Recommendation for a COUNCIL RECOMMENDATION with a view to bringing an end to the situation of an excessive government deficit in Hungary
Date: 2012-03-06
Institutions: European Commission
Subjects: EU control, Hungary, anti-crisis plan, budget deficit, budgetary control, financial year, stability pact

EUROPEAN COMMISSION 

Brussels, 6.3.2012  
COM(2012) 104 final 

Recommendation for a 

COUNCIL RECOMMENDATION 

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

{SWD(2012) 43 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. 

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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) 

(2) 

(3) 

(4) 

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

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.  

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.  

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 

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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).] 

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 
the 
the  basis  of 
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.  

forecast  underpinning 

targets  which,  on 

the 

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. 

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).  

(6) 

(7) 

(8) 

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(9) 

(10) 

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. 

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 3¼% 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  ¼%  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 ½% 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  1½%  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 1½% 
in 2010 and by ½% in 2011, the structural balance is expected to improve by close to 
2%  in  2012  before  deteriorating  again  by  ½%  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  2½%  of  GDP  in  2012  and  ½%  of 
GDP in 2013. 

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(12)  The budgetary outlook described above could be improved by more than ½% 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. 

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(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) 

(2) 

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

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 ½% 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) 

(4) 

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.  

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 

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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 

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