Economy 11 November 2024, 1:30pm

Hungary's 2025 draft budget full of pitfalls, government is only adding to the risks

Portfolio

Hungary's Fiscal Council reviewed the government's draft 2025 budget, which is submitted to Parliament on Monday, and identified risks surrounding next year's goals, e.g. the deficit or the GDP growth targets. The main objectives are: 3.4% GDP growth, 3.7% of GDP budget deficit, 3.2% annual average inflation, EUR/HUF 397.5. The FC's opinion reveals that the cabinet plans such small budget reserves for next year that it does not comply with its own rules. The Finance Ministry has taken note of the Fiscal Council's warning, but not the way you'd think. Instead of increasing the reserves and thus the stability of the budget, it is changing the rules, allowing itself the creating of smaller reserves. In other words, the government will in fact increase the tensions in the budget instead of easing them.

The three-member Fiscal Council stated that it has

no fundamental objections to the credibility and enforceability of the draft bill

on Hungary's 2025 central budget that would justify expressing disagreement.

The FC welcomed the fact that the government has postponed the planning and adoption of next year's budget until the autumn. According to the FC, this will reduce the predictability constraints on the macroeconomic conditions for budget planning and thus help the budget to fulfil its role as an economic compass.

Let us remind you that the government's original justification for the "late" submission of the draft budget was that the US presidential election could have such an impact on the Hungarian economy that it would be worth waiting for the results of the election to be known before preparing the budget. It seems that the government is waiting for the result of the US presidential election before submitting it, but knowing the lengthy process of preparing the budget (and the fact that the document was already in the KT days ago), we can say that the Hungarian government did not wait for the result before preparing the budget. It seems that the draft was in fact submitted after the US election, won by former President Donald Trump, but considering the lengthy drafting process and the fact that the FC had the document days before the 5 November election, the cabinet did not wait for the election results with the preparation of the draft budget draft.

They add, however, that the FC, continuing its practice, feels obliged to draw the attention of the government to several risks to the achievement of the targets.

Overall, by postponing the planning and adoption of next year's budget by six months, the government has significantly reduced the risk of slippage later on, so the foundation of the 2025 budget is more sturdy in this respect. But reading the opinion of the Fiscal Council, and from this understanding of the parameters of the budget, it is clear that there are substantial risks to next year's budget.

Base assumptions for 2025

We have learned the following from the FC's opinion published last Thursday that were reaffirmed by the draft budget submitted to Parliament today:

GDP growth is planned to reach 3.4% in 2025 after an estimated 0.8% in 2024.
Annual average inflation is to reach 3.2%.
On the demand side, growth is to be mainly supported by a 3.9% increase in household consumption and a 5.1% expansion in gross fixed capital formation, while the contribution of net exports is to be slightly negative (-0.1 percentage points).
Exports are projected to grow by 3.4%.
In 2025, the number of employed people is expected to increase slightly by 0.1%. The increase is to be entirely driven by the business sector, with no change in the public sector.
Average gross wages could rise by 8.7%, which would result in a 5.3% increase in real net wages in 2025.
The value of purchased consumption at current prices will increase by 7.8%, which, according to FC's assessment, could lead to a substantial increase in the tax base for VAT, a key tax for the budget.
Annual average EUR/HUF is expected to be 397.5.

We have already addressed the issue of VAT receipts:

2025-ben Achievability of 3.4% GDP growth target doubtful

Several risks to the government's growth forecast have been identified:

The draft budget bill for 2025 projects economic growth of 3.4%, at the upper end of the 2.5-3.8% forecast range of forecasts by international institutions and by domestic institutions creating analyses for the Fiscal Council.
The Council considers that the economic growth forecast by the government can be achieved, but that there are risks, such as the impact of the [Russia-Ukraine] war, energy security risks and the still lingering negotiations with the EU on funds frozen for Hungary.
There is also the risk of escalation of war in the Middle East, as well as global trade policy conflicts.
In particular, there are risks to the realisation of the positive investment trend reversal needed for the planned economic path.
According to the FC, at least a partial launch of the postponed investments and the continuation of the announced major investments are also needed to meet the 5.1% growth projected for investment.

The Council makes no mention of the potential risks arising from recent developments in the global economy, the threat of tariff increases from the US, which could turn into a tariff war, and its potentially negative impact on the Hungarian economy. If these risks are taken into account, the government's plans for 2025 may well look even more optimistic.

In addition, the more unpleasant effects on the Hungarian economy and budget through market processes should not be forgotten, either. Indeed, the imposition of stringent tariffs and other measures that appear inflationary could keep the yield environment permanently higher and reduce growth in Europe.

Zoltán Török, Senior Analyst at Raiffeisen Bank, spoke about this in a podcast of Portfolio Checklist last Thursday. Higher inflation numbers are on the horizon, through imported inflation as well as the exchange rate, which could also limit the MNB's room for manoeuvre in cutting interest rates.

In addition, US government bond yields are also on the rise, and on this basis, the analyst expects Hungarian government bond yields to rise, which will also increase the cost of financing government debt, making it more difficult to reduce the budget deficit.

Gov't ignores own rule

An interesting point in the Council's opinion is the one detailing that the government has set a deficit target of 3.7% of GDP for next year, above the 3% deficit that the FC considers necessary to achieve.

