VII. INVESTMENT CLIMATE A. Openness to Foreign Investment The ongoing transformation in Hungary has included extensive reform of the laws relating to business activity, opening the door to significant foreign participation. The current environment in Hungary encourages foreign investment and participation in almost all aspects of the Hungarian economy. Foreign investment may take any one of four forms: setting up a joint venture in existing businesses, obtaining equity in a state enterprise through privatization, establishing a new (greenfield) business venture, and making a portfolio investment. Parliament has passed a number of laws intended to facilitate foreign investment. Five laws are of particular importance: the Companies Act, the Investment Act, the two laws on privatization, and the Concessions Act. Act VI of 1988 on Economic Associations (the "Companies Act") defines the various forms of economic associations and regulates their foundation, organization, and termination. Foreign investment in Hungary most often takes the form of a limited liability company. Other commonly used forms are companies limited by shares (joint stock companies), joint enterprises, business associations, general partnerships, limited partnerships, and sole proprietorships. Current Hungarian legislation makes no provision for branch operations. Hungary's agreement with the EU calls for legal regulations permitting such operations to be in place within five years. (State-owned enterprises and cooperatives are not covered by the Companies Act.) Act XXIV of 1988 (as amended) on Investments of Foreigners in Hungary (the "Investment Act"), which sets forth the rules on the establishment and operations of companies with foreign participation, grants significant rights and benefits to foreign investors. It guarantees national treatment for foreign investments. It abolishes the old requirement for government approval of majority or 100 percent foreign-owned investments. It provides protection against losses resulting from nationalization, expropriation, or similar measures. The Investment Act establishes the investor's tax liability, but provides for an extensive system of tax allowances, described below, which are intended as investment incentives. Presently, privatization in Hungary is governed by Act LIII of 1992 on the Management and Use of Entrepreneurial Assets Remaining in Long-Term State Ownership and Act LIV of 1992 on the Sale, Use, and Protection of Assets in Temporary State Ownership. The Socialist-Free Democrat government formed in July 1994 has promised it will reexamine privatization to make it more transparent and to bring it to conclusion more quickly. Until the new government introduces new laws, Act LIII and LIV of 1992, which entered into force at the end of August 1992 replacing earlier privatization legislation, remain in force. Both acts provide a legal framework for the transformation of state enterprises into limited liability or joint stock companies. Such transformation is a prerequisite for any subsequent privatization. As specified in Act LIII, in conjunction with Government Decree 126/1992, the state will retain partial ownership in just under 200 companies, farms, and research institutes, and complete ownership of about 30 others (primarily defense-related industries or those connected with correctional institutions). Presently, the State Holding Company (AV Rt) is responsible for the management and sale of most of these assets. The State Property Agency (AVU) is charged in Act LIV with privatizing virtually all other state-owned business assets. (The AV RT and the AVU are expected to be rejoined in the revision of the privatization laws in 1994.) Interested foreign investors, AVU, or the state enterprise itself may initiate privatization, but Act LIV stipulates that all sales must be accomplished via tender. Act XVI of 1991 on Concessions authorizes the state to provide investors with concessions in return for their investment in infrastructure development and certain other sectors. The Concessions Act lists thirteen areas in which the state may, on the basis of a concession agreement, grant private investors a partial monopoly in activities normally reserved for the central and/or local governments. These include the construction of roads, railways and airports, power generation and transmission, mining, and operating games of chance. Concessions are normally awarded on the basis of a tender and include a time limit and a renewal limit (generally, 50 percent of the original period). More detailed regulations on specific concessions are contained in the laws on individual sectors, such as the Postal and Gambling Acts. In general, 100 percent foreign ownership is permitted in sectors open to private investment. Exceptions include restrictions on foreign investment in defense-related industries, in the media and on foreigners' acquisition of land. Under the Land Law (Act I of 1989) and related regulations, foreigners may acquire real estate in only a few instances, such as in compensation for a prior expropriation. Foreigners must make any payments in hard currency and must therefore obtain a permit from the foreign exchange authorities: the Finance Ministry or the Central Corporation of Banking Companies (Penzintezeti Kozpont). Thanks to the Investment Act, these requirements do not apply to companies incorporated in Hungary, even if 100 percent foreign-owned. Such companies, however, may only acquire real estate "required for its economic activities." The new Land Law (Act LV of 1994) deals primarily with agricultural land. Act LV restricts the purchase of land by foreigners to 6,000 square meters, but allows for leases up to ten years for up to 300 hectares or 6,000 golden crowns (a measure of land productivity). Act LV prohibits businesses from purchasing arable land, though they may lease amounts up to 2,500 hectares or 50,000 golden crowns. Both the prohibitions on foreigners and on businesses are seen as temporary and may be lifted when the real estate market reflects accurate land values. Screening of foreign investments does not normally occur. As noted earlier, the Investment Act abolished the old requirement for government approval of majority foreign-owned