1. General Policy Framework

Hungary's first democratic government in over 40 years took office in May 1990. Its ambitious four-year reform program seeks to replace central planning with private ownership and free markets. Hungary's receptive investment climate has attracted over half of all foreign investment in Eastern Europe, led by the United States with $800-850 million by late 1991 (of some $2 billion total). Hungary is also incorporating Western practices and business safeguards into its legal code.

The short-term result of this reform is a sharp recession. Unemployment could hit 370,000-400,000 (8 percent) by the end of 1991. Inflation for 1991 will be around 37 percent, fueled by subsidy cuts, freer prices and higher state prices. GDP for 1991 will drop 6-8 percent over 1990, industrial output 10-14 percent, and consumption 6-7 percent. Eastern export markets in the former Council for Mutual Economic Assistance (CMEA or COMECON) have collapsed following the change to hard currency payments and world market prices on January 1, 1991 although an aggressive drive to shift to Western markets raised hard currency trade above 70 percent of Hungary's total in 1990. An association agreement with the EC and a free trade agreement with the European Free Trade Association (EFTA) should go into effect in early 1992, though Hungary will still face barriers in Western markets hindering its export efforts.

Despite the short-term hardships, the commitment to marketization is already yielding positive results. Inflation is cooling rapidly. The small private sector, still omitted from official statistics, is booming, raising actual GDP and generating new jobs to cushion unemployment. There were 15,000 new private firms created in 1990 and over 12,000 more in the first half of 1991. Hungary's firm commitment to repaying its heavy foreign debt ($21 billion) has preserved its access to Western capital markets and buoyed foreign investors' confidence. By mid-1991 there were some 7,000 joint ventures in Hungary, up from only 200 in 1988.

Most economists do not expect Hungary's economy to start turning upward until late 1992 at the earliest. Meanwhile, the Government is pressing forward with its reform program. Monetary policy has been tightened, though financial discipline still is not strictly imposed on banks and enterprises. Subsidies will be cut from 9.6 percent of GDP in 1990 to 4 percent in 1993. Liberalization of imports and the abolition of the state monopoly on foreign trade have resulted in 30,000 firms and individuals engaged in foreign trade in mid-1991. Average import duties have been cut from 50 to 17 percent in two years, and should fall to 8 percent upon conclusion of the GATT Uruguay Round. Hungary aims to lower state ownership of firms from 90 percent in 1990 to under 50 percent by 1994, although privatization is going more slowly than hoped and officials are searching for ways to speed the process. Privatization of Hungary's commercial banks is slated to begin in the fall of 1991.

2. Exchange Rate Policies

The Government expects the forint (Ft) to be freely convertible by 1994, a goal which might be achieved as early as 1992 if the successful buildup of reserves continues. Hungarian officials see convertibility as a product of economic transformation, not a precondition for it. Among other things, reserves should rise to $3-3.5 billion (from $2.7 billion in October 1991), and inflation fall to around 15 percent from some 37 percent in 1991.

Internal convertibility has already been introduced: Hungarian firms may hold hard currency accounts and convert forint profits (but not take out loans) to buy hard currency imports. Importers of all goods must put the forint value of each import transaction in a blocked bank account. Companies may repatriate hard currency profits. Joint ventures must open a forint-denominated business account at a Hungarian bank (which may be a joint venture bank, but not an offshore one). Hard currency proceeds of a joint venture must be returned to Hungary and held in forints in the company's commercial account; this exposes such firms to inflation and devaluation risks. Hard currency imports by a joint venture are subject to prior approval from the Ministry for International Economic Relations (NGKM), though this is virtually automatic for liberalized products accounting for 93 percent of imports. Commercial banks may now trade among themselves in hard currency instead of through the central bank.

