REPORT FROM THE COMMISSION TO THE COUNCIL Commission report to the Council pursuant to Article -11(2) of Regulation (EC) No 1466/97 on the enhanced surveillance mission in Hungary, of 20 March 2019
Date: 2019-06-05
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: Hungary, budget deficit, economic convergence, economic reform, financial control, gross domestic product, multilateral surveillance, public debt, public finance, stability programme

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   EUROPEAN COMMISSION  Brussels, 5.6.2019  COM(2019) 542 final  REPORT FROM THE COMMISSION TO THE COUNCIL Commission report to the Council pursuant to Article -11(2) of Regulation (EC) No 1466/97 on the enhanced surveillance mission in Hungary, of 20 March 2019  
 
 
This report on an enhanced surveillance mission to Hungary is transmitted to the Council pursuant to 
Article -11(4) of Regulation (EC) No 1466/971. As foreseen by Article -11(5) of Regulation (EC) No 
1466/97,  the  provisional  findings  of  that  mission  have  been  previously  transmitted  to  Hungarian 
authorities for comments. 

Hungary – Significant Deviation Procedure 

Enhanced surveillance mission, 20 March 2019 

Report 

1. Introduction 

Following  a  significant  deviation from  its medium-term  budgetary  objective  (MTO) in  2017,  a 
Significant  Deviation  Procedure  (SDP)  was  launched  for  Hungary  in  spring  2018.  On  23  May 
2018, the Commission issued a warning to Hungary and proposed to the Council to launch a SDP. In 
its SDP recommendation of 22 June 2018, the Council asked Hungary to take measures to ensure that 
the  nominal  growth  rate  of  net  expenditure  does  not  exceed  2.8%  in  2018;  that  corresponds  to  an 
annual structural adjustment of 1.0% of GDP. 

According to the Commission 2018 autumn forecast, there was a risk of a significant deviation 
from the MTO for both 2018 and 2019; for 2018, this also implied a risk of non-compliance with 
the  SDP  recommendation.  The  Commission  2018  autumn  forecast  projected  the  2018  headline 
deficit  at  2.4%  of  GDP,  in  line  with  the  official  target.  Thus,  both  the  headline  and  the  structural 
deficit were expected to deteriorate compared to the 2017 outturn of 2.2% of GDP, as a result of an 
expansionary  fiscal  policy.  The  2019  budget,  which  was  adopted  in  July  2018,  aimed  at  a  general 
government deficit of 1.8% of GDP for 2019. This implied an improvement not only in nominal terms 
but  also  in  structural  terms,  as  the  (recalculated)  output  gap  was  projected  to  decrease.  The 
Commission 2018 autumn forecast projected the government deficit in 2019 at 1.9% of GDP, broadly 
in  line  with  the  official  target  and the structural  balance  was  estimated  to improve  by  ½  percentage 
points of GDP. That forecast expected the public wage bill together with social transfers to increase 
below inflation and some other items of government expenditure to be restrained. The impact of those 
restrictive measures was however forecast to be partly offset by expansionary fiscal measures, notably 
a 2 percentage-point cut in social contributions in the second half of the year, in addition to similar 
cuts in the previous years, and an increase in public investment.  

As  a  consequence  of  no  effective  action  taken  by  Hungary,  the  Council  issued  a  revised  SDP 
recommendation in  December 2018.  Based on  the September  2018  enhanced surveillance  mission 
findings and on the report submitted by the authorities, the Commission concluded that the authorities 
did not intend to act upon the SDP recommendation in 2018, and action was expected to be taken only 
with  respect  to  the  2019  general  government  deficit.  Therefore,  on  4  December  2018,  the  Council 
concluded that no effective action had been taken by Hungary and issued a revised recommendation. 
The Council asked Hungary to take  measures to ensure that the nominal growth rate of net primary 
government  expenditure  does  not  exceed  3.3%  in  2019,  corresponding  to  an  annual  structural 
adjustment of 1.0% of GDP in 2019. That recommendation translated into the need to adopt measures 

1 Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance 
and coordination of economic policies, OJ L 209, 2.8.1997, p. 1 

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of a total structural yield of 0.5% of GDP in 2019, as compared to the baseline from the Commission 
2018  autumn  forecast.  Hungary  reported  to  the  Council  on  action  taken  on  15  April  2019.  The 
Commission’s assessment of the report is being published as part of the European Semester package. 

