Pierre-Alain Pionnier
OECD Economic Surveys: Hungary 2024
OECD Economic Surveys: Hungary
2. Macroeconomic developments and policy challenges
The economy is emerging from a downturn and expected to pick up in 2024
Economic activity and confidence declined significantly
A strong post-pandemic recovery, largely driven by domestic demand, lifted the economy above its potential in late 2021 and early 2022 (Figure 2.1). Since then, growth has shifted into reverse with four consecutive quarters of falling GDP. High inflation has curtailed the purchasing power of households and weighed on private consumption, while private investment has been held back by higher interest rates and lower confidence. Public investment has decreased but public consumption has remained supportive. External demand has also supported growth, although mainly related to lower imports in the face of falling domestic demand.
Figure 2.1. Growth and confidence declined in 2022 and early 2023
Note: Panel A: Year-on-year GDP growth of non-seasonally adjusted GDP, and contributions of expenditure-side components. The Hungarian Central Statistical Office (HCSO) does not provide additive contributions of expenditure-side components to quarter-on-quarter seasonally-adjusted GDP growth. Panel C: Capacity utilisation is shown as a percentage-point deviation from its long-term (2005Q1-2023Q2) average, and the output gap is expressed in percentage points of potential output.
Source: Panel A: Hungarian Central Statistical Office (HCSO); Panel B and Panel C (capacity utilisation): European Commission (Joint Harmonised EU Programme of Business and Consumer Surveys); Panel C (output gap): OECD Economic Outlook 114 Database.
The labour market has held up well
Despite the contraction in output, the labour market has remained tight. The unemployment rate bottomed out at 3.5% in June 2022 at the peak of the recovery from the pandemic. It has increased again since, but this increase has been marginal and unemployment is only slightly higher than in 2019 amid a high number of job vacancies (Figure 2.2). Especially large firms have been hoarding labour despite the slowdown, possibly anticipating future hiring difficulties as the working-age population declines due to ageing, and supported by a recent strength in corporate profits (Magyar Nemzeti Bank, 2023, pp. 70-74[1]).
Figure 2.2. Despite plummeting economic activity, the labour market remains historically tight
Note: Unemployment refers to Labour Force Survey (LFS) unemployment.
Source: OECD Database on Short-Term Labour Force Statistics.
This tight labour market is putting pressure on wages and policies have exacerbated these pressures. The minimum wage was raised by 19.5% in January 2022, well above the 8% inflation rate at the time (Figure 2.3, Panel A). This marked the most significant minimum wage increase in the European Union (EU) in 2022, both in nominal and in real terms, albeit mitigated by a reduction in employers’ social contributions. Wage increases and one-off transfers to many civil servants extended this strong wage growth to the public sector. As a result, the year-on-year real wage growth in the total economy exceeded 20% in February 2022.
This strong wage increase was not sustained over time and year-on-year real wage growth turned negative in September 2022, thus adding no further pressure on inflation and leading to a decline in private consumption (Figure 2.3, Panel B). Similarly, the January 2023 nominal minimum wage increase of 16% fell short of inflation, at 25.7% between January 2022 and January 2023. Nevertheless, the minimum wage was raised again by 15% in December 2023, well above the inflation rate of 5.5% over the previous year.
Looking ahead, well-defined rules for minimum wage adjustments, based on advice from an independent expert commission, such as those existing in France, Germany, and Spain, may improve the transparency and predictability of minimum wage increases in Hungary, even though the exact combination of expert advice, pre-defined rules and negotiation between social partners may be adapted to national circumstances. The recent bout of inflation has raised questions about how to sustain the purchasing power of minimum wage workers without fueling inflation. Productivity growth would be a useful benchmark for future real minimum wage adjustments. At 40% of the average wage in 2021, the minimum wage level in Hungary is below the indicative reference level of 50% mentioned in the 2022 EU Directive on minimum wages (Eurofound, 2023[2]). Formal discussions involving social partners, the government and possibly an independent expert commission, would help clarify how the minimum wage should be revised in the coming years, in view of inflation and productivity developments, and the average wage level in the economy.
