Boom economy limits Hungary’s budget deficit reform options

Hungary celebrated the second anniversary of its EU membership by re-electing an incumbent government for the first time ever since the collapse of communism in 1990. After constant changes of governing coalitions and their programmes and priorities, this new mood of political continuity is sending positive signals to international investors. Yet most Hungarian politicians and experts agree that fundamental changes are now needed to keep the budget deficit under control. Shaping a coherent deficit reduction strategy is the new government’s major challenge.

Hungary’s 6.1% budget deficit last year was the largest of all the EU’s 25 member governments, even though when compared to some of the deficit figures of old and new members over the past two decades it was hardly that extraordinary. It nevertheless now demands a credible policy approach and a transparent roadmap. The main areas for cutting include streamlining the public administration, launching fundamental healthcare and education reforms and restructuring the handful of state-owned companies like the railways and other transportation areas that have been running up massive losses.

There’s no denying the seriousness of the budget deficit, but it is also true that surprisingly little attention has been paid to the more favourable areas of Hungary’s economy. Annual growth rates have been running at over 4%, export and investment levels have been the engines of growth and registered unemployment, although increasing slightly, is the lowest of all the new member countries. With over €60bn in foreign direct investment, Hungary remains one of the most attractive production locations in Europe, thanks to fast upgrading technology standards, unbroken improvements in competitiveness and the rising added value of its exports. The stock exchange has seen an encouraging inflow of foreign capital and the exchange rate of the national currency, the Forint, underlines the stable micro-economic foundations of the economy.

The corrections needed to reduce the budget deficit therefore have to be devised with care. They have to be strong and quick enough to send positive messages to current and potential investors, and they also have to be part of a multi-annual programme with a clear reform timetable. That means no shock impact but the start of a sustainable process that will actually enhance business confidence.

Even the gradual reduction of the budget deficit should not be the exclusive aim of this strategy. A number of EU countries have had much higher and more persistent budget deficits while modernising their economies and catching-up with the EU average. The pattern of the budget deficit is also an important consideration, as future-oriented investments in both physical and human infrastructures cannot be treated in the same way as deficits generated by unsustainable growth in private consumption.

Recent years have clearly shown that the Maastricht criterion of a 3% ceiling on budget deficits is out of the reach even of the EU’s richer countries. Rigid insistence on this rule apparently resulted in low growth, high unemployment, accumulated structural deficits and social problems. This is certainly not the way ahead for Europe in the 21st century, still less for new member countries endeavouring to catch up.

We therefore need to look at the factors determining stability and growth – the major framework conditions of a viable monetary union – in a wider perspective. The Hungarian strategy for reducing its budget deficit should be seen in this context.