No. 49, Gábor Oblath (1997): Capital inflows to Hungary in 1995-1996, composition, effects and policy responses

Hungary has had a long history of drawing on foreign capital to finance current account deficits. However, its experience with significant capital inflows accompanied by significant strengthening of the current account is rather recent. This paper attempts to analyse and explain this experience.A steady inflow of private foreign capital and an accompanying improvement on the current account – the two main features of Hungarian balance-of-payments developments since March 1995 – are the main topic of this paper. We focus on developments in the period 1995-96, and review the composition and characteristics of, as well as the policy responses to, net capital flows into the country. The earlier history of capital flows, that is, the accumulation of foreign public debt during the socialist era, is not covered in this paper and developments in the period 1990-94 are discussed only briefly. This paper focuses on the sectoral decomposition of net capital inflows and their implications for central bank intervention, as well as on the policies aimed at dealing with the consequences of conventional or “domestic” capital inflows. Our approach does not permit the direct analysis of behavioural relationships, since our framework attempts to explain why and how the effects of net capital flows to and from various sectors differ. Moreover, we only touch upon the real effects of capital inflows (e.g., on capital accumulation). We also neglect several important questions regarding the relationship between capital inflows and the policy responses to them; some of these (e.g. the effects of sterilization on inflows) are addressed by other authors. We make no attempt to review the extensive international literature on capital inflows, or to make direct comparisons between Hungary and other countries experiencing surges in net capital inflows. However, there is an implicit comparison in our treatment of the topic: our approach is mean to reveal the unconventional features of recent capital inflows (and related problems) in Hungary. The next section provides background for the discussion of the remainder of the paper: we discuss foreign capital flows to and from Hungary over 1990-94, and present the main features and implications of the March 1995 stabilization program. This is followed by a brief presentation of a conceptual framework for analysing developments related to capital inflows and separating out their sectoral components. The fourth section applies this framework to recent capital inflows to Hungary, it also contains a discussion of some relevant problems in interpreting official statistics. The fifth section reviews Hungary’s experience with sterilized intervention and the costs and effectiveness of sterilization. Finally we review some other policy responses to foreign and domestic capital inflows, touch upon the situation in 1997 and draw some conclusions.

Project leader:
Gábor Oblath