Economy 19 August 2020, 9:29am

Public debt jumps in Hungary but dramatic surge may be avoided

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Hungary's debt-to-GDP ratio rose sharply already in the second quarter of 2020 due to economic recession and a balooning budget deficit. A possible second wave in the coronavirus pandemic makes it difficult to see how the trend will turn out in the second half fo the year, but we have grabbed our usual model used to draw up different scenarios and, low and behold, we found that in case of a highly bearish scenario Hungary's debt ratio could rise to a six-year high. That would obliterate many years of hard work to reduce the debt.

Hungary's debt ratio jumps

Hungary's general government gross debt jumped to 71.9% by the end of June from 66.8% at the end of the first quarter of 2020, according to preliminary financial accounts data published by the central bank (MNB) on Monday. Although 2018 was not such a long time ago, the chart below shows that the two-year regression took place over merely three months; that is a sharp turnaround in the debt curve.

We should also highlight that these are only preliminary data for which the MNB calculated with an estimated GDP figure and the 71.9% ratio is likely to go higher during the revisions. The trend is clear, and there were two factors at play at once that caused the jump in the debt ratio:

Firstly, nominal debt increased a lot. According to data by the Government Debt Management Agency (ÁKK), general government debt rose by nearly HUF 1.5 trillion over April-June. The massive budget shortfall played a huge role in this. According to Finance Ministry statistics, Hungary posted a massive 1,837 billion forint general government deficit in the first half of 2020, after incurring the second-largest monthly deficit in June. It was partly due to a need to finance this gap why Hungary had to issue eurobonds to the tune of EUR 3.5 billion in the spring. Also, it had to rev up HUF issuances and the ÁKK has been holding for quite some time now regular weekly bond auctions instead of the previous two-weekly frequency.
Secondly, Hungary's GDP contracted by 13.5% year on year and 14.5% over Q1 in April-June. Not to mention that in the current financial accounts statistics the MNB calculated only with an estimated GDP, while the contraction was even greater than what analysts projected, which means that subsequent revisions will almost certainly result in a higher Q2 debt ratio.

IN OTHER WORDS, THE NUMERATOR WAS INCREASED AND THE DENOMINATOR WAS REDUCED IN THE DEBT/GDP DIVISION.

Where will the debt ratio be by the end of 2020?

A sharp jump in the debt ratio is a sure bet in view of first-half processes. But how serious this leap could be? Well, it depends basically on two factors:

Hungary's nominal debt at the end of the year. Our starting point is the HUF 30,324 billion general government gross debt plus the budget deficit at the end of 2019. So the first question is how wide the budget gap will be.
The second question is the rate of GDP contraction this year, i.e. Hungary's nominal gross domestic product by year-end.

We have used these two variables in our regular debt model. The latest data we have about the debt is that it stood at HUF 32,432 bn and that the budget deficit amounted to HUF 1,837 bn at the end of June. The latter figure means that the annual budget deficit target was nearly reached by the end of the first half, yet the cabinet's official goal remains unchanged at 3.8% of GDP.

Finance Minsiter Mihály Varga has recently said that instead of the currently official projection of a 3.0% GDP contraction, it is more realistic to expect a 5.0% recession for this year that could - as in various other countries - lead to a deficit of 8-10% of GDP.

partly because of this our three scenarios assume deficits of 5%, 7% and 9% of GDP, respectively.

The other variable is nominal GDP. There's the contraction we have to take into consideration, but there's also the so-called GDP deflator which measures the changes in prices for all of the goods and services produced in an economy. Let's think about it as inflation, shall we? We did not complicate things a lot here and assumed a fixed 3.0% price increase in each case.

Our GDP estimates were -4%, -6% and -8%, respectively.

The two variables with the three deficit and three GDP assumptions draw up nine possible debt courses for the end of the year.

The most optimistic one (4% GDP contraction, 5% budget deficit) would still result in a debt-to-GDP ratio of over 70% by the end of December, yet this would still imply a decline in the debt ratio in H2.
At the other end of the spectrum we have an 8% recession and a 9% shortfall, in which case the debt ratio would reach 77.4% by the end of 2020.

so These are the two extremes in our model. if reality does not turn out even worse, hungary's debt-to-gdp ratio should be somewhere between 70% and 77% at the end of this year.

Hungary's public debt was last over 70% of GDP at the end of 2018, while a debt ratio of over 77% was last recorded at the end of 2013.

We need to highlight that the difference between the nine scenarios is greater than how it seems at first glimpse. There's a link between growth and the budget deficit, namely that a larger shortfall stimulates economic growth in the short run. Consequently, if the economy contracted by 8% while the budget gap runs up to 9% of GDP (that's quite an economic stimulus), it would translate into a much more dramatic crisis situation than if Hungary could emerge from the coronavirus crisis with a 4% recession despite meagre stimulus measures.

In this particular analysis we do not scrutinise this internal connection; we merely present arithmetically what debt ratios could emerge from given economic situations. (Naturally, we have also taken into consideration that the same budget gap per GDP results in different nominal deficits at different growth scenarios.)

When can the debt ratio be back at the 2019 level?

It is the baseline scenario for every analyst that the budget deficit will jump only temporarily due to the coronavirus crisis and that there's a good chance that recession will not be lasting, either. In view of these assumptions we must admit that the debt scenarios are also uncertain because they are to be determined by two factors:

Firstly, if GDP rebounds in 2021, some of the growth in public debt will be reversed quickly. Most of the sharp increase stems from the decline in nominal GDP, i.e. the denominator in the division. It is difficult to estimate at this point when can the 2019 debt level be reached again. According to gloomier forecasts this could take years, while other economists believe the correction will take place more rapidly.
Secondly, the one-off surge of the budget deficit this year is to lead to a persistently high nominal debt therefore it will take quite some time to go back to a 66.3% of GDP debt recorded at the end of 2019.

Cover photo: Getty Images