Hungary’s New Government Faces Daunting Challenge to Keep Budget under Control

A hefty spending spree by the government ahead of April’s elections has left a significant hole in Hungary’s budget at a time when the war in Ukraine is putting further pressure on the country’s financials. With the budget deficit reaching nearly 75% of the annual target by the end of March, the new government will be forced to take drastic measures to rein in the deficit.

Analysts estimate that the price tag of the government’s pre-election spending spree stands at USD 5.35 billion. This comes on top of soaring energy prices, rising interest rates, lack of access to EU funds and an expected slowdown in industrial production that will all add to budget pressures.

Huge deficit
Hungary’s cash-flow-based budget deficit, excluding local councils, widened to HUF 2,309.4 billion (EUR 6.15 billion) at the end of March, equaling 73% of the government’s full-year target for 2022. The Finance Ministry said expenditures on home subsidies and on pensions were higher in January-March than in the base period. It added that Hungary’s year-end state debt-to-GDP ratio stood at 76.8% in 2021, while the budget deficit reached 6.8% of GDP.
“In the current situation of war, it is of crucial importance that Hungary’s economy and budget remain stable, and that households do not bear the burden of the war,” the ministry said in a statement.
The European Union requires member states to keep their budget deficit at or below 3% of GDP. While the bloc could ignore high budget deficits given the extraordinary circumstances, Hungary’s credit rating may deteriorate because of the wider shortfall.

Challenge ahead
Sovereign credit rating agency Fitch said it would be "challenging" for Hungary to meet this year's deficit target of 4.9% of GDP. Steadily rising inflation and the prospect of economic slowdown will have a negative impact on the budget and the government is likely to miss its the targeted budget deficit, according to Fitch.
Finance Minister Mihály Varga has already raised the prospect of a budget overhaul after the April 3 vote.
Meanwhile Standard & Poor’s noted that they might lower Hungary’s credit rating if fiscal deficits remain elevated, leading to rising debt to GDP, or if Hungary's external position weakens beyond current expectations.
Péter Virovácz, chief analyst at ING Bank is Budapest, said in a research note that the government needs to review the budget. “We see two different paths in front of policymakers. The easiest path would be to let the original deficit target (4.9% of GDP) go and amend the budget to reflect the new situation. With upwardly revised fiscal targets, we see an increased chance for a negative outlook regarding Hungary's sovereign credit ratings, while we don’t think that an immediate downgrade is on the cards. The other way would be to carry out austerity measures (first spending cuts then revenue boosters via sectoral/special taxes) reflecting the budget slippage,” according to Virovácz.
He added that the rule-of-law mechanism triggered by European Commission jeopardizes a significant inflow of EU funds and thus creates a hole in the cash-flow based budget.

Utility price freeze a strain on the budget
A regulatory price freeze to limit household utility bills, in place since 2015, may cost the budget HUF 1,300 billion (EUR 3.4 billion) this year, according to the calculations of GKI Economic Research Institute. Some analysts say that the measure may become unsustainable.
To make matters worse, the central bank is now making losses on its cheap financing for companies as interest rates rise. The losses, coupled with higher debt servicing costs, could cost the budget another HUF 1 trillion compared with 2019 levels, National Bank of Hungary Governor György Matolcsy wrote earlier this year.
The market fears that the government may return to the unorthodox fiscal measures seen after 2010, such as sectoral taxes to address budgetary woes.