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 26 September 2019
Date: 2019-11-20
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: Hungary, budget deficit, budgetary assessment, budgetary control, economic policy, gross domestic product, medium-term forecast, multilateral surveillance, stability pact, stability programme

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  EN 

   EUROPEAN COMMISSION  Brussels, 20.11.2019  COM(2019) 920 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 26 September 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, 26 September 2019 

Report 

1. Introduction 

Hungary  has  been  under  significant  deviation  procedures  since  spring  2018.  In  June  2018  the 
Council  found,  in  accordance  with  Article  121(4)  of  the  Treaty,  that  there  had  been  a  significant 
observed  deviation  from  the  medium-term  budgetary  objective  in  2017.  The  Council  issued  a 
recommendation  asking  Hungary  to  take  the  necessary  policy  measures  to  address  the  deviation.  In 
December  2018,  the  Council  concluded  that  Hungary  had  taken  no  effective  action  and  issued  a 
revised  recommendation.  However,  Hungary  took  no  effective  action  to  address  the  revised 
recommendation either2. 

Non-compliance  with  the  preventive  arm  of  the  Stability  and  Growth  Pact  in  2018  led  to  the 
opening of a new significant deviation procedure in June 2019. On 5 June 2019, the Commission 
issued  a  warning  to  Hungary  that  in  2018  it  had  again  deviated  from  the  adjustment  path  to  its 
medium-term budgetary objective and proposed to the Council to launch a new significant deviation 
procedure. 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 and 4.7% in 2020, corresponding to an 
annual  structural  adjustment  of  1.0%  of  GDP  in  2019  and  0.75%  of  GDP  in  2020,  with  the 
recommended  structural  effort  in  2020  contingent  on  compliance  with  the  requested  adjustment  in 
2019. 

To  this  date  there  is  no  indication  regarding  any  additional  planned  corrective  action  by  the 
authorities  in  response  to  the  Council  Recommendation  for  2019.  The  Commission  2019  spring 
forecast expected the deficit in 2019 to fall to 1.8% of GDP, from 2.2% of GDP in 2018, in line with 
the  authorities’  target  included  in  the  2019  Convergence  Programme.  However,  the  estimated  fiscal 
effort  for  2019  pointed  to  non-compliance  with  the  Council  Recommendation.  Macroeconomic 
indicators released for the first half of 2019 show a better-than-expected macroeconomic environment 
in  2019,  with  both  real  and  nominal  GDP  growth  exceeding  forecasts  of  the  authorities  and  the 
Commission. Private consumption benefitted from a strong labour market and the further reduction in 
employers’ social security contributions. This resulted in favourable budgetary data for 2019, pointing 
to  a  fiscal  deficit  outturn  of  1.8%  of  GDP  within  reach,  i.e.  in  line  with  the  authorities’  target. 
However, no additional measures for 2019 were adopted in response to the Council Recommendation. 

The 2020 budget, adopted on 12 July 2019, revised the fiscal deficit target to 1% of GDP, down 
from 1.5% in previous plans. The budget could not be taken into account in the spring assessment as 
it was adopted after the date of the adoption of the recommendations by the Council. The 2020 deficit 
target is set in the budget at 1% of GDP, 0.5 pps lower than the target of 1.5% of GDP included in the 

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 
2 Council recommendations and other related significant deviation procedure documents are available at: https://ec.europa.eu/info/business-
economy-euro/economic-and-fiscal-policy-coordination/eu-economic-governance-monitoring-prevention-correction/stability-and-growth-
pact/preventive-arm/significant-deviation-procedure_en#hungary 

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2019  Convergence  Programme  that  was  published  end-April.  This  lower  deficit  target  is  achieved 
mainly by better-than-previously-forecast tax revenues and lower expenditure due mainly to a cut in 
investment. At the same time, the 2020 budget also includes the expansionary measures contained in 
the “Economic Protection Action Plan” that the government adopted on 30 May 2019.  

