COMMISSION STAFF WORKING DOCUMENT Analysis by the Commission services of the budgetary situation in Hungary in response to the Council Recommendation of 7 July 2009 with a view to bringing an end to the situation of excessive deficit
Date: 2012-01-11
Institutions: European Commission
Subjects: EU control, Hungary, anti-crisis plan, budget deficit, financial year, stability pact

EUROPEAN COMMISSION 

Brussels, 11.1.2012 
SEC(2012) 53 final 

COMMISSION STAFF WORKING DOCUMENT 

Analysis by the Commission services of the budgetary situation in Hungary in response 
to the Council Recommendation of 7 July 2009 with a view to bringing an end to the 
situation of excessive deficit 

Accompanying the documents 

COMMUNICATION FROM THE COMMISSION 

Assessment of budgetary implementation in the context of the ongoing excessive deficit 
procedures after the Commission services' 2011 Autumn Forecast 

Recommendation for a 

COUNCIL DECISION 

Establishing that no effective action has been taken by Hungary in response to the 
Council Recommendation of 7 July 2009 

{COM(2012) 4 final} 
{SEC(2012) 49 final} 
{SEC(2012) 50 final} 
{SEC(2012) 51 final} 
{SEC(2012) 52 final} 

 
 
 
 
  
 
 
 
 
COMMISSION STAFF WORKING DOCUMENT 

Analysis by the Commission services of the budgetary situation in Hungary in response 
to the Council Recommendation of 7 July 2009 with a view to bringing an end to the 
situation of excessive deficit 

Accompanying the documents 

COMMUNICATION FROM THE COMMISSION 

Assessment of budgetary implementation in the context of the ongoing excessive deficit 
procedures after the Commission services' 2011 Autumn Forecast 

Recommendation for a 

COUNCIL DECISION 

Establishing that no effective action has been taken by Hungary in response to the 
Council Recommendation of 7 July 2009 

1. 

INTRODUCTION 

On 5 July 2004, the Council decided that Hungary had an excessive budget deficit and issued 
a recommendation under Article 104(7) of the Treaty establishing the European Community 
(TEC)  setting  a  deadline  for  correction  of  2008.  After  the  Council  had  decided  twice,  in 
January and November 2005, in accordance with Article 104(8) TEC, that Hungary had not 
taken effective action in response to its recommendations, it issued a third recommendation to 
Hungary  based  on  Article  104(7)  TEC  in  October  2006,  postponing  the  deadline  for  the 
correction of the excessive deficit to 2009.  

In July 2009, against the background of a severe economic downturn which triggered fiscal 
adjustment measures and the provision of EU/IMF balance of payments support, the Council 
concluded that Hungary had taken effective action and issued revised recommendations under 
Article 104(7) TEC, setting 2011 as the new deadline to correct the excessive deficit. 

In  particular,  the  Council  recommended  Hungary  to  limit  the  deterioration  of  the  fiscal 
position  in  2009  by  ensuring  a  rigorous  implementation  of  the  adopted  and  announced 
corrective  measures  to  respect  the  government  deficit  target  of  3.9%  of  GDP.  Starting  in 
2010,  Hungary  was  recommended  to  rigorously  implement  the  necessary  consolidation 
measures to ensure a continued reduction of the structural deficit and a renewed decline of the 
headline  deficit,  with  an  increased  reliance  on  structural  measures,  in  view  of  warranting  a 
lasting improvement of public finances. Moreover, the Council recommended spelling out and 
adopting in a timely manner the consolidation measures necessary to achieve the correction of 
the excessive deficit by 2011 and ensuring, at least, a cumulative 0.5% of GDP fiscal effort in 
2010-2011.  Finally,  the  Council  invited  the  Hungarian  authorities  to  ensure  that  budgetary 
consolidation  towards  its  medium-term  objective  of  a  structural  deficit  of  ½%  of  GDP 
sustained after the correction of the excessive deficit. In line with Article 3(4) of Regulation 

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(EC) No 1467/97, the Council established the deadline of 7 January 2010 for the Hungarian 
authorities to take effective action. 

In  its  27  January  2010  Communication  to  the  Council,  the  Commission  concluded  that 
Hungary  had  taken  effective  action  in  response  to  the  latest  Council  recommendations, 
notably since the deficit outcome for 2009 was expected to be very close to the target and a 
budget in line with the 3.8% of GDP target had been adopted for 2010. However, the Council 
"alerted about considerable risks attached to the 2010 deficit target, both on the revenue and 
the expenditure side". In view of the announcements of the government to cut personal and 
corporate income tax rates, on 28 October 2010, the Commissioner responsible for Economic 
and  Monetary  Affairs  asked  the  government  to  communicate  as  a  matter  of  urgency  the 
consolidation measures it was planning to take to compensate for the revenue losses stemming 
from the tax cuts. In March 2011, the government announced a package of consolidation and 
structural reform measures, essentially starting from 2012 and reaching its peak in 2013. 

The Council, in its 12 July 2011 opinion on the 2011 update of the Convergence Programme 
(CP)  of  Hungary,  concluded  that  the  fiscal  adjustment  strategy  was  mainly  based  on  the 
expenditure side and that the 2011 deadline set by the Council for bringing the deficit below 
the 3% of GDP reference value of the Treaty would only be met thanks to the significant one-
off  revenues,  notably  from  the  pension  assets,  and  the  structural  improvement  would  begin 
only in 2012. Taking into account the implementation risks, it could not be excluded that the 
threshold might be breached again in that year unless further measures would be taken. The 
Council recommended that Hungary "strengthen the fiscal effort in order to comply with the 
Council  recommendation  to  correct  the  excessive  deficit  in  a  sustainable  manner  …  and 
ensure  that  the  budget  deficit  is  kept  safely  below  the  3%  of  GDP  threshold  in  2012  and 
beyond, contributing to the reduction of the high public debt ratio". Moreover, Hungary was 
asked  to  fully  implement  the  already  announced  fiscal  measures  and  "adopt  additional 
measures  of  a  permanent  nature  if  needed  at  the  latest  in  the  2012  budget  to  secure  the 
budgetary target for that year". 