Figure 2.3. Strong wage growth fuelled inflation in early 2022
Note: The two opposite spikes in real wage growth in February 2022 and 2023 are related to one-off transfers to civil servants in February 2022.
Source: Panel A: Eurofound (2023[3]), Panel B: Hungarian Central Statistical Office (HCSO) and OECD calculations.
Inflation is receding after a record increase
Inflation increased continuously from mid-2021 to a peak of 25.7% in January 2023, a level not seen in over 25 years. Rising inflationary pressures were initially due to international factors such as increasing commodity prices and supply-chain bottlenecks following the COVID-19 pandemic, and the overheating of the economy, exacerbated by the income support policies implemented in early 2022, including large increases in the minimum wage and public sector wages, accompanied by income tax cuts. The surge in global energy and food prices following Russia’s war of aggression against Ukraine then amplified these price pressures. Compared to neighbouring countries like Czechia, Poland and the Slovak Republic, inflation was stronger in Hungary, partly related to the depreciation of the currency, and lasted longer (Figure 2.4, Panel A). Headline inflation declined to 3.8% in January 2024, but core inflation excluding food and energy remains high, at 7.9%.
The difference in timing and amplitude of inflation in Hungary compared to neighbouring countries is largely related to food and energy prices. Food and the closely related hospitality services prices accounted for 12 percentage points of the 25.7% inflation rate prevalent in January 2023 (Figure 2.5). In early 2023, these prices explained two thirds of the inflation gap between Hungary and the neighbouring countries, and their strong increase was closely related to the behaviour of agricultural prices (Box 2.1). The exceptional food price inflation in Hungary contributed 2.5 times more to inflation than retail energy prices, which did not rise much until price caps implemented by the government were relaxed in August 2022 for electricity and heating gas, and in December 2022 for motor fuels. Inflation of other goods and services was more in line with developments in neighbouring countries. Looking ahead, the pace at which inflation will recede for these core items will be key to bring inflation under control.
Figure 2.4. Headline inflation has declined but core inflation remains high
Note: Panel A refers to HICP inflation, which is the harmonised measure of inflation in the EU. Panel B refers to national CPI inflation. While this may not be the case for all countries, HICP and national CPI inflation measures for Hungary are usually very close to each other.
Source: Eurostat Database on Harmonised Indices of Consumer Prices (HICP), OECD Database on Consumer Price Indices
Figure 2.5. Recent inflation in Hungary has been largely driven by food prices
Note: Figure 2.5 refers to national CPI inflation. “Food” covers food and non-alcoholic beverages (COICOP 01). “Energy” covers electricity, gas and other fuels, as well as fuels and lubricants for personal transport equipment (COICOP 04.5 and 07.2.2).
Source: OECD Database on Consumer Price Indices.
Box 2.1. Explaining high food price inflation in Hungary
Final food prices are affected by many intermediaries along the food supply chain, but almost 80% of cross-country differences in food price inflation between the last quarters of 2019 and 2022 can be explained by divergences in agricultural producer prices. Agricultural prices rose by less than 45% in the EU over this period, but increased by nearly 120% in Hungary (Figure 2.6, Panel A).
One likely factor behind this is the drought that affected Hungary in 2022, but there were also striking differences in the development of agricultural input prices between Hungary and the EU. These grew by 53% in the EU, but they doubled in Hungary, mostly driven by fertilisers and animal feeding stuff (Figure 2.6, Panel B).
Figure 2.6. Higher agricultural input price growth led to higher food price inflation in Hungary
Note: Panel A: Each dot represents an EU country. Panel B: The histogram breaks down the difference in agricultural input price growth between Hungary (100%) and the EU (53%) into contributions from specific inputs. Fertilisers and animal feeding stuff contributed for most of this difference. The "other" category includes energy and lubricants, other goods and services, plant protection products and pesticides, and seeds and planting stock.
Source: Eurostat database on Agricultural Prices, OECD database on Consumer Price Indices, and OECD calculations.
