Lessons from the Hungarian “Exception”

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George Kopits

ICGFM Winter Conference “PFM in the 21st Century”
Washington, December 5-7, 2011

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Lessons from the Hungarian “Exception”

  1. 1. Lessons from the Hungarian “Exception” George K opits ICGFM Winter Conference “PFM in the 21st Century ” Washington, December 5-7, 2011
  2. 2. Outline <ul><li>Background </li></ul><ul><li>Broad fiscal trends </li></ul><ul><li>Exception 1.0 (in 2001-09) </li></ul><ul><li>Paradigm change? </li></ul><ul><li>Exception 2.0 (since 2010) </li></ul><ul><li>Implications for sovereign risk </li></ul><ul><li>Conclusion: Lessons </li></ul>
  3. 3. Background <ul><li>Mixed progress during the transition </li></ul><ul><li>Reforms in the tradable sector </li></ul><ul><ul><li>External liberalization </li></ul></ul><ul><ul><li>Domestic liberalization (incl. financial system) </li></ul></ul><ul><ul><li>Privatization (incl. effective bankruptcy procedures) </li></ul></ul><ul><li>Slow reforms in the non-tradable sector </li></ul><ul><ul><li>Public administration: workforce remained bloated </li></ul></ul><ul><ul><li>Social security system partially reformed </li></ul></ul><ul><ul><li>Tax system partially restructured </li></ul></ul><ul><li>Monetary policy: broadly successful IT regime </li></ul><ul><li>EU membership  moral hazard </li></ul>
  4. 4. Background <ul><li>Economic performance </li></ul><ul><li>Foreign direct investment: first high, then low </li></ul><ul><li>Swings in external performance </li></ul><ul><li>Near crisis in mid-90s, and late 2008 </li></ul><ul><li>Disinflation into single digits, but some persistence </li></ul><ul><li>Marked deceleration in economic growth </li></ul>
  5. 5. Background Real GDP Growth Rate xxxxxxxxxxxxxxxxxxxxxx
  6. 6. Background
  7. 7. Broad fiscal trends <ul><li>Distinguishing characteristics </li></ul><ul><ul><li>deficit bias </li></ul></ul><ul><ul><li>time inconsistency </li></ul></ul><ul><ul><li>procyclicality </li></ul></ul><ul><ul><li>debt sustainability problem </li></ul></ul><ul><ul><li>lack of transparency </li></ul></ul>
  8. 8. Broad fiscal trends
  9. 9. Broad fiscal trends
  10. 10. Broad fiscal trends
  11. 11. Broad fiscal trends
  12. 12. Broad fiscal trends Public Debt
  13. 13. Broad fiscal trends <ul><li> Lack of transparency </li></ul><ul><ul><li>inconsistent time-series data </li></ul></ul><ul><ul><li>overoptimistic macro-fiscal forecasts </li></ul></ul><ul><ul><li>abusive PPP practices </li></ul></ul><ul><ul><li>distorted accounting for SOEs </li></ul></ul><ul><ul><li>opacity in budgetary procedures </li></ul></ul><ul><ul><li>occasional arrears in expenditures and tax rebates </li></ul></ul>
  14. 14. Exception 1.0 (2001- 09) <ul><li>Center-left government </li></ul><ul><li>Expansionary stance during “Great Moderation” </li></ul><ul><li>government wage hikes </li></ul><ul><li>public pension hikes </li></ul><ul><li>VAT rate cuts </li></ul><ul><li>Contractionary stance during crisis (IMF-EU standby) </li></ul><ul><li>wage and pension freeze </li></ul><ul><li>VAT rate increase </li></ul><ul><li>some streamlining of social entitlements </li></ul><ul><li>rules-based fiscal framework </li></ul>
  15. 15. Paradigm change? <ul><li>Rules-based fiscal framework (FRL Nov. 2008) </li></ul><ul><li>policy rules: expenditure limit real debt limit (  limit on discretionary deficit) </li></ul><ul><li>procedural rules: pay-go rule MT budgetary planning </li></ul><ul><li>transparency norms </li></ul><ul><li>independent fiscal institution: Fiscal Council </li></ul>
  16. 16. Paradigm change? <ul><li>Fiscal Council </li></ul><ul><li>Contribute to goals of fiscal framework </li></ul><ul><ul><li>credibility in fiscal policymaking </li></ul></ul><ul><ul><li>transparency in public finances </li></ul></ul><ul><ul><li>public debt sustainability </li></ul></ul><ul><li>Basic characteristics, functions </li></ul><ul><ul><li>independence (incl. election, tenure of members) </li></ul></ul><ul><ul><li>arm’s length relation, equal access </li></ul></ul><ul><ul><li>decisions by consensus </li></ul></ul><ul><ul><li>surveillance (evaluation, compliance) </li></ul></ul>
