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Hungary risk: Foreign trade & payments risk
(RiskWire Via Thomson Dialog NewsEdge) COUNTRY BRIEFING
FROM THE ECONOMIST INTELLIGENCE UNIT
RISK RATINGSCurrentCurrentPreviousPreviousRatingScoreRatingScoreOverall assessmentB30B30Foreign trade & payments riskB21B21Note: E=most risky; 100=most risky.SUMMARY
Despite large current-account deficits, foreign trade and payments risk is quite low. Hungary places almost no restrictions on trade and capital account transactions. As of May 2004 tariffs are fully in line with those of the EU, and thus are generally low on such items as raw materials, machine goods and equipment, although agricultural tariffs remain high. Almost all forms of quota protection have been eliminated and converted to more transparent tariffs under World Trade Organisation (WTO) rules. Customs-clearance and statistical fees have been eliminated for all countries. Only minimal capital controls remain. With EU membership locking in most reforms, the risk is minimal that Hungary would be able to implement trade restrictions, outside of those implemented on an EU-wide basis. The danger of a trade embargo against Hungary is also very low. Risks now are mainly related to potential EU-US trade disagreements and the higher tariffs that Hungary must levy on some imports from suppliers outside of the EU.
SCENARIOS
A balance-of-payments crisis leads to forint devaluation and hits demand for imports (Moderate Risk)
Given favourable access to global capital markets, the risk of a balance of payments crisis is low. But external capital markets have been unreliable at times of international financial crisis and have closed to emerging markets issuance in the past. If such an external crisis coincided with a period of financial instability in Hungary a payments crisis could result. The Hungarian authorities would probably choose to see the forint devalue rather than impose capital controls to restore balance. Importers would thus face falling demand for their goods in Hungarian markets. Foreign investors should monitor economic developments with care, stepping up their scrutiny should current-account deficits fail to come down from their current highs. Importers and exporters alike should explore proper hedging strategies.
Possible abandonment of the currency band leads to a payments crisis for corporates and individuals (Low Risk)
Bolstered by high global liquidity and risk appetite, the forint traded at around Ft245-255:1 between January and early August. However, turbulence on financial markets arising from concerns over the US sub-prime mortgage market drove the forint down to about Ft261:1 by mid-August, and it has continued to fluctuate around Ft254-259:1 since then. The forint is likely to remain volatile over the coming months, owing to market turbulence and continued uncertainty regarding progress on fiscal reform. If the government demonstrates tangible commitment to continued reduction of Hungary's fiscal deficit, the currency will strengthen against the euro over the forecast period, particularly as growth picks up. However, if the budget deficit strays far from its targets over the forecast period, the forint could fall sharply. Foreign businesses should know that some of their suppliers and clients have been borrowing, often unhedged, in euro and could be facing insolvency problems in the medium term.
BACKGROUND
(Updated: September 21st, 2007)
Tariffs
The Customs Act (Act CXXVI of 2003) sets out the basic EU policies on which customs tariffs are decided. Government Decree 110/2004 regulates customs procedures and determines different product groups subject to licences. Most goods must be classified according to the Combined Nomenclature (CN), which is based on the Harmonised Description of Goods and Coding System. The Integrated Tariff of the Community (Tarif integre de la communauteTARIC) is an electronic database, accessible through the Internet, that presents all third-country and preferential duty rates applicable and all commercial policy measures. In EU vernacular, the tariff refers not only to the nomenclature and duty rates, but also to all other community legislation that affects the level of customs duty payable on a particular import, such as country of origin. The VPOP operates the Hungarian version of TARIC; it includes information on tariff suspensions, tariff quotas, preferential treatment, anti-dumping and countervailing duties, import prohibitions and restrictions, quantitative limits, export surveillance, licences andcertificates.