The war in Ukraine increased global fertiliser prices by cutting off major producers Belarus and Russia from global supply chains and raising the price of energy, a key input for fertilisers (Hebebrand and Glauber, 2023[4]). Recent estimates suggest that an increase in fertiliser prices by 10% leads to an average increase of 2% in agricultural prices (OECD/FAO, 2023[5]). Applying this result, the 190pp difference in fertiliser price growth between Hungary and the EU over 2019-2022 can explain a 40pp higher agricultural price growth in Hungary and a 20pp higher food price increase for final consumers (Figure 2.6, Panel A).
What can explain differences between Hungary and other EU countries? One explanation is the 25% depreciation of the Hungarian forint against the euro over the period 2019-2022, but it is unlikely to explain observed discrepancies in agricultural input prices. Another potential explanation relates to rising profit margins in the Hungarian manufacturing sector in 2022 (Magyar Nemzeti Bank, 2023, pp. 49-51[6]), which may have pushed up prices of agricultural inputs from the manufacturing sector such as fertilisers and animal feeding stuff, as well as processed food prices further down the value chain. Macroeconomic series are indeed consistent with rising profits in manufacturing, but not in agriculture, which indicates that agricultural prices were mostly driven by rising input prices, and not by rising producer margins (Figure 2.7). Similarly, there is no evidence that retailers contributed to a wider gap between agricultural and retail food prices in 2022.
Figure 2.7. Aggregate profits increased in 2022 in manufacturing, but not in agriculture or trade
Gross operating surplus over value added at factor costs, %
Note: Mixed income was split between gross operating surplus and labour income by imputing to self-employed workers the same hourly compensation as employees working in the same sector.
Source: Hungarian Central Statistical Office (HCSO, quarterly national accounts), OECD calculations
The disproportionate increase in food and energy prices in 2022 implied stronger real income losses for low-income households, who generally tend to spend more on food and energy. Households in the lowest income quintile faced a 4.4 percentage point higher inflation rate than households in the highest income quintile in December 2022, when food price inflation peaked and energy price inflation was increasing due to the phasing out of motor fuel price caps (Figure 2.8).
Figure 2.8. Inflation disparities between household income quintiles
Year-on-year inflation gap between the highest and lowest income quintiles, December 2022
Note: This chart follows the same methodology as (Causa et al., 2022[7]). It mostly accounts for the fact that expenditure shares for aggregate items such as food and non-alcoholic beverages, clothing and footwear, and transport differ across household income quintiles. Nevertheless, it does not account for very detailed consumption patterns, such as a higher consumption by poorer households of necessity products covered by food price caps. In this sense, the figure provides an upper bound of the inflation gap faced by poorer households due to food price inflation in Hungary. Results for comparator countries were updated to December 2022 while (Causa et al., 2022[7]) presented results for August 2022.
Source: Household Budget Surveys from the Hungarian Central Statistical Office (HCSO) and the national statistical offices of DEU, CZE, GBR and ITA; OECD calculations.
After a decline in 2023, economic activity is projected to pick up in 2024
Economic activity declined by 0.9% in 2023, mainly driven down by private consumption and investment in the first part of the year. The decline in energy and food prices, as well as economic activity, pulled down headline inflation from 25.7% in January to 5.5% in December 2023, supporting a gradual pickup in household real income and consumption in the second semester. Since core inflation, excluding food and energy, remains at 7.9% in January 2024, monetary policy easing may only be gradual. This, and the uncertainty related to the international environment, exchange rate developments and the release of EU funds (see below) will continue to hold back investment in 2024. Due to slow growth in Hungary’s main trading partners including Germany, exports are expected to pick up only progressively in 2024 and 2025. While international trade had a strong positive contribution to economic growth in 2023 due to the significant decline in imports, this contribution will be lower in 2024 and 2025 due to imports increasing along with the pick-up in economic activity (Table 2.1).
Table 2.1. Macroeconomic indicators and projections
Note: 1. Contribution to changes in real GDP; 2. As a percentage of potential GDP.
