“There were big mistakes by the former government which have been repeated by the current government, mainly due to goals that were set and unfulfilled,” said Eva Palócz, deputy general director at economic research institute, KopintDatorg.

In the past three years, Hungary has missed its budget deficit targets, which analysts attribute to unrealistic goals, massive government expenditures, a lack of household savings, high external debt and a shortfall of VAT revenues. For example, government officials projected a 2004 budget deficit of 4.6 percent of GDP in the beginning of last year. But that rate swelled to 5.3 percent by year’s end, owing to uncollected VAT revenues of at least HUF 300 billion and costs related to Hungary’s EU accession in May 2004.

Not a one-time occurrence

Last year wasn’t a one-time-only occurrence. In 2003, the government initially predicted budgetary deficit at 3.8 percent of GDP, but that too jumped to 6.2 percent by year’s end.

“Creditability questions are creating important problems in the Hungarian economy,”said Orsolya Nyeste, an analyst at Erste Bank. She said while financial markets typically pay little attention to government GDP or inflation projections, recent overshoots of the country’s budget deficit have caused some concern among investors and may further jeopardize Hungary eurozone admission, which was already revised from 2008 to 2010. “The main problem still is that this coming year’s budget plans are not totally in line with the planned accession date to the EMU,” Nyeste said.

Hungarian Finance Minister Tibor Draskovics, meanwhile, played down concerns over the country’s budget and monetary policy and said Hungary’s deficit in 2004 was the same as similarly-sized neighbor, the Czech Republic, which reported a 5.2 percent budget deficit last year.

But Palócz pointed out that Czech officials didn’t overshoot their budget deficit target to the same degree as in Hungary. “The problem is that Hungary wants to show it can improve its budget rapidly,” she said. “The government cannot cut expenditures dramatically if they want to maintain its popularity. Hungary’s bureaucracy is too wide, activities are duplicated among ministries and there is insufficient cooperation among government ministries and bodies.”

Despite missed targets, Draskovics defended the government and said Hungary should be lauded for reducing its budget deficit by 4 percent between 2002 and 2004. “We came down from 9.2 percent to 5.3 percent,” he said. “Could you show me any country in Europe with a similar result? The answer is no.”

He added that the reduction also came amid Hungary’s EU accession, which itself “deteriorated the budget position by 1 percent just because of the contributions to be paid into the EU budget, which are considered an expense.”

Outside critics

In mid-January, international ratings agency, Fitch, lowered its long-term rating on Hungary’s forint from A+ to A. Fitch highlighted concerns the Hungarian government may not reduce the country’s budget deficit to levels needed to adopt the euro.

“The local currency downgrade mainly reflects sizeable and persistent budget deficits, which have increased public debt, unbalanced the economy, exacerbated the current account deficit, eroded policy credibility and delayed Hungary’s timetable for adopting the euro,” Edward Parker, senior director at Fitch Sovereigns Group, said in a press release.

Fitch said it estimated Hungary’s 2005 budget deficit at 4.7 percent of GDP, a major contrast to the 2.8 percent in Hungary’s 2003 Pre-Accession Economic Program. The ratings agency also noted that fiscal concerns in Hungary forced the country, in 2003, to postpone its target for adopting the euro from 2008 to 2010.

Draskovics said the country’s ratings slip would have no impact on Hungary’s monetary policy. “Hungary is still rated in the investment category which is exactly the same rating as Poland or the Czech Republic,” Draskovics told Hungary’s International Press Association (HIPA), and added he would find it incomprehensible if other ratings agencies followed suit.

Nyeste at Erste Bank called the timing of the Fitch downgrade “surprising,” and said such a move would have been more logical six months ago. Still, she said Hungarian authorities must pay attention to such an action and view it as an important message that could influence opinions on the country.

On the heels of the Fitch modification was news that European Union finance ministers would continue excessive deficit procedures they started against Hungary last summer, in line with a recommendation issued by the European Commission in late December 2004.

