Commission warns that Hungarian economy has reached a dangerous turning point

Hungary is at a turning point in 2025: the economy faces complex challenges that could jeopardise fiscal balance, lower inflation and sustainable growth. The European Commission's latest in-depth analysis - the so-called in-depth review, which is carried out to identify macroeconomic imbalances - highlights a number of risks that fundamentally affect the future of the Hungarian economy.

According to the report, these problems stem from fiscal vulnerabilities, stubborn inflation, excessive house price increases and financial sector vulnerabilities, but also highlight the risks to the predictability of economic policy.

It also notes that vulnerabilities related to the external balance in 2024 have been reduced, but measures to stimulate domestic demand and continued high energy imports pose risks to external sustainability.

Mountain of debt not going away any time soon

One of the main vulnerabilities identified in the analysis is the high budget deficit, which, although declining in 2024, is expected to remain high in 2025-26. The Commission's autumn forecast projected the budget deficit at 4.8% of GDP, but final data published by the Hungarian Central Statistical Office (KSH) in April showed a government sector deficit of 4.9% of GDP in 2024. The current report notes that this is down from 6.7% in 2023, but still higher than the government's target of 4.5%.

In line with the European Commission's Autumn forecast, it now expects the budget deficit to remain at 4.6% of GDP in 2025 and 4.1% in 2026.

They note that the cabinet itself has indicated that it will raise this year's deficit target, with Economy Minister Márton Nagy adjusting the plans to 4.1%, but the EU executive seems to think that this is also an underestimate.

In Brussels, this persistent deficit is seen as a significant risk to Hungary's fiscal sustainability, especially as the public debt ratio will decline only slowly. The public debt-to-GDP ratio will rise to 73.6% in 2024, driven by the high deficit, currency depreciation and the delayed purchase of Budapest Airport.

The report notes that the large budget shortfall and lower nominal GDP growth are expected to limit medium term debt reductions - such as the phasing out of sectoral special taxes promised y the cabinet three years ago - and keep debt servicing costs and gross financing needs relatively high.

Dim forecast, but others are even more forlorn

Although the report is rather gloomy on Hungary's GDP growth prospects, the Commission is actually quite optimistic compared to analysts.

Real GDP is forecast to grow by 1.8% in 2025, accelerating to 3.1% in 2026.

Meanwhile, after a lousy first quarter GDP data that undershot all expectations, the consensus among analysts is now for growth of just 1-1.5% this year.

According to the in-depth review, the gradual recovery will be driven mainly by consumption, but it is also likely that demand for electric vehicles could increase, which could help domestic manufacturing and provide additional support for expansion through exports. Real GDP per capita growth is also projected to improve, rising by 2.1% in 2025 and 3.4% in 2026.

However, growth remains sensitive to a number of factors, including energy prices, uncertainties in the automotive sector and global investor sentiment, which could pose risks to the projected economic expansion.

Traditional cost-based indicators of competitiveness have also been analysed by the EC, and the data they present show that they have deteriorated in recent years, but are expected to improve. The index of nominal unit labour costs (ULC) is expected to increase by 36.5% in the three years to 2025 and, although slowing down somewhat, is still expected to increase by 23.5% in the three years to 2026.

The real effective exchange rate (REER), based on inflation, is projected to appreciate by 9.0% by 2025, before declining slightly by 1.7% in 2026.

Tax cuts create tension in the budget

The EC warns that the recently announced personal income tax (PIT) exemption for mothers with two children is estimated to decrease tax-to-GDP ratio by around 1% of GDP by 2029.

In 2025 and beyond, permanent fiscal measures, both on the revenue and expenditure side, would be needed to ensure that fiscal targets are achieved.

According to the Commission, the PIT exemption for mothers will put further pressure on public finances as the government tries to balance fiscal consolidation with social policy objectives. They note that the introduction and maintenance of the state of danger has increased the government's powers in implementing the budget, while reducing policy predictability and government accountability.

Inflation remains a persistent challenge for Hungary, with inflation rising to 5.7% in February 2025, according to the European Commission report. What the EC analysts could not comment on due to the data horizon was that in the meantime, partly due to the margin cap, CPI was only 4.7% in March and 4.2% in April.