Source: Hungarian Central Statistical Office (HCSO), OECD projections.
The growth outlook is subject to significant risks
A key source of uncertainty is the pace at which inflation will recede. While headline inflation peaked in January 2023, its decline in the following months was largely related to lower food and energy prices. Core inflation, excluding food and energy, has only been declining since April 2023, at a slow pace. If core inflation proved more entrenched than expected, the Central Bank would need to keep rates high for longer, affecting consumption and investment. A subsequent new surge in energy prices could have similar effects, while also straining Hungarian public finances, given the utility price cap that is currently in place.
Another major risk to the outlook is related to the delivery of EU funds which have been subjected to the implementation of rule-of-law reforms by Hungary (Box 2.5). These funds may have a signalling effect stretching far beyond their direct impact on public finances and investment. For example, rating agencies consider the uncertainty about EU funds as one of the key factors underlying their sovereign rating of Hungary (Fitch Ratings, 2023[8]). Setbacks in the negotiations with the EU may curb investor confidence, increase the cost of capital and put renewed pressure on the exchange rate, with negative implications for inflation and investment.
Financial sector risks, which include a potential deterioration of loan portfolios amid high business exits, may curb credit growth and could lead to lower growth outcomes, as discussed below.
Table 2.2. Events that could lead to major changes in the outlook
Monetary policy easing should be gradual
Price controls only managed to delay inflationary pressures
Price caps on gas, electricity and motor fuel prices have been the initial policy response against rising global energy prices up until mid-2022 (Box 2.2). The subsequent partial removal of energy price caps in the second half of 2022 then triggered an increase in headline inflation, similar to earlier developments in neighbouring countries. This delayed increase in retail energy prices explains why energy inflation did not decline in the first part of 2023, unlike elsewhere in Europe. Overall, energy price caps only managed to delay inflationary pressures while proving costly for the government budget due to their weak targeting.
Food price caps were more targeted on necessity items and provided some relief for low-income households, but they did not address the problem at its root and failed to contain food price inflation more widely. Food inflation became widespread and exceeded 40% for half of the food and beverage items in the household expenditure basket in December 2022. Rising retail margins on select substitute items for those subject to price caps may have somewhat reduced the effectiveness of price caps, but there is no evidence that retail margins increased overall between 2021 and 2022 (Figure 2.7) (GVH, 2023[9]).
Box 2.2. Food and energy price caps in Hungary
The government implemented different price cap mechanisms aimed to contain energy and food prices:
Utility price cap: Gas and electricity prices for households have been capped since 2014, but the caps were removed for the part of gas and electricity consumption exceeding the national average in August 2022.
Motor fuel price cap: Motor fuel prices were capped from November 2021 until December 2022. Coverage was initially universal, then narrowed to residents only in July 2022. The cap eventually ended earlier than initially planned in December 2022 amid supply shortages.
Food price cap: Prices of seven basic food products were capped at their October 2021 level in February 2022, and further caps on potatoes and eggs followed in November 2022. Caps affected around 2.5% of the total consumer basket, or 10% of households’ annual expenditure on food and non-alcoholic beverages (Balatoni, 2022[10]). All food price caps were eventually removed in August 2023. However, these products may still not be sold at a higher price than the purchaser price paid by retailers.
Monetary policy has tightened
Monetary policy started to tighten in mid-2021 when the first signs of increasing inflation appeared. The Central Bank progressively raised its base interest rate from 0.6% in June 2021 up to 13% in September 2022, marking the highest Central Bank base interest rate in the EU (Figure 2.9). In addition, all unconventional monetary policy measures related to the COVID-19 pandemic were phased out by December 2021.
Figure 2.9. The Central Bank significantly raised interest rates after mid-2021
Source: Hungarian Central Bank (MNB).
