Hungary has successfully narrowed its budget deficit to within the 3% of GDP limit required by the EU, but the IMF continues to dispute the sustainability of the country's fiscal consolidation effort.
IHS Global Insight perspective | |
Significance | Hungary's general government budget deficit came in at 2% of GDP in 2012, well below the 3% of GDP limit required by the EU. |
Implications | Despite the success of Hungary's fiscal consolidation effort, EU and IMF authorities continue to question the sustainability of the government's budget measures. |
Outlook | With the government again relying heavily upon new revenues rather than reduced spending in order to reach its budgetary goals for 2013, further budget revisions are likely to be needed later in the year if it is to keep the deficit below 3% of GDP. |
According to data released by the Economy Ministry on 29 March, Hungary's budget deficit in 2012 narrowed to 2.0% of GDP under the EU's ESA95 methodology: well below the government's original target of 2.5% of GDP and within the 3% of GDP limit required by the EU. According to data published by the Central Statistical Office (KSH), Hungary's general government sector posted a deficit of HUF567 billion in 2012, equivalent to 2.0% of GDP. Revenues fell by 12.3% compared with 2011; however this reflects high base effects given the revenue boost received in 2011 by the nationalisation of pension funds. Without this transfer, revenue grew by 6.6% in 2012 reflecting a 10.3% increase in revenue from value added taxation reflecting the increase in the highest rate to 27%. Meanwhile, expenditure decreased by 0.6% compared with 2011, reflecting a decline in the compensation of employees as well as the other expenditure category. The fall in the other expenditure category reflects favourable base effects, following the 2011 move by the central government to take on the debt of the Hungarian State Railways and the payment of losses for the Hungarian Development Bank. According to the figures of the National Bank of Hungary (MNB), general government debt amounted to HUF22,381 billion, 79.2% of GDP at the end of 2012, the KSH added. This was a modest improvement of gross debt levels equivalent to 81.4% of GDP in 2011.
The Ministry brought forward the publication of the full year data for 2012 following the publication of a report by the International Monetary Fund (IMF) on 29 March indicating that Hungary is likely to miss its budget deficit goal for this year. The aim of bringing forward the release was to silence doubts about the government's commitment to fiscal consolidation: the government is targeting a budget deficit of 2.7% of GDP in 2013; however, in its staff report for the 2013 Article IV consultations and third post programme monitoring discussions the IMF forecast that the fiscal shortfall would soar to 3.2% of GDP, once again breaching the EU limit, and to 3.4% of GDP in 2014.
Hungary has been subject to the EU's Excessive Deficit Procedure (EDP) for nearly ten years after consistently breaching the 3% of GDP limit and, in the eyes of the EU, falling to devise a sustainable long-term strategy for curbing the budget shortfall. With the increased focus on budget responsibility in the EU given the sovereign debt crisis, Hungary has been under immense pressure to bring its budget deficit under the 3% of GDP limit. However, EU and IMF authorities continue to question the sustainability of the government's fiscal consolidation measures. In 2011 Hungary achieved a budget surplus of 4.3% of GDP under the ESA95 methodology after the government controversially nationalised private pension funds. After revenue undershoots and expenditure overruns in the first half of 2012, the EU threatened to suspend Hungary's access to vital EU funds if it failed to curb the budget deficit. This prompted the Hungarian government to implement four new fiscal consolidation packages in the final quarter of the year. However, these once again relied heavily on controversial tax measures, including an extension of crisis taxes, which have hurt the business climate while failing to address the need for structural expenditure reform.
IMF recommendations
The IMF report has also accused the government of severe fiscal policy missteps which threaten to trap Hungary in a low growth cycle. The Fund warned that Hungary's large external and public financing needs are increasing risks and leave the country vulnerable to shifting investor sentiment, while banking deleveraging and rising non-performing loans (NPLs) could undermine economic activity. The report also touched upon the issue of central bank independence and encouraged the MNB to pause its cycle of monetary loosening as inflation expectations are "not well anchored" and a further lowering of borrowing costs could further weaken the forint. IMF staff issued a number of recommendations for the Hungarian government including improving the business climate through introducing a more predictable policy framework and more balanced fiscal consolidation; raising the low labour participation rate through a more friendly tax regime and upgrading public works; and strengthening competition.
Outlook and implications
While the IMF's recommendation would certainly boost the medium-term growth prospects of the Hungarian economy, they are unlikely to be implemented. Hungary's government has pursued a series of unorthodox economic policies since coming to power, designed to buffer households from the impact of the global economic slowdown while reigning in fiscal deficits and lowering unemployment levels. While the majority of these measures have been highly popular with the public, the spillover effects of policies such as the forced transfer of foreign exchange losses from households' to banks' balance sheets have been negative on the country's economic performance. This has been combined by a general weakening of domestic institutions and frequent policy clashes with the EU and IMF leading to an erosion of the investment climate in the country.
For this year the government has already implemented a number of revenue-raising measures, such as the financial transaction tax on the financial sector in force since January 2013 as well as excise taxes increases on alcohol, tobacco, junk food, and liquefied natural gas. Once again, the government is relying heavily upon new revenues rather than reduced spending in order to reach its budgetary goals, an approach that is likely to lead to more disagreements with the EU and IMF. In fact, a major new-jobs push is included in the 2013 plan that will cost an extra HUF300 billion. In all, the budget proposes only HUF397 billion in cuts for 2013, primarily from a freeze in teachers' wages and the reduction of thousands of public-sector jobs. As a result, the government will need to announce some budget revisions later in the year if it is to keep the deficit below 3% of GDP in 2013.