In view of Hungary’s fiscal performance, the government is increasingly seen as having ample manoeuvring room in 2017. The latest general government figures, however, tell a different tale, as they hamper the cabinet’s fiscal policy, analysts at OTP warned in research note published on Monday.
On the basis of the latest cash flow-based monthly figures and the quarterly statistics on the balance of the general government we might think the deficit target for this year is so safe that the cabinet may not only relax but it could also start spending some more, i.e. use the extra fiscal elbowroom. Analysts at OTP Bank, however, have warned this might not be the case. They claim that:
As the revised debt-to-GDP ratio shows a slower decline than the previous data vintage, Hungary is now on the brink of breaching the 1/20 debt reduction rule of the EU. Thus, risks to debt dynamics are a short-run constraint on fiscal policy.
The Central Statistical Office (KSH) last week published the Q2 fiscal data as well as revised national and government accounts for the past years. In 17Q2 the general government remained in surplus (+18.2 bn HUF). The ESA balance continued to improve; the 271 bn HUF surplus YTD exceeded last year’s value (87 bn HUF in 16H1). The 4-quarter rolling deficit fell to 1.3% of GDP in Q2 from and 1.4% in Q1 and 1.9% in Q416.
OTP’s analysts noted that although the rise in the surplus compared to 16H1 is largely attributed to one-offs, the underlying fiscal position also remained strong. The main one-offs were revenues from land sales, which amounted to 144 bn HUF in the first half but are expected to wear off in 17H2. However, tax collection was also robust thanks to a booming economy.
In the meantime, public expenditures increased by 7.5% in 17H1, driven by an 80% boost to public investments and an 8.1% expansion of the wage bill.
Incoming data confirmed the analysts’ view that the 2016 budget would have been broadly balanced if not for the last-ditch spending in December.
The picture is similar for this year despite cuts to social security contributions, corporate tax, and rebounding public investments. The government still has room to stimulate the economy before the 2018 elections.
The real danger
The stats office has revised upwardly both the 2014 and 2015 deficit figures by 0.7% and 0.5% of GDP, to 2.7 and 2.0% respectively. However, the future impact of methodological changes on the ESA balance is positive, the analysts said.
They reminded that the accounting of mobile telephone licenses was changed. Previously they were considered one-off revenues in exchange for the sale of non-financial assets. In the new methodology, they are classified as rent income, distributed over the life of the contract. This change reduced 2014 budget revenues by 145 bn HUF, and raised them in subsequent years (by 27.9 bn HUF in 2015).
Other, major changes to government accounts arose from the reclassification of deposit insurance, investor protection and bank resolution funds from the financial to the public sector. One-off spending from these funds after the collapse of Buda-Cash and Quaestor financial institutions amounted to 66 bn HUF in 2014 and 169 bn HUF in 2015. However, future spending from these funds may tend towards zero with a healthy financial system.
The effect of revisions on public debt was less benign. The 2013 debt-to-GDP ratio fell 0.6pp (from 76.6% to 76.0%), but the end-2016 figure decreased by just 0.2pp (from 74.1% to 73.9%). Thus, debt decreased on a shallower path than previously thought, the analysts noted.
The Maastricht debt rule stipulates that the three-year average rate of debt reduction should ensure that 1/20 of the difference between actual debt and the 60% reference value is eliminated annually. Failure to comply can trigger an Excessive Debt Procedure if the Commission also forecasts a continuing breach of the debt rule in the future.
According to the old series, Hungary complied with the Maastricht debt rule; according to the new series it balances on the edge.
For the 2013-2016 period the 1/20 rule required 0.8pp average; this was satisfied with previously available data, but revised figures show only 0.7pp decrease.
“If end-2017 data show continued breach of the 1/20 rule, the government may find itself in an awkward position, having to explain debt dynamics to Brussels just before elections," the analysts said
They think the government could invoke an escape clause by arguing that financial stability considerations - the Buda-Cash and Quaestor cases - increased debt. They also pointed out that the latest Commission forecast expected the fulfilment of the debt rule in 2018.
And the real limitation
To maintain compliance with the Maastricht rule, public debt should fall at least to 73% by end-2017; and further to at least 72.5% in 2018 and 71.8% in 2019. Updated fiscal plans target a 72.4% debt ratio in 2017 according to the 29 September EDP report of the Central Statistical Office (KSH), which means the cabinet does not believe there is a risk of not fulfilling the debt rule.
The analysts at OTP see three main risks to this debt target:
The most important factor is the absorption of EU funds. Advance financing of EU-related projects has shot up this year. In January-August, central government spending on EU projects (including co-payments) was 1,324 bn HUF (3.5% of GDP) while actual revenues from the EU amounted to just 291 bn HUF (0.8% of GDP). If EU funds do not arrive on time (for example due to accounting disputes), the short-term financing need of the public sector could exceed expectations, the analysts warned.
Accounting risks: Eurostat insists that Eximbank, the state-owned export-import bank be included in the public sector. Such a move would raise the 2013 debt ratio by 1.3pp to 77.3%, and the 2016 figure by 2.1pp to 76.0%. In this case, the actual debt decline would have been just 1.3pp instead of the 2.6pp required by the 1/20 rule, the analysts project. They previously argued that the Eximbank saga matters little; after recent data revisions they see it as pivotal. Another, future risk concerns the Paks 2 nuclear plant: the 10 bn EUR loan financing the investment may eventually be added to public debt. If the European Commission decides to take this loan into account, its debt projections may begin to look less benign.
Exchange rates: a quarter of public debt is still dominated in foreign currency, making the debt ratio vulnerable to exchange rates. Besides the EUR/HUF, the EUR/USD rate also matters as it affects the volume of mark-to-market (M2M) deposits, which arise because all FX debt of the government is swapped to EUR. However, OTP’s analysts deem exchange rate risks moderate at the moment. First, the year-end EURHUF was 311 last year; significant forint weakening beyond this level is not likely. Second, M2M deposits fell from 743 bn HUF in December 2016 to 424 bn HUF by August 2017 thanks to the strengthening of the euro. The switch of some USD debt with short remaining maturity to long-term EUR bonds and repayments in 17Q4 could further reduce the volume of M2M deposits by about 25 bn HUF, they added.
They also noted at OTP Research that some of the debt-related risks “can be mitigated by debt management wizardry", thus they expect that the debt reduction rule will be fulfilled at end-2017.
However, uncertainty may persist until the last day of the year, especially regarding the inflow of EU funds. Thus, although the temptation to spend before the 2018 elections is strong, the government may not risk major measures in 2017.
If EU revenues arrive as planned, some year-end spending may come, but its impact on 2017 GDP growth would be limited,
the analysts concluded.
That is why they believe major new stimulus measures could only arrive in 2018, just before elections.
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