# EUR-Lex - 52012PC0104 - EN

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# 52012PC0104

**Recommendation for a COUNCIL RECOMMENDATION with a view to bringing an end to the situation of an excessive government deficit in Hungary /* COM/2012/0104 final */**

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EXPLANATORY MEMORANDUM

On 5 July 2004, the Council decided in
accordance with Article 104(6) of the Treaty establishing the European
Community (TEC) that an excessive deficit exists in Hungary. On 24 January
2012, the Council decided in accordance with Article 126(8) of the Treaty on
the Functioning of the EU (TFEU), that Hungary has not taken effective action
in response to the latest Council Recommendation according to Article 104(7) of
the Treaty of 7 July 2009.

As a follow-up to the Council Decision of
24 January 2012 and in accordance with Article 126(7) TFEU and Article 3 of
Council Regulation (EC) No 1467/97, on [6 March 2012] the Commission should
adopt a recommendation for a new Council Recommendation with a view to bringing
an end to the situation of an excessive government deficit in Hungary.

Recommendation for a

COUNCIL RECOMMENDATION

with a view to bringing an end to the
situation of an excessive government deficit in Hungary

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty on the
Functioning of the European Union (TFEU), and in particular Article 126(7)
thereof,

Having regard to the recommendation from
the European Commission,

Whereas:

(1)
According to Article 126 TFEU Member States shall
avoid excessive government deficits.

(2)
The Stability and Growth Pact is based on the
objective of sound government finances as a means of strengthening the
conditions for price stability and for strong sustainable growth conducive to
employment creation.

(3)
The Council has decided on 5 July 2004, in accordance
with Article 104(6) of the Treaty establishing the European Community (TEC),
that an excessive deficit exists in Hungary and made recommendations under
Article 104(7) TEC with a view to bringing the excessive deficit situation to
an end by 2008.

(4)
In January 2005, in accordance with Article
104(8) TEC, the Council considered that Hungary had not taken effective action
in response to its recommendation and issued another recommendation based on
Article 104(7) TEC in March 2005, confirming the 2008 deadline for the
correction of the excessive deficit. In November 2005, the Council decided that
Hungary had for the second time failed to comply with the recommendations under
Article 104(7) TEC. Accordingly, it addressed a third recommendation under
Article 104(7) TEC to Hungary in October 2006, postponing the deadline for the
correction of the excessive deficit to 2009. In July 2009 the Council concluded
that the Hungarian authorities could be considered to have taken effective
action in response to the recommendations from October 2006 and, against the
background of the severe economic downturn issued revised recommendations under
Article 104(7) TEC, setting once more a new deadline for correction, i.e. 2011.
On 27 January 2010 the Commission concluded that Hungary had taken effective
action in response to the latest Council recommendations, but alerted about
considerable risks.

(5)
According to the provisions of Article 126(8)
TFEU, the Council decided on 24 January 2012 that Hungary did not take
effective action in response to the July 2009 Council recommendation within the
period laid down in this recommendation. While the nominal 3% of GDP reference
value was not breached in 2011, this was not based on a structural and
sustainable correction and hinged upon substantial one-off revenues. This was accompanied
by a structural deterioration in 2010 and 2011 of over 2% of GDP compared to a
recommended cumulative fiscal improvement of 0.5% of GDP. Moreover, while the
authorities were implementing structural measures in 2012 which were expected
to largely offset the previous deterioration, the 3% of GDP Treaty reference
value would again be respected in 2012 only thanks to one-off measures of close
to 1% of GDP and it would be breached in 2013. [Following this Council
decision, the Council decided [on 13 March] to suspend a part of the Cohesion
Fund commitment appropriations for the year 2013 for Hungary (in line with
Article 4 of Council Regulation (EC) No 1084/2006).]