This paper examines progress made by Hungary towards a timely and sustainable correction 
of  the  excessive  deficit.  In  particular,  it  examines  the  budgetary  developments  since  the 
Commission  Communication  to  the  Council  of  27  January  2010  on  action  taken.  The 
assessment  takes  into  account  all  decisions  publicly  announced  by  the  Government  on 
budgetary  developments  in  Hungary,  and  in  particular  the  information  contained  in  the  9th 
EDP progress report submitted to the Commission and the Council on 15 December 2011 and 
published on 6 January 2012. 

2. 

ECONOMIC DEVELOPMENTS AND OUTLOOK 

The post-2007 global economic and financial crisis hit Hungary particularly hard, also in the 
context  of  the  previously  accumulated  external  and  internal  vulnerabilities.  The  major 
frictions in the domestic financial systems, a sudden decline in external demand and the lack 
of fiscal space for stimulus measures (further budget cuts were in fact necessary to stabilise 
the deficit) were contributing factors to a recession that saw GDP contract by 6.7 % in 2009. 
This  outturn  was  close  to  the  6.3%  contraction  expected  in  the  Commission  services’  2009 
Spring Forecast, which was the latest available at the time of the Council recommendation to 
Hungary under Article 126(7) of the Treaty. The economy emerged from recession in 2010, 
supported  by  recovering  exports  on  the  back  of  better-than-expected  global  trade  demand. 
Without the balance of payments support from the IMF and the EU (the latter released EUR 

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5.5  billion  between  end  2008  and  mid  2009)  the  recession  would  have  been  considerably 
deeper and the recovery slower1. The current account deficit, which averaged over 7 % in the 
last  decade  preceding  the  crisis,  turned  into  surplus  owing  to  a  strong  performance  of  the 
export sector coupled with still contracting domestic demand. 

The economic recovery was considerably faster in 2010 than expected as GDP grew by 1.3% 
vs. the 0.3% contraction expected at the time of the Council recommendation. However, the 
growth  outlook  deteriorated  over  the  course  of  2011  due  to  the  weakening  of  the  external 
environment, which played out over several channels, as well as to the further contraction in 
domestic demand linked also to policy uncertainties. The Commission services' 2011 Autumn 
Forecast  projects  economic  growth  at  1.4%  in  2011  and  a  mere  0.5%  in  2012,  with  risks 
clearly tilted to the downside. Domestic demand is set to be affected in 2012 by consolidation 
measures  that  are  more  than  offsetting  the  overall  personal  income  tax  (PIT)  cut  –  which 
appears to have failed to stimulate consumption in 2011 – and contracting credit due largely 
to the government's financial sector policies. In 2013, GDP is projected to grow by slightly 
below  1.5%  again,  aided  by  the  assumption  of  an  improving  external  environment  and  the 
dissipation of associated uncertainties, with cautiously recovering domestic demand.  

By  contrast,  when  preparing  the  2012  budget  the  Hungarian  authorities  projected  GDP  to 
expand by 1.5% in 2012 and by 2.9% of GDP in 2013 (see also table below). The divergence 
between  this  official  forecast  underlying  the  budget  and  the  Commission  services'  autumn 
forecast was mainly on account of different expectations regarding private consumption and 
investment: for example, the authorities were markedly more optimistic about the impact of 
the early foreign exchange (FX) loan repayment scheme and the minimum wage raise. More 
recently, on 15 December 2011, the government revised down its growth forecast to 0.5% in 
2012,  acknowledging  that  the  contribution  of  domestic  demand  will  be  negative  so  that, 
overall, the updated official macroeconomic scenario for 2012 has become very close to the 
trajectory of the Commission services' 2011 Autumn Forecast. However, the macro-sensitive 
budgetary  items  have  not  been  updated  (e.g.  tax  revenue  estimates  were  not  revised 
downwards)  but  instead  deficit-improving  measures  of  0.4%  of  GDP  were  adopted  and  the 
extraordinary  buffers2  were  increased  with  the  corresponding  amount  of  0.4%  of  GDP  to 
compensate for the impact of lower growth and a weaker exchange rate on the budget. This 
being said, given the latest developments both in the international and national environment 
even these forecasts now appear optimistic (see budgetary risks below). 

1 

2 

The Council Decision of 4 November 2008 providing Community medium-term financial assistance for 
Hungary" can be found at:  
http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32009D0102:EN:NOT 
According  to  the  adopted  regulation,  the  extraordinary  reserves  cannot  be  used  before  September  30, 
2012 and the government may decide on the use only if in the Autumn 2012 Notification the expected 
EDP deficit for 2012 does not exceed 2.5% of GDP. 

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Table 1: Comparison of key macroeconomic projections 

Real GDP  
(% change) 

Current account balance 
(% of GDP) 

HICP inflation 
(% change) 

CP April 2011 
Draft 2012 Budget - Sept 
COM AF 2011  
CP April 2011 
Draft 2012 Budget - Sept 
COM AF 2011 
CP April 2011 
Draft 2012 Budget – Sept1 
COM AF 2011  

2010 
1.2 
1.2 
1.3 
2.1 
2.1 
1.0 
4.7 
4.9 
4.7 

2011 
3.1 
1.9 
1.4 
1.6 
2.5 
1.7 
4.0 
3.8 
4.0 

2012 
3.0 
1.5 
0.5 
2.8 
3.7 
3.2 
3.4 
4.2 
4.5 

2013 
3.2 
2.9 
1.4 
2.7 
2.1 
3.8 
3.0 
3.0 
4.1 

Notes: 
1 National Consumer Price Index (CPI) 
Source: 2011 update of Convergence programme (CP); Commission services’ 2011 Autumn Forecast (COM AF 2011); Draft 
2012 budget submitted to Parliament on 30 September 2012. 