investments. There remain two instances where screening is legally mandated: for investments in financial institutions and in insurance. Acts LXIX of 1991 and CXII of 1993 on Financial Institutions stipulate that government approval must be obtained for "the establishment of a financial institution owned fully or partly by foreigners as well as for participation by foreigners in a financial institution registered in Hungary." Such approval is not needed if total foreign participation in an institution will not be more than ten percent of its registered capital. The law sets out the necessary criteria, which include whether the applicant has the necessary capital, its business reputation and five-year track record, plans for training employees, and contribution to competition among similar institutions. Similarly, government approval is also required for foreign investments in insurance companies if the foreign share exceeds ten percent of the company's capital. The rationale for the screening described above is the government's need to monitor foreign exchange flows, given the inconvertibility of the forint, and to ensure the reliability of the financial system. Screening mechanisms are routine and non-discriminatory. As the large numbers of banks and insurance companies with foreign ownership currently operating in Hungary testify, screening does not constitute an impediment to investment or limit competition. Foreign firms are accorded national treatment in their participation in government financed and subsidized research and development programs. Foreign firms have not reported any difference in de jure and de facto practices. Although foreign investors are nearly always accorded equal treatment under the law, a few instances of negative discrimination do exist. For example, domestic investors may hold bearer shares, whereas the Investment Act allows foreigners to acquire only registered shares. National Bank regulations prohibit non-resident foreigners from directly purchasing state securities denominated in forints and limit them from acquiring more than 20 percent of the shares in those investment funds that have bonds, including state securities, in their portfolios. (There are no limits on the shares foreigners may buy in other investment funds.) In another sector, the 1991 Act on the Operation of Games of Chance sets the minimum fee paid to the state for a casino concession at $1 million for a company with foreign participation, versus 70 million forints ($700,000) for a purely Hungarian company. Additionally, Hungarian law and regulation excluded foreigners from certain privatization opportunities. Only Hungarian citizens were permitted to take part in the auctions of small retail and service establishments held under the so-called pre-privatization program, for example, however, this program has been wrapped up. (The law did not prevent the Hungarians from immediately re-selling the establishments to foreigners, however.) Only Hungarian citizens will be eligible to acquire state enterprises through leasing under a program which began in 1993. Finally, the government reserves the right to deny national treatment to foreign investments in medical, dental, veterinary and other health-related professional services. Under the Corporate Tax Act of 1991, an automatic tax holiday was available to companies meeting certain requirements including a certain level of foreign investment and participation in one of the 15 designated industries of strategic importance. The Corporate Tax Act was amended by Act IC of 1993 which eliminated the automatic tax holidays for new investments as of January 1, 1994. However, companies that qualified for tax abatements prior to the deadline retain these benefits. In place of the tax holidays under the Corporate Tax Act, Parliament introduced a discretionary new general tax reduction, effective January 1, 1994. The new incentive is available in the form of a tax reduction not exceeding 100 percent of the normal tax payable for a 5-year period and not exceeding 60 percent for the subsequent 5-years period if two conditions apply: 1) the company has share capital of at least HUF 500 million ($5 million) and 2) the company starts an investment of a least HUF 200 million ($2 million), as a result of which the company derives more than half of its revenues from the manufacture of a) environmentally friendly products, and/or b) high-tech products, and/or c) products requiring scientific research and that investment increases the company's export revenues or employment. It also reduced the corporate income tax rate from 40 percent to 36 percent and introduced a turnover tax which would come into effect if a companies tax liability fell below 2 percent of annual turnover. The discretionary tax reduction has come under some criticism. The new coalition government is expected to legislate a number of investment incentives, which will not discriminate between domestic and foreign investment. It has also stated it will eliminate the minimum 2 percent turnover tax. The Act on Separate State Funds (Act LXXXIII of 1992) established an Investment Promotion Fund to encourage foreign investment in infrastructure, new technology and public utilities. To qualify for subsidies from this fund, a company must have more than HUF 50 million ($500,000) in registered capital or capital stock, not less than 30 percent foreign ownership, and the foreign contribution must be in convertible currency and not less than 50 percent of the foreign partner's share. The third criterion may be waived if the technology is considered "environmentally superior" or "of technical excellence." Companies which received tax reductions under the Investment Act have their benefits "grandfathered". Pursuant to the provisions of the Investment Act, companies with at least 30 percent foreign participation and a minimum of 50 million forints ($500,000) in capital qualified for tax incentives. If such companies invested in manufacturing, and that investment generates more than half of their gross revenues, they may receive a 60 percent tax exemption for the first five years and a 40 percent exemption for the next five. The companies are only eligible for the tax breaks in the years that they