Developments since independence Hungary began its transition with some significant advantages over other Central European economies, such as higher living standards and a pragmatic economic policy initiated during the communist period. Soon after the change of regime, the country carried out structural reforms and stabilization measures. By the mid-1990s, however, macroeconomic performance deteriorated, leading to unsustainable current account and fiscal deficits. The country responded with a second round of far-reaching reforms that included enterprise, banking, and public sector reforms. Structural reforms were complemented with a strong fiscal-stabilization package (1995-1998) and the maintenance of sound macroeconomic policies. Robust economic performance followed, with real GDP growth averaging 4.4 percent during 1997-2001. Since 2000, economic policy priorities have shifted from structural reforms to rebalancing living standards and upgrading public infrastructure. Wages, pensions, and public sector investments have increased. This, together with some one-off spending elements, resulted in an increase in the general government deficit to over 8.5 percent of GDP in 2002. Output growth was driven mainly by private consumption. Despite some fiscal tightening in 2003 and a restrictive monetary policy, growth recovered from mid-2003 onward. In 2004, the deficit was reduced to 5.4 percent of GDP. Recent economic performance After moderate acceleration in 2004, real GDP slowed subsequently and reached a low of 1.4% in 2007. The main driver of GDP growth was the strong performance in net exports and investment. Due to intensified highway building, the expansion of construction activities surpassed growth in all other segments of the economy. Expanding external and domestic demand kept the GDP growth rate slightly above 4.5 percent in the first quarter of 2006. However, the impact of the fiscal austerity measures on demand have dampened growth in recent years. Inflation slowed to 3.5 percent in 2005, thanks to smaller increases in indirect taxes and prices of food and regulated items, together with stronger exchange rate. It then rose rapidly to a peak of 7.5 percent in 2007 in line with much of the region as a result of rising food and energy prices, but has subsequently eased a little. However, the disinflationary process could be jeopardized if the government were to relax fiscal policy ahead of the 2010 elections. Hungary 's unemployment rate remains high and is increasing. In 2008, the registered unemployed are 8 percent of the labor force. The fiscal stance remains tight and the government is on track to reduce the budget deficit below 4 percent, from 5.5 percent in 2007. However, prospects for meeting targets in 2009 and beyond are less certain. Pressures to ease fiscal policy will grow as the 2010 parliamentary elections approach. The government has recently proposed a new package of tax cuts, especially on labor, compensated for by an increase in tax collection through ‘whitening' the economy. However, there are no specific offsets on the expenditure side, which may limit the opportunity for fiscal consolidation. Challenges ahead Important remaining issues that still need to be addressed include:
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