Joaquin Almunia, EU Commissioner for Economic and Monetary Affairs, said Brussels was mainly concerned over Hungary’s fiscal policy and the fact it does not meet goals outlined in its convergence program. At the same time, disciplinary action was suspended against Cyprus, the Czech Republic, Malta, Poland and Slovakia, because the EU said these nations had taken steps to eventually reduce their deficits to no more than 3 percent of GDP, as defined by the EU’s Stability and Growth Pact.

Hungary and Greece are the only nations the EU is taking deficit procedures against. “We need a sharp reduction of the deficit to 4 percent in three years,” Draskovics told HIPA journalists. “That’s the job. That’s the homework. What I’m asking for is a fair assessment. I have to admit we missed the targets and that’s very bad because it deteriorated credibility and we are paying a high price for it.”

Some analysts added, however, that the EU action is not seen as having much of an impact on Hungarian fiscal policy, since Hungary is not yet a member of the monetary union.

Widening debts?

While Hungary’s budget deficit has to be kept in check and in line with estimates, analysts also voiced concern over Hungary’s large current account deficit, currently more than 9 percent. Hungary’s foreign trade deficit was EUR 4.074 billion during the first 11 months of 2004, compared to EUR 3.791 billion during the same period in 2003.

“That is certainly a large and unsustainable imbalance we carry on,” said György Barcza, an analyst at ING Bank. “It is not hurting the HUF exchange rate now because of eurobond issuance and local private entities’ foreign currency borrowing … but our net foreign currency debt to GDP ratio is increasing constantly so at some point it will reach a limit if the trend continues.”

Another element is a lack of household savings in Hungary. Household savings in 2003 came in around 0 percent, while in 2004 they are expected to be less than 1 percent of disposable income, according to Palócz. He added that normal household savings rate in a typical country are between 6 and 10 percent, with Japan leading the pack at 15 percent. An absence of household savings has led Hungary to increase its reliance on borrowing from abroad.

Palócz also cited the “disappearance” of at least HUF 300 billion in VAT revenues for Hungary in 2004, attributed to new procedures for paying the tax in light of EU accession. “Until May 1, importers paid VAT at the border and they couldn’t bring their goods in until the VAT was paid. From May 1, however, importers pay VAT in quarterly and monthly installments, in line with normal tax declarations. Somehow, VAT worth HUF 300 billion had reportedly disappeared in the second half of the year.”

She added that HUF 300 billion equals about 1.5% of Hungary’s GDP. Despite pledges by Draskovics to rein in the budget deficit to 4 percent of GDP in three years, analysts pointed out that Hungarian parliamentary and municipality elections to be held in 2006 would result in major expenses.

According to Nyeste, the government needs to make considerable efforts to cut expenditures and implement structural reforms. “However, we tend to believe that the coming 2006 parliamentary elections will prevent the government from this type of reform or any further tightening, leaving fiscal problems as the most critical issues in the future,” she said.

Much needed reforms

What Hungary could benefit from is badly needed reforms in health care, education and administration, Barcza said. “These sectors’ financing structure has to be reorganized and the number of public sector workers has to be cut by 20 percent.”

Barcza highlighted the fact, however, that Western European governments have made their share of mistakes in the past. “They [governments] all used exchange rate devaluations to generate surprise inflation and extra revenue for the budgets. The euro was invented [recently] and was delayed in the first attempt. ERM crisis and several balance of payment crisis in Scandinavia showed that adopting fiscal responsibility is [part of] economic history.”

Draskovics said Hungary’s deficit is sure to wane in light of higher than ever foreign direct investment (FDI), a booming stock exchange and a consistent reduction of rates by the Central Bank.

“We need a stronger thrust. But the assessment of investors is better than assessment of analysts,” he said, “I learned the very high price of not reaching the target and we don’t want to repeat that.”