 1: Sentiment indicators and economic prospects in Hungary Source: GKI Consumer confidence Economic prospect Business sentiment Chart 3: Retail trade volume in Hungary Chart 2: Consumer confidence* in Visegrád countries * seasonally adjusted data Source: European Commission Poland Czech Republic Slovakia Hungary Chart 4: Changes in economically active population* and the unemployment rate % 1% 1 1-1% - -3% Month/month (LHS) -1 Year/Year (RHS) thousand % 1 Changes in number of employed persons (LHS) Changes in number of unemployed persons (LHS) * employed people and Unemployment rate (RHS) registered job-seekers together thousand persons Chart 5: Number of employed persons by certain industries Agriculture Manufacturing Manuf. of food products Manuf. of metals Manuf. of computers Q2 212 / Q2 211 (LHS) Manuf. of transport equipment Construction Whole sale and retail trade Transport, storage Balance* (RHS) * compared to Q1 28 Accommodation, food service Financial services Public administration Education, health, social work TOTAL thousand persons Source: HCSO Chart 6: Employment expectations and number of employed persons in the manufacturing sector Source: European Commission, HCSO Employment expectations: 5 months adv Employment in manufacturing (y/y, RHS) thousand persons Employment expectations (LHS) Periscope October 212 1

11 Inflation Tax changes at the start of 212 keep the inflation rate high until the end of the year in Hungary The effect of the slowing word economy could be detected in the commodity prices as well: in September the price of Brent crude oil and CRB commodity and foodstuff indices were close to stagnation (Chart 1). However, from July to August the Chinese, the US and the eurozone inflation rate accelerated (Chart 2). While the Hungarian consumer price index rose from 5.8 to 6., in the other Central Eastern European economies the annual rate of inflation varied between 3 and (Chart 3). In the Hungarian economy the higher inflation is basically a consequence of the VAT hike in January 212 (Chart 4), while the rise in the inflation rate in August was mainly due to 3. increase in oil prices (on monthly comparison) (Chart 5). Despite of the significant decrease in wages at the end of last year, the outflows of wages accelerated in the Hungarian economy, and both net earnings and net real earnings started to rise (Chart 6). Chart 1: Commodity price indices and world crude oil price Chart 2: Consumer price index (y-o-y) in the eurozone, the USA and China , 1, , 7, Source: Reuters CRB commodity price index (LHS) CRB foodstuff price index (LHS) Brent Crude Oil (RHS) $/barrel 5, 2,, -2, Source: Reuters China Eurozone USA 5, 2,, -2, Chart 3: 12-month inflation rate* in CEE Chart 4: Impact of changes in tax rates on comsumer prices 1 3% 1% -1% % 1% -1% Hungary Poland Czech Republic Slovakia Romania Source: Eurostat * harmonised index of consumer prices. Chart 6: Monthly changes of consumer prices by the main groups of products and services 1 Source: NBH Constant tax rate index Consumer price index Core inflation Chart 6: Wages (y/y) in Hungary 1 3. Fuel -2.. Alcohol, tobacco.. Regulated goods & services -.1%.1% Market services.. Industrial products. -1. Market energy Foods -..1% Source: CPI (m/m) -.1% NBH August July , MFB Net wages* Net real wages* Gross wages** * excluding family tax benefits ** gross earnings without premiums and one month bonuses Periscope October

