Council opinion of 8 March 2005 on the updated convergence programme of Hungary, 2004-2008
Date: 2005-03-08
Institutions: Council of the European Union
Subjects: Hungary, stability programme

19.7.2005

EN

Official Journal of the European Union

C 177/13

COUNCIL OPINION

of 8 March 2005

on the updated convergence programme of Hungary, 2004-2008

(2005/C 177/05)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveil-
lance of budgetary positions and the surveillance and coordination of economic policies (1), and in particu-
lar Article 9(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

On 8 March 2005 the Council examined the updated convergence programme of Hungary, which covers
the period 2004 to 2008. The programme complies with the data requirements of the ‘code of conduct on
the content and format of stability and convergence programmes’. While it contains all the compulsory
data (2), one optional figure (long-term health care expenditure) is missing.

The macroeconomic scenario underlying the update envisages real GDP growth to gradually increase from
3,9 % in 2004 to 4,6 % until the end of the programme period. On the basis of currently available infor-
mation, this scenario seems to reflect somewhat favourable growth assumptions. The update's projections
for inflation appear broadly realistic.

themselves of this possibility and presented the general government deficit

On 5 July 2004, the Council decided that an excessive deficit existed in Hungary and recommended that
this be corrected by 2008. The update foresees the following deficit path: 4,4 % of GDP in 2004, 3,6 % in
2005, 2,9 % in 2006, 2,2 % in 2007 and 1,6 % of GDP in 2008. These figures are consistent with the deci-
sion by Eurostat of 23 September 2004, which allows a temporary reclassification until the March 2007
fiscal notification of second pillar pension funds inside the general government. The Hungarian authorities
figures
decided to avail
excluding the second pillar burden created by the 1998 pension reform (3). The update keeps the target
date for the correction of the excessive deficit. After the estimated consolidation of 0,9 percentage point of
GDP in 2004, the update projects an annual adjustment of some 0,6-0,7 percentage point for the
remaining years. The update bases its consolidation strategy on a reduction of the expenditure ratio, under-
pinned by structural reforms, coupled with a more moderate decline in the revenue ratio. The most
pronounced expenditure reduction would be carried out in 2005, mainly based on a 0,5 percentage point
decline in the interest burden and a 1,7 percentage point reduction of public investment expenditure. The
drop in public investment expenditure would be compensated by an increased recourse to PPP projects.
The foreseen timeframe and quantification of the outer years' expenditure-reducing measures are not
presented in a sufficiently detailed fashion. The adjustment path of the primary deficit would be similar to
the general government deficit reduction path. The primary deficit would turn into a slight surplus in
2008 (including the burden of the pension reform).

(1) OJ L 209, 2.8.1997, p. 1.
(2) The primary balance is not calculated according to the conventional definition.
(3) Including the pension reform burden, the general government deficit path would be 5,3 %, 4,7 %, 4,1 %, 3,4 % and

2,8 % of GDP between 2004 and 2008.

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Official Journal of the European Union

19.7.2005

The adjustment path described in the programme and in particular the deficit target for 2005 followed by
a further adjustment of 2 percentage points of GDP can be considered appropriate to correct the excessive
deficit by 2008 provided that it is backed by sufficient measures. However, the final target of 2,8 % of GDP
(including the burden of the pension reform) only leaves a small safety margin, which might be reduced
further because of a change in the starting position as there are still some uncertainties linked to the
outcome of the 2004 budget (1). The budgetary projections in the programme appear to be on the upside:
(i) As suggested by the Commission services Autumn 2004 forecast, the deficit targets for 2005 and 2006
seem to be subject to upward risks. For 2005, this takes into account that the Government has established
an ‘emergency’ reserve package of 0,5 % of GDP against a possible overshooting of the 2005 target. While
the existence of this reserve is welcome, the amount allocated to it seems insufficient, in view of the risks
surrounding the Budget 2005. Furthermore, there are concerns that freeing of these reserves could occur
too early in the year, thereby reducing the incentives for a rigorous implementation of the 2005 budget.
Missing the 2005 and 2006 targets would put increased pressure on the adjustment in the years 2007 and
2008. (ii) Expenditure cuts are subject to risks since the reform measures included in the 2005 budget are
not embedded in a comprehensive reform strategy. (iii) There are also concerns about the attainment of
the expenditure and revenue targets, since the objectives set in previous years were missed by a large
margin. Moreover, any possible cut in VAT rates in the framework of the ongoing tax reforms could
increase the risk to revenues even if the intention was to compensate it by an increase in other rates; its
timing would therefore require careful consideration and it would need to be made conditional upon the
full achievement of deficit targets. (iv) There could also be a risk from the fact that VAT refunds related to
economic activities in 2004 have been delayed, but the authorities have committed to accelerate these
refunds so that they will not burden the 2005 budget. On the other hand, this strengthened control on
VAT refunds initiated end-2004 might also contribute to a reduction of the expected shortfall of VAT
revenues, which constitutes a downward risk.

In view of this assessment, there is a risk that the budgetary outcomes could be worse than projected in
the update. Therefore, although the adjustment path contained in the programme and in particular the
deficit target for 2005 followed by a further adjustment of 2 percentage points of GDP can be considered
appropriate to correct the excessive deficit by 2008, the fiscal stance in the programme does not appear to
be sufficient to implement this path and therefore may not ensure that the deficit is reduced to below 3 %
of GDP by 2008. In order to make the adjustment path credible additional measures would be needed. In
it is paramount to meet the new 2005 target. In view of the above assessment, additional
particular,
measures of at least ½ a percentage point of GDP would be appropriate.

