European Commission says Hungary's solid growth overshadowed by twin deficit

The EU executive also raised its projection for Hungary's general gross government debt to 59.9% of GDP from 58% and next year's figure to 62% from 59.2%.

The report showed that Hungary will remain the EU's worst budget deficit offender.

Expenditures are projected to be higher than officially estimated, “as the budget lacks the necessary structural reforms targeting expenditure reduction."

Interest expenditure is also expected to be higher than budgeted in view of the projected rise in interest rates and the government debt level. Based on the usual nopolicy change assumption, the budgetary position is expected to worsen in 2007 to 7% of GDP, chiefly due to the second step of the planned tax cuts.

In its previous report, the EC projected 6.9% of GDP budget deficit for 2007.

The forecast includes the costs of military aircraft (0.3% of GDP in 2006, and 0.2% of GDP in 2007) purchased under a financial lease and to be delivered in those two years (these outlays were not included in the original official targets of 4.7% of GDP in 2006 and of 3.3% of GDP in 2007). It assumes that investment in new motorways built in public-private partnerships worth about 1% of GDP, are recorded as private investment and not as government expenditure.

The EC expects Hungary's re-elected Socialist-led government to present a credible austerity scheme by September, to enable it to take down the deficit to below 3% of GDP in 2008, two years before Budapest plans to join the euro zone.

Hungarian government sources have said a belt-tightening programme would be launched in the second half of this year.

A deficit of less than 3% of GDP is a key criterion for joining the euro zone and should be met two years before a candidate adopts the single currency.

In 2006, real GDP growth is forecast to accelerate to around 4.6%, the EC said, raising its forecast massively from 3.9% in its previous projection.

“Domestic demand is expected to fuel economic activity mainly because of the expansionary fiscal stance. Foreign demand is also expected to contribute to GDP growth in line with the pick-up in the international economic activity. In 2007, GDP growth is expected to ease somewhat to around 4.2%, due mainly to moderating private consumption," the EC said. Earlier it projected 3.9% economic growth for next year.

Throughout the projection period, private consumption is anticipated to be especially strong, supported by lower indirect taxes, rising social transfers and minimum wage increases. The EC sees private consumption growth at 3.8% this year and 3.2% in 2007, down from the respective forecast of 3.9% and 3.4% made last autumn.

Investment in construction will continue to benefit from extensive motorway construction, while investment in equipment will remain steady both in 2006 and 2007.

Imports are set to rise alongside private consumption and investment spending.

The EC sees imports growing by 10.3% in 2006 (vs. +10.5% yr/yr in the previous forecast) and 9.9% yr/yr in 2007 (vs. 9.8%). As exports are also expected to grow relatively strongly both in 2006 and 2007, the negative trade balance is set to stabilize at around 2.5% of GDP.

The EC projected export growth to come in at 11.6% in 2006 (vs. 10.3%) and 11.5% in 2007 (vs. 10.0% in previous report).

Due to the continuing fiscal expansion and robust private consumption, the current account deficit is projected to widen throughout the forecast period, reaching close to 8.5% of GDP. This figure compares with a 7.7% projection in the autumn. For 2006, however, the EC cut its deficit C/A deficit forecast to 8.3% of GDP from 8.4%.

“The increasing amount of public and private foreign debt-related interest expenditure will continue to strongly contribute to the expanding factor income deficit."

Employment is expected to slightly increase throughout the forecast period. “As the participation rate is projected to rise, the anticipated employment growth might not translate into a decline in the unemployment rate, which is expected to stabilise at above 7.5%," the EC said.

For 2006, the EC expects Hungary's jobless rate at 7.7%, up considerably from the previous projection of 6.9% and sees unemployment at 7.6% next year, also up from 6.7% in the autumn report.

Annual consumer price inflation is projected to further decelerate to about 2.3% in 2006 as a whole, mainly as a result of the cut in VAT rates, the EC said.

“The first monthly data for 2006 showed that so far the cut in the VAT only partially affected prices. However, the falling inflation expectations and the intensive competition in the tradable sector following EU accession are expected to cool inflationary pressures in 2006."

In 2007, fuelled by high oil prices and the weakening forint, consumer price inflation is forecast to return to close to 3.5%, broadly in line with the underlying inflationary trends in Hungary.

European Union

Economic growth is projected to rebound in 2006 to 2.3% in the European Union and to 2.1% in the euro area, up from 1.6% and 1.3% in 2005, according to the Commission's spring economic forecasts. The main impulses stem from a robust increase in investment, continued strong world growth and an improved outlook in Germany.

Growth is expected to edge slightly lower in 2007 to 2.2% in the EU and 1.8% in the euro area. The EU as a whole is expected to create 3 ½ million new jobs over the period 2006-07, after nearly 3 million in the previous two years. This will help reduce unemployment from a peak of more than 9% in 2004 to an expected 8.2% in 2007 in the EU. Inflation remains remarkably stable at slightly above 2% despite soaring oil prices, which remain the main risk to economic growth.

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