Hungary’s opposition wants to use EU funds and cleaner procurement to boost education and healthcare

Hungary’s opposition wants to use EU funds and cleaner procurement to boost education and healthcare
The Hungarian opposition alliance is a pact between the Democratic Coalition, Jobbik, LMP – Hungary's Green Party, Momentum Movement, Hungarian Socialist Party, and Dialogue for Hungary.
By bne IntelliNews March 15, 2022

Hungary’s opposition alliance is not planning a radical shift in economic policy if it wins the parliamentary elections on April 3. But rooting out institutional corruption and making public procurement more transparent will widen the currently very constrained fiscal leeway, Julia Kiraly, former deputy governor of the National Bank (MNB) and chief economic advisor of the opposition alliance told bne IntelliNews in an interview.

By tapping EU funds and a loan from Brussels’ Recovery and Resilience Facility (RRF), the six-party alliance wants to finance sectors neglected by Viktor Orban’s government, particularly education and healthcare, which are prerequisites for improving the long-term competitiveness of the country.

"What we need is not new economic policies but a change in philosophy," Kiraly says.

There will be a radical shift in the priorities, with a focus on education, social and green policies to ensure long-term competitiveness. Kiraly says she sees Estonia as an example to follow, with its digital and open economy and skilled workforce.

However, the Ukraine crisis will significantly narrow the room for manoeuvre of the new government, says the economic adviser to prime ministerial candidate Peter Marki-Zay. Weaker growth and higher inflation in the Eurozone will also have a major impact on Hungary’s open economy, and these effects will be pronounced if sanctions against Russia last for a long time, she notes.

The economic team of the opposition, which includes former MNB governors Gyorgy Suranyi, Akos Bod Peter and Graphisoft founder Gabor Bojar, has had to revise its macroeconomic outlook. They see Hungary’s economy slowing down to 3-4% from the 5-6% target, while inflation is set to rise to 8-9% compared to the 5-6% projection by the central bank due to the rise in energy prices and the weaker forint.

Hungarian economists, who have also revised their growth projections downwards, argue that the war has accentuated the country’s vulnerabilities, mainly the dependence on Russian energy and the high state debt. Though it is too early to assess the fallout yet, the forint’s recent slide is seen as a warning sign.

Before the crisis, even the Fidesz-appointed central bank board warned of the economy overheating and called for the end of the loose fiscal policy. There is a rising risk of a twin deficit of both public finances and the external current account, with a fast deterioration of the terms of trade due to higher energy costs.

Traps in the budget

After its last two election setbacks, the opposition parties united in 2019 to topple Orban’s government, which has cemented its powers over the last 12 years thanks to its supermajority in parliament. Polls show Fidesz leading slightly but it is still too early to call as the race will be decided in two dozen constituencies where there is a +/-5 point gap between candidates of the two main blocks.

Kiraly says that, if elected, the new government’s first priority will be to cut through the chaos in the public finances, as Hungary has the most opaque budget not only in the EU but among OECD countries.

Identifying hidden mines in the budget will be no less important, such as the huge liabilities taken on by state-owned Eximbank. The export insurance provider opened a €615mn credit line last summer for Hungarian businesses expanding in Russia, among other risky deals.

Another unacknowledged fiscal mine is the financing of artificially low energy prices for households, which will set back the budget by hundreds of billions of forints. The Fidesz government froze retail energy prices in 2013, but the surge in gas prices over the last year has plunged state utility giant MVM into the red in 2021, necessitating a massive government capital injection.

Kiraly estimates that the price tag this year will be at least HUF600bn (€1.57bn) or twice that of the government’s target. There is no money earmarked in the budget to help out MVM, she notes.

Keeping electricity and gas bills low is a key priority in Orban’s re-election campaign. For years market prices were at or below the price cap set by the government, but this has reversed over the last 12-18 months. Hungary’s government has vehemently opposed any proposals to extend sanctions against Russia to the energy sector, which could push prices up further.

A third mine is the government’s assumption that the EU will transfer RRF funds this year. Even though the EU froze Hungary’s RRF programme, the Orban government began to pre-finance programmes under the RRF. The economic team of the opposition assumes that the EU will hold back payments this year.

"The chances are slim that the EU will release these funds if Fidesz stays in power", Kiraly says.

If EU funds continue to be withheld, any new government will have to revise the budget as the shortfall could be much wider than projected and could reach 10%, she notes. This would seriously curb the government’s room for manoeuvre. 

Late last year, Finance Minister Mihaly Varga announced an increase in reserves by deferring state investments and subsequently reducing the 2022 deficit target from 5.9% to 4.9%.

Keeping this target won’t be as easy as the cash-flow-based deficit in the first two months reached 45% of the full-year projection due to massive pre-election one-off tax refunds and state transfers.

