Economy
Will a third austerity package land on Hungary?
Why tax hikes are needed?
A special characteristic of the 2009 Budget is that - unlikely in the previous two years - it is based on an unrealistic economic path. The 4.5% inflation target and 1.0% GDP contraction appear to be overly optimistic assumptions. Nominal GDP (lower inflation and larger downturn) could in fact be even 4% smaller, which can seriously eat into budget revenues.
Due to the opaque processes in the budget it is hard to say how seriously this would affect the deficit, which is planned at 2.6% of GDP for this year, but it is certain that we're talking about hundreds of billions of forints here. (It is likewise hard to tell how big last year's deficit would have been without the government pushing up spending at the end of the year or how successfully the whitening of the economy can continue in a recessional environment.)
Economists tend to project a HUF 200-300 billion overshoot of the target, which translates into an addition of 0.7-1.0 percentage points to the deficit in percent of GDP. According to press reports, the cabinet will set the new target at 2.9% of GDP, which is “only" an 0.3-ppt upward correction, which cries for further measures.
Why is a bigger deficit a problem?
In a favourable financing environment the aforementioned jump in the deficit could, in theory, be shrugged off wit no specific risks. Between 2002 and 2006 we had witnessed that the market can tolerate even a much bigger fiscal laxity. We have three reasons why this would not be the case right now:
1. In the current global environment, which is characterised by a shortage of liquidity, financing is ab ovo risky due to an elevated risk aversion from the part of investors. Hungary's foreign currency debt ratio is already above the tolerable level (downgrade is looming) and a runaway budget could have serious consequences.
2. The credibility of the Hungarian government is weak due to its poor track record. Consequently, a halt in the reduction of the deficit may carry a bad message to investors. The cabinet should definitely not set the target to above the Maastricht criterion (3.0% of GDP).
3. The IMF-led credit facility, aimed to preserve the solvency of the country, was granted to Hungary on the condition that the deficit will be lowered more drastically than before. Therefore, an overshoot of the original target could in fact bear more significance than it would otherwise do. Note that knees started to jerk already last week before IMF Director Strauss-Kahn's visit to Hungary, with rumours circling that the fund will terminate the USD 25 bn credit deal. This was, of course, uncalled for and totally unfounded, but it still tells us a great deal about the credibility of the government's economic policy.
When it comes to the relation between the budget and the IMF there is one other thing we need to highlight. The IMF will probably not freak out in January that the 2009 Budget was created in December on the macro assumptions agreed earlier. There was no sign at all that the cabinet would want to open purse strings. It was willing to adjust and readjust the budget to the continuously deteriorating external environment. In the end it had to rewrite it twice.
To hit a more critical tone on economic policy we must say the cabinet should not have consented to the IMF building its inflation prognosis to an exchange rate crisis scenario and that pending cases were not adjusted to deteriorating processes. When the 13th-month payments were scrapped, the compensations should have been radically cut or abolished altogether, as soon as it became evident that the budget target was in jeopardy (irrespective of the go-ahead given by the IMF).
We'd need a good ole' currency crisis. Or not...
So there is the need for yet another adjustment. This is a terrible situation not only because the standard of living will descend further, but also because the growth outlook is likely to deteriorate some more. A few weeks ago it still seemed that after three years the government has finally comprehended that at such a growth potential a debt spiral is unavoidable. Then we started to hear the mechanic responses, typically socialist notions such as “contribution cuts in exchange for VAT hike", which is far from being perfect, but after all it's a small country - with small plans. Now it seems Hungary will need to raise the rate of VAT just to save the budget, but that will certainly not create room for a marked reduction in contributions.
From a formal point of view - and taking into consideration the mistakes the government has made - the budget could be tidied up the following ways:
1. The increase of consumer prices should be adjusted to around the planned 4.5%. One way to achieve that is raising the rate of VAT. The other is to let the exchange rate run wild. The latter would virtually chime together with the IMF's assumption, but now that Hungary has successfully dodged a currency crisis it would be rather risky to create one artificially.
2. The cabinet might also try to bring economic growth closer to what is in the plans, meaning contraction should not be bigger than 1.0%. This, however, would be tricky in the short term, as recession waves are mostly hurling in from outside the borders. In a downward economic cycle a country that is up to its ears in debt and pursues a faulty economic policy should not try sail near the wind. One could always try, but the government has never been keen on measures that would foster potential growth, e.g. the overhaul of the tax regime and the welfare system. Moreover, these would only increase social tensions in the current environment.
3. There is still the choice of a drastic deficit cut, but the cabinet would not want to go down that road for similar reasons.
