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[December 15, 2005]
Hungary risk: Infrastructure risk (RiskWire)COUNTRY BRIEFING
FROM THE ECONOMIST INTELLIGENCE UNIT
RISK RATINGSCurrentCurrentPreviousPreviousRatingScoreRatingScoreOverall assessmentB26B26Infrastructure riskB28B28Note: E=most risky; 100=most risky.SUMMARY
Hungary is still far behind basic EU levels for infrastructure provision, which hampers some business activities. Physical infrastructure suffers from the neglect of the communist era, although significant gains have been made in the past decade especially in linking Hungary more firmly into the European road system. However, there is a long-term risk that the road system will become congested because of transport bottlenecks caused by floundering reform of the rail network and financial problems affecting the national airline, Malev. The national railway network is unreliable and reform of the railways is slow. The e-commerce sector is growing but is very small. The vast majority of electronic storefronts are not backed up with electronic-payment systems. Instead, they serve as order-processing platforms with payment then arranged through more conventional means.
Restructuring of the state railway (MAV) is delayed (High Risk)
The European Commission has called the restructuring of MAV an urgent task. A three-year cost-cutting and restructuring program is under way, aiming to cut annual operating costs by Ft47bn and staffing levels by 20%. The state faces tough choices to make MAV an efficient operator, especially as its possibilities for providing subsidies decline. Although the railways in Hungary have some problems, they are still a significant part of the transport picture, accounting for a 41% market share in commercial inter-urban transport and 29% in freight transport last year. Furthermore, unlike in the air sector, EU accession may mean more opportunities than threats for the state playerMAV is active in developing logistics centres in Hungary, which Western firms plan to use as distributing centres for the central European region. It is also working to bring in large contracts with Western retail chains to bring goods to Hungary, for which it has reasonable hope for success. As well as the potential for improving commercial opportunities in the EU, funds for investment are also set to flow more readily, given the EU's predilection for rail transportparticularly of freightas a viable alternative to roads. EU-supported investments will improve the quality of the main rail transport corridors, boosting the maximum speed of trains and reducing noise. Major investments are also needed to boost the proportion of dual tracks and electrified tracks, to boost the speed of the network. Companies should consider increasing their use of road transport, although they should be aware that many routes still involve local roads rather than motorways.
The state flag air carrier, Malev, is forced to declare bankruptcy (Moderate Risk)
One of the industries that saw the most drastic change with EU accession on May 1st 2004 was without a doubt air transport. The EU's "open skies" agreement came into force, immediately setting off a wave of flights on new budget carriers that had found it either too difficult or too expensive to serve the Hungarian market before. The new competition presents an immediate danger to the national carrier, Malev, and at the same time tight EU rules mean that Malev can no longer expect the steady diet of state subsidies and bailouts that have kept it aloft for years. Successive governments have known well that deep restructuring would be needed to save Malev in an era of competition, but all chose to postpone restructuring. In part, this is because the Hungarian authorities, like many others in Europe, did not recognise the growing power of no-frills carriers until it was too late. Malev went through changes of leadership at a remarkable rate, and the company was allowed to sink ever deeper into mismanagement and decay. Although the current government tried to implement a tough, last-minute restructuring programme on the eve of EU membership, success is still doubtful. A year of restructuring has begun to stabilise Malevrevenue was up in 2004, and the airline's load factor rose to above the European average. However, this may all be a case of too little, too late. Repeated attempts to privatise the airline so far have met with little investor interest. Businesses dependent on Malev should monitor the air carrier's financial health and the government's resolve in finding a solution. Businesses may want to make contingency plans, or start relying additionally on other carriers.
(Background material is updated twice yearly. Last update: July 27th, 2004)
Natural Resources and the Environment
Hungary has a land area of 93,030 sq km and a population in February 2001 of 10,198,315, which gives the country a population density of 109.6 per sq km, similar to that of France and Poland. The country is a low-lying plain divided roughly into three equal parts by two rivers running north-south, the more westerly Danube and the Tisza towards the east. The land is generally fertile, with about 70% suitable for agriculture. Hungary lacks extensive domestic energy resources and raw materials, except for bauxite.