qualify. If the revenues from the investment dips below the threshold, the company does not receive the tax break. If they invested in one of 15 designated sectors, they could receive a 100 percent tax exemption for the first five years and a 60 percent exemption for the second five. The 15 "activities of special importance" are: - electronics and aviation; - production of vehicles or vehicle parts; - manufacture of machine tools; - production of agricultural and food processing and machinery/equipment; - manufacture of machine parts; - production of packaging machinery, equipment, or materials; - productions of pharmaceuticals, pesticides, and agro-chemicals; - development of the domestic protein-stock; - food processing; - subcontracting industrial production in the above sectors; - production of propagating material and breeding stock; - production of wheat and corn; - telecommunications services; - tourism (the building and operating of hotels); - and the production of environmental products and equipment. The Investment Act also provides for the duty-free import of goods necessary to establish a joint venture. Furthermore, it allows joint ventures to reclaim 100 percent of the general turnover tax (similar to a value-added tax) paid on goods acquired for investment purposes. Other laws and regulations provide a number of investment incentives, available to both foreign and domestic investors. Tax allowances are granted for investments in the less developed regions of Hungary or in certain sectors, such as health care, cultural activities, and agriculture. Investors may receive more than one tax reduction and aggregate them to receive relief up to 100 percent of the tax due in a given year. In addition, foreign investors may receive grants or concessional loans from the investment promotion fund established by Government Decree 41/1991 The principal use of fund monies is the development of infrastructure (such as roads and electricity lines) in conjunction with existing or planned activities. Only companies with at least 30 percent foreign participation and a minimum of 50 million forints ($500,000) in capital may apply. With some exceptions, at least half of the foreign contribution to the investment must have taken the form of hard currency. Two import policies/practices that affect foreign investors exclusively are the Investment Law's provision for the duty-free import of capital goods by joint ventures and the government's establishment of semiannual quotas for automobile imports. For 1994, the number of automobile import licenses is limited to 96,000 (51,000 new, 30,000 used; 53 percent of each category imported from the EU and the remainder from the rest of the world). These quotas are meant to protect the markets of domestic automobile manufacturers, all of which are foreign-owned companies. B. Conversion and Transfer Policies The forint is not a fully convertible currency, though for business purposes it approaches full convertibility. There are no restrictions on transferring funds associated with an investment. The Investment Act guarantees foreigners the right to repatriate "in the currency of the investment" any dividends, after-tax profits, royalties, fees, or other income deriving from the operation or sale of the investment. The Act also grants foreign employees of a foreign investment the right to transfer abroad "in the currency of the country of their permanent domicile" fifty percent of their after-tax salaries. There is no queuing for foreign exchange, and there are no known instances of delay in repatriations. Foreign investors are allowed to keep any cash contributions made in a convertible currency in a foreign exchange account. The company may use these funds to import, duty-free, goods considered as part of the investment. Alternatively, it may import goods using foreign exchange bought for forints. All companies registered in Hungary, including those with foreign participation, are required to sell foreign exchange receipts from exports to the National Bank within eight days of receipt unless an exemption has been granted by the MNB. One notable exception allows a company to maintain a foreign currency account to pay for foreign travel, advertising and related expenses. All companies are required to receive permission from the National Bank before taking out a hard currency loan. In the event that forints accepted by OPIC would be made available to the Embassy, the Embassy and other U.S. institutions could use up to $ 6.8 million annually. The Mission purchases hard currency from the Foreign Trade Bank at the official buying rate. The value of the forint is determined by a currency basket consisting of 30 percent of the U.S. dollar and 70 percent of the European Currency Unit (ECU). The government of Hungary has pursued a policy of gradual devaluation. The MNB is permitted, by law, a free hand in devaluing the HUF within a 5 percent margin. That margin was extended twice in 1993. In 1994 that margin was extended for the first time in May. On August 5, the forint was devalued 8 percent bringing the total cumulative devaluation till then to 14.39 percent. Future devaluations are expected at least on par with the 1 - 1.2 percent; however, a larger devaluation cannot be ruled out. The forint's cumulative depreciation in 1994 is likely to exceed 18 percent. C. Expropriation and Compensation According to Article 13(2) of Hungary's constitution, "Expropriation of property shall be allowed only exceptionally and for public interests, in cases and ways determined by law and with full, unconditional and immediate indemnification." The Investment Act further states that "The foreign investor shall be promptly indemnified for any damage arising from any possible measure affecting his property, such as nationalization, expropriation or any measure involving a similar legal effect. Compensation shall be paid at actual value . . . in the currency of the investment." The Investment Act also stipulates that investors may appeal such measures to the courts. There have been no cases of expropriation of foreign-owned assets since the early 1950's. In 1973, the United States and Hungary signed an agreement settling Hungary's outstanding debts for U.S. assets seized in