Monetary policy tightening stepped up in October 2022 amid an accelerating depreciation of the currency. Between February and October 2022, the forint had lost 35% against the US dollar and 17% against the euro (Figure 2.10). The Central Bank reacted by increasing the overnight deposit rate (or one-day quick deposit tender), which then became the effective monetary policy rate, to 18%. Compared to the base interest rate, this overnight rate could be increased more quickly and abruptly, which made it an efficient tool to restore financial market stability and stop financial outflows leading to currency depreciation. This decision stabilised the exchange rate and triggered an appreciation against the US dollar and the euro, by 24% and 14% over the next six months, respectively.
Figure 2.10. The currency depreciated sharply in October 2022 but has recovered ground since then
Note: Inverted scale.
Source: OECD Main Economic Indicators (MEI).
This interest rate increase was complemented with higher minimum reserve requirements as of October 2022. This helped to limit credit supply more directly and maintain an effective credit channel for the transmission of monetary policy in a context of significant credit volumes subject to subsidised and capped interest rates (Box 2.3). New loans began to decelerate significantly in mid-2022, driven by both tighter lending standards and declining credit demand by households and firms (Figure 2.11) (Magyar Nemzeti Bank, 2023[11]).
Figure 2.11. Credit distribution to households and firms slowed down markedly
Note: The volumes of new loans to corporations and households have been calculated by deflating the corresponding values by the Hungarian quarterly CPI (2015 = 100). In Panel A, the volume of new loans to corporations is shown as a moving average over the last four quarters.
Source: Hungarian Central Bank (MNB), OECD calculations.
Until inflation is fully under control, monetary policy should remain cautious
The Central Bank started to ease monetary policy as of May 2023 by progressively decreasing the interest rate on the one-day quick deposit tender and reducing the gap with the base interest rate. This decision was appropriate because pressures on the exchange rate had eased, headline inflation had peaked in January 2023, and base effects were contributing to a faster decline in inflation in the second half of 2023.
The interest rate on the one-day quick deposit tender and the base interest converged at 13% in September 2023 and were further reduced by step to 10% in January 2024(Figure 2.9).
Continuing the gradual and moderate pace of monetary easing seems appropriate given the recent decline in inflation. Nevertheless, significant uncertainties remain. These include the evolution of global energy and food prices, which in turn depends on geopolitical developments and the global economic outlook, the speed at which core inflation will recede, and the evolution of the negotiations with the EU on the delivery of EU funds (see above). These uncertainties are reflected in the dispersion around the inflation projections of professional forecasters. They anticipate on average that inflation will be close to the Central Bank’s target of 3% within two years, but there is wide disagreement among them (Figure 2.12). While forecast dispersion used to be limited and similar for Hungary and the euro area before the pandemic, it is now much higher for Hungary. This may suggest that the anchoring of inflation expectations has weakened in Hungary more than in the euro area.
In this context, the Central Bank will need to remain vigilant and stand ready to keep monetary policy tighter for longer if upside inflation risks materialise. Fully anchoring inflation expectations, especially in the short term, is key to avoid a wage-price spiral and ensure that core inflation will recede (Jordà and Nechio, 2023[12]). The Central Bank should also be ready to pause monetary policy easing if needed, potentially due to renewed tensions on the exchange rate, in relation to interest rate developments outside Hungary or a lack of progress in the negotiations with the EU.
Figure 2.12. The anchoring of inflation expectations in Hungary is more fragile than before COVID
Inflation expectations, Hungary and Euro area, July 2019 and 2023
Source: Consensus Economics, OECD calculations.
Financial stability risks require vigilance
The housing market is turning down but credit default risks seem to be limited
Rising interest rates and declining consumer confidence have contributed to a downturn in the housing market that became visible from mid-2022 onwards. Nominal house price growth is slowing and real house prices are declining all over the country, and even more so outside the capital Budapest (Figure 2.13). In real terms, year-on-year house price growth in early 2023 was negative in all Hungarian regions.
Figure 2.13. Real house prices are declining
Source: OECD Database on National and Regional House Price Indices.