The forint is pegged to a basket of 11 currencies, weighted according to the currency composition of Hungary's foreign trade turnover in convertible currencies. The forint is depreciating against this basket due to the large inflation differential between Hungary and its Western trading partners. The National Bank can adjust the exchange rate by up to five percent without asking the government for a formal devaluation. Hungary devalued the forint by 15 percent in January 1991, and 5.8 percent in November 1991. The differential between the official and black market rates has narrowed to under 10 percent. However, falling trade competitiveness may make devaluation inevitable by the end of 1991. On January 1, 1991 the transferable ruble was replaced by hard currency accounting for all transactions among former CMEA trading partners.

3. Structural Policies

Hungary has had value added (VAT) and personal income taxes since 1988. A draft tax law is presently under debate within the government in preparation for its submission to Parliament. The Ministry of Finance has announced that tax concessions for foreigners working in Hungary, eliminated in an early draft of the law, will remain intact in 1992. The basic business profit rate is 40 percent, but joint ventures with capital of over Ft 50 million (about $660,000), over 30 percent foreign participation, and at least half of revenues from manufacturing or hotel construction and management are eligible for tax reductions of 60 and 40 percent in their first and second five years of operation. These rise to 100 and 60 percent for priority export sectors, including telecommunications, tourism, agriculture and food processing, machinery and machine tools, pharmaceuticals, electronics and vehicle components. Profits reinvested into either the original firm or another existing or new Hungarian company receive a tax allowance. A January 1991 amendment to the 1988 Investment Act maintains generous tax benefits for foreign ventures. New depreciation allowances in January 1992 should reduce the tax burden on enterprises. The United States has a bilateral tax treaty with Hungary.

Pricing policies: Since January 1991, over 90 percent of producer and consumer prices have been set by the market, up from 77 percent a year before. Price controls remain (with no distinction between domestic and foreign goods) on telecommunications, postage, milk and dairy products, transport, school textbooks, white bread, medicines and water. The Ministry of Agriculture can set minimum prices for wheat, maize, cattle and pigs for slaughter. Advance notice of price increases is required for printing paper, red pepper grist, sunflower oil and margarine. The Government can prohibit price increases by companies with a dominant market position.

Regulatory Policies: Controls requiring licensing are in place for trading in arms and radioactive and nuclear materials, as well as sensitive dual-use technology.

4. Debt Management Policies

Hungary has the heaviest per capita debt burden of Eastern Europe, seriously constraining privatization and new company formation. Gross foreign debt at the end of 1990 was $21 billion, an estimated 65 percent of GDP and about 200 percent of projected 1991 hard currency exports. The 1991 debt service ratio is estimated to be 40 percent of hard currency earnings. Annual debt service payments will be $3.5-4.2 billion through 1995. German and Japanese banks hold most of Hungary's debt; U.S. banks hold under $250 million.

However, four-fifths of Hungary's external debt is in medium- and long-term loans. Hungary's prompt repayment record and its firm refusal to request debt rescheduling or debt relief have given international investors much greater confidence in Hungary than the size of the debt suggests. In May 1990, agreement was reached with the IMF on a standby loan to help Hungary continue servicing its debt. In February 1991, Hungary signed a three-year standby credit agreement with the IMF, which requires that Hungary's 1991 current account and domestic deficits not exceed $1.2 billion and Ft 78 billion, respectively. The current account deficit will probably be only $200-300 million, while the domestic deficit is expected to be near Ft 90 billion.

5. Significant Barriers to U.S. Exports

Import licensing: Imports have been greatly liberalized to spur domestic competition and let profitable firms obtain materials needed to restructure or produce exports. As of January 1991, over 93 percent of imported goods require no import license, the main exceptions (on a "positive list") being energy and fuels, precious metals, military goods, certain pharmaceuticals, textiles, leather goods, some chemicals and mineral products, food products and telecommunications equipment. Import licenses are not needed when a joint venture imports goods using hard currency contributed by a foreign partner to the venture's incorporation capital. A global quota on consumer goods, maintained for balance of payments reasons, totals $650 million in 1991. NGKM may set quota ceilings for individual product groups, importers and countries, but quotas have remained unfilled and NGKM has issued licenses on request. An import license may be denied on grounds of national security, compliance with international obligations or to ensure the supply of basic necessities. As of January 1991, general licenses are no longer issued, and all license applications must by law be processed in 15 days. Licenses are normally valid for 12 months. All licensing requirements are slated to be abolished by 1992.

