The document reports that Hungary achieved a record high budget surplus in Q1 2017, indicating a strong fiscal position despite a rising cash deficit in Q2 primarily caused by advances on EU funds. Revenue growth persisted due to robust GDP performance and tax collections, yet increased spending measures may be needed to meet the 2.4% deficit target ahead of the 2018 elections, amid various implementation risks. The analysis suggests that underlying fiscal stability remains, with potential additional spending measures expected in the autumn.

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FLASH REPORT – GOVERNMENT DEFICIT
FLASH REPORT
7 July 2017
Massive Q1 surplus confirms favourable fiscal trends;
rising cash deficit in Q2 is largely due to advances on EU funds,
but the underlying fiscal position remains strong
 The budget amassed a record high surplus in 17Q1, confirming our view that the 2017
deficit was entirely due to year-end one-offs; 12-month rolling ESA deficit is 1.7%.
 Despite tax cuts, revenues continued to grow in Q1 briskly thanks to strong GDP
growth and a robust labour market. Expenditures were contained in 17Q1.
 The headline cash deficit of the central government rose massively in Q2, to 3.7% of
GDP on a 12-month rolling basis. This was mostly due to advance payments of EU
funds, which do not increase the ESA deficit to the same extent.
 By filtering the cash balance from EU-related items and one-offs, we arrive at a broadly
stable underlying balance, which has deteriorated only slightly in recent months.
 Data confirm our big picture: the government scales up spending and the absorption of
EU funds to achieve the 2.4% deficit target. However, this target may still be undershot
due to implementation risks with public investments. More spending measures could
come in autumn.
Record budget surplus in 2017Q1
We have argued repeatedly that the underlying fiscal position is very strong, and a
balanced budget would have been feasible last year without significant one-off spending
in December. 2017Q1 data confirm our view: the general government budget
achieved a record high surplus (178 bn HUF, 2% of 17Q1 GDP, which improved the
rolling four-quarter balance from -1.8% to -1.7% of GDP).
Chart 1 – Budget balance indicators
ESA balance and monthly cash balance
(% of GDP, 12-month rolling)
Central government cash balance
(bn HUF, 12-month rolling)
Note: underlying balance on right panel excludes EU-related expenditures and well-identified one-offs
(i.e. revenues from land sales, the growth tax credit scheme, and estimated one-off expenditures in
December 2016). EU-related balance is estimated for June 2016. Source: HCSO, Ministry for National
Economy, OTP Research
Revenue collection remained robust in Q1. Despite several tax cuts from January 2017
(to social security contributions, corporate income tax and VAT), total revenues increased
6.1% compared to 16Q1. The tight labour market, the 15% minimum wage hike and
selective pay rises in the public sector raised aggregate wage growth above 10%. Thus,
social security contributions managed to rise 3.4% even after the 5 pp cut to employers’
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FLASH REPORT – GOVERNMENT DEFICIT
contributions; meanwhile, taxes on income jumped 12.4%. VAT revenues were up 7.9% compared to 16Q1,
driven by strong consumption, rising housing and public investments. One-off revenues from land sales
amounted to 121 bn HUF (0.3% of GDP) in Q1; this item will fade in Q2 according to monthly data.
Expenditures grew at a slower pace than revenues (+5.1% compared to 16Q1). Interest expenditures
contracted thanks to exceptionally low interest rates. Its four-quarter average reached a historic low, 3.1% of
GDP. Surprisingly, intermediate consumption (purchases of goods and services) fell by 6.1%, even though
the 2017 budget expects this item to rise by a quarter compared to 2016. Social benefits grew at a modest
2.6%, mainly due to the indexation of pensions. However, the number of pensioners also decreased by 1%
compared to 16Q1, reflecting longer demographic trends. On the other hand, labour compensation was up
9% due to previously announced wage increases for selected public sector employees. Investments rose
55% compared to an abysmal 16Q1, and capital transfers (investment grants) also increased significantly.
Rising cash deficit in Q2 will not necessarily worsen the ESA balance
This week the Ministry of National Economy also published cash flow based data for June, which show that
the central government cash deficit is on the rise: in 17H1 was 911 bn HUF compared to 402 bn HUF in
the same period last year.
The rise in the cash deficit is mostly due to the increase in the EU-related deficit, which reflects a gap
between the cash-based and accrual-based accounting of EU funds. The amount of EU-related spending
rose by 579 bn HUF (approx. 1.5% of GDP) in 17H1 compared to 16H1. Advances paid to the private sector
and local governments may have been the main reason for rising EU-related expenditures. Meanwhile, the
accrual-based take-up of EU funds (which includes the own contribution of the government to EU-funded
projects) remained low, financing only 17% of public investments in 17Q1 according to quarterly ESA data.
According to the ESA methodology, the majority of advance payments will not appear in the ESA deficit (only
co-payments be the government will). A similar episode happened in 2015 (highlighted on Chart 1): the
government accelerated EU-related expenditures but actual capital inflows from the EU lagged behind. The
cash deficit rose, but this did not prevent the ESA balance from improving substantially.
To gain a clearer picture of underlying budget developments, we exclude the EU-related balance from the
cash deficit, and also filter out some one-offs. One-off revenues have increased since last year: land sales
started only in 16Q3 but lasted well into 17Q2. We also consider most of the cash deficit in December 2016
as a one-off because it was influenced by a last-minute discretionary spending spree, which does not reflect
longer-term budgetary trends. The resulting underlying balance remained broadly stable in 17H1
compared to 16H1, although 17Q2 brought a slight deterioration compared to 17Q1. This quarterly fall
in the underlying balance may signal a turning point in the spending behaviour of the government. After last
year’s surprisingly strong budget outturn, the public sector may scale up spending to approach the 2.4%
deficit target.
Downside risks to the 2.4% ESA deficit target
The government is committed to achieving its deficit target; with the 2018 elections around the corner, it has
every reason to pump up spending. However, the deficit may still turn out lower than the 2.4% target:
 We see implementation risks to public investments. The reconstruction of M3 metro line in
Budapest (worth around 0.4% of GDP) is a case in point. Works were initially expected to begin in late
2016, but due to internal debates about the financing of the project, the kick-off date was postponed to
June 2017 last November. A week into July, even the contract has not been signed (it is expected by
the end of the month). Meanwhile, technical issues have arisen with the refurbished carriages (worth
another 0.2% of GDP), which may delay their launch.
 Apart from procedural risks, widespread and well-publicized capacity shortages in the construction
sector may also delay public investment projects, resulting in lower than projected expenditures.
 We also note that actual budget outturns have been significantly better than government
forecasts in recent years. Since 2012, government nowcasts (as presented each spring in the
annual convergence programmes) have overestimated the current-year deficit by 0.4pp on average.
In light of the implementation risks and the recent track record of government deficit plans, we
maintain that there remains some room for manoeuvre in the 2017 budget. Additional spending
measures may arrive in the autumn.

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FLASH REPORT – GOVERNMENT DEFICIT
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