During the Great Financial Crisis (GFC) of 2008-09, the main factors that contributed to mortgage default risks in Hungary were the high share of mortgages denominated in foreign currency, the initial debt overhang of households and, to a lesser extent, the increase in unemployment (Balás, Banai and Hosszú, 2015[13]). Since then, the situation has changed markedly. In 2015, Hungary mandated the conversion of foreign-currency denominated mortgages into forint-denominated loans and restricted the possibility for households to take out new foreign-currency denominated loans. As a result, the share of foreign-currency households’ loans was 0.5% at the end of 2022, down from nearly 70% in early 2009 (Figure 2.14, Panel A). Moreover, tighter lending standards from 2009 onwards and the introduction of macroprudential measures by the Central Bank as of 2015 led to a decrease in the loan-to-value (LTV) ratio of new mortgages, thus limiting the debt overhang of households (Figure 2.14, Panel B). Finally, the share of variable-interest rate loans in the stock of outstanding households’ loans had come down to around 20% in late 2022, down from nearly 70% in early 2017 (Figure 2.16).
Figure 2.14. Credit policy has become more prudent and is expected to limit mortgage risks
Source: Central Bank of Hungary (MNB).
Non-performing loans are expected to increase, driven by business failures
Business failures have started to increase rapidly in 2022, driven both by the end of exceptional measures taken during the pandemic and the economic downturn. The construction sector was particularly hit by rising debt servicing costs and declining economic activity, followed by the trade sector, which suffered from the inflation-related decline in household consumption (Figure 2.15). Business failures in the construction sector were 2.5 times higher in the fourth quarter of 2023 than before the pandemic. Similarly, they were 40% higher than before the pandemic in the trade sector (Figure 2.17).
Figure 2.15. Economic activity has declined, especially in the construction and trade sectors
Value added, year-on year growth, %
Source: OECD Database on Quarterly National Accounts.
Contrary to household loans, most corporate loans in Hungary are subject to variable interest rates. The average interest rate on outstanding corporate loans increased significantly following the start of the monetary policy tightening cycle in June 2021, denting corporate profits (Figure 2.16). SMEs are slightly less exposed to rising interest rates than larger firms due a lower share of variable interest rate loans and because they can benefit from subsidised loans (Box 2.3).
Figure 2.16. Monetary policy tightening has pushed up interest rates on loans
Source: Hungarian Central Bank (MNB).
Box 2.3. Subsidised and capped interest rate loans in Hungary
Subsidised loans
The government provides subsidised loans to households with children, including prenatal baby support loans and loans granted in relation to the Home Purchase Subsidy Scheme for Families (HPS). The former accounted for 19.5% and the latter for 7% of outstanding household loans in late 2022. From 2024 onwards, subsidised loans will undergo significant changes. The HPS will be largely phased out except in rural areas, and the prenatal baby support loans will only be available to couples where the woman is below 30, with a temporary exception for women below 41 who are already pregnant in 2024. In 2024, a new HPS Plus Programme will be launched, which will provide housing loans with discounted fixed interest rates of at most 3% to married couples that agree having additional children in the future. Beyond the second child born while participating in the Programme, families will be granted a further HUF10 million in debt relief.
Subsidised loans are also available to corporations, mainly SMEs. They can be obtained from the Central Bank or the government and their share in newly subscribed loans increased significantly during the pandemic. Since the phasing out of the Central Bank’s Funding for Growth Scheme in September 2021, only government subsidised programmes are available. The interest rate differential vis-à-vis market lending can be substantial. For example, SMEs can obtain forint-denominated loans at an interest rate of 5% under the current Széchenyi Card Program in 2023.
Capped interest rate loans
Variable-interest rate mortgages and government-subsidised loans which were supposed to undergo interest rate revisions have been subjected to interest rate caps from December 2021. The cap was extended to mortgages with a period of fixed interest rates of up to 5 years and non-overdraft forint-denominated SME loans in November 2022, and to some student loans in January 2023. Interest rates on eligible mortgages are capped at their October 2021 level, and those on SME loans are capped at their June 2022 level. The cost of these caps are borne by banks.
The share of non-performing loans (NPLs) is already higher than the OECD average and expected to rise further in view of the rapidly rising number of business failures (Figure 2.17) (Figure 2.18, Panel A).
