Hungarian gov't announces further tax cuts – but where will the money come from?

Revised figures

On Tuesday, Minister of National Economy Márton Nagy provided a thorough and comprehensive overview of the government's views on the latest outlook for the Hungarian economy (GDP growth, inflation, wages) and the current budget situation. Several important messages were conveyed at the event, but the most significant ones were as follows:

1. The NGM cut its GDP growth forecast for 2025 from 2.5% to 1% and reduced its growth forecast for 2026 from 4.1% to 3.1%.
2. Meanwhile, according to the ministry's argument, this year's deficit target and next year's target will remain unchanged due to the worsening macroeconomic outlook. They argue that the pro-rata fulfillment of the main tax types (VAT, personal income tax) significantly exceeds that of previous years.
3. On top of all this, there may even be some room for manoeuvre in the 2026 budget (thanks to the activation of the national defense exemption clause).

Based on the above, there appears to be some contradiction between the above economic policy elements. We will attempt to explain the background to this contradiction.

Is there a hole in the budget, or not?

Based on the first point presented above, it would be logical to conclude that if the government's GDP growth expectations deteriorate, this will also worsen the budget deficit figures. However, this did not happen again (as was the case in March), but this is not surprising, as we predicted in Portfolio last week. At the same time, this does not rule out the possibility that the government's deficit forecast for this year may even rise in the coming months (the expected deficit level as a percentage of GDP is currently 4.1%, after the original target of 3.7%). According to some analysts, a further increase in the 2025 deficit cannot be ruled out (Raiffeisen Bank economists are predicting 5.5%, while OTP Bank analysts recently forecast 4.8% for this year).

In other words, it seems very likely that the underlying processes are not developing favorably for the 2026 budget. This is compounded by the risks that the Ministry of National Economy has just acknowledged on the growth side: the GDP growth assumption for 2026, on which the budget for next year adopted by parliament just over a month ago is based, has already become invalid (the inflation forecast for next year has also changed, but not significantly: from 3.6% to 3.7%). To put it simply,

one of the cornerstones of next year's budget has crumbled in the space of a few weeks.

It is no coincidence that some domestic analysts predicted at the time of next year's budget vote that achieving the 3.7% GDP deficit target for 2026 seems like a pipe dream. OTP analysts estimate that without further measures, the budget deficit will be 5.2% next year. Based on this, there is already a 1.5 percentage point gap in next year's budget in terms of GDP, which in nominal terms (assuming a GDP of HUF 95 trillion next year) represents a shortfall of HUF 1,400-1,500 billion.

But then where will the money come from?

Despite all this, the government is not concerned about the feasibility of next year's budget, which was adopted not so long ago. At Tuesday's briefing, the minister, speaking strictly from a finance minister's position, emphasized that the fiscal policy he proposes is based on three plus one pillars:

• the budget deficit must be reduced every year,
• public debt must be reduced to around 74%,
• Hungary must not fall back under the excessive deficit procedure, and
• the primary balance must remain close to zero.

At the same time, however, it should be noted that the Minister of National Economy is responsible for supporting and stimulating growth, and it is clear that the latest figures (growth dynamics falling short of expectations and the 4% GDP growth slipping further and further into the future) will put pressure on the minister to continue supporting growth with new measures, and this pressure will only be reinforced by the political balance of power ahead of the parliamentary elections. In other words, the goal of keeping the budget under control and the need for a looser fiscal policy to stimulate growth will come into conflict by early 2026 at the latest. It is interesting to note that, as of this year, this will no longer be a conflict between two ministries, as the Ministry of Finance was abolished in January, but rather an economic policy dilemma within the Ministry of National Economy.

How can this contradiction be resolved, or at least mitigated? This question may arise in many people's minds after this. According to the ministry, the answer is as follows:

• The general budget reserve planned for next year, originally increased from HUF 50 billion to HUF 192 billion, has been frozen and cannot be spent; it serves to mitigate the impact of the shortfall in revenues. This is a very positive development from the perspective of fiscal discipline, especially after the practice of previous years (the government spent the general reserve for all kinds of purposes), but it will not save next year's budget, which is already significantly behind schedule, as the reserve amounts to 0.5% of GDP.
• The EU-approved defense clause comes into play here. In this regard, the ministry emphasized in its presentation that “this tool will allow for a budget deficit higher than 3.7% by 2026.” “Thanks to the activation of the clause, there will be significant budgetary leeway next year,” which, according to the ministry, “will help achieve economic development goals.” At the briefing, the minister drew attention to the importance of the Economic Development Framework. Under the clause, 0.9% of GDP is available for general purposes and an additional 0.6% of GDP is available for defense purposes.

Hypothetically, therefore, there is room for maneuver (legally and in terms of budgetary technicalities) for the government to spend an extra 0.9% of GDP next year on virtually any purpose. In theory, therefore, with this move, the government has found itself with around HUF 850 billion of leeway for next year.