There are three primary geographic regions. Transdanubia, the area lying west of the Danube, is a hilly region extending to the foothills of the Austrian Alps. It is primarily an agricultural area with crops, livestock and viticulture. The Great Plain (Nagy Alfold), lying east of the Danube and including the Tisza river basin, contains about half of the country and includes regions of fertile soil, sandy areas and wetlands. Drainage projects in the late 19th century curbed the traditional floods and opened the land for cultivation, although the flood problem has returned to the region in recent years. The northern hills run from north of Budapest to the north-east along the Slovak border. The countrys limited mineral deposits (and the Tokay wine region) are largely located in this area, which was the location for most of the heavy industries of the communist era.
There are a few moderately high ranges of mountains, but only 2% of the country reaches heights of 300 metres or more. The highest peak is Kekes at 1,014 metres. Lake Balaton in Transdanubia is the largest lake in central Europe, measuring 78 km in length and between 3 km and 14 km in width. The hills surrounding the lake are an important site of viticulture. Budapest and much of the remainder of the country have numerous thermal spas. The climate is subject to dramatic changes. Average daytime temperatures in Budapest range from minus 1-4C in January to 16-28C in July. There is a slight variation in the climate across the country, with the south slightly warmer and the north and east slightly cooler.
Transport, Communications and the Internet
Decades of underinvestment during the socialist period left rail, road and telephone systems dilapidated. The trend has been reversed since 1989 as significant inflows of international capital have been directed towards infrastructure. Public finance constraints, however, have led to the scaling-down or cancellation of some long-awaited projects.
Since the early 1990s upgrading of the motorway network has been one of Hungarys main infrastructure priorities, although only one motorway so far--that connecting Budapest to Vienna--has been extended to one of Hungarys borders. In 2000 the government approved a seven-year roadbuilding programme, involving the construction of 702km of roads, that was later extended to 15 years and expanded to include other infrastructure projects. The current government has vowed to continue its predecessors programme, with preference still being given to routes that form part of European transport corridors. With support from the European Bank for Reconstruction and Development (EBRD) and the EUs instrument for structural policies for pre-accession (Ispa), the M3 motorway (running north-east from Budapest) was completed. The motorways running south-west and south-east from Budapest are also under development, as are several bridges over the Danube and Tisza, and non-motorway inter-city roads and ring-roads.
Road transport has replaced railways as the primary form of freight haulage, reflecting both the improvements in main road provision and past lack of investment in the state-owned railway, MAV. Waterway shipping began to recover in 1996 after the lifting of sanctions against Serbia and Montenegro (formerly Yugoslavia), but growth slowed in 1997-98 and another reversal was inflicted by damage to bridges over the Danube at Novi Sad in Vojvodina during NATOs air strikes against Serbia in 1999. Although most of the debris had been cleared by mid-2000, temporary pontoon bridges continued to disrupt river traffic. Air cargo plays a minor role in the freight system, although small volumes of higher value-added products are imported and exported this way.
Although the dominant form of long-distance passenger traffic is still bus travel, the private car plays an important role in Hungarian life. Car ownership increased from 188 per 1,000 of the population in 1990 to 246 per 1,000 in 2002. Air passenger traffic has grown rapidly in the past five years, but it still makes only a small contribution to total long-distance passenger traffic. Capacity at Budapest Ferihegy, the international airport, rose to 5.5m passengers per year after a recent expansion.
Matavs hold over the countrys main telecoms networks has been difficult to break, and this is partly responsible for a loss of momentum in recent years that has left Hungary with some of the regions highest call and Internet access charges. Official figures showing 21 people per 100 population using the Internet probably overstate the numbers with access to the web--the number of regular Internet users is probably about 1m. Besides the high cost of access, one of the main obstacles to the growth of Internet use is the relatively low numbers of personal computers for home use.