Standards, testing, labelling and certification: Hungary is a signatory to the GATT Agreement on Technical Barriers to Trade (Standards Code). National standards, which are in conformity with international norms, are issued by the Hungarian Standardization Office. They are binding and supercede any sectoral standards issued by ministries or other government agencies. The main labelling requirement is that basic data be indicated in Hungarian; there are some specific rules for products containing alcohol or vitamins, cosmetics, and human and animal pharmaceuticals. New consumer goods, including imports, can only be introduced into Hungary if they meet national health, safety and consumer protection regulations. Domestic and foreign pharmaceuticals must be registered with the National Hungarian Institute for Pharmacy (OGYI), after which an approval for merchandising must be requested from the Ministry of Health. Veterinary drugs, also subject to registration, can only be imported by designated importers. Imports of animals and animal products require a veterinary permission from the Ministry of Agriculture.

Investment barriers: Because of the importance of foreign capital in Hungary's restructuring plans, neither investments nor services are subject to major restrictions. Poor telecommunications and transport infrastructure and unsettled housing and real estate markets are the main barriers to U.S. investment. Foreign investments currently enjoy more favorable tax treatment than domestic investments and are released from some central regulations. Joint ventures are guaranteed national treatment and protection against expropriation. There have been no cases of seizure of foreign assets in Hungary since the early 1950's, and in 1973 Hungary settled all outstanding debts for U.S. assets expropriated in the early days of Communist rule. In the area of services, foreign banks, airlines and other businesses may operate freely in Hungary, although banks continue to need special licenses and cannot be licensed for all banking activities. A 100 percent foreign-owned company is not permitted in insurance. The 1990 securities law lets foreign firms participate in stock and bond markets. Representation and service offices no longer need official permission to open, and now simply register their establishment as does any Hungarian company. A foreign-owned company may acquire any type of real estate as an in-kind contribution from a Hungarian partner, or buy it after the company is established. Acquired property can be mortgaged, leased, sold, or developed in accordance with relevant zoning and building codes. In practice, however, the lack of well-defined property rights complicates property acquisition by such companies. Property may not be acquired for speculative purposes.

Customs procedures: Although customs laws themselves pose no significant barriers, local U.S. businesses have complained that customs officials' ignorance of regulations and lack of convenient customs facilities sometimes hinder business. Another barrier to increased U.S. exports is Hungarian firms' hesitancy to disrupt their strong ties with West European suppliers. Many U.S. firms also prefer to source Hungarian orders from West European subsidiaries.

Government procurement practices: The Hungarian government discourages countertrade, but lets individual companies decide whether to conduct it. The phase-out of import licensing has resulted in a drop in countertrade. There are no specific legal provisions for government procurement, and Hungary does not apply any local content requirements.

As of January 1, 1991 Hungary has adopted safeguard measures based on its GATT accession protocol; these allow one-year safeguard actions to be taken if any product is being imported into Hungary in such increased quantities or under such conditions as to cause or threaten serious injury to domestic producers of like or directly competitive products. Hungary has signed, and incorporated into its legal system, the GATT Antidumping Code. To date, Hungary has not taken antidumping actions, although it is reportedly considering antidumping measures against "unfair competition" from subsidized cement producers in other parts of Eastern Europe.

6. Export Subsidies Policies

Hungary is not a signatory to the GATT Subsidies Code. In 1980, Hungary declared that, except in agriculture, it did not provide any export subsidies. In 1988, a value added tax was introduced which is refunded on exports. The Export Development Program (EDP) was established in 1985 to spur exports to hard currency markets, particularly in engineering, chemicals, food, metallurgy and light industry. EDP expenditures in 1990 were an estimated Ft 8 billion. Hungary also offers export credit insurance to cover economic, political and exchange rate risks. A Trade Promotion Fund (TPF) also supports hard currency exports with loans (to 75 percent of incurred costs) or grants (to 50 percent). The TPF received Ft 4.2 billion in 1990. The General Intervention Fund (GIF) has been used to support agricultural exports and ensure the supply of basic foodstuffs, but its export support function has been cut back; its 1991 budget is only Ft 700 million.