The  enhanced  surveillance  mission  by  the  Commission  took  place  on  26  September  2019.  The 
mission was carried out on the basis of Article 11(2) of Regulation (EC) 1466/97. The mission met the 
State  Secretary  for  public  finances  at  the  Ministry  of  Finance,  Mr.  Peter  Beno  Banai;  the  executive 
director  responsible  for  economic  sciences  and  priority  matters  at  the  Magyar  Nemzeti  Bank,  Mr. 
Daniel Palotai; and the President of the Fiscal Council, Mr. Arpad Kovacs. The aim of the mission was 
to  receive  detailed  information  about  the  fiscal  developments  in  2019  and  about  the  2020  budget 
adopted by the authorities in July 2019, 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 significant deviation procedure recommendation. This report is based on information obtained 
until and during the mission. 

2. Findings of the mission 

The Commission delegation noted that the economy is in good times, with an improvement in the 
overall  fiscal  situation  (both  the  general  government  deficit  and  debt  decreasing).  The  mission 
acknowledged the good macroeconomic performance of Hungary in 2018 and in the first half of 2019. 
Together  with  the  new  ambitious  2020  fiscal  target,  these  developments  point  to  an  improvement 
compared  to  recent  years.  However,  looking  ahead,  both  external  and  cyclical  factors,  which  have 
been supporting growth in recent years, are expected to gradually wear off, following the slowdown in 
some  core  Western  economies  and  in  sectors  that  play  an  increasingly  important  role  for  the 
Hungarian economy. The Hungarian authorities agreed that, in a context of decelerating EU growth, it 
will be challenging for Hungary to maintain growth rates observed in past years, and recognised that 
the  main  concern  of  the  Hungarian  government  was  future  growth  rather  than  fiscal  policy.  The 
mission, finally, recalled the Council Recommendation addressed to Hungary, pointing to the need to 
seize  the  opportunity  of  the  positive  momentum  to  secure  its  fiscal  position  and  reduce  further  the 
general government debt. 

Despite  the  better-than-expected  macroeconomic  and  fiscal  data  so  far,  the  authorities 
confirmed  that  they  do  not  plan  to  revise  their  deficit  target  for  2019  nor  to  reduce  further 
public debt. 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 and confirmed in the 2019 Convergence 
Programme. Compared to the originally approved 2019 budget, there are significant extra revenues. At 
the same time, these are expected to be entirely absorbed by higher expenditure, in particular, by the 
financial correction on EU funds recently agreed with the Commission related to the fraudulent use of 
EU funds. The correction in 2019 relates to projects implemented over the period from 2017 to 2019 
and  is  expected  to  deteriorate  the  budget  balance  by  0.3%  of  GDP.  The  remaining  amount  of  the 
financial  correction,  i.e.  about  0.3%  of  GDP  will  fall  on  future  years.  Also,  the  take  up  of  the 
‘demographic programme’ (following both a higher number of requests and a higher average value of 
the requested prenatal loan) is expected to be higher than planned. For the latter, the authorities have 
also increased the estimation for the following year. 

The authorities acknowledged recurrent end-of-year spending spurs, however, they pointed out 
that  the  size  of  it  decreased  last  year,  taking  into  account  the  significant  deviation  procedure 
Recommendation. Over the last three years (2016-2018), the authorities have based their budget on 
systematically  cautious  fiscal  projections  and  used  the  fiscal  space  accumulated  over  the  year  on 
unbudgeted end-year spending. The Hungarian authorities pointed out that these end-year expenditures 

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were non-recurrent spending on investment and that, at end-2018, the government decided not to use 
the  full  room  for  manoeuvre  that  was  available,  in  line  with  the  significant  deviation  procedure 
Recommendation. Without this spending, the fiscal position could have been better.  