3. 

BUDGETARY SITUATION AND PROJECTIONS FOR THE PERIOD 2011-2013 

3.1. 

Estimated outturn for 2011 

The 2010 update of the CP set the deficit targets at 3.8%, 2.8% and 2.5% of GDP in 2010-
2012  in  line  with  the  Council  recommendation  of  July  2009  based  on  a  somewhat  more 
favourable  macroeconomic  scenario  than  the  Commission  services  forecast  at  the  time.  In 
2010, the actual deficit of 4.2% of GDP exceeded the target in light of expenditure slippages 
mainly in the local government sector3.  

In 2011, the deadline for correcting the excessive deficit, the 2011 update of the CP expects 
the  general  government  balance  to  turn  into  surplus  despite  significant  tax  cuts  of  2½%  of 
GDP  in  the  second  half  of  2010  and  in  2011.  The  budgetary  surplus  is  achieved  primarily 
thanks to huge one-off revenues (amounting to 9¾% of GDP according to the autumn 2011 
notification)  linked  to  the  elimination  of  the  obligatory  private  pension  scheme.  In  order  to 
maximise the number of people switching from the private to the public pension pillar, strong 
incentives  were  provided  and  penalties  were  imposed4.  The  elimination  of  the  obligatory 
private pension scheme did not only result in one-off revenues stemming from the transfer of 
the  accumulated  assets  but  also  in  permanent  revenues  of  around  1.3%  of  GDP  since  the 
pension contributions of those who switch to the public pillar are permanently paid into the 
public pillar instead of the private one. 

The headline budgetary outcome also reflects temporary extraordinary levies of 0.9% of GDP 
introduced  in  2010.  At  the  same  time,  the  budget  integrates  permanent  saving  measures  of 

3 

4 

The deficit outcome exceeded the target not only in 2010 but also in 2009 by 0.7% of GDP according to 
the latest data. It is also worth highlighting that the 2008 and 2009 deficit numbers were significantly 
revised upwards compared to the first notification (from 3.4% of GDP to 3.7% of GDP regarding 2008 
and from 4.0% of GDP to 4.6% of GDP as far as 2009 is concerned).  
For instance, real yields accumulated in the private pension funds were paid out for those who switched 
to the public pillar, while people had to personally indicate if they wanted to stay in the private pillar 
(the default option was the transfer to the public pillar). Importantly, for those choosing to remain in the 
private pillar pension rights were no longer going to accrue on the basis of contributions paid by their 
employers.4 Consequently, 97% of the private fund members switched to the public pension pillar.  

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close to 1% of GDP at the line ministries which at the time compensated for the lower than 
earlier expected economic growth.  

The Commission services' 2011 Autumn Forecast shows a somewhat lower surplus of 3.6% 
of  GDP  in  2011  than  the  official  target  of  3.9%  of  GDP,  notably  since  it  includes  an 
assumption  of  part  of  the  debt  of  public  transport  companies  (0.2%  of  GDP),  which  was 
decided after the most recent update of the official deficit forecast5. The government deficit 
net of one-off effects is estimated to be around 6% of GDP. This is very substantially above 
the  3%  of  GDP  reference  value  of  the  Treaty  and  implies  that  without  these  one-offs  the 
deadline would not have been met. Based on recent information on one-offs, the surplus in the 
headline  balance  will  be  lower  than  3.6%  of  GDP  given  (i)  a  capital  injection  into  the 
Hungarian  Development  Bank;  (ii)  higher  than  previously  expected  reclaims  of  VAT 
payments related to an EU Court decision6; and (iii) tax rebates from the financial sector levy 
linked  to  the  partial  compensation  of  banks'  losses  from  the  early  repayment  of  FX  loans 
(such recording, in particular the accounting year of the tax rebate in ESA terms is subject to 
confirmation)7.  

In  its  latest  recommendation  of  9  July  2009,  in  view  of  the  economic  crisis,  the  Council 
postponed the deadline for correcting the excessive deficit by two years to 2011 and invited 
Hungary to ensure, at least, a cumulative fiscal effort of 0.5% of  GDP  over  2010  and  2011 
and  that  budgetary  consolidation  towards  its  medium-term  objective  is  sustained  after  the 
excessive deficit has been corrected. Instead, in the light of significant tax cuts that were not 
sufficiently compensated by structural measures, the structural balance deteriorated by 1½% 
of  GDP  in  2010  and  a  further  expected  1¼%  of  GDP  in  2011.  This  has  occurred  against  a 
slightly better macro environment than projected by the Commission services around the time 
of  the  recommendation.  Therefore,  the  cumulative  fiscal  effort  was  strongly  negative  over 
2010  and  2011  (around  -2¾%  of  GDP  -  see  Table  2)  against  the  recommended  cumulative 
0.5% of GDP structural adjustment. The measures announced after the 2011 Autumn Forecast 
do not change this assessment, since they impact from 2012 onwards.  