Nearly US$6bn in telecommunications investment, US$3bn of this from foreign investors, has transformed the moribund telecoms system inherited from the communist era into one of the best in the region. At the start of the 1990s Hungary had one of Europes least-developed telecoms systems, with an installed base of less than 1m main lines, a penetration rate of only nine lines per 100 inhabitants, and a call completion rate of less than 40%. The government soon transformed the fixed-in line monopoly, Matav, into a joint-stock company, which oversaw the overhaul of the system. Full automation was achieved in 1996 and digitalisation has reached over 90%. The number of fixed lines has quadrupled over the past ten years. Matav, now controlled by Deutsche Telekom (Germany), still dominates the Hungarian fixed-line telephone system, but a new telecoms law has opened the local, domestic and international markets in fixed-line phone services to competition. However, alternative telecoms providers were already on the scene, because voice over Internet protocol (VOIP) services were deemed not to violate monopoly concessions. There is free competition in non-public fixed-line services, such as intra-company or data networks. Number portability, important to the easy switching of customer accounts, is not envisaged until mid-2004.
The telecommunications infrastructure continues to grow and improve throughout the country. Growth and overall availability of service is best in Budapest. With the official liberalisation of the market on December 23rd 2001 by Act XL of 2001, Matav lost its monopoly on long-distance and international fixed-line calls. However, since many of the government decrees needed to interpret the law were missing, the resulting uncertainty slowed the development of competition. According to a report in the first half of 2002 by Bell Research and Think Consulting (local research firms), 66% of large businesses, 85% of medium-sized ones, and 90% of micro and small businesses said they had not gained any advantages from the market liberalisation.
The government is drafting new legislation to replace the Unified Telecommunication Act in order to fully comply with EU regulations and to speed up competition from 2004.
Beside Matav, Vivendi Telecom Hungary, PanTel and eTel Hungary have licences to provide public local, long-distance and international telephone services. The most competitive areas of the market will probably be those with high revenues. Matav expects to lose market share in domestic calls and international calls.
ISDN (integrated services digital network) penetration is on the rise, and cable operators like UPC offer full-scale Internet access in several regions. Within fixed lines, the share of ISDN lines was 16.2% at the end of April 2003, compared with 14.1% a year earlier. Global Telesystems announced in May 2000 that it had built the first fibre-optic connection to Budapest from the companys EU-wide fibre network. Other fibre connections from Budapest to hubs in Vienna are being developed
Broadband communications solutions are spreading rapidly, and most modern services are available or will soon be. ADSL (asymmetric digital subscriber line) services were launched in late 2000, by Matav, the dominant telecoms company, and by Vivendi, the second-largest fixed-line provider. Since then, ADSL penetration has been increasing rapidly and had reached 2% by the end of 2002. With the liberalisation of the telecoms market, UPC (Hungarys leading cable provider) and other players are introducing voice and data transmission over television cables. It is estimated that about 45% of Hungarys 3.8m households subscribe to cable television.
Mobile-phone penetration is growing rapidly: it was at 71.2% in May 2003, up from 56% in May 2002, according to the Communication Authority. There are three GSM 900 providers, which also provide DCS 1800 services. An auction for UMTS (universal mobile telecoms services) frequency concessions is scheduled for late 2003.
The dominant mobile provider, Westel, launched GPRS (general packet radio services) in 2000 and offered full coverage of the country in August 2001; rival Pannon launched its own service in July 2001. This will eventually increase the speed of mobile data transmission from the present fastest speed of 20 kb/s to 100 kb/s with the use of a GPRS handset.
Westel launched wireless local area network (WLAN) service in November 2002 at Budapests Ferihegy Airport. The service is available at 28 points throughout Hungary, with additional points to be added soon.
The revised telecom law will introduce mobile-phone-number portability from May 2004, the IT ministry has said. Under EU regulations, users must be able to transfer existing phone numbers to new providers. Companies that fail to offer this service will have to pay a fine.
