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Wednesday, January 23, 2008

EU Comission Warns Hungary on 2008 Budget Deficit

The EU commission published this morning its convergence programme assessment for Hungary and warned that slower-than-forecast economic growth over the next two years may adversly affect deficit-cutting plans and told the government to take further measures if needed. According to economics Commissioner Joaquim Almunia:

Hungary must take adequate action to ensure the correction of the excessive deficit as planned, where necessary through additional measures.

I think this point is absolutely obvious, and I realise that in many ways this is a routine document, but I do feel that the way the Commission is expressing itself seems to suggest that they are completely out of touch with the real tightrope Hungary is being forced to walk at the moment. Here is the relevant part of the full text:

Thanks to the consolidation measures and structural reforms, Hungary is set to considerably outperform its 6.8% of GDP deficit target for 2007. It also improves the target for 2008 to 4% of GDP compared to the previous programme which, in view of the better-than-expected outcome in 2007, is both feasible and desirable. However, the lower deficit targets are combined with higher-than-previously-planned expenditures on the back of better-than-expected revenues, which cannot be counted on after 2008. Moreover, from 2009 the achievement of the budgetary targets is subject to increasing risks, linked mainly to possible expenditure overruns if the wide-ranging reform agenda is not fully carried out. Ensuring the adjustment is durable requires a strengthening of fiscal governance and the completion of structural reforms. This is also crucial in order to improve the long-term sustainability of public finances, for which Hungary remains at high risk, and to move towards lasting convergence.

In view of the Commission assessment and of the recommendation under Article 104(7) of 10 October 2006[3] and given the need to ensure sustainable convergence, the Council should invite Hungary to: (i) rigorously implement the 2008 budget, take adequate action to ensure the correction of the excessive deficit by 2009 as planned; where necessary through additional measures; and allocate the better-than-expected revenues to further deficit reduction, also given the insufficient margin in 2009 in view of the risks, thereby also contributing to accelerating the pace of debt reduction towards the 60% of GDP threshold; (ii) ensure permanent expenditure moderation by continuing to enhance fiscal rules and institutions and by adopting and swiftly implementing the remaining streamlining measures announced in the fields of public administration, healthcare, and the education system; (iii) in view of the level of debt and the increase in age-related expenditure, improve the long-term sustainability of public finances by making adequate progress towards the MTO, and continue to reform the pension system as announced after the initial steps taken in 2006-2007.

As I indicated in this post yesterday Central Bank monetary policy is effectively stuck, and from now on will be driven by the need to try to protect the value of the forint against the currency risk involved in all the non-forint denominated external borrowing. A difficult external environment will make increasing exports very hard, tight internal monetary conditions will weaken internal demand, and if additional fiscal tightening is brought into play then there will be no platform to put under the downward spiral in the economy.

This is now a difficult situation indeed. Hungarian economic growth was only 0.9 percent in the third quarter, the slowest annual rate in the EU. The government expects expansion to accelerate to 2.8 percent this year and 4 percent in 2009, but this forecast now seems hopelessly optimistic.

Prime Minister Ferenc Gyurcsany has already carried out a campaign of cutting public sector jobs, raising taxes and reducing subsidies to slash the EU's widest budget deficit. Hungary was aiming to narrow the budget shortfall to within the 27-nation bloc's requirements by next year from an estimated 5.7 percent of gross domestic product in 2007, but again, and as the EU commission recognises, this now seems very optimistic indeed.

On the other hand, there is one growing source of funds for Hungary at the present time, the European Union itself. Portfolio Hungary reported today that:

According to preliminary data, Hungary received over EUR 1.1 billion worth of funds from the European Union in 2007, more than 1% of gross domestic product expectedly generated last year.

The result of the warning was not hard to predict since the forint weakened to 258.45 per euro by 12:24 p.m. this morning in Budapest from 256.94 late yesterday.

As I said in my January 2008 forecast on Hungary only a couple of weeks back:

I will be very surprised if we see calendar year 2000 as high as 1.8%, but more to the point 2.6% seems to be assuming a strong rebound, an assumption for which there is no real substantive evidence. In particular even to get what growth we have been getting in 2007 the Hungarian govenment has been running a deficit of around 6% of GDP. This is going to tighten yet further in 2008, so there is no supportive fiscal environment. And as I keep arguing, it is very hard to see a supportive monetary one. The IMF in their October World Economic Outlook also put a similar figure of 2.7%, while the EU commission in November 2007 came in with the same 2.6% as the OECD.

I think I am reasonably confident in holding to my recession forecast for 2008, although of course, "recession" does not mean negative growth for the whole year (technically it is simply 2 consecutive quarters of negative growth), so we might then go on to see what, between 0.5 and 1% growth over whole year 2008 (and the only really doubt is whether the contraction starts in Q4 2007, or in Q1 2008). But it is what happens in 2009 and 2010 that matters really, and at this point so many variables are in play (and interrelated ones to boot) that I can only say I envy those who have the courage - or the temerity - to stick their necks out). And of course, if we get a large correction in the value of the forint, then all those carefully weighed and weighted forecasts will, without a shadow of a doubt, go straight and directly off into the bin.

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