5 

6 

7 

The  public  transport  sector  (in  particular  the  state-owned  railway  sector)  has  been  making  a  loss  for 
decades, which has necessitated numerous ways of state intervention including debt assumption, capital 
injection as well as extraordinary budgetary support.  
Following  a  ruling  of  the  European  Court  of  Justice  in  July  2011  establishing  that  the  Hungarian 
regulation on VAT refunds is against the VAT rules, the authorities made possible for corporations to 
reclaim the outstanding amount of VAT this autumn, resulting in a one-off revenue loss of close to 1% 
of GDP. 
In the last month of 2011 the indirect tax and corporate tax revenues exceeded the earlier expectations 
by  around  0.3%  of  GDP.  However,  it  is  largely  off-set  by  higher  expenditures,  in  particular  by  the 
reduction of the budgetary institutions' arrears.  

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Table 2: Comparison of fiscal efforts (change in the uncorrected and corrected 
structural balance, % of GDP) 

Cumulative change in 
structural balance over 
2010 and 2011  

Cumulative change in 
structural balance  
over the entire EDP period 
(again 2010 and 2011) 

Fiscal effort 
recommended by 
the Council 

Deadline for correction 

Uncorrected  Corrected 

Uncorrected 

Corrected 

-2.8 

-2.4 

-2.8 

-2.4 

at least cum. 0.5% 
in 2010-2011 

2011 

Notes:  
The  uncorrected  cumulative  change  in  the  structural  balance  is  the  estimated  change  in  the  structural 
balance from the Commission services' 2011 Autumn Forecast. The corrected cumulative change in the 
structural balance is the uncorrected cumulative change in the structural balance plus a correction factor 
capturing the effect of revisions to potential output growth between the projections at the time of the EDP 
recommendations  and  the  Commission  services’  2011  Autumn  Forecast  (see  European  Commission 
(2004) Public Finances in EMU – 2004, European Economy, Brussels; and European Commission (2006) 
Public Finances in EMU – 2006, European Economy, Brussels). 
Source: Commission services. 

3.2. 

Deficit projections for 2012  

The  Hungarian  authorities  submitted  the  2012  draft  budget  to  Parliament  on  30  September 
2011.  It  targets  a  deficit  of  2.5%  of  GDP  in  line  with  the  latest  CP,  which  assumes  the 
continuation of temporary sectoral levies of 0.9% of GDP.  

It incorporates, first of all, several structural measures on the expenditure side, mainly in line 
with  the  Széll  Kálmán  Plan  announced  in  March  2011.  In  particular,  passive  labour  market 
benefits  were  reduced  in  the  second  half  of  2011,  while  disability  pensions,  pharmaceutical 
subsidies  and  price  subsidies  in  the  public  transport  sector  are  going  to  be  reviewed. 
Nevertheless,  as  acknowledged  in  the  official  estimations,  the  expected  expenditure  cuts  of 
close to 1¼% of GDP are 0.3% of GDP lower than originally planned; in net terms (i.e. taking 
into account also second-round macroeconomic effects and filtering out taxes paid on public 
expenditure) this would lead to a deficit improvement of around 1% of GDP. 

Second, in line with the 2011 update of the CP, additional measures of around 1¼% of GDP 
are also budgeted, such as the nominal wage freeze and the limited increase in the purchase of 
goods and services in the government sector.  

Third, the budget contains additional (i) revenue increasing measures of around 2% of GDP, 
including  a  hike  by  2  pps.  in  the  standard  VAT  rate  and  excise  duties,  the  increase  of  the 
social security contribution rate and the full elimination of the employment tax credit as well 
as (ii) expenditure saving measures of ½% of GDP at the line ministries. At the same time, 
these  deficit  improving  measures  are  partly  offset  by  deficit-increasing  decisions  of  around 
1%  of  GDP,  such  as  the  expansion  of  the  public  works  programme  and  the  faster  than 
previously  planned  narrowing  of  the  personal  income  tax  (PIT)  base  ("phasing  out  of  the 
supergrossing").  

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Finally,  in  order  to  counterbalance  the  negative  budgetary  effect  of  potential  unforeseen 
adverse developments, the government created a substantial extraordinary budgetary reserve 
of 0.7% of GDP (on top of the standard general reserve8 of 0.3% of GDP).  

Overall, the authorities estimate the deficit-decreasing effect of the measures incorporated in 
the draft budget to be around 4% of GDP.  

Table 3: Comparison of key fiscal projections 

General government balance  
(% of GDP) 

Government gross debt  
(% of GDP) 

Structural balance1 
(% of GDP) 

CP April 2011 
Draft 2012 Budget - Sept 
COM AF 2011 
CP April 2011 
Draft 2012 Budget - Sept 
COM AF 2011 

CP April 2011 
Draft 2012 Budget - Sept 
COM AF 2011 

2010 
-4.2 
-4.2 
-4.2 
80.2 
81.3 
81.3 

-3.1 
n.a. 
-3.8 

2011 
2.0 
3.9 
3.6 
75.5 
73.9 
75.9 

-4.2 
n.a. 
-5.0 

2012 
-2.5 
-2.5 
-2.8 
72.1 
71.8 
76.5 

-2.5 
n.a. 
-2.6 

2013 
-2.2 
-2.2 
-3.7 
69.7 
n.a. 
76.7 

-1.8 
n.a. 
-3.2 

Notes: 
CP April 2011= 2011 update of Convergence Programme, COM AF 2011= Commission services' 2011 Autumn Forecast 
1 Cyclically-adjusted budget balance excluding one-off and other temporary measures. 
Source: National authorities and Commission Services.. 