The debt ratio is estimated to be 56,7 % of GDP in 2004 (it would reach 59,9 % of GDP including the
just below the 60 % of GDP Treaty reference value). The programme
burden of the pension reform,
projects the debt ratio to decline by about 7 percentage points over the programme period. Risks to the
debt ratio correspond to those for the deficit projections.

With regard to the long-term sustainability of the public finances, Hungary appears to be at some risk on
grounds of the projected budgetary costs of an ageing population. Risks are in part related to the uncer-
tainty regarding the long-term budgetary trends due to the lack of information on health-care expenditure
projections. The strategy outlined in the programme is mainly based on the budgetary consolidation in the
next few years and additional reform measures to be implemented in the future. The reformed pension
system, including the introduction of the funded second pillar, contributes consistently to reducing the
budgetary impact of ageing and to reducing risks of unsustainable public finances. However, it is important
to pursue other reforms, particularly in the field of the health-care as well as to resolutely implement the
planned budgetary consolidation in the medium-term.

(1) There are accounting uncertainties related to agricultural subsidy payments which could reduce the difference
between the cash based and the accrual based deficit, thereby increasing the accrual based deficit in 2004. If the
refunds of VAT are accelerated, as was indicated by the Hungarian authorities, they might increase the deficit of
2004 by almost 0,7 percentage points.

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Official Journal of the European Union

C 177/15

The economic policies outlined in the programme are partly consistent with the country-specific broad
economic policy guidelines in the area of public finances. The general government deficit was to be
reduced ‘in a credible and sustainable way within a multi-annual framework in line with the decisions to
be taken by the Council in the context of the budgetary surveillance exercise’. Although Hungary did
implement a fiscal adjustment in 2004, it has not complied with the 104(7) recommendations of the
Council of 5 July 2004 under the excessive deficit procedure, as decided by the Council on 18 January
2005 based on Article 104(8) of the Treaty.

In view of the above assessment and in the light of the recommendations made by the Council under
Article 104(7) on 8 March 2005, the Council is of the opinion that Hungary should:

(i)

take action in a medium-term framework in order to bring the deficit including the burden of the
pension reform below 3 % of GDP by 2008 in a credible and sustainable manner,
in particular
through additional measures to achieve the deficit target for 2005 and a subsequent adjustment of 2
percentage points of GDP to correct the excessive deficit by 2008 and by seizing every opportunity to
accelerate the fiscal adjustment;

(ii) make the timing and implementation of any tax cuts conditional upon the achievement of the deficit

targets of the convergence programme update submitted in December 2004;

(iii) progress with the envisaged reforms of the public administration, health and education systems as

committed also with a view to improving the long-term sustainability of the public finances.

Comparison of key macroeconomic and budgetary projections

Real GDP
(% change)

CP Dec. 2004

3,9

4,0

4,2

4,3

4,6

2004

2005

2006

2007

2008

COM

3,9

3,7

3,8

n.a.

n.a.

CP May 2004

3,3-3,5

3,5-4,0

cca.4

4-4,5

4,5-5,0

HICP inflation
(%)

CP Dec. 2004

6,8

4,5

4,0

3,5

3,0

COM

6,9

4,6

4,2

n.a.

n.a.

CP May 2004

cca.6.5

cca.4.5

cca.4

cca.3.5

cca.3

General government
balance
(% of GDP)

CP Dec. 2004 (1)

– 4,4

– 3,6

– 2,9

– 2,2

– 1,6

With pension reform (2)

– 5,3

– 4,7

– 4,1

– 3,4

– 2,8

COM (3)

– 5,5

– 5,2

– 4,7

n.a.

n.a.

CP May 2004 (4)

– 4,6

– 4,1

– 3,6

– 3,1

– 2,7

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Official Journal of the European Union

19.7.2005

Primary balance
(% of GDP)

Government gross debt
(% of GDP)

CP Dec. 2004 (1)

With pension reform (2)

COM (3)

CP May 2004 (4)

CP Dec. 2004 (1)

With pension reform (2)

COM (3)

CP May 2004 (4)

2004

2005

2006

2007

2008

– 0,4

– 1,1

– 1,1

– 0,5

56,7

59,9

59,7

59,4

0,0

– 0,9

– 1,2

– 0,2

55,5

58,6

59,5

57,9

0,2

– 0,7

– 1,1

0,1

53,0

56,8

58,9

56,8

0,6

– 0,3

n.a.

0,3

50,6

54,9

n.a.

55,6

1,0

0,1

n.a.

0,4

48,3

53,2

n.a.

53,7

Note:
(1) The Hungarian authorities decided to use the transitional period granted by Eurostat to classify the second pillar pension funds inside
the government sector. Compared to the May 2004 programme, this lowers the yearly figures for the government deficit by 0.9-1.2
percentage point between 2004 and 2008. The transitional period ends with the March 2007 notification.

(2) These figures are not adjusted, i.e. they include the burden of the pension reform. They are presented for the sake of comparison
with the previous programme and with the Commission services autumn 2004 forecast, and given that the 2007 and 2008 target
will not benefit from this re-classification of the second pillar pension funds.

(3) These Commission forecasts are non-adjusted figures, i.e. including the burden of the pension reform.
(4) These figures included in the May 2004 Convergence programme of Hungary include the pension reform burden.

Sources:
Convergence programme (CP); Commission services autumn 2004 economic forecasts (COM); Commission services calculations.