This is where we stand now. Let's see what policymakers will conjure up from the hat this week.
A special characteristic of the 2009 Budget is that - unlikely in the previous two years - it is based on an unrealistic economic path. The 4.5% inflation target and 1.0% GDP contraction appear to be overly optimistic assumptions. Nominal GDP (lower inflation and larger downturn) could in fact be even 4% smaller, which can seriously eat into budget revenues.
Due to the opaque processes in the budget it is hard to say how seriously this would affect the deficit, which is planned at 2.6% of GDP for this year, but it is certain that we're talking about hundreds of billions of forints here. (It is likewise hard to tell how big last year's deficit would have been without the government pushing up spending at the end of the year or how successfully the whitening of the economy can continue in a recessional environment.)
Economists tend to project a HUF 200-300 billion overshoot of the target, which translates into an addition of 0.7-1.0 percentage points to the deficit in percent of GDP. According to press reports, the cabinet will set the new target at 2.9% of GDP, which is “only" an 0.3-ppt upward correction, which cries for further measures.
Why is a bigger deficit a problem?
In a favourable financing environment the aforementioned jump in the deficit could, in theory, be shrugged off wit no specific risks. Between 2002 and 2006 we had witnessed that the market can tolerate even a much bigger fiscal laxity. We have three reasons why this would not be the case right now:
1. In the current global environment, which is characterised by a shortage of liquidity, financing is ab ovo risky due to an elevated risk aversion from the part of investors. Hungary's foreign currency debt ratio is already above the tolerable level (downgrade is looming) and a runaway budget could have serious consequences.
2. The credibility of the Hungarian government is weak due to its poor track record. Consequently, a halt in the reduction of the deficit may carry a bad message to investors. The cabinet should definitely not set the target to above the Maastricht criterion (3.0% of GDP).
3. The IMF-led credit facility, aimed to preserve the solvency of the country, was granted to Hungary on the condition that the deficit will be lowered more drastically than before. Therefore, an overshoot of the original target could in fact bear more significance than it would otherwise do. Note that knees started to jerk already last week before IMF Director Strauss-Kahn's visit to Hungary, with rumours circling that the fund will terminate the USD 25 bn credit deal. This was, of course, uncalled for and totally unfounded, but it still tells us a great deal about the credibility of the government's economic policy.
When it comes to the relation between the budget and the IMF there is one other thing we need to highlight. The IMF will probably not freak out in January that the 2009 Budget was created in December on the macro assumptions agreed earlier. There was no sign at all that the cabinet would want to open purse strings. It was willing to adjust and readjust the budget to the continuously deteriorating external environment. In the end it had to rewrite it twice.
To hit a more critical tone on economic policy we must say the cabinet should not have consented to the IMF building its inflation prognosis to an exchange rate crisis scenario and that pending cases were not adjusted to deteriorating processes. When the 13th-month payments were scrapped, the compensations should have been radically cut or abolished altogether, as soon as it became evident that the budget target was in jeopardy (irrespective of the go-ahead given by the IMF).
We'd need a good ole' currency crisis. Or not...
So there is the need for yet another adjustment. This is a terrible situation not only because the standard of living will descend further, but also because the growth outlook is likely to deteriorate some more. A few weeks ago it still seemed that after three years the government has finally comprehended that at such a growth potential a debt spiral is unavoidable. Then we started to hear the mechanic responses, typically socialist notions such as “contribution cuts in exchange for VAT hike", which is far from being perfect, but after all it's a small country - with small plans. Now it seems Hungary will need to raise the rate of VAT just to save the budget, but that will certainly not create room for a marked reduction in contributions.
From a formal point of view - and taking into consideration the mistakes the government has made - the budget could be tidied up the following ways:
1. The increase of consumer prices should be adjusted to around the planned 4.5%. One way to achieve that is raising the rate of VAT. The other is to let the exchange rate run wild. The latter would virtually chime together with the IMF's assumption, but now that Hungary has successfully dodged a currency crisis it would be rather risky to create one artificially.
2. The cabinet might also try to bring economic growth closer to what is in the plans, meaning contraction should not be bigger than 1.0%. This, however, would be tricky in the short term, as recession waves are mostly hurling in from outside the borders. In a downward economic cycle a country that is up to its ears in debt and pursues a faulty economic policy should not try sail near the wind. One could always try, but the government has never been keen on measures that would foster potential growth, e.g. the overhaul of the tax regime and the welfare system. Moreover, these would only increase social tensions in the current environment.
3. There is still the choice of a drastic deficit cut, but the cabinet would not want to go down that road for similar reasons.
This is where we stand now. Let's see what policymakers will conjure up from the hat this week.