The  Commission  services,  in  their  2011  Autumn  Forecast,  project  the  2012  general 
government deficit to reach 2.8% of GDP, also taking into account the 0.9% of GDP one-off 
revenues. Compared to the draft budget this higher deficit forecast reflects: 

(i) 

(ii) 

lower  revenue  projections  of  0.4%  of  GDP,  in  particular  for  consumption-related 
taxes,  linked  to  the  lower  real  GDP  growth  by  1  pp.in  the  Autumn  Forecast 
compared to the budget;  

a  more  cautious  assessment  of  revenue  changes  by  around  0.1%  of  GDP,  most 
notably  for  personal  income  tax  and  gambling  tax;  The  lower  personal  income  tax 
revenue mainly reflects the somewhat larger net deficit increasing impact (0.05% of 
GDP)  of  the reshuffling of  the personal income  tax  system  (gradual  phasing-out of 
the so-called supergrossing9 in parallel with the full elimination of the employment 
tax  credit)  The  foreseen  shortage  of  the  gambling  tax  revenue  is  linked  to  the 
expected  behavioural  adjustment  both  to  the  tax  hike  and  the  widening  of  the  tax 
base; 

(iii) 

higher outlays of ¼% of GDP chiefly related to state-owned transport enterprises and 
maintenance  of  roads.  Regarding  the  state-owned  public  transport  enterprises  the 
Commission  services  estimated  higher-than-budgeted  financing  needs  based  on 

8 

9 

The  inclusion  of  this  type  of  reserve  appropriation  into  the  budget  law  is  prescribed  by  the  Public 
Finance Act. The main function of this reserve is to meet unforeseen expenditures and could be used 
rather  discretionally  by  the  Government  (the  only  constraint  that  maximum  40%  of  the  total  annual 
appropriation could be released in the first half of the year). 
Supergrossing  is  used  as  term  when  the  base  of  the  personal  income  tax  includes  the  social  security 
contributions paid by the employers. 

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historical  data.  As  far  as  the  maintenance  of  roads  is  concerned,  the  budgetary 
support was halved without changing the tasks which raised some doubts to realise 
these savings; 

(iv) 

higher expenditures of ¼% of GDP due to the fact that the technical assumptions of 
the Autumn Forecast for nominal exchange rates and bond yield are higher than the 
assumption  underlying  the  draft  2012  budget  (even  if  they  do  not  reflect  the  latest 
financial market developments).  

These  revenue shortfalls and expenditure slippages amounting altogether  to 1% of  GDP  are 
assumed  to  be  largely  counterbalanced  by  the  extraordinary  additional  budgetary  reserve  of 
0.7%  of  GDP.  This  approach  takes  into  account  the  governing  regulation  contained  in  the 
budget  bill  which  is  expected  to  ensure  a  cautious  use  of  this  reserve.  According  to  the 
adopted regulation, the extraordinary reserves cannot be used before September 30, 2012 and 
the government may decide on its use only if in the Autumn 2012 notification the expected 
EDP deficit for 2012 does not exceed 2.5% of GDP, which is not expected according to the 
Commission  services  assessment.  As  a  consequence  of  this  approach,  only  a  limited 
contingency buffer remains to offset any unforeseen adverse impacts (i.e. based on historical 
evidence, only part of the general reserve of slightly over 0.3% of GDP). 

On 20 December 2011, Parliament  adopted the 2012 budget. The amendments  compared to 
the draft budget and the detailed legislations altogether could decrease the 2012 deficit by ¼% 
of GDP. This mainly reflects:  

(i) 

(ii) 

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11 

12 

in  parallel  with 

the additional consolidation package of 0.4% of GDP, which was announced on 15 
December  2011 
the  official 
macroeconomic  forecast.  The  consolidation  package  includes  the  diversion  of  the 
employees'  pension  contributions  of  0.15%  of  GDP  from  the  private  pension 
schemes to the state pillar, higher excise duties of 0.05% of GDP as well as savings 
of 0.2% of GDP from the appropriations of line ministries, which are fully taken into 
account in this updated assessment despite some implementation risks10.  

the  downward  revision  of 

Moreover,  in  the  context  of  the  discussion  of  the  draft  budget,  other  revenue 
increasing  measures  of  ¼%  of  GDP  were  adopted,  such  as  the  introduction  of  an 
extra tax on fringe benefits in the form of a health contribution and the hike in the 
simplified business tax. These budgetary improvements are to a large extent offset by 
additional deficit increasing effects of 0.4% of GDP, in particular the more generous 
than  earlier  assumed  wage  compensation  schemes11  as  well  as  decisions  on  other 
extra  expenditures  (e.g.  wage  increases  for  judges  and  public  prosecutors).12 

The releated provisions were submitted to Parliament on 19 December 2011 and were voted into law on 
the  same  day.  In  practice,  the  entire  amount  of  0.4%  of  GDP  was  added  to  the  different  types  of 
extraordinary  reserves  (thus  by  now,  it  amounts  to  1.1%  of  GDP),  which  can  only  be  released  in  Q4 
2012  if  the  attainment  of  the  official  deficit  target  of  2.5%  of  GDP  is  ensured  (as  explained  also  in 
footnote one). 
These budgetary support schemes are available for those private companies that increase wages by more 
than 5%, partly triggered by the sizeable (18%) increase of the minimum wage and aimed at offsetting 
the elimination of the employment tax credit. 
In  contrast  to  the  Commission  services'  calculations,  the  government  expects  a  net  deficit  decreasing 
impacts of 0.4% of GDP as a result of the above mentioned measures. This is explained by the official 
assumption that the adopted amendments to the budget were deficit-neutral, and the wage compensation 
would not cost more than originally envisaged.  

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(iii) 

Regarding  both  revenues  and  expenditures,  the  authorities  have  a  more  optimistic 
view,  in  particular  they  expect  more  revenue  from  the  tax  hike  related  to  the 
simplified business tax although it is questionable in the light of historical data. 

