Council opinion of 27 February 2007 on the updated convergence programme of Hungary, 2006-2010
Date: 2007-02-27
Institutions: Council of the European Union
Subjects: Hungary, budget estimate, economic convergence, economic forecasting, public finance, stability programme

28.3.2007

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Official Journal of the European Union

C 71/23

COUNCIL OPINION

of 27 February 2007

on the updated convergence programme of Hungary, 2006-2010

(2007/C 71/07)

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 particular
Article 9(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

(2)

(3)

On 27 February 2007 the Council examined the updated convergence programme of Hungary, which
covers the period 2006 to 2010.

The programme's macroeconomic scenario expects a slow-down of economic activity for the years
2007 and 2008, as a result of the fiscal consolidation measures, with a recovery to pre-consolidation
growth rates by 2009. Assessed against currently available information, this scenario appears to be
broadly plausible for the years up to 2008 and might even be slightly cautious, while for the outer
years it seems rather favourable. The programme projects inflation to surge in 2007 and rapidly
decline thereafter; however, the projected inflation path over the entire programme horizon is some-
what favourable.

For 2006, the general government deficit is estimated at 10,1 % of GDP in the Commission services'
autumn 2006 forecast, in line with the revised target of the September 2006 update (2), and against a
target of 6,1 % of GDP set in the December 2005 update of the convergence programme. The over-
shoot compared to the original deficit target took place almost entirely on the expenditure side
(around 5 % of GDP), mainly operational costs of central budgetary institutions, pension and health-
care expenditure and local government investment. It also reflects the inclusion of motorway invest-
ment inside the general government (1,1 % of GDP). The budgetary corrective package of 1½ % of
GDP adopted in summer 2006 consists of revenue-increasing measures,
together with some
immediate expenditure cuts in the areas of health-care, gas price subsidies and public administration.
These measures (except the withdrawal of the 0,3 % of GDP general reserve of the budget) are
expected to produce important effects also in 2007 and thereafter.

(4)

The main goal of the update is to correct the excessive deficit by 2009 (reducing the deficit from
10,1 % of GDP in 2006 to 3,2 % of GDP in 2009 (3)), in line with the September 2006 update

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The

documents referred to in this text can be found at the following website:
http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

(2) In its opinion on the December 2005 update of the convergence programme, the Council had considered that the planned
cut in expenditures of 7,5 % of GDP was not backed by concrete measures. Therefore, it had invited Hungary to present by
1 September 2006 at the latest an adjusted convergence programme update identifying concrete and structural measures
fully consistent with its medium-term adjustment path. In accordance with this request, Hungary submitted its adjusted
programme on 1 September 2006 to the Council and the Commission.

(3) The deficit target of 3,2 % of GDP in 2009 would still exceed the 3 % of GDP threshold specified in the Treaty. It is
assumed in the programme that the Council and the Commission take into account 20 % of the yearly burden on the
budget arising from the pension reform (which is expected to amount to 0,3 % of GDP in that year) when taking a decision
on abrogating the excessive deficit procedure for Hungary (in line with Council Regulation (EC) No 1467/97 as amended,
Article 2 paragraph 7, which stipulates that if the general government deficit ‘… has declined substantially and continuously
and has reached a level that comes close to the reference value’, the Council and the Commission should consider the net cost of a
pension reform that includes a fully-funded pillar on a linear degressive basis for a transitory period of five years, and
taking into account the implementing provisions in the code of conduct).

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against a background of a broadly similar macroeconomic scenario, with a further reduction in 2010.
The improvement in the primary balance is of the same magnitude. The planned adjustment is front-
loaded, with nearly half of the reduction in the deficit ratio to take place in 2007. The planned
nominal adjustment over the programme period is to be achieved by increasing the revenue-to-GDP
ratio by nearly 1 percentage point and by reducing the expenditure-to-GDP ratio by 6.5 percentage
points. An initial increase in the tax burden by 1,6 percentage points of GDP in 2007 is progressively
replaced by measures on the expenditure side. On top of the expenditure cuts and budgetary freezes
adopted since summer 2006, the authorities have started to strengthen expenditure controls and
enhance the institutional framework of public finances. Moreover, the programme spells out a broad
structural reform agenda aimed to ensure the achievement of the deficit targets, especially in the
outer years of the programme.

(5)

(6)

(7)

(8)

The structural balance (i.e.
the cyclically-adjusted balance net of one-off and other temporary
measures) calculated according to the commonly agreed methodology is planned to improve from
9¾ % of GDP in 2006 to around 3 % at the end of the programme period. The medium-term objec-
tive (MTO) for the budgetary position presented in the programme is a structural deficit of 0,5 % of
GDP, which the programme does not aim to achieve within the programme period. This is somewhat
more ambitious compared to the previous update of the programme, which put forward an MTO-
range of a structural deficit between 0,5 % and 1 % of GDP. The MTO adequately reflects the debt
ratio and average potential output growth in the long term. As the MTO is more demanding than the
minimum benchmark (estimated at a structural deficit of around 1½ % of GDP), achieving it should
fulfil the aim of providing a safety margin against the occurrence of an excessive deficit.