He has already allocated funds from this for salary increases for certain municipal employees (as well as for the Home Start Programme, although its net impact will be zero next year), which Márton Nagy explained yesterday in response to Portfolio, saying that it will cost HUF 25 billion. In other words, almost all of the leeway is still available. (We will return to this later, but to avoid confusion, we would like to note that this room for manoeuvre is apparently available – as a basis for spending – as long as we take seriously that the budget is on track with the official deficit target. If we no longer take this seriously, then this room for manoeuvre is practically non-existent.)

What will be the exact figures then?

It is not yet known how much of the hypothetical room for manoeuvre the government will use. In response to our inquiry, Márton Nagy emphasised that this is hypothetical room for manoeuvre and that the government has fiscal principles that limit excessive use of this. The minister believed that this room for manoeuvre cannot be used in its entirety with impunity, because the market and financiers are monitoring the government's spending.

This refers to the 3+1 fiscal principles outlined above, but it is worth noting that not all of them have an effective coercive effect and restrict the government's fiscal room for manoeuvre, quite the contrary. Here's why:

• Diminishing budget deficit. This assumption may arise even if this year's deficit rises to 4.8%, as it would still be possible to achieve a deficit of 4.7% next year, which is higher than the current target of 3.7%.
• Debt ratio falling to around 74%. At the end of last year, this figure stood at 73.5%, so the figure of around 74% may seem acceptable. Experts at the National Bank of Hungary (MNB) are predicting that debt will rise by the end of this year.
• Excessive deficit procedure. This could be a more serious constraint, but the government may have more time to reach the appropriate deficit level. OTP analysts recently predicted that the EDP procedure will not be an effective limiting factor.
• The primary balance should remain close to zero. We do not know what "close to zero" means in practice, and we may only find out during the year whether, for example, a negative primary balance of 0.7-0.8% falls within the government's own tolerance range.

The factor most likely to limit budget spending is probably the fact that the 2026 budget is already behind schedule (as mentioned above), and it is quite possible that the baseline scenario will not be that the 0.9% surplus spending under the defense clause will be added to next year's 3.7% deficit target, but rather that the surplus spending will be added to a deficit of around 5% next year. If such a scenario were to occur, the question arises, especially in the months leading up to the parliamentary elections (when the state coffers are already in a more spendthrift mood), to what extent the NGM will abandon its fiscal principles and put budgetary discipline on the back burner in order to restore growth.

It is indicative that the ministry always tries to appear active in this area. At Tuesday's press conference, for example, Márton Nagy said that consumption is strongly supported by the government's measures, which are now being imposed on the population. According to Nagy, if there were no increase in consumption, GDP growth would have been negative long ago; in other words, he argued that "if it weren't for the government's series of economic policy measures, GDP would already be negative due to the external environment, and that the government is able to keep GDP growth afloat."

At the same time, he pointed out that credit rating agencies also assess fiscal policy, and their decisions can effectively influence how much the government spends, as it is an important goal for the government to avoid a downgrade in the fall. It is not acceptable to risk a downgrade in Hungary in the autumn, the minister said. The market must also be monitored to see what it will allow in terms of extra spending and deficit increases. The EU will allow it, but it is not certain that the market and thus the credit rating agencies will tolerate it, Márton Nagy explained.

Summary

Legally and technically, therefore, there is scope for significant spending next year, just before the elections. As things stand (in light of the current political landscape) there may well be an intention to do so, as Minister for National Economy Márton Nagy strongly hinted on Tuesday.

He indicated that tax cuts (not tax exemptions or tax refunds) may be on the way, which would mean significant relief in terms of the general tax rate (which, in our interpretation, could even affect key types of taxes, such as VAT or personal income tax). He also suggested that when wage agreements are renegotiated in the fall, the government will provide all possible assistance to employers, which suggests that there may also be tax relief for employers in 2026 (social security contribution cuts).

Based on all this, it is very likely that major economic policy announcements will be made by the government in the fall with the aim of significantly improving the income situation of the population (this process has already begun), which will have a significant impact on the 2026 budget. The theoretical room for maneuver is there, and we know its extent: it could exceed HUF 800 billion.

In such a scenario, the only question will be how much Hungary will pay for this expenditure if the government decides to go ahead with it (as the minister himself acknowledged that such a move cannot be made "with impunity" ), which in practice means whether there will be a rise in yields on the government securities market (i.e., the state will have to pay more for financing), whether Hungary will receive a warning from credit rating agencies, and whether, in parallel with this, investors will become uncertain about the forint market.

With regard to credit rating outlooks, it is worth mentioning that Standard & Poor’s will be the first to announce its opinion on October 10, followed by Moody’s at the end of November and Fitch in early December, when they will publish their latest decisions on Hungary.

Hungary's credit rating escaped the spring review round with minor scratches: Fitch did not change its rating and the outlook remained stable, Moody's did not touch the rating either, but maintained its negative outlook, while S&P gave a negative outlook in April, leaving the BBB- category in place. Most people will be watching the latter credit rating agency's next move closely, as we are only one notch above the investment grade category with a negative outlook. Thus, a possible downgrade by them would be painful, as it would immediately put us in the non-investment grade category.

Cover photo (for illustration purposes only): Minister of National Economy Márton Nagy's Facebook page