Finally,  the  budgetary  outlook  for  2012  is  also  impacted  through  the  budgetary 
effects of the agreement between the government and the banking sector on how to 
share  the  burden  stemming  from  the  support  schemes  for  distressed  mortgage 
borrowers possessing FX loans concluded on 15 December 2011. Apart from the tax 
rebate of around 0.3% of GDP mentioned above (the recording of which should be 
clarified),  the  fiscal  costs  include  (i)  the  introduction  of  interest  subsidies  for  the 
overflow  accounts  of  the  fixed  exchange  rate  support  scheme;  (ii)  a  five-fold 
extension  of  the  operation  of  the  National  Asset  Management  Company;  (iii)  the 
deductibility  of  banks'  losses  stemming  from  the  25%  debt  forgiveness  for  non-
performing  loans  as  well  as  the  potential  reduction  of  this  levy  for  those  financial 
institutions  that  increase  the  credit  supply  in  2012;  and  (iv)  the  extension  of  the 
recently adopted housing subsidy scheme.  

Based  on  the  calculations  of  the  Commission  services,  these  direct  costs  (both  higher 
expenditures and lower revenues) related to the agreement between the government and the 
banks would amount to 0.4% of GDP in 2012, which appears to be in line with the projections 
of  the  government.  At  the  same  time,  this  deficit-increasing  effect  is  expected  to  be  partly 
counterbalanced by growth-increasing second-round effects (which are difficult to quantify at 
this  stage)  as  well  as  the  increase  in  corporate  income  tax  (given  that  the  bank  levy  is 
deductible  from  the  tax  base).  According  to  the  calculations  of  the  Commission  services, 
roughly  half  of  the  costs  (deficit-increasing  impact  of  0.4%  of  GDP)  could  be  recouped 
through  these  positive  impacts,  in  particular  through  a  more  favourable  credit  expansion 
compared to the baseline scenario, thus the net deficit-increasing effect of the recently agreed 
various schemes is estimated at 0.2% of GDP.13 For 2012, this would imply an updated deficit 
forecast of 2¾% of GDP, i.e. below the 3% of GDP reference value of the Treaty.  

However, it should be stressed that this updated forecast of 2¾% of GDP takes into account 
one off revenues of 0.9% of GDP from sectoral levies without which the 3% of GDP Treaty 
threshold would also be breached in 2012. Moreover, it does not take into account the recent 
deterioration of the macro economic outlook and the recent deterioration of financial markets 
(which - taken in isolation - would also push the deficit above the 3% of GDP threshold.) 

3.3. 

Deficit projections for 2013  

The Hungarian government in the 2011 update of the CP reiterated its commitment to reduce 
the budget deficit in 2013 to 2.2% of GDP despite the planned phasing out of the temporary 
extraordinary levies (0.9% of GDP). This reduction is mainly predicated on additional savings 
expected  from  the  Széll  Kálmán  Plan  in  the  following  areas:  introduction  of  the  electronic 
road toll, reform in the local government sector, review of the disability pension system and 
the  pharmaceutical  subsidies  and  reforms  of  the  higher  education  and  public  transport 

13 

For  the  macroeconomic  indirect  impacts,  the  Commisson  services  accepted  the  model-consistent 
estimations published in the December 2011 Inflation Report of the National Bank of Hungary, which 
showed that around 0.1% of GDP additional improvement can be expected from the agreed schemes. 
On  top  of  this,  Commission  staff  estimated  the  positive  impact  on  corporate  income  taxes  stemming 
from  the  improved  banking  balance  sheets  and  from  the  fact  that  less  extraordinary  bank  tax  can  be 
deducted from the pre-tax profits to be around 0.1% of GDP. 

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systems.  These  measures  were  originally  expected  by  the  government  to  produce  an 
additional savings of 1.2% of GDP in 2013, but this was later revised to 1.1% of GDP.  

Since at the time of the Commission services' 2011 Autumn Forecast, most of the structural 
reform  measures  were  not  yet  sufficiently  specified,  based  on  the  usual  no-policy  change 
assumption and the need for taking into account well specified measures, only 0.2% of GDP 
of  the  1.1%  of  GDP  was  incorporated  at  that  time.  In  particular,  the  information  was  not 
sufficient  regarding  plans  for  (i)  the  introduction  of  the  electronic  road  toll,  which  the 
Hungarian  authorities  expected  to  increase  by  0.3%  of  GDP  (a  very  recent  announcement 
seems to acknowledge that this plan cannot be implemented as planned),; (ii) streamlining of 
the institutional network of the local government for which details were not yet clear (savings 
of 0.3% of GDP); (iii) further savings from the reorganisation of the public transport sector 
(0.05%  of  GDP);  (iv)  the  further  savings  from  the  reform  of  the  disability  pension  system 
(0.1%  of  GDP);  as  well  as  deficit-decreasing  measures  of  0.15%  of  GDP  related  to  the 
pharmaceutical  sector.  This,  coupled  with  a  considerably  worse  (1.4%)  than  officially 
expected (around 3%) GDP growth outlook for 2013 as well as the carry-over of the higher-
than-officially  expected  deficit  in  2012  resulted  in  a  deficit  forecast  of  3.7%  of  GDP  in  the 
Commission services' 2011 Autumn Forecast.  