Although most customs duties are charged on the value of goods, many agricultural products are also subject to specific duties based on weight or quantity, under the EUs Common Agricultural Policy (CAP). A few products are subject to mixed duties, which consist of value-based and specific duties. The actual type of applicable duties depends on the classification of the different products or goods. At Hungarys accession to the EU, the average tariff level in Hungary was reduced to 3.6% (from 6.9%), according to the Ministry of Finance. The adoption of EU customs rules resulted in the drop of tariffs for an estimated 5,500 products, whereas tariffs increased for about 1,600 goods. The average value-added tariff on goods was 4.2% in 2005, resulting from 5.9% tariffs on agricultural goods and 4% tariffs on other goods. In addition, non-value-added tariffs made up 5.9% of the total.
Tariff preferences are based on the origin of products. Non-preferential rules of origin apply when no tariff preferences are involved, and when other trade measures (such as anti-dumping duties or trade embargoes) specify a particular non-tariff treatment for goods from a given country. Preferential rules of origin apply in most free-trade agreements and bilateral customs unions between the EU and third countries. But origin marking should not be confused with rules of origin: there are no EU requirements for goods to bear marks indicating their origin, nor is there anything to prevent voluntary origin marking where traders wish to do so.
As with other EU member countries, firms operating in Hungary may apply for autonomously granted customs contingencies (usually bearing a duty of 0%) to import several industrial, agricultural and fishery products from third countries, up to a quantitative limit. Most are unprocessed food items, semi-finished industrial goods and raw materials. The list of these products is determined by legislation (EC 2285/2003) and is available from the foreign ministry in Hungary.
Companies may also apply for several types of customs-duty relief. Part of the customs duty is waived for goods that were temporarily exported to a non-EU country for processing and then re-exported to the EU. Non-EU goods imported to Hungary for processing and re-export may also be free of customs duties and value-added tax if they leave Hungary within the period determined by the customs authority.
Hungary is a signatory to the ATA Convention on Temporary Imports and Exports, and it accepts ATA carnets (permits). The holders of these carnets may import goods to Hungary on a temporary basis and be totally exempt from customs duties if the products are professional equipment, commercial samples or are used and displayed at exhibitions and fairs. Carnets are valid for one year, and the regional chambers of commerce issue them in Hungary.
Value-added tax (VAT) also applies on imports, usually at the standard VAT rate of 20%. Hungary also has a preferential rate of 15%, but this rises to 20% on September 1st 2006. VAT on a handful of product groups, most importantly pharmaceuticals, is 5%. But sales transactions between Hungary and other EU members are considered intra-community acquisitions or supplies, in which the taxpayer may issue an invoice to its EU-based buyer without charging VAT if it has proof that the goods left Hungary. The buyer then settles the VAT payment. Since May 1st 2004 non-EU taxpayers supplying services or products to Hungary must use a financial representative for their Hungarian VAT transactions.
Hungary has simplified the execution of triangular transactions, in which the Hungarian intermediary does not have to charge VAT on goods resold to a third EU-based party since the transaction qualifies as an intra-community supply in Hungary. From January 2005, however, this rule does not apply to triangular transactions if the intermediary is registered for VAT in Hungary.
Since May 1st 2004 VAT on imports has been filed through self-assessment, and firms preparing their own VAT returns could reclaim VAT in the same return. But since July 1st 2005 companies may no longer determine their VAT liabilities by self-assessment unless they hold a permit from the customs authorities. As a result, input VAT can be reclaimed only with a delay.
Non-Tariff Barriers
Following Hungarys accession to the EU on May 1st 2004, several goods traded by Hungarian enterprises require an import licence and can be traded according to certain quantitative quotas. Under EU decree 1291/200/EC and complementary Hungarian regulations, the following agricultural products require import licences: pork, beef, calf, sheep, goat, poultry, eggs, milk and dairy products, fresh and processed fruits (such as bananas or tangerines) and vegetables (such as garlic), sugar, oil and fat, seeds and grains, flowers, wine and ethyl alcohol. Companies can import these products only up to certain limits or quotas, which are determined by the EU. Under Government Decree 135 of 2004, a prior deposit is required to import most agricultural goods. No licences are required to import milk and dairy products up to 150 kilograms, seeds up to 100 kgs, meat products up to 100 kgs or 200 kgs (depending on the type of product), sugar up to 2,000 kgs, fruits and vegetables up to 350 kgs, grains up to 1,000 kgs or 5,000 kgs and wine up to 30 hectolitres.