The  2020  deficit  target  is  more  ambitious  than  previously  planned,  using  good  times  to 
accelerate  fiscal  consolidation  as  recommended  by  the  Council.  The  2020  budget  revised  the 
deficit target to 1% of GDP, making it more ambitious than the 1.5% of GDP target indicated in the 
2019  Convergence  Programme.  The  authorities  stressed  the  better-than  expected  macroeconomic 
scenario, measures to increase tax compliance yet to be defined and expenditure containment as major 
factors  to  ensure  the  reaching  of  the  more  ambitious  2020  fiscal  target.  At  the  same  time,  the 
authorities have maintained 2023 as the year by which they aim to reach a balanced budget in nominal 
terms. Thus, the revised deficit target for 2020 implies a faster path towards this target. Namely, the 
authorities target a deficit of 0.7%, 0.4% and 0.0% of GDP for 2021, 2022 and 2023, respectively. In 
the 2019 Convergence Programme, the deficit trajectory was planned at 1.2% and 0.5% and 0.0% of 
GDP  for  the  same  years.  Overall,  according  to  the  calculations  of  the  Ministry  of  Finance,  the  new 
headline  targets  imply,  for  2020,  a  greater  improvement  in  structural  terms  than  the  effort 
recommended by the Council, and the overachievement of the medium-term budgetary objective  – set 
as a structural deficit of 1.0% of GDP – already in 2021. 

The authorities expect significantly higher-than-budgeted revenue in 2019, with a positive base 
effect in 2020. The revenue projection in 2020 is only partly underpinned by discretionary revenue or 
spending measures, with the only newly specified measure being an increase in excise duties. While 
the  macroeconomic  scenario  was  not  revised  by  the  authorities,  revenue  growth  already  takes  into 
account  the  higher  revenue  expected  in  2019,  with  a  significant  positive  base  effect  for  2020. 
However, it remains unclear whether new measures will be introduced and if yes, at which point in 
time.  

The authorities are working on new measures to increase tax compliance and curb the shadow 
economy,  however,  without  any  clear  timeline  for  adoption.  New  measures  will  build  on  the 
success  of  similar  measures  introduced  in  recent  years.  The  authorities  stressed  the  impressive 
reduction in the VAT gap which is estimated to have decreased from 21% in 2013 to 9% in 2018, well 
below the EU average of around 10% (source: European Commission). In particular, the introduction 
of online invoicing for major companies in July 2018 is estimated to have contributed to the reduction 
of the VAT gap, and the measure is expected to have some carry-over effect in 2019. For small and 
medium  sized  enterprises,  in  2013  the  authorities  introduced  two  simplified  tax  schemes  (Kata  and 
Kiva) aimed at fighting the shadow economy which have proven quite successful so far in collecting 
revenues. The authorities are currently working on two fronts: (i) new measures to fight the shadow 
economy,  for  example  incentives  for  the  use  of  electronic  means  of  payment;  and  (ii)  simplifying 
administrative tax obligations for enterprises estimated, among others, to reduce the number of hours 
spent  by  companies  on  tax-reporting  obligations  (from  the  actual  277  (Source:  Paying  taxes  2019, 
PwC)  to  below  100  hours)  and  introducing  the  pre-filled  VAT  system,  tentatively  in  2021.  The 
authorities could not yet reveal the details of the new measures, while on the timeline, in their view a 
modification of the tax bill could start in autumn 2019, which would make the measures effective in 
the second half of 2020. 

Fiscal  consolidation  in  2020  is expected  to  be  achieved mostly thanks  to a projected  contained 
evolution of expenditure items. The 2020 budget specified expenditure ceilings, with the main area 
of expenditure cuts being public investment, especially in the construction sector (buildings) which is 
in  a  boom  phase.  The  cut  of  state-funded  projects  is  not  expected  to  have  any  negative  impact  on 
economic growth as there are observed capacity constraints in the supply side of the economy and the 

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expected crowd-in of private investments. As an example of the projects that were cut, the authorities 
mentioned  the  Modern  City  Programme,  with  a  lower-than-expected  expenditure  in  2020  (from 
initially  estimated  HUF  135  bn  to  HUF  85  bn).  At  the  same  time,  other  expenditure  items  were 
expected to be more dynamic, e.g. due to a higher take up of the ‘demographic programme’ and the 
extension of the housing programme. 