Turning the EU money tap back on

Just three weeks before the election, Orban received some good news on Monday when media reported that Brussels is unlikely to trigger the new rule-of-law mechanism before the elections, due to the impact of the war and the refugee crisis on the country's economy. The mechanism allows the EU to withhold money if a member state’s violation of the rule of law is judged to endanger the bloc’s funds.

It remains to be seen how other EU institutions such as the parliament would react if the EU looks the other way and continues to disburse billions of euros to Orban’s government despite concerns about its democratic backsliding and opaque public tenders.

Hungary is one of the biggest beneficiaries of EU cohesion funds and it is also slated to receive €6bn from the RRF fund if approved.

The use of EU funds, accounting for 3% of the GDP, is a core pillar of the opposition’s election promises to finance spending on healthcare and education, while keeping existing Orban handouts, such as family subsidies, fixed energy prices for households, and the 13th-month pension.

The Fidesz government has turned down the €9bn loan under the RRF scheme, but the opposition is committed to using these funds to finance Hungary’s energy transformation and cut dependence on Russian gas and oil.

The overall policy goals laid out in the RRF plan submitted by the government are in line with that of opposition, Kiraly says, but the corruption in the system needs to be rooted out.

"We need to launch EU tenders as soon as we can and dismantle Viktor Orban’s mini-state by eliminating institutional corruption," Kiraly said.  

Overhauling public procurements could reduce spending by 15-30% and lead to a saving of at least 1% of the GDP.

A fresh report by the Corruption Research Centre Budapest shows that more than 40 companies of a dozen businessmen close to Fidesz won 20% of all EU funds between 2005 and 2021. Crony companies had much higher odds of winning state contracts, compared to firms without political ties last year.

Tweaking tax policy

There have been debates within the opposition camp on how to transform taxation policy, but there will be no tax major changes. The new government will keep the 15% flat income tax rate but lower-income families will see their net wages rise due to tax refunds. It is a shift from Orban’s policies, which has prioritised affluent families in social policy.

The six-party alliance is promising to put an end to direct cash subsidies to large companies and focus on SMEs instead. The Orban government has generously funded multinationals and made Hungary a favourite investment destination with the lowest corporate tax rate in the EU. The opposition is not planning to amend the 9% tax rate, according to Kiraly.

When asked about positive steps taken by Fidesz, Kiraly says that the government has pursued a relatively tight fiscal policy since 2012, although often its peers were posting positive primary balances during the same period. Boosting the employment activity rate from Europe's second-lowest and reducing the country’s FX debt ratio from 50% to 20% were also successes. Whitening of the economy helped tax collection and reduced the tax wedge, policies that will be maintained, she says.

While Hungary’s budget proceeds grew dynamically amid radically lower tax rates, public spending on education and healthcare remained below that of other EU countries in terms of GDP. The vulnerability of the country’s healthcare system was exposed by the COVID-19 pandemic.

The government is also leaving behind a fragile pension system after the nationalisation of some HUF3 trillion of private pension state funds in 2011. The money from the "pension grab" was used to curb state debt and lower the budget deficit to below 3% of GDP to escape from the EU’s excessive budget procedure.

The economic team of the opposition is revising the long-term viability of the pension system, as Hungary faces a dire demographic decline in the coming decades. The calculation for pensions will change and the annual increase will also take into account the rise in wages and not just inflation.

"At present adjusting pensions to higher inflation rates will be a challenge", she admitted. 

When asked about the Hungarian National Bank (MNB), Kiraly made it clear that its independence will be fully respected if there is a change of government. The stability of independent institutions, including the MNB, is a priority and there has been a bipartisan consensus in this since 1990, says Kiraly, who was deputy governor between 2007 and 2013.

However, she disagrees with the MNB on its dual monetary policy instrument policy. "It takes a while to explain to foreign financial experts the difference between the policy rate and the effective rate", she noted. The base rate set is by the Monetary Council, as the central bank’s supreme decision-making body, but the effective rate (one-week deposit rate) is set by MNB directors. The former stands at 3.4%, the latter at 5.85%. 

When the National Bank raised the interest corridor by 100bp on March 8, the markets were hoping for a similar increase in the one-week deposit rate two days later at the weekly tender but the rise was only 50bp. This caused the forint to weaken sharply against the euro.

Hungary’s opposition alliance will put the economy on track for the adoption of the euro within five years, according to its election programme. 

"We will do our utmost to join ERM 2 as soon as possible, but we will take more than one term as Hungary does not currently fulfil the conditions", she says.

The government and the central bank argued that Hungary's economy would need to catch up to reach 90% of Austria's GDP to enjoy the benefit of eurozone membership, but Kiraly says that this is just a political pretext for putting off euro adoption.

"We need to study the accession of countries like Slovakia or the Baltic states, which seem to have been successful", she says, even though they were far from Austria’s GDP.

Julia Kiraly

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