Hungarian banks are capitalised with more than twice the international capital Pillar I capital requirement of 8%, although slightly below the OECD average (Figure 2.18, Panel B). In view of the deteriorating economic environment, they have started to increase loan provisioning in 2022 and the Central Bank expects this trend to continue in 2023. The Central Bank’s latest stress tests show that while bank capital buffers would be significantly reduced in a scenario of GDP declining by 4% in 2023, there would be no capital shortage (Magyar Nemzeti Bank, 2023[11]). Nevertheless, the Central Bank should closely monitor business failures and their impact on non-performing loans. Tighter macro-prudential policies for sectors facing economic difficulties may limit a further build-up of non-performing loans.
Along with rising interest rates in Hungary, the demand for corporate loans has shifted towards foreign-currency (FX) loans (Figure 2.11, Panel A), which may increase currency mismatch risks. Analysis by the Central Bank, however, suggests that the majority of corporates borrowing in foreign currency have export revenues that limit the credit risk for banks (Magyar Nemzeti Bank, 2023[11]).
Figure 2.17. Business failures have increased
Note: Business failures are defined as the sum of forced deletions and liquidations. Forced deletions correspond to the removal of economically inactive businesses from the business register, without any judiciary procedure. These forced deletions were temporarily suspended during the pandemic. Moreover, the 2021 insolvency law stipulates that, from June 2022 onwards, forced deletions cannot occur when total claims against a company exceed HUF 400,000, thus turning cases that were previously handled as forced deletions into liquidations. Therefore, the recent increase in business failures, defined as the sum of forced deletions and liquidations, may be partly related to the resorption of the backlog of forced deletions accumulated during the pandemic. Under the 2021 insolvency law, these accumulated cases may give rise to forced deletions or liquidations depending on business claims.
Source: Hungarian Central Statistical Office (HCSO), OECD calculations.
Figure 2.18. Non-performing loans are higher and bank capitalisation slightly lower than the OECD average
Non-performing loans to gross loans, %
Note: Panel A: All credit institutions, and all loans granted to both domestic and foreign borrowers (households, non-financial and financial corporations) are covered.
Source: IMF Database on Financial Soundness Indicators.
Table 2.3. Past recommendations on monetary policy and financial stability
Source: (OECD, 2021[14]), Government of Hungary.
Fiscal policy needs to further consolidate
As in most OECD countries, the COVID-19 pandemic led to a substantial deterioration of Hungary’s fiscal position, both in terms of the fiscal deficit and public debt (Figure 2.19). The structural primary balance deteriorated by 3.2 percentage points (pp) of GDP between 2019 and 2021. Public debt peaked at 79% of GDP in 2020 and has declined since then. Nevertheless, it is projected to remain above its pre-pandemic level in 2025 (Figure 2.20). In the coming years, fiscal policy will be constrained by the Hungarian fiscal framework which imposes that government budgets put public debt on a downward trajectory as long as it is above 50% of GDP (Box 2.4).
Box 2.4. Hungary’s fiscal framework
Hungary’s fiscal framework is based on three different laws.
The debt brake rule included in the Constitution stipulates that, as long as public debt is above 50% of GDP, Parliament may only adopt a budget that is consistent with a decline in the debt-to-GDP ratio. The government may only derogate to this rule in special circumstances such as a GDP decline, and only to an extent that is justified by these circumstances.
The Act on Public Finances sets as an obligation for the government to release revenue, expenditure and public debt projections for the next three years with each annual budget.
The Stability Act describes the functioning of the Fiscal Council. It is an independent fiscal institution in charge of monitoring compliance of the budget with the constitutional debt break rule. It informs the Parliament before the budget is voted. If the Fiscal Council formulates a negative advice, the government has to reconsider the draft budget.
Since 2015, the government has submitted the budget of the following year to the Parliament every year in June. This early submission process has the advantage of managing market expectations well in advance. Nevertheless, the macroeconomic assumptions underlying the budget have sometimes been revised even before the budget started to be executed.
