(Adds details, charts) The recovery of the EU economy has stopped. Sharply deteriorated confidence is affecting investment and consumption, weakening global growth is holding back exports, and urgent fiscal consolidation is weighing on domestic demand, the European Commission has said in its Autumn Forecast 2011-13 published on Thursday.
The EU executive projects that gross domestic product in the EU will stagnate until well into 2012. It expects Hungary’s GDP to grow by a mere 0.5% in 2012, while the government sticks to its estimate of 1.5%.
Commission Vice-President for Economic and Monetary Affairs Olli Rehn said that in the EC’s view Hungary’s budget deficit will exceed the government’s target next year, but still remain below the 3.0% EU ceiling. However, the EC suggests further action to be taken by the cabinet and so it does not propose ending the excessive deficit procedure (EDP) against Hungary. Another said “message" of the autumn forecast is that the EC expects Hungary’s public debt to rise following a temporary drop this year.
Growth for the whole of 2012 is forecast at about 0.5%, the EC said.
By 2013, a return to slow growth of about 1.5% is expected. No real improvements are projected for labour markets, and unemployment is forecast to remain at the current high level of around 9.5%.
Inflation is set to return below 2% over the coming quarters. Fiscal consolidation is forecast to progress with public deficits set to decline to just above 3% by 2013 under an assumption of unchanged policies.
"Growth has stalled in Europe, and there is a risk of a new recession. While jobs are increasing in some member states, no real improvement is forecast in the unemployment situation in the EU as a whole," said Commission Vice-President for Economic and Monetary Affairs Olli Rehn.
“The key for the resumption of growth and job creation is restoring confidence in fiscal sustainability and in the financial system and speeding up reforms to enhance Europe's growth potential. There is a broad consensus on the necessary policy action. What we need now is unwavering implementation. On my part, I will start using the new rules of economic governance from Day one," he added.
EDP remains
Responding to a question Rehn told a press conference that Hungary has been under the EU’s excessive deficit procedure (EDP) for eight years now.
“The budget will close this year with a surplus, thanks to the systemic overhaul of the pension system. While the deficit can remain below 3% next year, based on our current information it may exceed 3% again from 2013. So the balance is not sustainable, we are not proposing to lift the excessive deficit procedure," he said.
“For this reason the European Commission is proposing further measures that can ensure sustainable budget processes."
Slower growth seen in Hungary
A government official has on Thursday denied a local press report that the cabinet has lowered its GDP estimate for 2012 to 0.9% from the current 1.5%.
The EC, however, forecasts that the Hungarian economy will grow by no more than 0.5% next year and its estimates for 2013 and 2014 are also below the government’s prognoses.
“Contrary to earlier official expectations, the large overall personal income tax cut appears not to have succeeded in lifting domestic demand, although it has cushioned the impact of negative developments," the EU executive said in the report on Hungary.
“On the other hand, the payout of the real yield achieved on private pension fund investments repatriated into the state pension pillar was larger than estimated in the spring due to the favourable timing of the stock market, which may have delivered some boost to consumption (assuming a degree of myopic behaviour)."
In the EC’s view, export capacity will increase next year as new plants are set to start production (Mercedes and Hankook). “But uncertainty surrounding global economic activity will be an important factor in determining growth in the small, open Hungarian economy, although its impact in either direction is mediated by the high import content of exports."
It added, however, that fiscal policy is weighing on growth prospects. (Note that according to the latest estimates the government is to carry out a fiscal adjustment of HUF 1,400-1,600 bn.)
What about the budget deficit?
The EC’s economists believe Hungary’s budget surplus will be larger than what the government projects, while it forecast larger shortfalls for 2012 and 2013 than the official targets. In the EC’s view, the budget deficit will come in at 2.8% of GDP in 2012 vs. the cabinet’s 2.5% goal.
The official estimate for this year's surplus has been revised up from 2% of GDP (contained in the April 2011 Convergence Programme update) to 3.9% of GDP in the autumn notification, the EC noted.
The larger surplus is mainly due to:
(i) higher one-off revenue stemming from the elimination of the obligatory private pension scheme (now amounting to 9.75% of GDP, i.e. 0.5% of GDP higher than previously assumed);
(ii) an intention not to assume the debt of the public transport companies (1.4% of GDP) and not to buy out selected PPP projects (0.7% of GDP), contrary to earlier plans; and
(iii) additional measures of 0.4% of GDP adopted in September 2011.
“These factors are only partly counterbalanced by one-off expenditure of around 0.9% of GDP triggered by a decision of the European Court of Justice against Hungary on the rules of carrying forward excess VAT for enterprises. The forecast shows a somewhat lower surplus projection (3.6% of GDP), notably since it assumes a partial assumption of the debt of public transport companies (0.2% of GDP) based on recent information."
The National Economy Ministry published a document (in English) last week that said some of the debts of transport companies MÁV and BKV will be consolidated.
Regarding 2012, the draft budget submitted to Parliament on 30 September targets a deficit of 2.5% of GDP as set in the latest Convergence Programme.
“In order to achieve this, the budget proposal contains several measures altogether amounting to a gross effect of more than 4% of GDP to reduce the underlying deficit of around 6% of GDP in 2011 and to compensate the earlier enacted personal income tax (PIT) cut of close to 1% of GDP," the EC added.