the early years of the communist regime. The government is concluding a program intended to compensate those who lost property under the communist and fascist regimes. Hungarians and foreign citizens are equally eligible to receive compensation. Victims or their heirs receive compensation vouchers, which may be sold or exchanged for stocks, real estate or annuities. There will be no "reprivatization" or restitution of lost properties. D. Dispute Settlement Foreign investors virtually shunned Hungary until the late 1980's, just before the change in regime. Thus, the Hungarian government does not have a record of handling investment disputes. There have been no major investment disputes, and there are no outstanding expropriation/nationalization cases. The courts have proved to be an effective vehicle for enforcing property and contractual rights. Should conciliation and negotiation fail to resolve an investment dispute between foreign investors and the state, Hungary will accept binding international arbitration. Hungary is a member of the International Center for the Settlement of Investment Disputes (ICSID), also known as the Washington Convention, and a signatory of the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. As in the United States, Hungary's Constitution is the basis for the legal system. Any decree or law that contradicts the provisions of the Constitution may be appealed to the Constitutional Court, which has the right to rule on any government law or decree and strike it down with or without retroactive effect. All decisions by the Constitutional Court are final and cannot be appealed further. Parliament appoints the President of the Constitutional Court. Below the Constitutional Court are the Municipal Court of the Capital (Budapest), county and local courts. The County courts and the Municipal Court of the Capital are the highest courts that hear tax cases. A panel of professional judges and lay assessors hear cases. The State President appoints the professional judges. Neither judges nor prosecutors may be members of political parties nor active in politically. With the political changes in 1989-90, priority was given to private property ownership. The Constitution declares Hungary a market economy with equal legal protection given to common and private property. The number and scope of laws that apply to business operations have recently been expanded and can be expected to continue to develop. The Act on Bankruptcy Procedures, Liquidation Procedures and Final Settlement became law on January 1, 1992, and was later amended in 1993. The law's provisions encompass all commercial entities, except banks (which have their own regulatory statutes), state companies, trusts and other state-owned enterprises. Bankruptcy proceedings can only be initiated by the debtor and only if the debtor has not sought protection under bankruptcy in the past three years. Within 90 days of seeking bankruptcy protection, the debtor must call a settlement conference to which all creditors are invited. Majority consent of the creditors present is required for settlement plans. If agreement is not reached, the court can order liquidation. Judgments are made in forints, but investors have the right to convert the money into the currency of the investment for repatriation. The law establishes the priorities of claims which are: 1) liquidation costs; 2) secured debts; 3) claims of individuals; 4) social security and tax obligations; and 5) all other debts. Any remaining proceeds are distributed among the owners. Creditors may request the court to appoint a trustee to perform an independent financial examination. The trustee has the right to challenge any contract concluded within 12 months preceding the bankruptcy, if there are reasons to suspect that the contract constituted conflict of interest. E. Political Violence Political violence in Hungary is minimal. Although in early 1994, there were three bombings directed at sites of cultural value. No group has claimed responsibility nor have the police identified potential perpetrators. There has been no violence directed at foreign-owned companies. The several million ethnic Hungarians living in adjacent countries have been a source of friction for Hungary's relations with its neighbors. In contrast to previous government policy, the new government publicly states that it places improvement of relations with its neighbors one step above its support of the rights of the Hungarian minorities. Disturbances in the former Yugoslavia have not spilled into Hungary. Still the situation is observed with concern by Hungary given there is a sizeable population of ethnic Hungarians living in the Vojvodina region (Serbia). The loss of trade with the former Yugoslavia -- due to UN economic sanctions which are enforced by Hungary -- has cost Hungary over $2 billion. F. Performance Requirements/Incentives Hungary does not impose performance requirements as a condition for establishing, maintaining, or expanding an investment. In the case of foreign investments, there is no requirement that nationals own shares, that the share of foreign equity be reduced over time, or that technology be transferred on given terms. G. Right to Private Ownership and Establishment Foreign and domestic private entities may establish and own business enterprises and engage in all forms of remunerative activity, save for those prohibited by law. The Companies Act guarantees the right of private entities to freely establish, acquire, and dispose of interests in business enterprises. Hungary's constitution also provides related guarantees. Article 9 states that "(1) The economy of Hungary is a market economy where public and private ownership shall be equally respected and enjoy equal protection. (2) The Republic of Hungary shall recognize and support the right of entrepreneurship and free economic competition." Article 13 guarantees "the right to property." De jure, competitive equality is the standard applied to private enterprises in competition with public enterprises with respect to access to markets, credit, and other business operations, such as licenses and supplies. De facto, state enterprises sometimes enjoy superior access, usually simply because they have been