For market-protection purposes, Hungary restricts the import of metallurgy and steel products through (1) prior licence requirements for imports from all third (non-EU) countries; (2) double licence requirements (a licence is needed from both the sending country and Hungary) without quantitative limits for imports from Russia, Romania and Macedonia; and (3) double licence requirements with quantitative limits for imports from Russia, Kazakhstan and Ukraine. The import of textile and clothing products also is subject to strict regulations and is restricted under five different procedures. In the most stringent category, Hungary requires double licences and limits imports from Argentina, Bangladesh, Belarus, China, India, Russia and South Korea, among others. Non-textile industrial products, including Chinese shoes, porcelain and ceramics products and also Vietnamese shoes can be imported only up to the predefined quotas.
The import, export and transit of chemical materials that can be used for the illegal production of drugs and psychotropic materials is subject to licensing and strict documentation requirements in Hungary under Government Decree 87 of 2004. Companies trading with military and field engineering equipment, explosives and arms also must be licensed, according to Government Decrees 16 and 110 of 2004.
Documentation requirements are rather extensive. Detailed information should be provided on the importer and the goods by due expiration dates of certain quotas. There are no foreign-exchange restrictions and safety, health and labelling requirements are not onerous. Applications with the necessary attachments must be submitted to the recently created Hungarian Trade Licensing Office.
Payment Restrictions
Resident and non-resident companies and individuals may borrow from abroad without approval from the central bank, regardless of the maturity of the credit. Remittance of interest and principal is not restricted. There are no documentation requirements, and such remittances are at the prevailing exchange rate of the bank making or receiving the transfer.
Non-resident companies generally have equal access to credit on the local market. There are a few exceptions: special government credits to small businesses and loans extended by international financial organisations are usually available only to businesses registered in Hungary. Residents may grant loans to non-residents both in domestic and foreign currency. Foreign individuals may be able to obtain credit in Hungary if they hold a residence permit and have sufficient collateral, but there are few banks where such loans are available.
There is no withholding tax on interest paid to foreign organisations (either parent organisations or financial institutions). Interest payments received by domestic companies are part of taxable income and taxed at a corporate rate of 16%. Domestic individuals receiving interest remain subject to withholding tax, although the rate is now 0%. This will probably rise in 2006, and the government also plans to increase taxes on capital gains.
There are no restrictions on foreign exchange (forex) payments related to exports, and companies may keep their foreign currency in forex or forint accounts.
There are no restrictions on import payments, which are freely negotiated between parties. Resident companies may enter agreements with foreign companies on advance or deferred import payments. Export proceeds received in foreign currency are calculated in forints for accounting purposes using the valid exchange rate of the central bank.
Leading and lagging of payments are allowed for both imports and exports for both foreign and domestic firms.
Since Hungarys accession to the European Union, several goods traded by Hungarian enterprises require an import licence and can be traded only according to certain quantitative quotas. Importers and/or exporters are obliged to apply for a licence for the following products, under the relevant decree, as indicated:
pork, beef, calf, sheep, goat, poultry, eggs, milk and dairy products, fruits and vegetables, sugar, oil and fat, seeds and grains, flowers, wine and ethyl alcohol (Government Decree 29 of 2004)
weapons, military products, explosive and pyrotechnic products; security paper and cardboard products; environmentally protected products (such as ivory, tortoise shell and coral); radioactive materials (under Government Decree 110 of 2004);
meat products (exporting producers rather than exporters must be licensed under Ministry of Agriculture and Provincial Development/Ministry of Health, Social and Family Affairs Joint Decree 90 of 2003);
materials for forestry reproductive purposes (Ministry of Agriculture and Provincial Development Decree 110 of 2003); and
materials for growing wine grapes (Ministry of Agriculture and Provincial Development Decree 90 of 2004).Finance Ministry Decree 8 of 2004 contains detailed procedures for requesting permits for the export of products subject to excise tax.
