Re-drafting: almost $2 billion worth of deficit and sustained deterioration of competitiveness in 2012 (December 20, 2011)
(This is a brief summary of an updated risk assessment for the 2012 budget. The full version – in Hungarian – can be downloaded from here.)
The Patriotism and Progress Foundation’s “budget explaining” project, The Common Pot has published its updated risk assessment for the 2012 national budget. The study contends that the current level of budget deficit reaches $2 billion. At the same time, the government’s economic policies are increasingly hijacked by the misconception that transitional adjustment measures better serve the country’s competitiveness than those aimed at improving the long-term structural balance. The Foundation believes that letting go of this misbelief is crucial not only for the sake of the 2012 budget, but also because of its effects for 2013 and 2014. The outcome of the negotiations with the European Commission and the IMF is also expected to be dependent on changes in these government policies.
The tensions and risks that eventually led to the failure of the 2012 draft budget have been visible from previous Common Pot Project analyses. The government of Hungary itself has recognized the need for a new budget. The Prime Minister recently announced that the key indicators will not change, but the budget must be recalculated on a much less favorable forint-euro exchange rate, and the rate of economic growth must be reduced to 0.5 percent. However, according to the Foundation’s updated risk assessment, the reality is much bleaker. The equivalent of 2 billion dollars is missing from the system, which would be necessary to keep the key indicators unchanged. Therefore, an adjustment of at least this dimension would be necessary. Furthermore, the Hungarian economy may actually shrink by up to 1.1 percent. The analysis prepared in cooperation with the Fiscal Responsibility Institute of Budapest, Hungary reports that this is mainly due to three factors: the failure to improve the structural balance; the inhibitory effects of the government’s economic policies on long-term growth; and, by consequence, sustained decline in employment in the private sector.
This decrease is mainly the result of the increasing burden on labor (including measures such as raising the level of minimum wage), the study argues. In terms of the economic policies’ impact on long-term growth, the amortization of foreign-currency loans deserves special notice. It led to commercial banks curbing their lending due to the loss it produces, thereby hindering innovation and investment. This slows down the economy, contributing to further deterioration of the fiscal balance.
According to the Foundation’s calculations, the adjustment requirements at present are as high as 1.3 percent of the GDP, amounting to approximately 2 billion dollars. However, based on government information, the current austerity package only covers 1.6 billion dollars. 1 billion dollars would come from the reserves, while 0.6 billion dollars would be retrieved from a “mixed” austerity package. This includes the final absorption of the benefits of the remaining members of the private pension system, resulting in the annihilation of the second pillar of the pension system itself. This decision is against the principles of the rule of law to begin with; moreover, it further erodes trust against the Hungarian economy. It is particularly pernicious for the trust of Hungarian families in the security of their savings, ultimately destroying their faith in the Hungarian government – this at a time when the indebtedness of the population is one of the most important issues of the country.
Due to the policy uncertainties related to the adjustment requirements, our risk assessment estimates that the 2012 budget will not only exceed the original 2.5 percent target, but also surpass the 3 percent Maastricht threshold. This is partly caused by the revenue-reducing effect of the expenditure-reducing measures, and partly the result of the additional hidden risks in the 2012 budget, which would be difficult to mitigate after the subsequent depletion of the reserves. (A detailed analysis identifying and quantifying these risks is available in Hungarian on www.kozoskassza.hu .)
The Foundation believes that Hungary’s situation is further complicated by the Prime Minister’s strategy, which appears to be intentionally excluding our country from the decision-making processes of the EU. However, if Hungary is solely the “victim” of these decisions but does not take part in shaping them, the country ultimately limits its own sovereignty more than if it had participated actively in the common European progress towards a fiscal union.
Peter Oszko, Finance Minister of the crisis management government, argues that Hungary is adopting the economic misconception that the economic growth of country in a situation like ours can be jump-started without long-term fiscal adjustment. However, besides pushing the boundaries of the rule of law, the current government’s economic policy is basically a waiting game based on one-time adjustment measures. This is complemented by another false belief, namely that even if boosting internal growth through consumption stimulation inevitably fails, competitiveness can – and must – be improved through exchange rate policy, nominal devaluation in particular.
In contrast, the reality is that Hungary has no room for maneuver for nominal devaluation, as both the private and the public sectors face large external debts. The currency loan rescue package and its most recent stage, the agreement with the Association of Banks, will not make the debts disappear; it may “nationalize” parts of the private debts at most. The interest rates of loans converted to Forint will increase significantly. Hungarian experience shows that internal devaluation consisting of restructuring and spending cuts – which also improves the structural balance – may result in restoring growth in competitiveness and financial stability at the same time. Experience from the 2009-2010 crisis management period – when recession turned to economic growth while the fiscal balance improved by 4 percent – also attests to the success of this policy. Clearly, Hungarian national interest would be best served by adopting this practice. Apart from regaining our economic credibility, this is another reason why reaching an agreement with the IMF would be crucial for Hungary: compliance with the points of the agreement would most likely enforce the long-term structural balance improving measures that are essential to increase our stability, growth and competitiveness.