established longer and are better known. This is especially true in regards to access to credit, where state enterprises may benefit from the banks' (almost always mistaken) assumption that the state is backing the loan. Foreign participation in Hungary's privatization program has been extensive. In general, foreigners participate in the privatization process on the same terms accorded to Hungarian citizens. The exceptions being their ineligibility for the leasing program and various other non-cash financing methods such as "Existence credits". H. Protection of Property Rights The Hungarian legal system protects and facilitates the acquisition and disposition of property rights. The basic legislation providing protection for inventions is Act II of 1969 (as amended) on the Patent Protection of Inventions. The Patent Act provides twenty years of protection from the date of filing at the National Office of Inventions, as opposed to the American system which extends protection to the date of invention. Licenses may be granted. Compulsory licensing to a Hungarian enterprise may be ordered under certain conditions, if a patent has not been used within four years of the date of application or three years from the date of issue. Act III of 1969 (as amended) on Copyrights is intended to protect literary, scientific, and artistic creations. "Computer programs and the related documentation" (software) are expressly included in the list of protected works. According to the law, "the consent of the author shall be required for any use of his work" or of the title of the work. "Use" is defined as "the process in the course of which the work or a part thereof is communicated to the public" and pertains to "alterations, adaptations, and translations." The law includes under communication "posters, newspapers, programs, films, radio, television, etc." relating to the work. There have been numerous complaints that Hungarian enforcement of the Copyrights Act has not been sufficiently vigorous and that significant quantities of pirated and counterfeit software, sound recordings, etc., are marketed here. The registration and protection of trademarks is governed by Act IX of 1969 on Trade Marks and related decrees. The application process can take from six months to a year. Foreigners are required to appoint a Hungarian attorney to represent them. Decisions by the National Office of Inventions to deny an application or cancel a registration may be appealed up to the Supreme Court. Registrations are valid for ten years and can be renewed. Licensing of trademarks is permitted. The law protects well-known marks, stating that "the existence of a well-known mark (whether registered or unregistered) is a bar to registration of an identical or confusingly similar mark, regardless of the goods concerned." While there are no statutory use requirements, "failure to use a mark over a five-year period renders the registration open to cancellation." Trade secrets are protected by Act LXXXVI of 1990 on the Prohibition of Unfair Market Practices. The law expressly forbids obtaining or using business secrets "in an unethical way" and disclosing them to unauthorized persons or making them public. Business secrets are defined as "every such fact, information, solution, or data related to economic activity that it is in the entitled person's interest to have remain secret." Two new laws protecting intellectual property entered into force in January of 1992. Act XXXVIII of 1991 protects utility models, and Act XXXIX of 1991 protects the topography (layout design) of semiconductor chips. In 1993, the U.S. and Hungary signed a comprehensive Intellectual Property Rights Treaty. Law Number VII (1994) on the Amendment to Industrial Property and Copyright Legislation was adopted by Parliament and implemented on July 1, 1994. This law amends the following existing laws: Law Number III (1969) on Copyright; Law Number II (1969) on the Protection of Inventions by Patents; Law Number IX (1969) on Trademarks; Decree-Law Number 28 (1978) on the Protection of Industrial Designs; and, Law XXXVIII (1991) on Utility Model Protection. In short, the amendments extend patent protection for pharmaceuticals (previously, Hungary issued only process protection); address who controls the rights of works; extends and unifies the terms of protection; expands protection for the original layout designs incorporated in semiconductor chips; provides the legal means to prevent proprietary information from being disclosed or acquired without the consent of the trade secret owner by other than "honest commercial practices"; and, ensures enforcement procedures are available under civil, criminal or administrative law to permit effective action against IPR infringement. Hungary is a member of the World Intellectual Property Organization and a signatory of important agreements on this issue, such as the Paris Convention for the Protection of Industrial Property, the Nice Agreement on the Classification and Registration of Trademarks, the Madrid Agreement concerning the Registration and Classification of Trademarks, the Patent Cooperation Treaty, the Universal Copyright Convention, and the Bern Convention for the Protection of Literary and Artistic Works. H. Regulatory System: Laws and Procedures The above-mentioned law protecting business secrets, Act LXXXVI of 1990 on the Prohibition of Unfair Market Practices (the "Competition Act"), is actually a comprehensive law intended to foster the establishment and maintenance of a competitive market. The Competition Act forbids consumer fraud, the restriction of competition, abuse of a dominant market position, and unfair competition. Acts considered as unfair competition include spreading of false rumors about competitors, withholding goods from the market in order to cause price increases, and conditioning sales on the buyer's commitment to boycott competitors. The Competition Act created the Economic Competition Office. This office is responsible for investigating and stopping any unfair market practices. It is also authorized to review any merger where, in the preceding calendar year, the combined market share of the parties involved exceeded 30 percent or their combined gross sales totalled more than 10 