Economy 30 May 2023, 3:00pm

Hungarian government is building a castle on a swamp - blindly

Portfolio

Hungary’s Finance Minister Mihály Varga has submitted the 2024 budget bill to Parliament on Tuesday. This means the government has shrugged off risks relating to the early adoption of next year’s budget, including a gaping gap on the 2023 budget. The icing on the cake that in its current form the bill is actually illegal for it does not include compensation for the central bank’s loss, and so it only pretends it is ready. In our snap analysis we sum up what we need to know about the 2024 budget, and a detailed analysis will follow shortly.

A treacherous path but we’ll stick to it (not that there’s no other path through lulling meadows right next to it)

Regardless of the obvious risks, the cabinet stuck to an early adoption of the 2024 budget. While stability, transparency, and calculability were the key ideas behind early budgets in the previous years, it has been proven that these are all out the window by now. The 2023 budget, for example, was adopted last summer, amended by decree in December, and finalised only this March! There’s some predictability for you.

In addition to this, we already know - from the European Commission's calculations - the risks and costs that the government takes on by not submitting the budget at the end of the year (relying on six months more of factual data). The graph below shows how much higher the forecasting error in the draft budget was after the practice of early budget planning was adopted.

Upbeat to a fault

The Finance Ministry is highly upbeat also in its key macroeconomic assumptions. It projects GDP growth of 4.0% for 2024, while the consensus estimate of analysts polled by Portfolio earlier this month shows 3.3% growth for next year.

In its budget bill review published last week, the Fiscal Council also pointed out that international organisations and local analysts expect significantly lower investment and export growth figures than the government.

Deficit target would be missed without the windfall tax

In line with our expectations, and contrary to its promise made to the affected sectors and the European Commission, the government is not phasing out the windfall tax at the end of this year and will only lower it in some cases.

The tax package will be available next week, and so far we only know that the extra profit tax burden will be halved for banks, pharmaceutical producers and energy companies. Insurers, airlines and retailers are expected to pay the same as currently.

Violating the law

It turned out at a press conference on Tuesday that this haste comes at a very specific cost, as hundreds of billions of forints of expenditures have been left out of the draft, as the cabinet “forgot” to include the reimbursement of the central bank’s losses.

Varga argued in favour of the early budget adoption by saying that in a period marred by a war in neighbouring Ukraine one cannot wait to see if the threats will materialise, hence they came up with a budget that takes account of the unforeseen risks.

Yet, compensating the loss of the central bank is a pretty solid expenditure item, not some distant and vague possibility. And if the cabinet were not in such a hurry, it would have more accurate data in this respect too. As of today, the budget bill does not include this spending item estimated at some HUF 200 billion, and the government leaves it up to legislation to do something with it at a later date.

In other words, the draft budget submitted to Parliament is not ready.

This view is confirmed by the opinion of the Fiscal Council published last week, in which it shares with the public the information it received from the Finance Ministry. Some measures are still being worked out. In the bill, the government adds that "the government shall adopt and, if enacted, submit to the National Assembly all measures and amendments to legislation in a timely manner that will provide the basis for expenditure and revenue appropriations. These measures therefore will become known to the public when the content of the legislation or other measures is presented and justified. To make public the full range of measures presented to the Council would be premature and would jeopardise the proper triggering of the legal effect they contain."

It will be interesting to see how this challenge is addressed by the government. Mihály Varga said that the government will take the decision of the parliament as the guide. This could mean that the government and the governing parties will deal with the budget by proposing amendments to the budget to include this expenditure item in the budget.

But the biggest question here will be how much spending will have to be found and how the government will compensate for it. It is possible that the solution will be hidden in an amendment to an 'omnibus amendment', either by the Finance Ministry raising a revenue item on paper (typically done with the VAT revenue target) or by an unexpected tax increase, mainly in special taxes.

Nor can it be ruled out that the government will use some legal technique to resolve quagmire, so as not to overburden next year's budget. It is also worth mentioning that, for the sake of budgetary transparency, the calculations behind such an item of expenditure should be public and the government should present in an impact study how the item of expenditure on the central bank loss compensation was arrived at.

Oh, those landmines...

There are several well-identifiable landmines in the 2024 draft budget on top of the risks stemming from the overestimated GDP growth. These are

First of all, there is uncertainty about meeting this year's budget goal. The latest monthly budget developments point to the fact that even the plans revised in March this year, and thus the 3.9% of GDP target, are in doubt. On the revenue side, the over-planning of VAT revenues at the beginning of the year is causing problems this year, and worse-than-expected base processes are also weakening the foundations for next year's budget. But equally, higher-than-expected interest expenditure this year should also be a warning sign for the 2024 budget.

The Fiscal Council pointed out that targeting a growth in the operating expenditure of budgetary institutions that is smaller than the projected rate of inflation jeopardises the quality and sustainability of services. In other words, there is no funding for normal operation in many cases, an implicit risk the government is carrying with it into the future.
The government has set a deficit target of 2.9% of GDP for next year's budget. The Fiscal Council also pointed out that this leaves a margin of only HUF 51 billion below the 3% deficit level, which will be watched with a wary eye by the European Commission next year.
EU funds: the government has planned to spend HUF 3,605 billion on EU programmes, and expects Brussels to transfer nearly HUF 2,500 billion. Given the protracted negotiations in the rule of law procedure, it is worth pointing out that there are risks to the disbursement and timely receipt of the money, which, if they come to a head, could worsen the cash balance.

All in all, with the 2023 budget on shaky ground (weak base) and early adoption (unforeseeable risks), it is as if the government is trying to build a castle in a swamp, almost blindly.

Where will the budget get funds?

Although the draft is now being uploaded to parliament.hu, the Fiscal Council's opinion published last week showed how much of the main revenues the government expects to receive and how this compares with this year's expected outturn.