The budgetary outcomes could be worse than targeted in the programme, especially from 2008. The
risks to the deficit path stemming from the macroeconomic outlook are broadly balanced until 2008,
but lower-than-projected GDP growth in the outer years could lead to a higher deficit. Although the
short-term expenditure cuts and temporary budgetary freezes were incorporated into the 2007
budget as planned, there is still some uncertainty about the effective enforcement of the expenditure
freezes (also because of the poor track-record of similar controls in 2004-2006). The effectiveness of
the new fiscal rules and the initial steps taken towards a multi-annual budgetary framework in rever-
sing the pattern of regular expenditure overruns will have to be tested. The Government has taken
decisions on a number of steps to reform the public administration, health, pension, price subsidies
and education systems. Based on these measures the budgetary outcomes could be closer to the
deficit targets for 2007 and 2008 than expected in the Commission services' autumn 2006 forecast.
However,
the remaining structural reform steps, necessary to replace the expenditure-curbing
measures that expire at the end of 2008, still need to be further specified and fully implemented. In
addition, in the outer years of the programme, there is a risk of a budgetary loosening as evidenced
by past experience. Finally, should the restructuring plans of the public transport companies fail to
yield the expected results, the accumulating losses of these companies might temporarily increase the
deficit.

In view of this risk assessment, the budgetary stance in the programme seems broadly consistent with
a correction of the excessive deficit by 2009 as recommended by the Council provided that the
budgetary strategy is fully implemented. This concerns in particular the full implementation of the
consolidation measures announced in the 2007 budget and in the new programme as well as the
further specification and timely adoption of the announced additional structural reform measures. In
2010, after the planned correction of the excessive deficit, the pace of the adjustment towards the
MTO implied by the programme should be strengthened. This would also be a first step towards
providing a sufficient safety margin against breaching the 3 % of GDP deficit threshold with normal
macroeconomic fluctuations, which is not in place.

The government gross debt is estimated to have reached 67½ % of GDP in 2006, which is above the
60 % of GDP Treaty reference value. The programme projects the debt ratio to increase to 71¼ % in
2008. After 2008, it is expected to decrease again and return to 67½ % in 2010. The evolution of
the debt ratio is likely to be less favourable than projected in the programme given the risks to the
budgetary targets mentioned above. In view of this risk assessment, the debt ratio would not be suffi-
ciently diminishing towards the reference value until the end of the programme period.

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(9)

(10)

The long-term budgetary impact of ageing in Hungary is well above the EU average, notably as a
result of the high increase in pension expenditure as a share of GDP over the long term. While first
important steps have been taken, full implementation of further reform measures aimed at containing
the significant increase in age-related expenditures as planned in the programme would contribute to
reducing risks to the sustainability of public finances. Moreover, and importantly, the weak initial
budgetary position, having deteriorated substantially compared with 2005, constitutes a risk to
sustainable public finances even before the long-term budgetary impact of an ageing population is
considered. In addition, the current level of gross debt is above the Treaty reference value. Further
budgetary consolidation as planned would contribute to reducing risks to the sustainability of public
finances. Overall, Hungary appears to be at high risk with regard to the sustainability of public
finances.

The convergence programme contains a qualitative assessment of the overall impact of the Hungarian
October 2006 revised national reform programme within the overall medium-term strategy. In addi-
tion, it provides some information on the direct budgetary costs or savings of the main reforms envi-
saged in the national reform programme, but its budgetary projections do not explicitly take into
account all the public finance implications of the actions outlined in the national reform programme.
The measures in the area of public finances envisaged in the convergence programme seem consistent
with those foreseen in the national reform programme. In particular, the structural reform plans and
recently adopted measures outlined in the convergence programme entirely correspond to the reform
agenda presented in the national reform programme, notably the reform steps adopted in the fields
of public administration, health-care, pension and education and various subsidy systems.

(11)

The budgetary strategy in the programme is broadly consistent with the broad economic policy
guidelines included in the integrated guidelines for the period 2005-2008.

(12) As regards the data requirements specified in the code of conduct for stability and convergence

programmes, the programme provides all required and most of the optional data (1).

The Council considers that the programme plans to reduce the very high deficits of the past years through a
frontloaded adjustment effort and is broadly consistent with correcting the excessive deficit by 2009, the
deadline set by the Council. A number of revenue-increasing and expenditure-containing measures have
been taken since the summer of 2006, as well as initial reform steps in the fields of public administration,
health care, pension and education reform. However, there are risks to the achievement of the deficit and
debt targets, especially from 2008.

In view of the above assessment, and also in the light of the recommendation under Article 104(7) of 10
October 2006, the Council encourages Hungary to continue the highest efforts and invites Hungary to:

(i) Rigorously implement the 2007 budget and take adequate action to ensure the correction of the exces-
sive deficit by 2009, if necessary through additional measures; and ensure, including by using any extra
revenues for deficit reduction, that the gross debt-to-GDP ratio is brought onto a firm downward trajec-
tory, preferably before 2009.

(ii) Improve budgetary control by enhancing fiscal rules and by strengthening the institutional framework

of public finances, building on the first steps undertaken in the budget for 2007.