billion forints ($100 million). It also reviews cases where one business entity is acquiring a majority interest in another business and their combined market share exceeds 30 percent. The Office may deny licenses for these mergers or sales if it determines that they would hinder commercial competition. The Competition Office also administers controlled prices, which are set by government decree and are imposed on a small number of goods and services. The Agriculture Ministry may establish minimum prices for wheat, corn, pork, and beef. Maximum prices are mandated for all energy supplies, postal and telecommunications services, rail and bus transportation, pharmaceuticals for humans, and public water services. Though many foreign investors believe Hungarian taxes are high and the Labor Code too liberal, they generally do not judge these, or the health and safety laws, to constitute impediments to the efficient mobilization and allocation of investment. Hungary overhauled its tax system in the late 1980's, instituting a western-style system. The Tax and Financial Supervision Office is responsible for the collection and administration of taxes. For a foreign investor, the most important taxes are: company tax (36 percent of corporate profits); the general turnover tax (a value-added tax attached to the value of goods and services supplied domestically, imported, or exported; current rates are 0, 10, and 25 percent, but the Socialists propose eliminating the 10 percent rate); and personal income tax (a progressive tax assessed on total income received during a tax year, less exempt income and deductions; current rates range from 0 to 36 percent, but a proposal before Parliament would add from 1993 a 50 percent bracket for those whose annual earnings exceed one million forints -- $12,500). In addition to taxes, employers must also pay contributions to the Social Security and Solidarity (unemployment) Funds. These are 44 and 5 percent, respectively, of the wage bill. (Employees pay an additional ten and one percent.) The government has approved a proposal to increase contributions to the Solidarity Fund to six percent for employers and three percent for employees beginning in 1993. Unfortunately, bureaucratic procedures are all too often lengthy and lacking in transparency. This is especially true in regards to company registration and many aspects of the privatization process. Company registrations are extremely slow, sometimes requiring several months, mainly because the courts have been overwhelmed by the number of applications. In addition, unclear lines of authority sometimes make it difficult for a foreign investor and Hungarian government officials to determine who, in which ministry, can make the necessary decisions. I. Efficient Capital Markets and Portfolio Investment Hungary implemented a major bank reform in 1987, creating a two-tiered system by separating the functions of the commercial banks from the National Bank. Aside from the National Bank, all financial institutions in Hungary are regulated by Act LXIX of 1991 on Financial Institutions and Financial Institution Activities ("Banking Law"). The provisions of the Banking Law are similar to those in western countries and include stricter capital adequacy provisions and loan classification requirements. The law specified that those financial institutions authorized to perform deposit transactions establish a mandatory deposit protection fund. Other clauses limit large credits, internal credits, and credits for securities transactions, real estate investments, and durable investments. The office of State Banking Supervision, a government agency, and the National Bank are both involved in judging license applications and overseeing the activities of financial institutions. At present, more than 50 commercial banks, including 17 with foreign participation. Foreign investors have access to credit on the local market, generally on the same terms as domestic investors. Exceptions include special governmental credit concessions, such as Existence and Start loans, intended to boost domestic small business. Because interest rates in Hungary are relatively high and longer term credits sometimes difficult to obtain, however, most foreign investors prefer to borrow abroad. (As noted earlier, the National Bank must approve in advance any foreign currency loans.) Close ties to old (usually state-owned) clients, the larger and safer profits available from investing in state securities, unfamiliarity with loan application evaluations, and inadequate bank reserves have acted to constrain commercial bank credit to the private sector. There is a wide variety of other sources of credit for private investors, whether foreign or domestic. These include the Hungarian-American Enterprise Fund, the European Bank for Reconstruction and Development, and the International Finance Corporation. The estimated total assets of the five largest banks in Hungary is over HUF 1,650 billion ($16 billion): National Savings and Commercial Bank (HUF 831 billion); Hungarian Credit Bank (HUF 358 billion); Hungarian Foreign Trade Bank (HUF 204 billion); Budapest Bank (HUF 165 billion); and the Post and Savings Bank (HUF 123 billion). Banking reform is a priority for the government of Hungary. The previous government executed two debt consolidation programs which injected at least HUF 300 billion into the larger state banks in an effort to improve their capital adequacy ratios -- first to 4 percent and later to 8 percent. Smaller banks were required to raise their capital adequacy ratios to 4 percent. Prior to the debt consolidation program, as much as 30-35 percent of the assets of the largest eight banks were thought to be non-producing. Forced to write down as much as 45 percent of their bad loans, the collective portfolios of the largest eight banks is estimated to be approximately 20-25 percent. The Budapest Stock Exchange, the first to reopen in Eastern Europe, was formally reestablished in 1990. Act VI of 1990 on Securities and the Stock Exchange, along with rules approved by both the Stock Exchange Council and State Securities Supervision, govern the public issue of and trade in bonds, shares, and other securities. At the end of May 1994, 86 securities, with