Budget stringency cannot be a subject of debate: Hungary must sacrifice a little growth

The budget situation is disappointing

Although I could, I will not begin to analyze at length why the budget is in an extremely difficult situation. Even here, in these columns, we have already learned in detail what the biggest problems are. However, a quick reference can’t hurt, based on one selected example.

The interest burden of the public finances increased drastically this year.

Of course, this can hardly be surprising, given the extremely high inflation environment and the accompanying extraordinary interest rate environment. The government also expected interest expenses to rise, but not to this extent. After last year’s interest expenditure of roughly HUF 2,100 billion, the budget calculated this year’s expenditure of approximately HUF 2,500 billion. On the other hand, based on the first four months – compared to the base for the same period in 2022 – the interest expenditure is already HUF 517.6 billion higher. Only a third of the year has passed and a slippage of several hundred billion forints is already being outlined.

Of course, this is fair if we take into account the fact that the interest income is also exceeded.

The only problem is that this overperformance barely exceeds HUF 78 billion. In other words, even on a net basis, the extra burden is approximately 440 billion. Even with a generous nominal GDP, this is a slippage of more than half a percent.

We can also take a look at the revenue side, which, although at first glance it is gaining weight, still seems to be seriously lagging behind. The 2023 budget determined a revenue corner figure that is HUF 6,572 billion higher than the actual figure for 2022. A third of the year has passed and so far HUF 1,551 billion has come in from this planned surplus. In terms of proportions, this is only 24 percent of the plan. Obviously, the simplification is oversimplified, as not all income is met in proportion to time. Last year, 33 percent of the total annual revenue flowed into the budget by the end of April. This year, this ratio is 31 percent. This difference does not seem to be much, but if this cannot be done by the end of the year and in the end 98 percent of the plan is only fulfilled:

this also means an extra deficit of slightly more than HUF 700 billion, i.e. 0.9 percent of GDP.

Achieving the growth target depends on the weather

To put the situation very simply, it seems that unless the Hungarian economy shows an unexpected revival, it will be difficult to implement the budget plans in their current form. Part of the slippage of the budget stems precisely from the fact that the Hungarian economy is not moving along the macroeconomic trajectory envisioned by the government.

The forecast – and thus one of the bases of the budget – is that this year’s GDP volume will expand by 1.5 percent. After last year’s weak year-end, the carryover effect is -0.5 percent.

In other words, if the Hungarian economy were to stagnate throughout the year, real GDP in 2023 would decrease by half a percent.

Add to this the fact that in the first quarter the performance of the economy fell by 0.2 percent and we are already at a GDP figure of -0.7 percent this year. That is, the in the remaining three quarters, the Hungarian economy should continuously produce growth of 1.4-1.5 percent quarter/quarter to achieve this.

The last time the economy produced such a performance was during the post-Covid recovery, when the budget was in a relaxation cycle, and not a small one at that. Since we are writing at the end of May and inflation is still extremely high, real wages continue to shrink, savings are dwindling, lending is shrinking and unemployment is going up rather than down, we can hardly expect the Hungarian economy to produce this in the second quarter. At the press conference following the May interest rate meeting, Vice President Barnabás Virág spoke about how

according to the MNB’s latest calculations, the economy may continue to shrink even in the second quarter.

But let’s be kind and anticipate a quarter/quarter-year stagnation. This would put an end to the technical recession. Instead, for the second half of the year in both quarters, the GDP should expand by nearly 3-3 percent on a quarterly basis. The Hungarian economy has never produced anything like this beforeand it does not seem that, for example, the budget would run on such an impulse now.

With this, we have reached the point where the 1.5 percent economic growth set for this year is almost unattainable.

Only agriculture can save the honor of the uniform. And the weather so far is encouraging. After last year’s extremely bad year, even an average performance this year can bring a 40-50 percent increase in agriculture. Although the weight of agriculture is small, with such an expansion, the sector alone may be able to push this year’s GDP growth by 1.5-2.0 percentage points. Based on this, it is perhaps already understandable why the government still insists on the growth target. Because we can even be close to it if the other sectors recover somewhat in the second half of the year or if agriculture produces an above-average year.

It is not reasonable to let go of the deficit target

The only problem with the growth goal achieved in this way is that the budget income side will not gain weight simply from the agricultural base effect and some extra performance, and of course its expenses will not be much smaller either. At the same time, it also becomes apparent that in such a situation, when the growth figure may even come in and the budget is burdened with risks, the government cannot do anything to stimulate the economy. In other words, to the question posed by Gergely Csiki that “it is a big question whether the government will accept further adjustment measures that will also slow down economic growth, even risking recession, or rather give in to the deficit target even this year”, my answer is: it is not rational releasing the deficit target.

Not to mention that, considering the political risks and benefits, it doesn’t make sense to chase 1.5 percent growth by further upsetting the budget.

The population will hardly feel overflowing joy just because the increase was not 0.2 or 1, but 1.5 percent. Three quarters of the Hungarian economy is in a technical recession, the majority of companies are still not thinking about massive downsizing. Meanwhile, wage growth is still over 15 percent. This is what matters politically. If the labor market remains so strong even in an economic state that is close to stagnation, then there is no need to stress over the GDP statistics. In addition, the spending – for which there is emphatically no room for maneuver in addition to the original plans – even threatens with an inflationary surplus, which would endanger even the most easily achieved victory: the single-digit inflation target at the end of the year. This can almost be seen by looking at the current performance of the economy, the repricing dynamics and the base effects.

The excessive deficit procedure returns

So, I think it is clear that relaxing the budget is not reasonable. But what about slipping? If the government does not manage it, there is a real danger that the deficit target will be missed. At first glance, the internal political cost of this is small. At least in the short term. But missing the target this year also means that next year’s plan (deficit planned for 2.9 percent of GDP) can only be kept with another adjustment.

In 2024, however, there is no escape: the excessive deficit procedure (TDE in Hungarian, EDP in English) will intensify.

The European Commission decided to put an end to budgetary alcoholism and send the member states into withdrawal. Due to the Covid crisis and then the war, the Stability and Growth Pact and its correction mechanism, the EDP, were suspended. However, the Commission has started to work on its reform, the adoption of which is expected by the beginning of 2024, and together with this, budgetary rigor will again become more stringent. The member states must meet the deficit target below 3 percent and the public debt ratio below 60 percent.

And if they are above it, they are forced to make a strong budget adjustment.

We could even think that it had been like this before, but nothing came of it. Most Member States must have broken the rules once or twice in the last decade, but the Commission was lenient. Essentially, this temporary mistake will be legalized by the new system and the penalty will be when the non-fulfilment is systematic. In the case of the latter, on the other hand, in exchange for a more flexible system, persistent violations will actually be punished.

However, when the new framework enters into force – expected at the beginning of 2024 – the European Commission can once again initiate the EDP against recalcitrant member states. This will be based on the 2023 budget year. In other words, we can already expect that the Commission will bring Hungary under the procedure. In such a situation, it does not matter at what high deficit level the mandatory correction must be started.

Looking at it from this point of view, it is still much better to take some steps already this year in order to comply with the set deficit target. So next year, we really have to tighten our belts a bit more to finally fit under the 3 percent deficit target by 2024. In this way, the EU penalty and the shaking hands of the credit rating agencies can be avoided due to the declared unsustainable budget policy. At this point, one of the messages of MNB President György Matolcsy, which was given at the press conference after the interest rate decision, becomes clear: the MNB also sees that the budgetary processes will support the monetary policy goals. Budget stringency cannot now be a subject of debate.

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