The outlook contained in the 2011 Autumn Forecast could be updated on account of a number 
of  factors.  First,  the  measures  adopted  in  the  2012  budget  compared  to  the  draft  budget 
decrease  the  2013  budget  deficit  by  around  0.3%  of  GDP14.  Second,  based  also  on  the 
information contained in the recently submitted EDP progress report, a number of decisions 
were  recently  taken  with  the  structural  reform  programme  which  could  lower  the  deficit 
forecast by an additional 0.3% of GDP in 2013.15 In particular, local government expenditure 
is  expected  to  decrease  somewhat  due  to  the  merger  of  local  government  administrative 
offices  and  thanks  to  central  administration  control  of  local  government  debt  accumulation 
based on cardinal laws adopted by Parliament. In addition, the recently adopted launch of a 
gradual review of the working capability of disability pensioners (whose health damage is less 
serious and  who  are under  the age of 57) may lead to lower expenditure on social benefits. 
Furthermore, the cut in the number of students with full state scholarship is expected to bring 
additional  savings  in  2013.  Finally,  the  net  deficit-increasing  impact  of  the  agreement  with 
banking  sector  for  2013  (0.1-0.15%  of  GDP  as  estimated  by  the  Commission  services,  for 
explanation  see  the  calculations  for  2012  above)  will  need  to  be  also  incorporated.  These 
factors taken together, the 2013 forecast could be updated to 3¼% of GDP. 

14 

15 

The deficit-decreasing effect in 2013 is larger than in 2012 as the wage compensation mechanisms are 
assumed to be continued in a reduced size, although there may be implementation risks regarding the 
further unsubstantiated cuts in appropriations.  
It may be noted that the impact of the planned reforms could be further deepened and contribute to a 
reduction of the deficit forecast by over ½% of GDP if certain measures now under preparation would 
be  sufficiently  specified  and  decided,  which  is  currently  planned  to  take  place  only  in  the  course  of 
2012. For instance, concerning the local government reform the authorities project further savings from 
merging institutions in the primary and secondary education and the health care sectors as well as other 
institutions  currently  maintained  by  the  county  level  administration.  This  would  be  facilitated  by  the 
recently  adopted  takeover  of  the  ownership  of  these  institutions  by  the  central  government  from  the 
LGs. In the area of the pension system a nominal freeze of the early pensioners' benefits may result in 
further savings, which is a possibility from 2012 due to the regulation contained in the new constitution. 
As far as higher education is concerned, less outlay would stem from the review of the capacities of the 
institutions. Finally, further revenues are expected from the extension of the road toll system.  

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To  sum  up,  the  difference  between  this  updated  assessment  and  the  official  target  (2.2%  of 
GDP) notably stems from the following elements: 

(i) 

(ii) 

In the absence of specific, steps about half of the structural reform programme could 
not be taken into account (about ½% of GDP).  

The remainder is related to a higher expenditure forecast notably in the area of state-
owned transport enterprises and the maintenance of roads (more than ¼% of GDP). 

(iii) 

There is a difference in growth assumptions regarding 2013 (more than ¼% of GDP). 

Table 4: Budgetary overview table 

Budgetary measures/forecasts 

Starting point: budgetary balance at the time of the 
publication of the 2011 Autumn Forecast 

Further specification of planned structural measures 
following the 2011 Autumn Forecast 

Net  impact  of  the  amendments  to  the  2012  draft 
budget incorporated in the 2012 budget adopted by 
Parliament on 20 December 

Consolidation package announced on 15 December, 
incorporated 
the  2012  budget  adopted  by 
Parliament on 20 December  

in 

Expenditure cuts at the line ministries 

Increase of the employees' pension contribution 
revenues 

Increase in excise duties on tobacco products 

Budgetary  implications  of  the  agreement  with  the 
banking  sector  concluded  on  15  December,  net 
impact 

p.m.  Budgetary  implications  of  the  agreement  with  the 
banking sector, gross impact (not additive) 

Total of new measures announced since the cut-off 
date  of  the  2011  Autumn  Forecast  (net  sum  of  the 
above new measures) 

Updated forecast of the general government budget 
balance  (without  update  of  the  macroeconomic 
scenario) 

Budgetary impact (% of GDP)  
as estimated by the 

Hungarian authorities 

Commission services 

2012 

-2.5 

0.0 

0.0 

0.4 

0.2 

0.15 

0.05 

n.a. 

2013 

-2.2 

0.0 

0.0 

0.4 

0.2 

0.15 

0.05 

n.a. 

2012 

-2.8 

2013 

-3.7 

0.0 

0.3 

-0.15 

0.4 

0.2 

0.15 

0.05 

-0.2 

-0.1 

0.4 

0.2 

0.15 

0.05 

(-0.1)-
(-0.15) 

-0,4 

-0,25 

-0.4 

-0.25 

n.a. 

n.a. 

0.05 

0.45-0.50 

n.a. 

n.a. 

-2¾ 

-3¼ 

In  view  of  the  developments  explained  above,  including  in  particular  the  insufficient 
specification of the structural reform programme but also the related implementation risks, the 
deficit would exceed the 3% of GDP reference value of the Treaty in 2013 (at 3¼% of GDP, 
see also Table 4 and 5). Thus, the correction of the excessive deficit in 2011, which is based 
on very large one-off revenues and is followed by a deficit of just below 3% of GDP that still 
depends on substantial one-off revenues, is not of a sustainable nature.  

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Table 5: Comparison of budgetary projections, including impact of measures 
announced/taken post Commission services' 2011 Autumn Forecast, general government 
balance (% of GDP) 

COM AF 2011  
National authorities 

COM Jan 2012 

2010 
-4.2 
-4.2 

-4.2 

2011 
3.6 
3.9 

3.5 

2012 
-2.8 
-2.5 
(-)2¾%  

2013 
-3.7 
-2.2 

(-) 3¼ 

Notes: COM AF 2011= Commission services' 2011 Autumn Forecast. National authorities= 
Projections by the national authorities dated as of 30 September 2011 (confirmed in the 15 
December EDP report); COM JAN 2012: Commission services' assessment as of Jan 2012; 
takes into account the measures contained in the 2012 draft Budget and a further 
consolidation package of 15 December.  
Sources: National authorities and Commission services. 