Government Decree 142 of 2004 established the need for a licence to export or import chemical materials used for the production of certain drugs and psychotropic materials.
The list also includes other goods imported from third countries, for example China. Applications should go to the Hungarian Trade Licensing Office (Magyar Kereskedelmi Engedelyezesi Hivatal).
Risk of Trade Embargo
There is little, if any, danger of a trade embargo against Hungary.
Capital Flows and Foreign Debt
Hungary entered transition with the heaviest foreign debt burden in central Europe. The external debt declined in the early 1990s, but rose again with the dramatic increase in current-account deficits in 1993-94, to reach US$31.2bn (71% of GDP) at the end of 1995. Unlike Poland, Hungary did not default, and so did not secure a reduction or rescheduling from creditors. As a result, external debt was still more than 60% of GDP in 1998, compared with less than 44% for Poland and less than 10% for the Czech Republic. Falling interest rates and a growing domestic investor base allowed extensive repayment of foreign-currency with forint-denominated debt, with external debt levels remaining remarkably steady at around US$29bn in 1998-2001. As a result, debt/GDP ratios and debt servicing as a percentage of total exports declined markedly between 1995 and 2000. The burgeoning budget deficits from 2002, however, started driving up government borrowing and external debt. Gross external debt reached 59% of GDP by 2006.
Large current-account deficits have had to be financed increasingly by debt, although recovery in foreign direct investment (FDI) in 2004 and 2005 was a boon for financing. It is not just government debt that is financed by foreign investors, as a consumer credit boom based on foreign-currency lending has also been financed by Hungarian banks, borrowing heavily from foreign parent banks. Much of this borrowing is short-term in nature and makes for higher debt servicing. This boom in private borrowing is reflected in changes in the structure of medium- and long-term (MLT) debt. Until 2000 the major share of MLT debt was owed by the NBH and the government, but by 2005 non-guaranteed private debt has more than tripled.
Hungary has been one of the most accommodating countries in eastern Europe for foreign investors. Until the late 1990s, no other country had been as prepared to sell majority stakes in sensitive sectors, such as banking or energy, to foreign investors. The free repatriation of after-tax profit and capital is guaranteed. No industrial or service sectors are entirely off-limits to foreign investment, although foreigners are formally barred from buying farmland. Some sectors, such as defence, transport, pipelines, electric power and gambling, can be entered only under the terms of a specific licence or concession. Major investments in banking, securities trading and insurance are also subject to government approval.
After taking an early and commanding lead in FDI in the region in the mid-1990s, Hungary fell back late in the decade as investor attention turned to major privatisation drives in other countries. However, a change in NBH methodology in 2004 showed higher inflows of FDI than previously reported. FDI inflows in 2005 reached US$6.5bn, a value that was boosted by the purchase of 75-year operating rights for Budapest Airport by the UK-based BAA for 1.83bn (US$2.3bn), which set a new standard for airport valuations in Europe. In 2006 FDI slowed down, in part owing to uncertainty surrounding economic policy in an election year, and the introduction of austerity measures in the second half. Nevertheless, FDI inflows remained strong, at US$6.1bn. Apart from large deals, foreign investment is underpinned by a steady flow of smaller investments by medium-sized companies from Europe and elsewhere that are aiming to reduce costs but to retain most of the conveniences associated with doing business in Western markets. In all, FDI now relies mainly on reinvested earnings and greenfield and follow-on investments, rather than on privatisations. The total stock of FDI reached US$94.9bn in the third quarter of 2006.
Copyright 2007 Economist Intelligence Unit
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