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The following OECD assessment and recommendations summarise Chapter 1 of the Economic survey of Hungary, published on 22 May 2007.
Fiscal consolidation dominates the policy agenda
After re-election of the centre-left coalition in April 2006, the government announced ambitious plans for fiscal consolidation, following admission that its deficit could be well over 10% of GDP without consolidation measures and indication that entry to the euro area in 2010 was impossible. The 2006 deficit, at 9.2% of GDP, indeed marked another peak in Hungary’s strong electoral spending cycle. The government’s goals imply breaking out of this. The aim is for a deficit below 3%, and on a sustainable basis for the future, by the next election in 2010. The consolidation programme comprises immediate revenue and spending measures, many of which are intended to be temporary, combined with wide ranging structural reform to public spending. The potential payoff is large. A permanently low deficit would put public debt on a downward path and return dividends to the economy via lower interest rates, reduced current account imbalances and fewer problems with exchange-rate volatility.
The government’s austerity programme is temporarily slowing growth
Given the size of fiscal imbalances, there was no alternative to drastic revenue-raising measures in the first phase of the programme. These began in autumn 2006 with hikes in employee social contributions, value-added tax and business taxation. The resulting squeeze on households’ disposable incomes and businesses is damping demand. Indeed, real GDP growth will dip well below its long-term average of around 4% to between 2 and 3% for this year and next. The increase in value-added tax, plus reduced gas-price subsidies, have generated a spike in inflation, creating uncertainty for rate setting in monetary policy.
Long-term payoff from the programme depends crucially on success in structural reforms and in resisting spending pressures.
Two major challenges lie ahead. The first is ensuring adequate delivery on structural reform. A number of key measures have yet to pass through Parliament and some reforms are inherently difficult to implement, even if the necessary legislation is in place. The second challenge is ensuring that the various temporary measures stay on track. The two challenges are interrelated, as timely progress on structural reform will help prevent the derailment or unwanted extension of temporary measures. The biggest test of the consolidation programme will be from 2009 onwards, when structural reform is supposed to deliver more of the deficit reduction but when, also, pressures for new spending measures are likely to mount due to elections in 2010.
Reasonable progress is being made in supply-side reforms to encourage higher labour utilisation
Hungary’s low employment rate remains a key structural handicap to achieving higher living standards. The widening of tax wedges and damping of spending due to austerity measures means a temporary weakening of labour demand. Furthermore, public-sector layoffs are initially going to increase unemployment, though the release of these resources will help output growth in the longer term. The government is nevertheless continuing with positive supply side reforms which should improve the employment response when demand picks up again. As discussed above, useful reforms have been made in the key areas, namely early retirement, disability and old-age pensions. Unemployment insurance schemes have also been improved through more front-loading of benefit. All of these reforms are along the lines recommended in detailed analysis in previous Surveys.
Developments on other fronts are mixed. Welcome efforts are underway to simplify active labour market programmes. The impact of the additional “guaranteed wage minima” that are based on educational and vocational qualification required for the job must be very closely monitored. The system is whitening employment through reductions in undeclared cash top-ups and in-kind benefits but is likely to be pricing some jobs out of the market and driving others fully into the hidden economy. Other, less costly, ways of reducing grey-sector activity should be sought. Incentive problems via the tax schedule remain. The allowances aimed at cutting the income-tax bills for low-wage workers should be reformed, or replaced by an alternative mechanism, to smooth the effective average and marginal tax schedules.
General government deficit, history and goals
% of GDP
Note: the dotted line from 2007 to 2010 shows the deficit path as outlined in the Government's Convergence Programme of December 2006.
Source: OECD estimates and Convergence Programme of Hungary 2006-2010.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic survey of Hungary 2007 is available from:
For further information please contact the Hungary Desk at the OECD Economics Department at email@example.com. The OECD Secretariat's report was prepared by Philip Hemmings and Alessandro Goglio under the supervision of Andreas Wörgötter.