The  above  estimates  do  not  take  into  account  a  number  of  deficit-increasing  risks.  Firstly, 
based  on  the  latest  available  information,  in  particular  concerning  a  deteriorating  external 
outlook,  a  more  realistic  growth  forecast  for  2012  would  be  around  zero.  Indeed,  the  latest 
projections of the National Bank of Hungary released on 20 December 2011 already show a 
meagre 2012 growth figure of 0.1% (while its 2013 projection is still 1.6%, i.e. slightly higher 
than the Commission services' 2011 Autumn Forecast). As regards budgetary implications, a 
worse  growth  in  2012  by  half  a  percentage  point  compared  to  the  2011  Autumn  Forecast, 
chiefly  on  the  account  of  less  positive  net  exports,  can  be  estimated  to  have  a  deficit-
increasing impact of 0.1% of GDP for both 2012 and 2013. Secondly, an update of the debt 
service projections (short-term yields are currently around 100 bps. higher, long-term yields 
are 150-200 bps. higher, while the exchange rate against the euro is around 4-5% weaker at 
the  end  of  2011  than  the  technical  assumptions  used  in  the  Commission  services'  2011 
Autumn  Forecast),  would  increase  the  budget  deficit  further  by  0.3%  in  2012  and  0.4%  of 
GDP in 2013.  

Moreover, if the tax rebates of around 0.3% of GDP from the financial sector levy linked to 
the banks' losses from the early repayment of FX loans have to be (partly) accounted for in 
2012 in ESA terms (rather than all attributed to 2011 which is currently the case), the updated 
2012  figure  would  also  increase  well  above  3%  of  GDP.  In  addition,  possible  EU  court 
decisions  linked  to  the  extraordinary  sectoral  levies  may  also  potentially  result  in  one-off 
expenditures.  

On the other hand, there are also some positive risks as revenues from indirect taxes over the 
recent  months  as  well  as  the  intake  from  the  corporate  income  tax  in  December  2011 
exceeded  previous  expectations.  Moreover,  based  on  cumulative  data  for  Q1-Q3  2011,  the 
budgetary  discipline  at  the  local  government  level  was  also  better  than  expected.  The 
continuation  of  these  trends  represents  a  positive  risk  from  2012  onwards.  Finally,  the 
possible  pressures  on  those  who  are  still  members  of  the  earlier  obligatory  private  pension 
scheme may result in a new round of stepping back into the public pension pillar (this option 
was opened up again by 31 Mach 2012). This can generate additional one-off revenues of up 
to  ¾%  of  GDP  in  2012,  although  the  eventual  size  is  highly  uncertain  and  significantly 
affected by the behavioural response of the private pension funds and their members. 

3.4. 

Debt developments 

The Council recommended that the authorities should ensure that the government gross debt 
ratio be brought onto a firm downward trajectory. According to the deficit forecasts and the 
exchange rate assumptions of the Commission services' 2011 Autumn Forecast, gross public 

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debt  was  expected  to  increase  again  to  nearly  77%  of  GDP  following  a  temporary  drop  in 
2011  due  to  the  takeover  of  the  private  pension  assets.  However,  based  on  the  end-2011 
HUF/EUR exchange rate of 311 (i.e. around 12% weaker than the technical assumption used 
in  the  Autumn  Forecast)  and  the  slightly  revised  deficit  projections  for  2012  and  2013,  the 
debt  ratio  could  be  around  80%,  while  it  is  now  anticipated  to  stabilise  at  around  78.5%  in 
both 2012 and 2013. 

Beyond  2013  and  under  the  assumption  of  no  further  policy  changes  on  top  of  the 
Commission services' 2011 Autumn Forecast, the debt ratio would be on an increasing path 
and reach 88% of GDP by 2020. An additional annual structural fiscal consolidation of 0.5 % 
of GDP from 2014 onwards in order to reach the Medium-Term Budgetary Objective (MTO) 
– in the case of Hungary a deficit of 1.5% of GDP in structural terms - would bring the gross 
debt ratio onto a downward trajectory from 2017, reaching 76% of GDP in 2020.  

3.5. 

Fiscal governance 

Finally,  the  Hungarian  authorities  were  invited  to  implement  with  vigour  the  fiscal 
responsibility law, including the compliance with the new numerical rules, as well as improve 
budgetary  planning  procedures  and  monitoring  of  the  budget  execution  with  a  view  to 
enhancing the medium-term budgetary framework. Until mid-2010, the new fiscal governance 
system  was  phased  in  relatively  successfully  in  line  with  original  plans.  However,  in  the 
second  half  of  2010,  the  new  government  took  a  number  of  steps  that  effectively  watered 
down the framework. In particular, in December 2010, it abolished the technical staff of the 
Fiscal  Council  and  replaced  the  independent  members  of  the  body.  More  recently,  the 
authorities adopted the key elements of a changed set-up in the new Constitution (in effect as 
of  1  January  2012),  providing  a  welcome  Constitutional  base  for  rule-based  fiscal  policy 
making. Most notably, a nominal debt ceiling was set at 50% of GDP and veto right over the 
budget was granted to the rearranged Fiscal Council. A follow-up legislation to establish the 
new operational numerical rules both at the central and the local level of government as well 
as the stipulation on the governing arrangements of the Fiscal Council was adopted late 2011 
in a 'cardinal law' despite a request by the Commission to postpone this law until it could be 
verified  that  it  is  in  line  with  the  new  EU  governance  framework.  Moreover,  some  of  its 
provisions  do  not  seem  to  be  in  line  with  the  Council's  relevant  country  specific 
recommendation addressed to Hungary in July 2011. 

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