Macroeconomic indicators for 2018 are better than expected. Compared to both the Commission 
2018  autumn  forecast  and  the  Hungarian  authorities’  forecast  published  in  December  2018,  data 
released in March 2019 show a better-than-expected macroeconomic environment in 2018, with both 
real and nominal GDP accelerating further compared to 2017. Private consumption benefitted from a 
strong  labour  market  and  large  administrative  wage  increases.  The  reduction  in  employers’  social 
security  contributions  so  far  mitigated  the  pass-through  of  wage  increases  to  inflation.  Nonetheless, 
consumer  prices  accelerated  further  in  2018  to  2.9%.  As  a  result,  major tax bases, including  wages, 
grew faster than expected, pushing up tax revenues above the budget forecast.  

Additional deficit-increasing measures were announced in the recent months. In December 2018, 
an  investment  programme  for  small  villages  (the  “Hungarian  village  programme”)  was  announced, 
according to which 150 billion HUF (0.35% of GDP) will be allocated to settlements with less than 
5,000  inhabitants,  one-third  of  which  will  be  spent  on  renovation  of  subsidiary  roads.  In  February 
2019, the authorities have announced a so-called “demography programme” targeted at boosting the 
birth rate. Those measures include, among others, a new subsidised “pre-natal” loan aimed at young 
married couples, which is convertible to a capital grant after the birth of a second and third child after 
taking out the loan; the expansion of a loan and subsidy programme for families with children to help 
them buy homes; subsidies for car purchases; and waiving personal income tax for women raising at 
least four children; introduction of childcare payments for grandparents, and development of nurseries. 
The new spending would be financed from general reserves and windfall revenues in the 2019 budget. 
The  programme  may  cost  up  to  HUF  150  billion  (0.4%  of  GDP)  in  2020,  the  first  full  year  of 
implementation,  but  some  budgetary  impact  could  materialise  already  in  2019.  In  addition,  new  tax 
measures  were  included  in  a  recent  draft  bill,  amongst  which  the  exemption  of  retail  government 
bonds from interest tax and a reduction of financial transaction duty for households, with an estimated 
impact  of  around  0.02%  of  GDP  in  2019,  and  0.05%  in  2020.  As  from  2019,  in  order  to  enhance 
electronic  payments,  a  tax  exemption  on  bank  transfers  up  to  HUF  20,000  per  transaction  has  been 
introduced  for  private  individuals.  In  addition,  retail  government  bonds  have  been  exempted  from 
interest tax. The authorities estimate the budgetary impact of those measures to be negligible in 2019-
2020.  The  authorities  have  also  floated  the  idea  of  a  programme  supporting  learning  of  foreign 
languages for pupils costing an estimated of 0.2% of GDP from 2020. 

The enhanced surveillance mission by the Commission took place on 20 March 2019. The mission 
was carried out on the basis of Article 11(2) of Regulation (EC) 1466/97. Commission staff met the 
State  Secretary  for  public  finances  at  the  Ministry  of  Finance,  Mr.  Peter  Beno  Banai;  the  executive 
director responsible for monetary policy, economic analysis, foreign reserves and risk management at 
the Magyar Nemzeti Bank, Mr. Barnabas Virag; and the President of the Fiscal Council, Mr. Arpad 
Kovacs. The aim of the mission was to receive detailed information about the fiscal measures recently 
announced by the authorities, the fiscal actions planned by the authorities, and to point to fiscal risks 
related to the expected slowing down of economic growth and to encourage compliance with the SDP 
recommendation. This report is based on information obtained until and during the mission. 