a nominal value of $5.99 billion, were listed on the exchange. A number of the member institutions -- brokers, broker-dealer companies, and banks -- are partly or wholly foreign-owned. Starting in 1993, banks were no longer permitted to be members. Act LXIII of 1991 on the Investment Funds created the possibility for the operation of both close-ended and open-end mutual funds. The first such fund in Hungary was launched in February of 1992. There are limitations, described earlier, on foreign participation in some investment funds. J. Bilateral Investment Agreements The following countries have concluded bilateral investment protection agreements with Hungary: Germany, France, Belgium, Great Britain, Greece, Sweden, the Netherlands, Italy, Denmark, Austria, Finland, Switzerland, the Republic of Korea, Cyprus, Uruguay, Kuwait, Spain, Norway, China, Israel, Australia, Canada, Morocco, Turkey, Portugal, and Thailand. With the following countries Hungary has signed investment protection agreements, but has not yet ratified the agreements: Indonesia, the Czech Republic, Slovakia, Argentina, Malaysia, Paraguay, Romania, and Poland. Hungary and the United States have been in negotiations for a business and economic treaty but have not yet concluded one. Hungary has concluded treaties on the elimination of double taxation with many countries, including: Albania, Austria, Belgium, Cyprus, Denmark, Finland, France, Germany, Greece, India, Italy, Japan, Luxembourg, Malta, the Netherlands, Norway, Poland, Romania, Spain, Switzerland, Sweden, Thailand, the United Kingdom, the Czech Republic, Slovakia, and the United States. In addition, Hungary signed such a treaty with the former Yugoslavia and concluded a multilateral agreement on this topic with the former CMEA states in 1979. K. OPIC and Other Investment Insurance Programs The U.S. Overseas Private Investment Corporation (OPIC) has been operational in Hungary since October 1989. OPIC offers American investors insurance against political risk, expropriation of assets, damages due to political violence, and currency inconvertibility. OPIC can also provide specialized insurance coverage for certain contracting, exporting, licensing, and leasing transactions undertaken by U.S. investors in Hungary. France, Germany, Japan, and Great Britain offer insurance similar to OPIC's for investments in Hungary. Political risk insurance is also available for foreign-owned companies in Hungary from several private carriers in the United States and Western Europe, and from the Multilateral Investment Guarantee Agency (MIGA), which is a World Bank affiliate. In addition, the National Bank of Hungary, for a fee, will issue to a foreign-owned company its guaranty of the Investment Act's commitments regarding expropriation and profit repatriation. L. Labor Hungary's civilian labor force of 5 million women and men is highly educated and highly skilled. The literacy rate in Hungary tops 98 percent. About two-thirds of the workforce has completed some form of secondary, technical, or vocational education. Hungary is particularly strong in engineering, medicine, economics, and the sciences. While many foreign investors have praised the productivity, motivation and adaptability of Hungarian workers, some others have disparaged them. Overstaffing and the consequent need to lay off workers to achieve efficient operations are problems encountered by foreign companies investing in existing enterprises. Foreign investors often try to solve these problems via early retirement and worker retraining programs. Investors often wish to discourage the Hungarian practice of holding down two or three jobs simultaneously and can usually do so by offering higher wages. The recent boom in foreign investment in Hungary has resulted in shortages of employees with western-style management skills. The lack of foreign language skills, formerly a major problem, is becoming less so, especially among younger Hungarians. Labor factors have not significantly affected investors' choice of technology. The economic recession has hit labor hard. Unemployment peaked in February 1993 at over 13 percent and now stands around 10-11 percent. There are wide regional discrepancies. In the Northeastern counties unemployment exceeds 20 percent, while in Budapest and the western portion of the country, unemployment is closer to 5 percent. Unions in Hungary are relatively weak and divided, however. About half the workforce is unionized (down from 90 percent under communism). Labor-management relations tend to be collegial, with both sides negotiating labor issues at the company level, as well as the national level (within the sphere of the Interest Reconciliation Council, made up of government, employer, and organized labor representatives). The Hungarian National Association of Labor Unions (MSzOSz), which Hungary adheres to the ILO Convention Protecting Worker Rights. The ILO opened an Eastern European Office in Budapest in 1992. Hungary's new Labor Code, modelled after German legislation, came into effect on July 1, 1992. The Labor Code guarantees employees the right to form or join trade unions and gives unions the right to operate inside a company. Unions are entitled to conclude collective bargains. Employees may elect factory councils, which the employer is obliged to consult on a number of questions, such as the privatization of the company or plans for worker retraining. The Labor Code limits the work day (to 12 hours) and overtime, guarantees maternity leave, at least 20 days of annual leave, at least 30 days notice, and severance pay for those employed at least three years. The law also forbids discrimination based on sex, age, or nationality. The minimum employment age is 16 years, except that apprentice programs may begin at 15. A national minimum wage is set by the Ministry of Labor upon the recommendation of the Interest Reconciliation Council; labor and management can agree upon a higher (not lower) minimum wage for a given industry. M. Foreign Trade Zones/Free Ports The Investment Act allows foreign investors to set up or acquire interest in companies in a duty-free zone. Since "a duty-free zone shall be deemed as foreign territory from the aspect of the customs, foreign exchange, and