In March 1991, Hungary set up an Investment Promotion Fund for infrastructure development, with an initial 1991 capital of Ft 1.5 billion. Joint ventures can receive grants or low-interest loans if their initial or share capital exceeds Ft 50 million, foreign participation is over 30 percent and at least half the foreign contribution is in cash in hard currency.

7. Protection of U.S. Intellectual Property

Hungary provides protection for a wide variety of intellectual property rights including patents, trademarks, copyrights, and inventions. It is a member of the Paris Convention for the Protection of Industrial Property, the Berne Convention for the Protection of Literary and Artistic Works, and the Madrid Agreement Concerning the International Registration of Trademarks. A draft law under discussion will protect integrated circuit layout designs.

Hungary's patent protection is far from adequate. The existing patent law only protects the process by which chemical compounds are produced, not the product itself. Based on this, the Hungarian pharmaceutical sector has developed into a major industry by inventing new processes to make drugs developed outside of Hungary, then producing them for both the local market and for export. The result has been a number of disputes between Hungarian pharmaceutical firms, who have one percent of world trade, and manufacturers in other countries, including the United States. Pharmaceuticals are a key export for Hungary, earning up to $80 million in export revenues annually. The Hungarian pharmaceuticals industry has successfully blocked the government's efforts to bring Hungary's patent laws into line with those of the United States and the EC. The United States and Hungary are negotiating a business and economic treaty in which IPR issues are a central issue.

8. Worker Rights

a. Right of Association

Legislation passed in 1989 recognizes the right to organize, establishing the possibility of trade union pluralism. Excluding judicial and military personnel and the police, workers have the right to associate freely, choose representatives, publish journals, openly promote members' interests and views, and go on strike. A number of competing trade union formations have emerged. The 1989 legislation guaranteed workers the right to call strikes to defend their economic and social interests, but strike to defend their economic and social interests, but strike action has been limited and more often directed against government policies rather than employers.

b. Right to Organize and Bargain Collectively

The right to bargain collectively exists in law, although in practice wages have been excluded and are centrally negotiated in a tripartite macroeconomic policy body to control the rate of inflation. The right to bargain collectively was established in a 1969 law, which was amended in 1989 to allow collective bargaining at the enterprise and industry level. The Ministry of Labor is responsible for drafting labor-related legislation, while special labor courts enforce labor laws. the decisions of these courts may be appealed to the civil court system. Under the new legislation passed in July, employers are prohibited from discriminating against unions and their organizers. It is too soon to judge the effectiveness of this legislation. There are no export processing zones.

c. Prohibition of Forced or Compulsory Labor

Forced or compulsory labor is prohibited by law, which is enforced by the Ministry of Labor.

d. Minimum Age for Employment of Children

Labor courts enforce the minimum employment age of 16 years, with exceptions for apprentice programs, which may begin at 15. There does not appear to be any significant abuse of this statute.

e. Acceptable Conditions of Work

The legal minimum wage is established by the Interest Reconciliation Council (IRC) and subsequently implemented by Ministry of Labor decree. The average official workweek varies between 40 and 42 hours, depending upon the nature of the industry. The amended Labor Code of 1967 sets the workweek at 42 hours, but this varies slightly in some industries. Under existing law, workers receive overtime, a minimum of 15 days' paid leave per year, free health care, maternity leave, and pensions. Labor courts and the Ministry of Labor enforce occupational safety standards set by the Government, but specific safety conditions are not always up to internationally accepted standards.

f. Labor Conditions in Sectors with U.S. Investment

Labor conditions in sectors with U.S. investment do not differ significantly from those in Hungarian firms.

Source: National Trade Data Bank, Agency: U.S. Department of State