The bigger than expected decline in Hungary’s economic output has dealt a significant blow to the government’s budget plan for 2020. As a result of the weak GDP data in the second quarter and further restrictive measures made necessary by the second wave of the epidemic, the Finance Ministry was forced to revise its budget deficit forecast to a staggering 7-9% of GDP.
Earlier market concerns regarding the ramifications of the deeper-than expected recession that hit Hungary in the second quarter of 2020 are now starting to turn into a somber reality. The Finance Ministry announced earlier this week that the government’s budget deficit forecast for 2020 is no longer feasible; instead, the shortfall is likely to be double the projection included in the country’s convergence report submitted to Brussels each year.
Based on the weaker performance of the economy in the second quarter, public finance data so far and the planned new economic protection measures, Hungary’s budget deficit may widen to 7-9% of GDP in 2020, according to a statement from the Finance Ministry. That’s an astonishing jump from the initial forecast of 3,8% and means that the 2020 deficit will rise to historic highs, as we last saw such shortfalls a decade and a half ago. Although the economic fallout triggered by the coronavirus epidemic was not as serious as in some other countries of the European Union, Hungary’s economy shrank by 13.6 percent in the second quarter of 2020.
Not unique in the developed world
The Ministry’s statement justified the huge increase in the deficit target by saying that the government's goal is for the budget to fully cover the costs of the epidemic-related measures and to provide economic protection in the future as well. In other words, the reasons for the ballooning deficit are threefold: the direct costs of measures implemented to curb the spread of the epidemic, the economic recovery measures designed to counterbalance the economic impact of the crisis and the recession. The economic slowdown and the tax cuts announced so far will jointly reduce annual budget revenues by more than HUF 1,400 billion, which equals roughly 3% of this year’s GDP.
The Ministry pointed out that the new deficit forecast is not unique among developed countries, some EU countries for instance are calculating with budget shortfalls averaging 9% of GDP. The deteriorating global economic backdrop is underpinned by the European Commission, which predicts that the GDP decline in the European Union as a whole will be 1 percentage point higher compared to the spring forecast, and the International Monetary Fund, which sees the recession in developed countries being 2 percentage points worse than in April.
The government has embarked on this year’s fiscal journey with a deficit target of 1% of GDP, but it quickly became clear that the coronavirus crisis has rendered this target unattainable. For a while, policy makers held on to the prospect of keeping the deficit below 3%, but finally the Cabinet set a deficit target of 3.8% in the convergence program. Recently, Finance Minister Mihály Varga sent cautious warnings that the deficit may end up being higher, but until earlier this week, the official government target was 3.8%. Prime Minister Viktor Orbán justified the government’s spending plans, which were restrained by international standards, by stressing that the level public debt should also be taken into account, because after the crisis, countries with a steep increase in indebtedness are bound to fare much worse.
Hopes of further decreasing Hungary’s indebtedness were swiftly crushed by reality as the public debt level rose to 71.9% of GDP by June from 66.3% at the end of 2019. The wider budget deficit forecast means that the country’s public debt will continue on an upward trajectory in the foreseeable future. The State Debt Management Agency also made an announcement this week, saying that the cash-based deficit of the central government will likely be HUF 1,710 billion higher than the original plan of HUF 3,600 billion this year. In view of the country’s increased financing need, the agency revised its financing plan for 2020 and plans to increase the sale of retail government securities from HUF 7,766 billion to HUF 8,547 billion by the end of 2020. The statement also added that Hungary would not issue additional foreign-currency bonds as a result of the change in the budget deficit target. In other words, the planned foreign-currency financing, for this year remains EUR 4 billion, of which the country has already raised EUR 3.5 billion in April and June, respectively.
The way forward
The most difficult question is how much room for maneuver is left for policy makers for further economic recovery measures in light of the current deficit target of 7-9%. A second wave of the epidemic now seems more of a certainty than ever and it raises the specter of further economic malaise down the road. Any additional measures aimed at softening the blows of the epidemic will require state funding and are likely to put pressure on the country’s finances. One of the two government risk scenarios projects that the pandemic will be curbed only in the third quarter of this year and economic recovery will start in the last quarter. In that case, the economy is set to shrink by 5.6% in 2020. If the recovery starts only in 2021, the recession could reach 7.3% this year, worse than after the 2008 financial crisis.