Increased state interference and "frequent and unpredictable" changes in policy by the government of Prime Minister Viktor Orban are undermining confidence in Hungary, hurting the investment climate and hindering growth, the IMF warned Friday.
In its annual report on Hungary, the Washington-based International Monetary Fund noted that investment levels were at a 10-year low.
The economy meanwhile contracted by 1.7 percent of gross domestic product in 2012 and was expected to remain "broadly flat" in 2013.
"Weak growth in recent years has been due to an adverse external environment, structural factors,such as the ongoing balance sheet adjustment in the economy, and policy missteps by the government," Thanos Arvanitis, the IMF's mission chief for Hungary, said in the report.
"Hungary needs a different mix of policies to jump start growth and increase employment," he added.
The IMF cited the poor investment climate as one of the factors that would keep medium-term growth low.
"A more business friendly set of policies is key to revive the economy," it concluded.
Higher growth would also contribute to lowering public debt, which currently stands at about 80 percent of GDP, making the country "vulnerable to financial market volatility," the report said.
The IMF welcomed the government's efforts to keep deficits below 3.0 percent, but criticised that "recent fiscal consolidation has relied excessively on controversial tax measures," affecting the banking, telecom, electricity, and retail sectors.
"Fiscal policy must refocus on quality," it urged.
After eight straight months of interest rate cuts by Hungary's central bank, which have brought the base rate down to 5.0 percent from 7.0 in July, the IMF also encouraged it to "pause for now."
"Policy rate cuts cannot substitute for other policies to jump-start growth," it said.
"Ensuring the legal and operational independence of the central bank would be of paramount importance for the credibility of the inflation targeting regime," the IMF added, in a veiled reference to the recent controversial change of leadership at the bank.
Earlier this month, former economy minister Gyorgy Matolcsy, a loyal ally of Orban, took over as governor, stoking concerns over the bank's independence.