12 Exchange rates The movement of HUF/EUR exchange rate had no direction in September In contrast to the relatively strong global risk appetite in September the forint showed a poor performance mainly as a consequence of country specific factors. The NBH cut the base interest rate in both August and September by 25 bp, the expectations of Hungarian economic actors for recession strengthened and the decrease of Hungarian country risk premium ceased in September (Charts 1-3). The Hungarian currency depreciated by. against the euro, at the end of the previous month the exchange rate was HUF/EUR. However, the forint strengthened by 2. and.3% against the American dollar and Swiss franc respectively as a result of increasing trust toward the common European currency (Chart 4). The exchange rates of the regional currencies moved in different directions in September. The Czech koruna and the Romanian leu lost their values by 1.2 and 1. respectively, while the Polish zloty appreciated by 1.7 (Chart 5). In spite of the different movement in September the HUF/EUR exchange rate correlated with the PLN/EUR to a relatively high level, but the synchrony between them fell to a 5-month low level (Chart 6) Chart 1: The HUF/EUR exchange rate and the global risk appetite* Hungarian sovereign debt is downgraded to junk status increasing risk appetite Sources: ECB, Reuters VIX index (LHS) HUF/EUR (RHS) the beginning of negotiations with EU and IMF * VIX stands for the volatility index of the S&P 5 and is often referred to as a global fear index basis point Chart 2: The forint to euro exchange rate and the 1-year CDS in Hungary Sources: ECB, Reuters year CDS premium (LHS) the beginning of negotiations with EU and IMF Hungarian sovereign debt is downgraded to junk status HUF/EUR (RHS) Chart 3: The HUF/EUR exchange rate and the economic sentiment index (ESI) in Hungary Chart 4: The exchange rate of the forint against the Swiss franc, the US dollar and the euro HUF/EUR (monthly average, LHS) ESI (RHS) improving sentiment inverted scale weakening forint Source: ECB Sources: ECB, European Commission HUF/EUR (LHS) HUF/USD (RHS) HUF/CHF (RHS) Chart 5: The exchange rates of Central and Eastern European currencies against the euro Chart 6: The exchange rate of the forint and the zloty against the euro 11 1 strengthening against the euro * =1 Source: ECB strengthening against the euro 5,2 5, 4, , Source: ECB 4,4 4, CZK/EUR PLN/EUR HUF/EUR RON/EUR HUF/EUR (LHS) PLN/EUR (RHS) * grey period: Hungarian sovereign debt is downgraded to junk status 4, 3,8 Periscope October

13 General government and its financing The general government balance continued to improve as a result of rising income and decreasing expenditures In the first eight months of 212 the deficit of central budget was HUF billion (by HUF billion lower compared to the same period of the previous year). The expenditures fell behind by HUF billion and the revenues exceeded the previous year s data by HUF 66.6 billion. The declining deficit was due to the rising taxes imposed on consumption and especially an additional HUF billion VAT income, which was generated basically by the standard VAT rate hike in January. However, the corporate tax payments lagged behind compared to both the same period of the last year and the target which was a result of the lower than expected GDP growth (Table 1, Chart 1). The 5-year CDS spread has been dropped to around 36 basis points, which is a record low level that has not been seen since August 211 (Chart 2). Particularly the short end of the yield curve decreased as a consequence of the improved global investment environment and the central bank base rate cut, the yields on 3 and 6 months discount treasury bills fell by 41 and 25 bp respectively (Chart 3). However, the average yield on 1-year bonds decreased by only 1 bp, and the reference yield in the end of the month (7.2) has continued to be still high compared to the regional average (Chart 4). Table 1: The revenues of the central government and the social security funds by main groups thousand billion HUF CENTRAL GOVERNMENT Taxes imposed on corporations Corporate income tax Simplified entrepreneurial tax Special taxes on banks and branches Taxes imposed on consumption total income (estimation) January - August % of yearly revenues yearly revenue target January - August % of yearly revenue target % % % % % % Value added tax % Excise tax % Taxes imposed on households Personal income tax Social contributions (Pension Fund) Social contributions (Health Care Fund) Source: NGM , 11, 1, 1, 9, 9, 8, 8, 7, 7, 6, 6, Chart 1: Revenues and expenditures of central budget in Januray - August period (billion HUF) Chart 2: Yields on 5-year Hungarian government bonds and the 5-year CDS spread Sources: Reuters, Government Debt Management Agency Payment of economic organizations Taxes in consumption Payment of housholds Central budgetary institutions Other revenues Family benefits, social subsidies Payments of central budgetary institutions Transfers to gen. gov. subsystems Debt service Other expenditures Balance of central budget value of balance Yields on 5-year Hungarian government bonds (LHS) 5-year CDS spread (RHS) basis point 11, 1, 1, 9, 9, 8, 8, 7, 7, 6, 6, 5, Chart 3: Reference yields on Hungarian government securites Source: Government Debt Management Agency , 1, 1, 9, 9, 8, 8, 7, 7, 6, 6, 5, 3-month 6-month 12-month 5-year 1-year 11% 1 3% 1% Chart 4: Yields on 1-year government bonds Source: Reuters Hungary Romania Poland Czech Republic Periscope October