A government office is working on detailed policies to introduce electronic government in Hungary. The Tax and Financial Inspection Office plans to make filing monthly and quarterly tax returns via the Internet mandatory for the 10,000 largest taxpayers from the end of 2003.
Hungary is poorly endowed with natural resources, and has to import more than half of its energy needs. Indigenous oil reserves, estimated at 58m tonnes, enabled domestic primary production of 1.8m tonnes in 2001, about one-fifth of refining input. Oil production declined steadily through the 1990s, after averaging around 2m tonnes/year before 1989. No new major oil discoveries are expected. Estimated gas reserves are around 113bn cu metres, with domestic production now meeting around one-fifth of consumption, down from almost two-thirds of consumption in 1980. This reflects rising domestic consumption of gas, especially as a substitute for the less environmentally friendly coal, and a steady decline in domestic gas production from the 6.2bn cu metres recorded in 1989. There are natural gas deposits near Szeged, Miskolc and in eastern Hungary, and smaller crude oil deposits near Szeged, Zala county (western Hungary) and in other areas. Although there are small uranium deposits, the main mining company based near Pecs has closed after unsuccessful attempts to sell the enterprise, leaving the Paks nuclear power plant (in central Hungary) dependent on imports.
Although energy consumption is forecast to rise as the economy expands, its growth has so far been held down by sharp improvements in industrial energy efficiency. Electricity consumption growth is estimated to have been around 2% per annum in 1997-2001, even as overall economic growth was running at about 4%. Under communism, energy use per unit of GDP was around 2.5times the OECD average. The 1989 level of industrial production was regained during 1999 with around 25% less fuel use. Savings were achieved mainly through the closure of inefficient enterprises, motivated by a rise in industrial fuel prices as subsidies were withdrawn.
As elsewhere in Europe, oil and natural gas had replaced coal as the primary source of energy by the end of the 1970s. Gas already accounts for about 40% of Hungarys electricity production, and most households and businesses rely on gas for heat. Hungarys dependence on natural gas from the former Soviet Union was broken in 1996, when a pipeline between Gyor and Baumgarten linked it to Austrias gas grid for the first time. Oil supply has also started to diversify, with the opening of a pipeline to the Adriatic.
Hungary continues to pursue reform of its energy and electricity markets, which has proceeded in fits and starts since partial privatisation of the sector in the mid-1990s. Power generators and distributors are now foreign-owned, but a state-run entity, MVM, still owns and operates the national power grid, maintaining a monopoly in the wholesale market. As of January 1st 2003, however, about one-third of the retail electricity market has been liberalised, as the government allowed roughly 200 firms to begin choosing their supplier. These large consumers are only able to buy 50% of their power from foreign suppliers (Hungary currently imports only a small portion of its electricity consumption annually), and now that Hungary has joined the EU, electricity imports will be fully liberalised. This is just the beginning of what Hungarian authorities see as a ten-year process to reform the sector fully.
The National Oil and Gas Trust (MOL)
MOL, the Hungarian oil and gas company, was privatised in 1994, and the six regional gas distribution companies (GDCs) in 1995. A subsequent share offering in 1997 reduced the state stake in MOL from 59% to 25% plus one golden share, with foreign investors holding more than 30%. In 2004 the government sold a 10.5% stake in MOL through an international private placement, reducing the states shareholding in the company further to 12.2%. However, this did not mean an end to political influence on the companys activities. MOL is the sole domestic producer, dominates imports (which account for 85% of Hungarys gas needs), owns a network of high-pressure gas transport and collection pipelines, is Hungarys largest company in terms of sales and is the sole distributor to the regional gas suppliers.