Domestic legislation temporarily allowed the deficit to remain above 3% of GDP, but the suspension has ended, so the current set of rules prescribes a 3% deficit criterion next year.

According to the Finance Ministry, the government is initiating an amendment to this rule, which will be adopted by Parliament before the entry into force of the Budget Act, the Fiscal Council said.

This means that the 2025 budget bill is against the rules at the time of its submission, and the government only plans to address this problem later. This is another message about how seriously the government takes its own fiscal rulebook. This move is not surprising, however, as the government has done the same with previous budget bills. At the time, they used the emergency situation as an excuse to circumvent the fiscal rule of a deficit below 3%. Recall that in Hungary, the Economic Stability Act states that the deficit can only be above 3% if GDP shrinks.

Risks surrounding the 3.7% of GDP deficit target too

The Council considers that

there are risks to the achievement of the 2025 deficit target.

Here's the list:

On the revenue side, there is a risk that economic growth in 2025 will be lower than expected, which would reduce budget revenues.
Secondly, the Council sees a risk in planned inflow of EU funds, as the uncertainty surrounding the availability of EU funds persists, which would increase the cash deficit if revenues from the Recovery and Resilience Fund and cohesion funds for 2021-2027 are not received, assuming unchanged expenditure.
Achieving the deficit target may be made more difficult by undershooting some revenues targets in 2024, mainly related to consumption, which, as in 2023, will worsen the base of these appropriations.
Managing the risks is hampered by the fact that the reserve of HUF 100 billion in the Extraordinary Government Measures appropriation is not only below what is stipulated in the current rules, which require a 0.5% (HUF 220 billion) reserve as a share of total expenditure, but also low compared to the risks identified. According to the Finance Ministry, the government will also initiate the amendment of this rule, so that it will be adopted by Parliament before the Budget Act would enter into force.
In view of the risks surrounding the implementation of the budget, the Council does not consider it advisable to amend the law to reduce the obligation to set aside reserves to cover these risks.

In other words, despite the FC's recommendation, the government is removing another important brake on fiscal rules to avoid having to include a higher general budget reserve than it had planned in next year's budget.

This is presumably because the general budget reserve has to be included on the expenditure side, and if it were to be increased, it would have to be covered by a supplementary decision: the government would have to take the necessary sum from other expenditure targets or increase revenue in return. It does not want to do this apparently, so it does not accept the FC's argument for increasing the general budget reserve.

This also means that the government is planning to create very small reserves to deal with the risks encoded in the budget. (It is also worth noting, based on the fiscal practice of recent years, that the government has met a wide variety of spending targets from the Extraordinary Government Measures appropriation, not exactly subordinating this expenditure, or rather safety net, item to balance considerations.)

The details of the FC's opinion document also reveal that, according to the draft, the reduction in the budget deficit compared to the 2024 estimate is mainly due to a reduction in high interest expenditure as inflation falls.

"Interest expenditure as a share of GDP on a gross accrual basis will fall from 4.8% in 2024 to 3.8% in 2025 under the draft law, mainly due to the repricing of inflation-linked government bonds to lower interest rates," the Council said.

In addition, the deficit reduction will be helped by a number of tax measures and a total savings commitment of HUF 350 billion by budgetary bodies under the government's control.

Based on the forecast approved and delivered by the central bank's (MNB) Board in April and a review of international experience, there is currently no need to recapitalise the MNB under the current rules. This, the FC concluded, should help next year's budget.

Another supportive factor for next year's budget is that the budget foresees a high level of public spending on energy and energy subsidies, which could provide a buffer against falling world energy prices, but a substantial increase in energy prices would lead to higher expenditure.

Risks to debt reduction identified

The debt-to-GDP ratio could fall to 73.2% in 2024 from 73.4% this year, before dropping further to 72.6% by the end of 2025, according to the FC. In the Council's assessment, this will be supported by a reduction in the general government deficit and economic growth, as well as a reduction in the debt of the non-central subsystem.

Based on the currently known circumstances, the debt ratio in 2024 may be higher than indicated in the draft bill, which will not affect the reduction next year per se, but will result in a higher debt trajectory, the Council said.

"The debt reduction of 0.6 percentage points in the draft budget bill is achievable with nominal GDP growth in line with the macroeconomic path of the budget and a reduction in the stock of non-central debt of 0.5 percentage points of GDP in the draft.

"However, the lower-than-expected economic performance, the slower pace of non-central debt reduction, and the increasing exchange rate risk due to a rising foreign exchange ratio of central government debt close to 30% would make it materially more difficult to meet the planned debt reduction," the FC pointed out.

They pointed out that changes in the forint-euro exchange rate have an impact on the debt ratio through the revaluation of foreign currency debt. This impact is smaller the lower the share of foreign debt in government debt. Currently, a change of 10 forints in the forint-euro exchange rate changes the government debt-to-GDP ratio by about 0.6 percentage points.

We have previously written about this here:

If the public debt ratio is above 50%, the Constitution requires the adoption and implementation of a budget law to reduce the ratio. The requirement of the Stability Law is that the government debt ratio must be reduced by at least 0.1 percentage point, while respecting EU rules on debt reduction. According to the draft, the requirement of the Stability Law will be fulfilled, the FC concluded.

Cover image (for illustration purposes only)forrása: Getty Images