(6)
In accordance with Article 126(7) TFEU and Article
3 of Council Regulation (EC) No 1467/97 on speeding up and clarifying the
implementation of the excessive deficit procedure (which is part of the
Stability and Growth Pact), the Council is required to make recommendations to
the Member State concerned with a view to bringing the situation of excessive
deficit to an end within a given period. The recommendation has to establish a
deadline of six months at the most for effective action to be taken by the
Member State concerned to correct the excessive deficit as well as a deadline
for the correction of the excessive deficit, which should be completed in the
year following its identification unless there are special circumstances. In
deciding whether special circumstances exist, “relevant factors” as clarified
in Article 2(3) of Regulation (EC) No 1467/97 should be taken into account.
Furthermore, in a recommendation to correct an excessive deficit the Council
should request the achievement of annual budgetary targets which, on the basis
of the forecast underpinning the recommendation, are consistent with a minimum
annual improvement in the structural balance, i.e. the cyclically-adjusted
balance excluding one-off and other temporary measures, of 0.5% of GDP as a
benchmark.

(7)
The Hungarian economy emerged from recession in
2010 as GDP grew by 1.3%. The recovery was considerably faster in 2010 than the
Commission services' projection in spring 2009 of -0.3% (i.e. at the time of
the Council recommendation). In 2011, GDP is expected to have continued
expanding at a moderate rate of 1.7%, still driven exclusively by the external
balance. However, the growth outlook deteriorated over the course of 2011 due
to the overall weakening of the international environment, which played out
over several channels, as well as to the further contraction in domestic demand
linked also to policy uncertainties. In this vein, the
Commission services' February 2012 Interim Forecast projects GDP to contract slightly,
by 0.1%, before it would resume growing again.

(8)
Following a deficit of 4.2% of GDP in 2010, the
general government balance is expected to turn into a surplus in 2011, but only
thanks to substantial one-off revenues of almost 10% of GDP linked to the transfer
of pension assets from private pension schemes. The official estimate for the 2011
budget surplus is 3.9% of GDP as specified in the December 2011 EDP progress
report. Taking into account the recent information about better-than-expected
cash-flow budgetary developments for some revenue items as well as for the
local government subsector, the surplus may even be slightly higher (at around
4.1% of GDP based on the Commission services updated assessment).

(9)
Regarding 2012, the adopted budget targets a
deficit of 2.5% of GDP to be achieved on the back of a number of consolidation
packages – to a large extent these were announced in the Széll Kálmán Plan
and the 2011 update of the Convergence Programme (CP) –
in part intended to correct the effect of the sizeable tax cuts decided in the
second half of 2010, that amounted to somewhat over 2% of GDP, while setting
aside an extraordinary reserve buffer (contingent expenditure cuts) of 1.1% of
GDP. The achievement of the target is also supported by net one-off revenues of
0.7% of GDP from the temporary extraordinary taxes. Based on recent
economic and budgetary developments the updated Commission services' forecast currently
expects the deficit to be at 3% of GDP, i.e. above the authorities' official
target. Compared to the adopted budget, this higher deficit forecast reflects,
among others, lower economic growth by half a percentage point as well as a
more prudent assessment of revenue and expenditure developments. At the same
time, it assumes that the extraordinary reserves will not be used (i.e.
contingent expenditure cuts will be carried out). The updated Commission
services' forecast of 3% of GDP is 0.2% of GDP higher than the projection at
the time of the adoption of the recommendation for a Council decision under
Article 126(8). This is explained by the fact the better-than-expected base
effect (from 2011) is not sufficient to counterbalance the budgetary impacts of
the further downward revision in the 2012 economic outlook and the impact of the
higher bond yields. In line with established practice in EU fiscal
surveillance, the new consolidation plans of 0.4% of GDP published by the
authorities on 21 February 2012 cannot be incorporated in the Commission
services' forecast since they have not been sufficiently substantiated yet.