The  authorities  stressed  that  the  2020  budget  includes  an  unusually  high  level  of  reserves  and 
that, excluding these reserves, the budget could be at balance. The 1% of GDP deficit target for 
2020  includes  a  significant  level  of  budgetary  reserves,  amounting  to  1%  of  GDP  (against  0.5%  of 
GDP  in  2019).  Overall,  total  reserves  are  set  at  1.4%  of  GDP,  against  0.8%  of  GDP  in  2019.  The 
increase compared to the previous year is due to a significantly higher so-called “Country Protection 
Fund”, which is set at almost 0.8% of GDP, against 0.1% of GDP in 2019. The authorities stressed 
that the large amount of reserves could cover the potential additional risks in the risk scenario. Main 
risks  were  stemming  from  a  possibly  worse-than-expected  macroeconomic  developments  as  well  as 
from higher-than-budgeted spending such as related to the ‘demography programme’ and/or measures 
of  the  “Economic  Protection  Action  Plan”  (see  below).  The  authorities  also  recalled  the  rules  and 
safeguards  that  are  in  place  for  the  within-year  use  of  the  reserves.  If  all  went  according  to  the 
projections  and  if  the  reserves  are  not  spent,  this  could  eventually  result  in  a  balanced  budget  in 
nominal  terms  in  2020.  Commission  staff  expressed  doubts  about  that  possibility,  noting  that  the 
reserves have been recurrently spent at the end of the year in the past years and pointed to suboptimal 
budgeting practices.  

The  “Economic  Protection  Action  Plan”  aims  at  sustaining  economic  growth  ‘at  2  percentage 
points above the EU average’. The “Economic Protection Action Plan” adopted by the government 
on 30 May 2019 has an estimated deficit-increasing impact of 1% of GDP in 2020. The main measure 
included  in  the  Plan  is  the  continuation  of  the  stepwise  reduction  of  employers’  social  security 
contributions that started in November 2016: the budget includes a further cut by 2 percentage points. 
According  to  the  authorities,  the  Plan  serves  the  protection  of  the  results  achieved  so  far  by  the 
Hungarian economy and aims at sustaining economic growth at above the EU average by 2 pps even 
in the event of a slowdown in the euro area and other partner countries. 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. The authorities admitted that, given that Hungary is an open economy, closely linked to the 
EU, a significant slowdown in economic growth at the EU level would not leave Hungary unaffected. 
Therefore, they do not exclude the possibility of an additional Plan in 2020, which had already been 
mentioned  by  the  Prime  Minister.  The  delegation,  thus,  recalled  that  the  government’s  loose  fiscal 
policy  in  recent  years  has  likely  contributed  to  excess  demand  in  the  economy  leading  to  sustained 
inflation. Given that Hungary has one of the highest expenditure-to-GDP ratio and investment ratio in 
the EU, the mission underlined the risk of inflationary effects that additional expenditure could trigger. 

The authorities pointed to methodological remarks concerning the statistical treatment of some 
items, complaining about double standards in the application of the rules. In the authorities’ view, 
the  end-of-year  spending  should  be  considered  as  a  one-off  type  of  expenditure.  The  authorities 
acknowledged  the  commonly  agreed  methodology  used  by  the  European  Commission  for  the 
estimation of the output gap. However, given its procyclicality, in their view the methodology used by 
the Hungarian Ministry of Finance seems to better reflect the situation of the Hungarian economy. In 
addition, the authorities also mentioned the reservations that Eurostat expressed on the classification of 
certain  institutions:  (1)  the  long-standing  issue  regarding  the  sector  classification  of  the  MNB’s 
foundations and their subsidiaries, because of which Eurostat expressed reservations on the quality of 
data  reported  by  Hungary  for  EDP  purposes;  and  (2)  the  nature  of  the  Hungarian  Hydrocarbon 

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Stockpiling Association (Magyar Szenhidrogen Keszletezo Szovetseg - MSZKSZ). In Eurostat’s view, 
which  is  not  shared  by  the  authorities,  both  the  MSZKSZ  and  the  MNB  foundations  should  be 
classified  inside  the  general  government,  which  would  increase  government  debt  while  the  deficit 
figure  would  remain  unchanged.  In  the  authorities’  view,  Eurostat  is  not  applying  rules  of 
classification in a transparent and objective manner, leading to an unequal treatment between Member 
States. Finally, the authorities reassured that they will follow Eurostat’s guidance in the classification, 
thereby allowing Eurostat to remove the reservations in the next EDP notification. The delegation took 
note of the authorities’ complaints while insisting that Eurostat had clear rules of classification which 
were  applied  equally  to  all  and  stressing  that  such  technical  issues  needed  to  be  discussed  with 
Eurostat.  