(iii) Curb expenditure in a permanent manner through the adoption and swift implementation of the
announced streamlining of the public administration and healthcare systems and the envisaged reform
of the education system.

(iv) In view of the level of debt and the increase in age-related expenditure, improve the long-term sustain-
ability of public finances by making adequate progress towards the MTO and taking additional pension
reform measures as announced.

(1) In particular, data are missing on government expenditure by function as well as on hours worked, the government's finan-

cial assets and financial debt; some data on the long-term sustainability of public finances are also not provided.

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Comparison of key macroeconomic and budgetary projections

Real GDP
(% change)

HICP inflation
(%)

CP Dec 2006

COM Nov 2006

CP Sep 2006

CP Dec 2005

CP Dec 2006

COM Nov 2006

CP Sep 2006

CP Dec 2005

Output gap
(% of potential GDP)

CP Dec 2006 (1)

COM Nov 2006 (5)

CP Sep 2006 (1)

2005

2006

2007

2008

2009

2010

4,2

4,2

4,1

4,2

3,6

3,5

3,6

3,5

0,5

0,6

0,3

4,0

4,0

4,1

4,3

3,9

3,9

3,5

2,1

2,2

2,4

2,2

4,1

6,2

6,8

6,2

3,0

2,6

2,7

2,6

4,1

3,3

3,9

3,3

2,4

4,2

4,3

n.a.

n.a.

4,1

n.a.

3,0

n.a.

n.a.

2,8

n.a.

n.a.

3,0

n.a.

n.a.

n.a.

0,9

– 0,4

– 1,2

– 0,5

0,4

1,0

0,1

– 0,5

n.a.

n.a.

0,8

– 0,3

– 0,9

0,0

n.a.

General government
balance
(% of GDP)

CP Dec 2005 (1)

– 1,0

– 0,5

– 0,1

0,4

n.a.

n.a.

CP Dec 2006

– 7,8

– 10,1

– 6,8

– 4,3

– 3,2

– 2,7

COM Nov 2006

– 7,8

– 10,1

– 7,4

– 5,6

n.a.

n.a.

CP Sep 2006

– 7,5

– 10,1

– 6,8

– 4,3

– 3,2

n.a.

CP Dec 2005 (6)

– 7,4

– 6,1

– 4,7

– 3,4

n.a.

n.a.

Primary balance
(% of GDP)

CP Dec 2006

– 3,7

– 6,2

– 2,4

0,0

0,9

1,1

COM Nov 2006

– 3,7

– 6,1

– 2,9

– 1,4

n.a.

n.a.

Cyclically-adjusted
balance
(% of GDP)

CP Sep 2006

– 3,4

– 6,3

– 2,4

– 0,2

0,8

CP Dec 2005 (6)

– 3,8

– 2,9

– 1,7

– 0,7

n.a.

n.a.

n.a.

CP Dec 2006 (1)

– 8,0

– 10,5

– 6,6

– 3,8

– 3,0

– 2,9

COM Nov 2006

– 8,1

– 10,5

– 7,4

– 5,4

n.a.

n.a.

CP Sep 2006 (1)

– 7,6

– 10,5

– 6,7

– 3,9

– 3,2

n.a.

CP Dec 2005

n.a.

n.a.

n.a.

n.a.

n.a.

n.a.

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Structural balance (2)
(% of GDP)

CP Dec 2006 (3)

– 8,0

– 9,8

– 5,6

– 3,7

– 3,0

– 2,9

2005

2006

2007

2008

2009

2010

Government gross debt
(% of GDP)

COM Nov 2006 (4)

– 8,5

– 10,3

– 6,5

– 5,1

n.a.

CP Sep 2006

CP Dec 2005

CP Dec 2006

COM Nov 2006

CP Sep 2006

CP Dec 2005 (6)

– 7,6

– 9,7

– 5,8

– 3,6

– 3,2

n.a.

61,7

61,7

62,3

61,5

n.a.

67,5

67,6

68,5

63,0

n.a.

70,1

70,9

71,3

63,2

n.a.

71,3

72,7

72,3

62,3

n.a.

69,3

n.a.

70,4

n.a.

n.a.

n.a.

n.a.

67,5

n.a.

n.a.

n.a.

Notes:
(1) Commission services calculations on the basis of the information in the programme.
(2) Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures.
(3) One-off and other temporary measures taken from the programme (0,7 % of GDP in 2006 and 1,0 % of GDP in 2007 and 0,1 % of

GDP in 2008; all deficit increasing).

(4) One-off and other temporary measures taken from the Commission services' autumn 2006 forecast (0,4 % of GDP in 2005, deficit

reducing; 0,3 % of GDP in 2006; 0,9 % of GDP in 2007 and 0,3 % in 2008; all deficit increasing).

(5) Based on estimated potential growth of 3,7 %, 3,6 %, 3,4 % and 3,2 % respectively in the period 2005-2008.
(6) For the sake of comparability, the budgetary figures of the December 2005 Convergence Programme were adjusted to include pension

reform-related costs.

Source:
Convergence programme (CP); Commission services' autumn 2006 economic forecasts (COM); Commission services' calculations