(10)
In 2013, the deficit is expected to rise again
to around 3.6% of GDP (up from 3% of GDP), which exceeds the Commission
services' forecast of 31⁄4% of GDP at the time of the adoption of the Council
decision that Hungary has not taken effective action based on Article 126(8)
TFEU. This higher deficit number is mainly due to deficit increasing
developments of 0.4% of GDP (such as lower tax revenues due to the lower growth
forecast in 2012) that also contributed to the higher 2012 deficit forecast.
Moreover, interest expenditures will increase more in 2013 than in 2012 (by
0.1% of GDP). These effects are expected to be only partly offset by other
effects such as the lower than earlier expected financing need of the central
bank in 2013 (by 1⁄4% of GDP). When compared to 2012, the deficit increase to
3.6% in 2013 stems essentially from the phasing out of sectoral levies with a
net budgetary effect of 0.7% of GDP in 2013, the higher debt service
expenditures of 1⁄2% of GDP as well as the tightening of the tax base of the PIT
with a budgetary effect of 0.3% of GDP. These deficit increasing effects,
totalling some 11⁄2% of GDP of GDP are expected to be only partly counterbalanced
by the further implementation of the Széll Kálmán structural reform programme
resulting in savings of 0.4% of GDP and other savings of 0.4% of GDP, such as
the nominal freezing of the wages in the public sector. Finally, the budget is expected
to benefit somewhat from the foreseen economic recovery.

(11)
According to the latest Commission services' estimates,
after a deterioration by 11⁄2% in 2010 and by 1⁄2% in 2011, the structural balance
is expected to improve by close to 2% in 2012 before deteriorating again by 1⁄2%
of GDP in 2013. If the government would take the
necessary measures to achieve its fiscal targets in 2012 and 2013, the
structural improvement would amount to broadly 21⁄2% of GDP in 2012 and 1⁄2% of GDP
in 2013.

(12)
The budgetary outlook described above could be
improved by more than 1⁄2% of GDP in 2013 if reforms foreseen in the Széll Kálmán
Plan would be sufficiently specified and implemented. Further expenditure
savings published on 21 February 2012 need to be substantiated, in particular
in the areas of reduction of the subsidy of the public transport companies and pharmaceuticals,
whereas additional revenues could be expected from the planned introduction of
the electronic road tolls. Beyond these measures, in order to achieve a durable
correction of the excessive deficit, Hungary could benefit from better targeting
the universal child benefit (possibly in connection with the recently
introduced generous family tax allowances), introducing a centralised, value-based
property tax and from enhancing the progressive nature of the flat income tax
scheme; the latter issue was covered by the Council Recommendation to Hungary
of July 2011 in the context of the European Semester.

(13)
After having increased from 79.7% of GDP in 2009
to 81.3% in 2010, the government gross debt slightly decreased to 80.3% of GDP,
in 2011. This slight improvement reflects the significant primary surplus of 8%
of GDP, generated by the one-off revenue from the takeover of the private
pension assets, which is largely offset by the exchange rate depreciation.
Looking further, given the anticipated deficit numbers and based on a stronger
technical exchange rate assumption compared to the level at the end of 2011 as
well as assuming a further sale of the former private pension fund assets of 1%
of GDP, government gross debt is expected to be around 76% of GDP in 2012 but
it is expected to increase again from 2013.

(14)
Past fiscal developments point to a weakness in
fiscal governance and the transparency of budgetary planning and implementation.
After effectively weakening the previous fiscal governance framework that was
still in its infancy in the second half of 2010, the authorities introduced the
key elements of a changed set-up in the new Constitution (in effect as of 1
January 2012). Most notably, a nominal debt ceiling was set at 50% of GDP (to
be achieved through a continous debt reduction from the current high level), and
a veto right over the budget was granted to a rearranged Fiscal Council (FC). Follow-up
legislation to establish the new operational numerical rules both at the
central and the local level as well as the stipulation on the governing
arrangements of the FC was adopted late 2011 in a 'cardinal law'. The adopted
new annual numerical rule still appears to focus too much on the annual
budgetary cycle and does not seem to be conducive to medium-term budgetary
planning, which was recommended to be strengthened by the Council in its recommendation
of July 2011 in the context of the European semester. In that same
country-specific recommendation the Council also asked Hungary to broaden the
analytical remit of the Fiscal Council (e.g. through the preparation of regular
macro-fiscal baseline projections), which is not yet ensured, also after the
adoption of the Economic Stability law in December 2011.