2. Findings of the mission 

The authorities explained that the better-than-expected fiscal outcome in 2018 was due to both 
cyclical and structural factors. Real GDP growth turned out better than expected (at 4.9% compared 
to  4.3%  projected  by  the  authorities),  driven  by  domestic  demand  (both  private  consumption  and 

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investment).  Revenues  benefitted  from  the  buoyant  macroeconomic  developments  and  also  from 
structural measures to improve tax compliance. In particular, as of July 2018, companies are required 
to  report  their  larger  invoices  real-time  to  the  tax  authority.  The  introduction  of  online  invoicing  is 
estimated to have played a significant role in reducing the size of the informal economy, pushing up 
indirect taxes and reducing the VAT gap below the EU average. The higher-than-expected revenues 
were  partly  counterbalanced  by  higher-than-projected  expenditure.  Specifically,  the  government 
decided to use, at the end of 2018, some of the in-year savings and higher-than-expected revenues to 
finance  non-recurrent  expenditure  on  specific  categories  (culture,  religion  and  sport)  that  cannot  be 
financed  by  EU  funds.  The  authorities  noted  that,  without  the  non-recurrent  expenditure  that  took 
place  at  the  end  of  2018,  the  general  government  deficit  would  have  been  at  1.6%  of  GDP.  While 
similar  one-off  end-year  payments  have  been  taken  by  the  government  recurrently,  the  authorities 
stressed that they were on a decreasing trend, with the payment made in 2018 being the lowest since 
2016.  In  addition,  around  0.1%  of  GDP  expenditure  was  brought  forward  from  2019  to  2018.  The 
authorities also confirmed that the total amount of committed but not spent funds (mainly related to 
EU funds projects) remained unchanged at the end of 2018 compared to end-2017. They also agreed 
that for forecast purposes it would be beneficial to better align commitments and timing of expenditure 
of such projects, even though to do so would affect the general government deficit in accrual terms. 

The authorities underlined the steps taken to fight tax evasion and reduce the size of the shadow 
economy and to broaden the tax base. The authorities stressed that public finances rely heavily on 
consumption taxes, and many measures were introduced to fight the shadow economy.  In particular, 
the introduction of online invoicing as of July 2018 is estimated to have contributed significantly to 
diminishing the role of the informal economy and represents one of the most important actions taken 
in the past years. In 2018, VAT revenues (in accrual terms) increased by around 14%, of which around 
4  percentage  points  was  due  to  that  measure  and  some  additional  impact  is  also  expected  in  2019, 
although to a limited extent. Additional measures for reducing the size of the informal economy  are 
expected to be approved by Parliament in spring 2019. Steps were also taken to broaden the tax base.  

In recent years, the authorities have tended to initially underestimate revenues, but then spend 
most unbudgeted windfall revenues towards the end of  the year. Since the beginning of the six-
year  agreement  with  employers  on  wage  increases  and  employers’  social  contribution  cuts,  the 
authorities  have  consistently  used  conservative  estimates  of  planned  revenues.  Over  the  past  three 
years,  large  unexpected  revenues  appeared  compared  to  budgetary  plans.  Those  revenues  were 
typically spent towards the end of the year on non-recurrent items (including for nurseries and schools, 
churches, sport facilities as well as for Hungarian minorities abroad), largely in the form of current and 
capital  transfers.  The  authorities  argue  that  those  non-recurrent  expenditures  constitute  an important 
source of fiscal buffer (in their assessment, 0.6% of GDP in 2018), although decreasing over time.  

During  the  mission,  Commission  staff  noted  that  the  economy  is  in  good  times  and  additional 
effort  should  be  put  in  reducing  the  general  government  deficit  and  debt.  The  mission 
acknowledged  the  good  macroeconomic  performance  of  Hungary  in  2018,  with  part  of  the  extra 
growth achieved  in 2018 being explained also by the fiscal stimulus. However, economic growth in 
Hungary seems to have reached the peak and it is expected to moderate in the medium term, due also 
to the worsening external environment. As a result, fiscal buffers are expected to decrease in the next 
years. It is to be noted that the Hungarian authorities do not agree with the estimation of the cyclical 
component  by  the  Commission:  in  their  view,  based  on  a  methodology  that  takes  into  account  both 
financial and real economic cycles, the output gap would be negative. The mission recalled that the 
Council asked for an additional structural effort in 2019 and, in light of the expected moderation of the 
economic  conditions  in  the  next  years,  Hungary  should  seize  the  opportunity  of  the  positive 

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momentum to secure its fiscal position and reduce further the general government debt, which remains 
high for a small open economy.  