The companys distribution network must be open to competition if Hungary is to conform to the EU gas directive (which took effect in 2000), but progress towards this and a liberalised price regime has been slow. Gas liberalisation raises the politically sensitive problem that prices to industry and households will rise, owing to the withdrawal of subsidy, before greater competition and efficiency leads to a fall. The date for full market liberalisation has been delayed several times, but liberalisation could begin as early as mid-2004. Fearing the impact on inflation, and on poorer households welfare, of a sharp rise in residential gas prices, governments past and present have usually restricted these to below inflation. The persistent losses inflicted by these price controls have prompted attempts by MOL to sell its wholesale gas business. It has also prepared for eventual liberalisation of the sector, by seeking stakes in the GDCs, and has invested aggressively in pipelines and utilities in other countries in the region.
After choosing to refocus on upstream production and downstream fuel retailing, MOL has undertaken a number of projects to diversify its supply bases, joining consortia seeking to produce oil and natural gas in Russia, Greece, Syria and other locations in the Middle East. Aware that the domestic market is too small, MOL is expanding its processing operations regionally. It acquired a strategic stake in Slovak refiner Slovnaft in 2001, and completed its majority takeover in March 2003. A merger with Croatias INA has long been under discussion. However, MOL and INA are also open to acquisition by a larger multinational, with Austrias OMV a possible bidder. Downstream, MOL operates a network of more than 325 retail petrol outlets and plans to expand this to 400 in the coming years. It also has retail operations in neighbouring Romania and has recently announced a regional expansion plan. The current government has mooted plans to sell its remaining share, but no timetable has been set.
Hungarian Electricity Works (MVM)
State-owned MVM operates the electricity grid and is the dominant exporter, importer and wholesaler of electricity. Vertical separation between these functions must be achieved to satisfy EU directives. The government plans to sell a 50% minus one vote stake in MVM via a public listing. This transaction is not expected until 2005, however, and privatisation plans for MVM have been delayed in the past. Deregulation, to allow regional distributors to buy from (and generators to sell to) companies other than MVM, and users to choose their distributor, has picked up momentum recently, with a little more than 30% of the market liberalised as of January 1st 2003. The liberalisation is limited to large consumers, who will only be allowed to buy half of their power from foreign suppliers.
MVM, like MOL, the Hungarian oil and gas concern, will need to have its network opened to upstream and downstream competition before EU energy directives are satisfied. In principle, deregulation could reduce power prices, because of the surplus capacity that would be forced into greater competition. However, the government fears that this could render MVMs present purchase agreements with domestic generators uneconomic (especially the Paks plant). The risk of new electricity market arrangements making peak-time supplies unavailable, or prohibitively expensive, has also induced some heavy users to install their own reserve generating capacity.
The continuation of government-administered prices is of particular concern to foreign investors in the sector. During privatisation, power generators entered into long-term power purchasing agreements (PPAs) with MVM, under deals that encouraged capital improvements. The government has sought to abrogate these PPAs before liberalising prices, however, which not only inflicts stranded costs on producers, but also affects MVMs bottom line, since the national power grid struck 20-year fixed-price PPAs worth some Ft3trn (about US$28bn at the time) in the early 1990s. Despite ongoing market liberalisation, prices remain roughly half the level they are in western Europe, which has caused some complaints from Hungarys six electricity distribution companies. The majority owners, E.ON and RWE of Germany and Electricite de France, were promised 8% returns on their investments, but this looks optimistic as long as prices are kept artificially low and business customers continue to subsidise households purchases of electricity. In the short term, liberalising prices will be a lower priority than achieving government inflation targets.
Structure of energy sources (production plus imports)(% of total)19971998199920002001Coal15.013.914.313.913.4Hydrocarbons69.071.570.368.669
.5Crude oil & petroleum33.134.9184.108.40.206Natural gas35.936.637.136.538.0Electricity from nuclear power220.127.116.112.612.5Imported electricity18.104.22.168.12.8Other energy (firewood, charcoal, hydroenergy, etc)2.01.91.91.81.8Total100.0100.0100.0100.0100.0Ratio of imports54.757.457.959.360.3Sources: KSH, Statistical Yearbook.
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