Headline inflation declined significantly from 17.0% in 2023 to 3.7% in 2024, as the impact of earlier energy and food price increases and supply chain bottlenecks dissipated. The rebound was driven by renewed energy and food price increases, as well as elevated service price inflation and indirect tax hikes. Underlying inflation pressures have remained elevated, with HICP inflation excluding energy, food, alcohol and tobacco averaging 5.9% in 2024 (half of the 2023 print) and the core inflation differential between the euro area and Hungary remaining one of the highest in the EU, at 3.1 percentage points. Nominal wage growth remained strong, reflecting an adjustment in real wages in the aftermath of high inflation in previous years. This, according to the EC, increases inflationary pressures, hampering central bank efforts to anchor inflation expectations.

Monetary policy has been tight, but its transmission to the real economy has been weakened by government interventions. Fiscal targets and commitments are not fully backed by detailed measures over the medium-term,

the EC stressed.

The central bank cut its base rate by 425 bps in 2024 in the context of lower inflation. Looking ahead, monetary conditions may remain tight, the Commission said. "A tight policy mix can help further anchor expectations and contain inflation in the medium run and could be instrumental to improve the cost competitiveness of the economy."

The interest rate ceilings on new mortgage loans fuel housing demand and create distortions in the credit market. [...] Subsidised lending remains significant, negatively affecting capital allocation and public finances and limiting the effectiveness of monetary policy,

the EC warned.

The interest rate ceiling on new mortgages has contributed to a surge in household lending in 2024. Moreover, the Hungarian Banking Association launched a new mortgage scheme in late 2024, which features an interest rate ceiling of 5% (well below the 5-year interbank reference rate in February 2025) to be applied between April and October 2025, targeting debtors under the age of 35 who meet specific eligibility criteria. The freezing of floating mortgage rates to 2021 levels continues to be in place, compromising the transmission mechanism of monetary policy. The MNB indicates that maintaining such pricing policies in the long term may drive riskier debtors out of the mortgage market and that banks may increase the price of other financial services to offset lower profit on household lending.

Hungary also faces risks stemming from trade dynamics and the current account, the Commission said. The current account surplus increased in 2024 due to declining imports, linked to a slowdown in investment and improvements in the terms of trade. However, the sustainability of the surplus depends on export growth and energy price developments. The current account balance is projected to remain positive, but risks could increase if export growth remains sluggish or energy prices rise significantly.

The external balance is still impacted by domestic policies. Vulnerabilities related to the external balance reduced in 2024, but policies aimed at boosting domestic demand and remaining substantial energy imports pose risks to external sustainability.

Government energy subsidies have stimulated - or at least not curbed - household energy consumption and increased energy imports, while regulatory measures to reduce energy intensity and import dependence remain absent or inadequate.

According to the European Commission, this dynamic poses a risk to the sustainability of external balances, particularly in the light of global economic uncertainties and the disruption of globalised trading systems caused by the tariff war.

There's a threat on the real estate market too

House prices picked up in 2024, on the back of increased lending after it had markedly but briefly moderated, but housing undersupply remains an issue. The policy mix remains broadly unchanged, the EC said.

"House prices have risen on the back of strong demand and restricted supply. Nominal house price growth reached 13.4% year-on-year in Q3 2024 driven by lower mortgage interest rates, higher wages and government subsidy schemes. The strong housing demand was not met with a corresponding increase in supply. In 2024, new dwelling construction declined by 29% compared to 2023." 

Undersupply is leading to further price rises and affordability problems, posing a risk to the stability of the housing market.

The financial sector is marked by capital and liquidity buffers and a solid credit portfolio. However, the bank-sovereign link has deepened due to tax incentives for domestic banks in return for purchasing government debt, the EC said.

It is important to note that while the European Commission used to explicitly urge Member States to borrow from their own banking system, this year Brussels' stance has changed: it is increasingly warning Member States against a home bias situation due to the development of interdependence.

The EC noted that the share of government bond holdings in banks' total assets increased from 14% in December 2023 to 16% by the end of 2024, driven by a tax incentive that allows banks to reduce their windfall tax liability by increasing their government bond holdings in 2024 and 2025.

Furthermore, government contingent liabilities to the financial sector were one of the highest in the EU in 2023.

These developments increase risks associated with the bank-sovereign nexus.

Hungary's "policy mix remains broadly unchanged. Monetary policy has been tight, but its transmission to the real economy has been weakened by government interventions. Fiscal targets and commitments are not fully backed by detailed measures over the medium-term," the EC said.

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