foreign trade regulations," such companies are legally considered to be foreign companies (versus the consideration of a foreign-owned company registered in Hungary as a Hungarian firm). Offshore companies are required to keep their accounts and make most of their transactions in hard currency. They must establish a forint account at a Hungarian bank to meet any expenses (such as taxes and wages) that the Act specifies must be paid in local currency. N. Capital Outflow Policy Capital export and outward direct investment has been allowed since 1974, but requires the prior permission of the Hungarian government. The National Bank, the Ministry of Finance, and the Ministry of Industry and Trade (MIT) review license applications. According to government statistics, Hungarian entrepreneurs invested abroad HUF 11.4 billion ($114 million) in 1,298 joint ventures by the end of 1993. In 1993, the Hungarian National Bank recorded $11 million of capital outflow, an average of less than $1 million a month. Two-thirds of the registered new joint ventures are located in neighboring countries. However, Hungarian ventures may be found in Western Europe (mainly Germany and Austria), the United States and in countries with favourable taxation laws such as Cyprus and Lichtenstein. The sectors targeted for investment abroad are trade, tourism, and service sectors. In Germany and Austria, most investment is directed to the construction industry. In neighboring Romania, for instance, Hungarian investment is in consumer goods and basic materials industries, followed by production (furniture and ready-made garments). Approximately 120 of the 1,298 registered ventures are operating in Russia. The ventures are extremely cautious because of the risks involved; capital transfer is very low with 60 percent of the capital typically as contribution in kind. Hungarian Investment Abroad in 1991 cash technical total forint (000) contribution equivalent (mil) ----- --------- ------ -------- USSR USD 3,351 12,595 15,946 1,191.1 Germany DM 3,118 80 3,198 159.2 Austria ATS 15,560 -- 15,560 109.9 UK GBP 672 -- 672 95.2 UK-Jersey Is. USD 1,042 -- 1,042 77.8 Romania USD 676 554 1,230 91.9 Holland NLG 925 -- 925 36.8 CSFR USD 380 258 638 47.7 USA USD 316 50 366 27.3 Yugo. USD 326 36 362 27.0 Other USD 485 1,304 1,789 133.7 (Note: Average exchange rate in 1991 was $1 = HuF 74.8) Number of Hungarian Investments first Half 1991 1992 ---- --------- Romania 87 54 CSFR 64 28 USSR/CIS 52 55 Germany 45 23 Austria 31 7 UK 12 n/a USA 10 n/a Other 66 n/a TOTAL 367 197 O. Foreign Direct Investment Statistics Hungary has attracted more than half of all foreign direct investment (FDI) made in Central Eastern Europe. As off the end of April 1994, total foreign direct cash investment reached USD 6.02 billion. Non-cash contributions bring current FDI to over USD 7 billion. Since the beginning of the year, FDI for the first five months of 1994 has been USD 433 million, with a low point in February of USD 20 million. There are over 20,000 joint ventures registered in Hungary, up from 13,000 two years ago. Investment began pouring into Hungary with the liberalization of the investment regime, even before the transition to democratic rule. Ministry of International Economic Relations (now merged with the Ministry of Industry & Trade) and IMF statistics show the rapid growth in the amount of foreign investment. The dollar amounts represent actual inflows and do not include investment commitments. FDI in Hungary ($ mil) Year Value ---- ----- 1972-88 250 1989 300 1990 900 1991 1,700 1992 1,471 1993 2,328 01-04 1994 433 ------- ----- Total 7,382 More than one-third of the joint ventures operating at the end of 1991 were established with one million forints (the minimum required to establish a limited liability company), while the founding capital of 543 (6 percent) exceeded 100 million forints. Of the companies with foreign participation set up in the first half of 1992, however, approximately two-thirds were established with the minimum one million forints capital. Only 45 companies (2.2 percent) had founding capital greater than 100 million forints -- though their founding capital represented 82.5 percent of the total for the JV's set up in the first half of 1992. For investments made though 1991, 57 percent of foreign capital was invested in industry, 16 percent in trade, 16 percent in services, and 6 percent in construction. For investments made in the first half of 1992, 60.6 percent of foreign capital was invested in industry, 10.4 percent in trade, and 8.7 percent in services. According to the Ministry of Industry & Trade, as of January 1994, the leading foreign investors are: United States $3.1 billion Germany $1.4 billion Austria $1 billion France $0.6 billion Other major investors are Great Britain, Japan, Switzerland, Sweden, Canada, and Italy. P. Major Foreign Investors A list of the largest investments in Hungary follows and is comprised largely from a December 1993 list published by the economic weekly "Budapest Business Journal". COMPANY INDUSTRY INVESTOR ($ mil) (Country) -------- -------- --------- Hungarian Telephone Company (MATAV) ($875) telecom Ameritech (US) Deutsche Telecom (GER) Tungsram ($550) light bulb General Electric (US) Audi Hungary ($420) car engines Volkswagen/Audi (GER) Westel ($330) telecom US West Int'l (US) GM Hungary ($300) autos, parts General Motors (US) Magyar Suzuki ($250) finished autos Suzuki (JPN) Pannon GSM ($250) telecom Scandinavian PTTs Hungaria Biztosito ($220) insurance Allianz (GER) Hungarian Euro-Expwy. ($200) construction Various (FR - AUS) KOFEM ($165) aluminum Alcoa (US) NMV ($160) food/soap Feruzzi (IT) Unilever food/soap (HOL/UK) Dunapack/Halaspack ($160) paper Prinzhorn (Aus) Ganz ($130) elec. eng. Ansaldo (IT) FAU ($169) beverages Pepsico (US) Hunguard ($100) glass Guardian Glass (US) MALEV ($100) airline Alitalia/Simest (IT) NIKEX ($100) investment Hungarian Inv. (UK) Chinion ($100) pharmaceuticals Sanofi (FRA) Ford Hungaria ($100) automotive parts Ford (US) Compack ($100) food processing Sara Lee/Douwe Egbert (US/NETH) Coca-Cola ($100) beverages Amatil (AUSTRL) Kempinski Hotel ($95) hotel Dresdener Bank (GER) Kempinski (GER) Intercsokolade Kft ($94) food processing Nestle (SW)