The 4% of GDP worth of measures are the following, in the EC’s view:
1) In compliance with the CP and the announcement of the Széll Kálmán Plan in March 2011, the draft budget reflects structural measures in several areas, but the expected gross saving of around 1.5% of GDP is 0.3% of GDP lower than the original plans.
2) Additional measures already announced in the CP of around 1.25% of GDP are also included, such as the nominal wage freeze and the limited increase of purchase of goods and services in the public sector as well as the cut of the employment tax credit.
3) The budget contains additional revenue increasing measures of around 2% of GDP (including a hike in indirect tax rates, the increase of the social security contribution rate and the full elimination of the employment tax credit) and further saving measures of 0.5% of GDP.
These measures were summed up by the ministry last week, and the expected impacts are shown in the table below.
The EC mentioned two other areas.
4) The deficit-decreasing measures are partly counterbalanced by deficit-increasing decisions of around 1% of GDP, such as the expansion of the public works programme, the tightening of the tax base of the PIT as well as the supplementary wage both in the public and the private sector.
5) In order to counterbalance the negative budgetary effect of unforeseen adverse developments, the government, based on the revenue-increasing steps, created a substantial reserve of 0.7% of GDP.
2.8% of GDP gap seen in 2012
In contrast to the deficit target set by the government, the Commission projects the 2012 general government deficit to reach 2.8% of GDP.
Compared to the draft budget this higher deficit forecast reflects on the revenue side:
(i) lower economic growth by 1 pp. as well as a more cautious assessment of revenue developments resulting in a higher deficit of around 0.5% of GDP; and on the expenditure side:
(ii) higher outlays of 0.25% of GDP related to state-owned transport enterprises and maintenance of roads; as well as
(iii) higher interest expenditure and higher contribution to the EU budget (altogether 0.25% of GDP) due to exchange rate and yield assumptions.
“At the same time, these revenue shortfalls and expenditure slippages amounting altogether to 1% of GDP are assumed to be largely counterbalanced by the extraordinary reserves of 0.7% of GDP taking into account a recent proposal to amend the budget bill so that a cautious use of this reserve is ensured."
Deficit to deteriorate again in 2013
In 2013, the EC expects Hungary’s budget deficit to deteriorate again, saying that “the phasing out of the extraordinary levies on selected sectors (including the financial one) is not expected to be counterbalanced by the structural reform programme reaching its peak."
This is based on the usual no-policy-change assumption and does not take into account potential measures that the government may take to achieve its deficit target of 2.2% of GDP.
“In particular, the decisions aiming at savings in local government and the public transport sector, as outlined in the CP, are not appropriately specified and planned revenue from the introduction of the electronic road toll is not backed by measures."
Positive and negative risks
On the one hand, the EC says expenditure of the line ministries may be higher than budgeted if some of the detailed measures underpinning the savings are not fully implemented. Moreover, a further deterioration of the macroeconomic environment compared to what is already projected may result in additional revenue shortfalls.
“On the other hand, mainly in 2013, the full implementation of structural reform plans as set out in the CP could generate significant savings compared to the current forecast."
Following a structural deterioration of 1.5% in 2010 and 1.25% in 2011, the structural balance is expected to improve by 2.5% in 2012, in large part due to the measures described above. In 2013, a structural deterioration of 0.5% of GDP is expected.
“Given both the forecast deficit numbers and the exchange rate assumptions, gross public debt is expected to increase again to nearly 77% of GDP following a temporary drop in 2011 due to the takeover of the private pension assets," the EC said.
EC sees ascending debt path
What may be even worse than the EC’s forecasts on Hungary’s growth and budget deficit is its estimate on the country’s state debt. While the cabinet is hell bent on cutting both the budget shortfall and the debt, the EC is way less optimistic in this regard.
“Given both the forecast deficit numbers and the exchange rate assumptions, gross public debt is expected to increase again to nearly 77% of GDP following a temporary drop in 2011 due to the takeover of the private pension assets," the EC said.
What is the view of Brussels on the early repayment scheme?
The EC’s report addresses the law adopted in September 2011 - which the EU executive called a “surprise move" - that allows the early repayment of FX mortgages at a discount to the prevailing exchange rates.
It said the law “appears to intend to reduce the drag on household consumption", noting that “the households that are most likely to be able to participate in the scheme are the ones that have been relatively better able to weather the hike in FX loan repayments."
“Those who will be putting their savings towards repayment may then focus on rebuilding precautionary savings in the shorter term, even though their net asset position will not change dramatically. Households with longer than average FX loan maturities could face higher instalment payments for the duration of the new loans, since their maturity may need to be shorter in order to make the switch financially attractive. The full magnitude of the effect of the scheme will depend on the eventual participation rate, but its net impact on consumption among participants is ambiguous at best."
“Furthermore, households in the greatest predicament are the where jobs have been lost or are at risk. The measure will have a negative impact on their consumption through: (i) further increasing the loan repayment burden in the case of households ineligible to participate in the scheme thanks to the depreciation of the forint; (ii) tightening credit to enterprises due to the resulting losses for the banking sector and hence endangering employment and, more generally, the investment climate..
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