While  on  a  decreasing  trajectory,  Commission  staff  pointed  to  challenges  related  to  high 
financing  costs  of  the  general  government  debt.  The  delegation  acknowledged  the  positive 
developments  in  the  recent  years,  including  in  the  structure  of  the  general  government  debt,  with  a 
shift towards HUF-denominated assets and domestic ownership. At the same time, this came at a cost 
of  relatively  high  financing  costs,  due  also  to  high  premiums  offered  on  retail  bonds.  This  also  has 
distributional effects, since the benefits tend to go to richer households, while the high costs are paid 
by all tax payers. The delegation encouraged the authorities to use unspent budgetary reserves to pay 
back  some  more  expensive  bonds.  According  to  the  authorities,  this  is  a  political  decision.  They 
emphasised  that,  in  spite  of  slippages  in  terms  of  structural  effort,  the  public  debt  remained  on  a 
downward trajectory also thanks to higher nominal GDP growth. The lower deficit target for 2020 also 
goes into the direction of a lower debt-to-GDP level.  

The  Fiscal  Council  praised  the  economic  achievements  of  recent  years.  The  economy  was 
performing  well,  with  an  improvement  in  the  sustainability,  both  of  public  finances  and  of  the 
economy.  The  potential  growth  rate  of  the  economy  had  increased  significantly  during  the  years 
(reaching the actual 3-3.5%), supported by external factors (foreign trade and exchange rate) and EU 
funds.  In  the  future,  potential  growth  would  have  to  rely  more  on  competitiveness  and  on  less  EU 
funds. In the Fiscal Council’s view, the country would be able to manage a milder growth slowdown, 
as opposed to a global crisis or a bigger slump in the German economy which would be more difficult 
to manage. Concerning the fiscal situation, the Fiscal Council stressed that this is the first time ever 
that the authorities have mentioned the possibility to reach a balanced budgetary position in nominal 
terms. The Fiscal Council repeated the authorities’ arguments that reaching a balanced budget in 2020 
was a matter of political decision. Questioned about the high level of reserves in the 2020 budget, the 
Fiscal Council stressed the importance to maintain social peace. If the reserves were not spent, some 
programmes would inevitably suffer, namely in sensitive areas like public investments and the health 
care system.  

Discussions with the central bank focused on potential signs of overheating in the economy. The 
central bank discussed its recently published macroeconomic projections with the mission. The central 
bank  argued  that  despite  fast  economic  growth  and  labour  shortages,  no  signs  of  overheating  have 
appeared  in  the  economy  and  therefore  it  preferred  to  describe  the  situation  as  ‘high-pressure’ 
economy. Fiscal policy was becoming increasingly restrictive in 2020, while monetary conditions are 
set  to  remain  accommodative.  At  the  same  time,  the  attractively  priced  new  retail  bond  was 
encouraging  household  saving  and  curbed  limiting  speculative  demand  for  housing.  Low  household 
debt contains risks in the housing market. Inflation appears to have peaked as external disinflationary 
forces are strengthening. The central bank argued that Hungarian industry managed to decouple from 
the German manufacturing thanks to changes in the product structure of the automotive industry. The 
central  bank  also  confirmed  that  the  early  take-up  of  the  ‘demography  programme’  exceeded 
expectations, but they argued that it was mostly related to timing and the total size of the programme 

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may  not  be  increased  by  the  same  magnitude.  At  the  same  time,  the  take-up  of  extended  housing 
subsidies remained below expectations in the first months. 

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