The  authorities  do  not  plan  to  take  additional  steps  in  2019  in  response  to  the  revised  SDP 
recommendation.  Despite  the  better-than-expected  outcome  in  2018,  the  authorities  do  not  plan  to 
revise  the  deficit  target  for  2019.  In  2019,  the  authorities  intend  to  stick  to  their  initial  general 
government  deficit  target  of  1.8%  of  GDP  as  set  in  the  2019  budget  approved  in  July  2018.  In 
particular, the base effect related to the better fiscal outturn in 2018, implies lower expenditure on the 
Public  Work  Scheme  and  other  items;  however,  they  are  expected  to  be  entirely  absorbed  by  the 
above-mentioned  recently  announced  deficit-increasing  measures.  The  impact  of  the  demographic 
programme is expected to be limited in 2019 and to reach 0.4% of GDP in 2020, even though its take-
up  can  only  be  assessed  with  great  uncertainty.  While  agreeing  on  the  general  macroeconomic 
framework  characterized  by  a  worsening  external  environment,  the  authorities  emphasised  that  they 
intended  to  keep  economic  growth  high  through  the  adoption  of  economic  policy  measures.  In  the 
authorities’ view, this will ensure that the deficit is reduced and that the relatively high debt-to-GDP 
ratio remains on a declining trend. 

Long-term sustainability of public finances is an issue in Hungary. In the medium- to long-term, 
Hungary  appears  to  face  fiscal  sustainability  risks  mainly  related  to  the  budgetary  position,  the 
projected ageing costs as well as to possible shocks to economic growth. The authorities stressed that 
the  demographic  programme  is  part  of  a  long-term  sustainability  programme.  The  competitiveness 
programme is also a medium-term project, focussed on many areas, with the aim to bring GDP growth 
to the EU average + 2 pp. over a longer term. So far, no concrete measure has been adopted. Finally, 
the authorities agreed that the high level of public investment has an impact on prices in some areas 
(i.e. construction).  

Discussions at Magyar Nemzeti Bank mainly focused on growth challenges in the coming years. 
MNB argued that recent high wage growth will induce companies to raise productivity, thus a loss in 
external competitiveness can be avoided. It also argued that Hungary is in a good position to carry out 
structural reforms, for which there appears to be momentum among decision-makers. According to the 
MNB,  the  general  government  deficit  is  expected  to  remain  around  1.5%  of  GDP  in  both  2019 and 
2020. The positive development in tax revenues is anticipated to offset newly announced expansionary 
measures. In the assessment of the MNB, the fiscal stance, which was accommodative in 2017-2018, 
is  estimated  to  become  countercyclical  in  2019.  The  general  government  debt  is  also  forecast  to 
decline by around 2 pps every year. 

High public investment contributes to rising house prices. Overall, total investment in the economy 
has  reached  a  high  level,  at  around  25%  of  GDP.  Public  investment  is  also  high,  potentially 
contributing  to  a  crowding-out  of  private  investment  as  well  as  to  an  increase  in  prices  (rather than 
output). In addition, the quality of those investments is of some concern. At the same time, the risk of 
bubbles in the private sector seems limited given that the household credit-to-GDP ratio remains low 
with the rapid growth in nominal income. 

According to the Fiscal Council, the budget aims to balance growth and stability objectives. The 
Fiscal  Council  pointed  out  that  the  current  period  of  high  growth  without  external  indebtedness  is 
unique  in  the  country’s  economic  history,  and  the  constellation  of  strong  growth  with  low 
vulnerability  should  be  preserved.  Therefore,  the  budget  should  remain  cautious  with  spending 
commitments.  Nonetheless,  because  of  the  need  to  progress  with  economic  convergence,  it  was  not 
politically feasible to push for faster debt reduction. The Council argued that the budget has sufficient 

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fiscal  space  to  manage  a  milder  than  expected  growth  slowdown,  thanks  to  the  larger  amount  of 
budgetary  reserves  in  2019  compared  to  2018.  In  the  Council’s  view,  the  government  may  indeed 
announce further stimulus measures, in case a slowdown materialises. 

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