  17. 17. Paradigm change? <ul><li>Fiscal Council: surveillance functions </li></ul><ul><li>Evaluation at aggregate level </li></ul><ul><li>Evaluation at disaggregate level </li></ul><ul><li>Compliance with standards and procedures </li></ul><ul><li>Compliance with fiscal rules </li></ul><ul><li>Communication (government, press, etc.) </li></ul>
  18. 18. Paradigm change? <ul><li>Fiscal Council: performance </li></ul><ul><ul><li>strong technical staff </li></ul></ul><ul><ul><li>early tail winds (during adjustment program) </li></ul></ul><ul><ul><li>favorable press coverage </li></ul></ul><ul><ul><li>positive feedback from civil society </li></ul></ul><ul><ul><li>no interference from government </li></ul></ul><ul><ul><li>first government complied, second did not </li></ul></ul><ul><ul><li>de facto abolition at end-2011 </li></ul></ul>
  19. 19. Exception 2.0 (since 2010) <ul><li>Center-right government </li></ul><ul><li>Major policy (reform?) measures </li></ul><ul><li>flat tax, without exempt threshold </li></ul><ul><li>temporary taxes on selected activities </li></ul><ul><li>record VAT rate (27%) </li></ul><ul><li>nationalization of private pension funds </li></ul><ul><li>Institutional changes </li></ul><ul><li>limits on Constitutional Court, on fiscal matters </li></ul><ul><li>political appointment as head of State Audit Office </li></ul><ul><li>attempts at curtailing independence of NBH </li></ul><ul><li>de facto abolition of Fiscal Council </li></ul>
  20. 20. Exception 2.0 (since 2010) <ul><li>Demise of the Fiscal Council </li></ul><ul><li>Critical assessments by the Council </li></ul><ul><ul><li>changes in accounting rules </li></ul></ul><ul><ul><li>effects of various changes in tax law, pension reform </li></ul></ul><ul><ul><li>forecasts of four-year macro-fiscal outlook </li></ul></ul><ul><li>Reactions by the government </li></ul><ul><ul><li>limited access to information </li></ul></ul><ul><ul><li>proposal to drastically cut funding </li></ul></ul><ul><ul><li>disbandment of FC staff </li></ul></ul><ul><ul><li>narrowing remit of FC to opinion on budget bill </li></ul></ul><ul><ul><li>appointment of new FC chair (following resignation of former) </li></ul></ul>
  21. 21. Implications for sovereign risk
  22. 22. Implications for sovereign risk <ul><li>Comparison with the UK </li></ul><ul><li>Common features </li></ul><ul><ul><li>fiscal sustainability problem </li></ul></ul><ul><ul><li>low policy credibility </li></ul></ul><ul><ul><li>contemporaneous election of center-right governments </li></ul></ul><ul><li>United Kingdom </li></ul><ul><ul><li>clear medium-term fiscal target </li></ul></ul><ul><ul><li>front-loaded adjustment program </li></ul></ul><ul><ul><li>establishment of Office for Budget Responsibility </li></ul></ul><ul><li>Hungary </li></ul><ul><ul><li>mixed and opaque policy signals </li></ul></ul><ul><ul><li>adoption of distortionary stop-gap measures </li></ul></ul><ul><ul><li>abolition of Fiscal Council </li></ul></ul>
  23. 23. Implications: sovereign risk premium
  24. 24. Implications: sovereign default risk premium
  25. 25. Conclusion: Lessons <ul><li>“ Exception” leads to stagnant activity, long-term sustainability problem, and vulnerability to crisis (lacking a natural resource base) </li></ul><ul><li>Government should not succumb to populist instincts or to moral hazard </li></ul><ul><li>Government ignores financial markets at its peril </li></ul><ul><li>IMF can provide financial and technical assistance, but policy credibility must be home-grown </li></ul><ul><li>New government must use opportunity to signal paradigm change and follow up with action </li></ul>
  26. 26. References <ul><li>Kopits, G., “Monetary and Fiscal Policy from Transition to EU Integration: A Comparative Assessment” in B.Y. Kim and C. H. Lim, eds., Financial Sector Reform in Transition Economies (Seoul National University, 2009), pp. 29-61. </li></ul><ul><li>Kopits, G., “Brussels Can’t Monitor 27 Budgets” The Wall Street Journal (October 11, 2010) </li></ul><ul><li>Kopits, G., “Goulash Populism” The Wall Street Journal (February 25, 2011) </li></ul><ul><li>Kopits, G., “Independent Fiscal Institutions: Developing Good Practices” OECD Journal on Budgeting (November 2011) </li></ul>

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