(15)
Regular and timely monitoring of the progress
made in the implementation of the fiscal consolidation strategy for correcting
the excessive deficit is supported by Article 10a of Council Regulation (EC) No
1497/67, which foresees that the Member State concerned shall provide all
necessary information. In this context, a separate chapter in the update of Hungary's
Convergence Programme should be prepared in 2012 and subsequently as well as in
the regular bi-annual reporting on progress until the end of the Excessive
Deficit Procedure, in line with the Hungarian authorities' commitment.

(16)
Budgetary consolidation measures should secure a
lasting improvement in the general government balance, while being geared
towards enhancing the quality of the public finances and reinforcing the growth
potential of the economy,

HAS ADOPTED THIS RECOMMENDATION:

(1)
The Hungarian authorities should put an end to the
present excessive deficit situation by 2012.

(2)
The Hungarian authorities should bring the
general government deficit below the 3% of GDP reference value in a credible
and sustainable manner in accordance with the multi-annual path outlined in
Hungary's updated convergence programme of 15 April 2011 as endorsed by the opinion
expressed by the Council on 12 July 2011. Specifically to this end, the
Hungarian authorities should:

(a)
Ensure the attainment of the 2012 defict target
of 2.5% of GDP compared to the expected outcome of 3% of GDP based on the
macroeconomic framework after the 2012 February Interim Forecast of the
Commission services, which would require an additional fiscal effort of at
least 1⁄2% of GDP on top of the 1.9% of GDP that is already foreseen; in particular,
this should be done through a further specification and rigorous implementation
of the deficit-decreasing measures included in the Széll Kálmán Plan and
the 2011 update of the Convergence Programme as well as the adoption of further
consolidation measures of a structural nature as necessary. Allocate possible
windfall gains for improving the headline balance, including possible one-off
revenues stemming from the step back of beneficiaries from the private to the
public pension pillar.

(b)
Take necessary additional measures of a
structural nature as needed to ensure that the deficit in 2013, estimated to
exceed the 3% of GDP threshold of the Treaty by 0.6% of GDP based on the
macroeconomic framework after the 2012 February Interim Forecast of the Commission
services, remains well below the threshold even after the expected and
recommended full phasing out of one-off revenues of close to 1% of GDP. These measures
could include a further specification and implementation of the planned
structural reforms included in the Széll Kálmán Plan.

(c)
Incorporate sufficient reserve provisions in the
forthcoming budget laws (on top of the general reserve prescribed by the Public
Finance Act), to ensure the achievement of the budgetary targets even in case
of unforeseen events.

(3)
The above-mentioned budgetary adjustment should
contribute to bringing the government gross debt ratio on a declining path. In
particular, sufficient progress toward compliance with the debt reduction benchmark
should be ensured throughout the three years following the correction of the
excessive deficit, in accordance with Article 2 (1a) of Regulation 1467/97.

(4)
As recommended by the Council in July 2011, the
Hungarian authorities should operationalise the key constitutional fiscal rules
by adapting the cardinal law on economic stability. The numerical rules should
ensure that the budget process is embedded into a binding medium-term framework
and the analytical remit of the Fiscal Council should be broadened .

(5)
The Council establishes the deadline of [13 September
2012] for the Hungarian government to take effective action and to specify the
measures that will be necessary to progress towards ensuring a durable
correction of the excessive deficit. The assessment of effective action will
take into account economic developments compared to the updated outlook presented
in the Staff Working Document accompanying the Commission recommendation for
this Council recommendation.

The Hungarian authorities should report on
progress made in the implementation of these recommendations in a separate
chapter in the update of the Convergence Programme, which will be prepared in
2012 and subsequently, as well as in the regular bi-annual reporting on
progress until the end of the Excessive Deficit Procedure, in line with Hungary's
commitment.

In addition, the Council highlights the
importance of achieving the medium-term objective (MTO) for ensuring the
sustainability of public finances or a rapid progress towards such
sustainability. It therefore invites the Hungarian authorities to take the
necessary structural effort to reach its budget target of a deficit of 2.2% of
GDP for 2013 in a way that ensures that the MTO – currently a structural
balance of -1.5% of GDP – is sustained alongside the durable correction of the
excessive deficit.

This recommendation is
addressed to Hungary.

Done at Brussels,

For
the Council

The
President