Figure 2.19. Fiscal policy expanded during the pandemic but remained accommodative for long
Government budget balance, % of GDP
Note: Except when tax innovations are introduced, government revenues tend to track GDP very closely. By contrast, in absence of spending innovations, the level of government expenditure tends to be stable over the business cycle. Since government expenditure represents around 50% of GDP, the government expenditure-to-GDP ratio decreases by 0.5 percentage point when GDP increases by 1%. This explains the difference between the headline and the structural (cyclically-adjusted) deficit-to-GDP ratios. Tax and spending innovations are reflected to the same extent in both ratios, but the structural deficit-to-GDP ratio controls for business cycle effects. Finally, the structural primary deficit excludes debt servicing costs. All details of the OECD methodology are explained in (Price, Dang and Botev, 2015[15]).
Source: Hungarian Central Statistical Office (HCSO), OECD
At 6.2% of GDP, the 2022 headline fiscal deficit remained 4.2pp of GDP above its 2019 level, despite the removal of most pandemic-related measures. While profit taxes in specific economic sectors enhanced revenues by 1.3pp of GDP, the deficit widened due to the reduction in employers’ social contributions (2pp of GDP since 2019), the introduction of a reduced VAT rate on new housing and a reduced business tax for SMEs (0.4pp of GDP), higher debt servicing costs (0.6pp of GDP), and new measures related to the war in Ukraine and the surge in energy costs. Even without accounting for the latter, the fiscal stance in 2022 remained accommodative despite the fact that the economy was running above potential with a positive output gap, which contributed to higher inflation (Figure 2.1, Panel C). Measures taken to mitigate the impact of the war in Ukraine included significant additional energy subsidies to households and small firms worth 1pp of GDP. Moreover, the government purchased natural gas reserves to bolster energy security, at a cost of 1.2pp of GDP, which was recorded as a deficit-augmenting transaction according to EU accounting rules.
It is estimated that the headline deficit recorded a further increase in 2023, to 6.5% of GDP. On the revenue side, the sale of agricultural land owned by the government (0.4pp of GDP) and a further increase in sectoral profit taxes (0.9pp of GDP) contributed to the fiscal consolidation. These temporary windfall taxes concern the banking, insurance, energy, retail, telecommunication, aviation, and pharmaceutical sectors. Nevertheless, the decline in private consumption led to a fall in VAT revenues (by 1.2pp of GDP). On the expenditure side, it is estimated that the share of public consumption and investment in GDP declined by 0.4pp, along with the share of various capital transfers (by 0.6pp). Moreover, the exceptional purchase of gas reserves was not repeated, saving 1.2pp of GDP. At the same time, it is estimated that energy-related subsidies increased by 1.5pp of GDP and debt-servicing costs by 1pp of GDP, due to rising interest rates.
In 2024, the deficit is expected to fall to 4.5% of GDP. On the revenue side, the partial phasing out of temporary windfall taxes and the expected decrease in property income will reduce revenues by 0.8pp and 0.5pp of GDP, respectively. At the same time, the expected rebound in private consumption is expected to increase VAT revenues (by 0.8pp of GDP). On the expenditure side, the main measures are expected reductions in public consumption, public investment, and energy subsidies, due to lower energy prices, by 0.3pp, 1.1pp and 1.2pp of GDP, respectively. At the same time, debt-servicing costs are expected to increase by 0.3pp of GDP.
Based on the Convergence Programme released in the spring of 2023, all temporary windfall taxes are expected to be removed in 2025, which will reduce revenues by 1.4pp of GDP compared to 2024. Moreover, VAT revenues would revert back to their usual level as a share of GDP. At the same time, public consumption and investment are expected to decline by 1.2pp of GDP all together, along with debt servicing costs and capital transfers, by 1.0pp of GDP. As a result, the fiscal deficit is expected to narrow to 3.4% of GDP in 2025.
Even though, according to the latest estimates, the headline fiscal deficit increased marginally from 6.2% to 6.5% of GDP between 2022 and 2023, the fiscal consolidation was significant in cyclically adjusted terms, with a reduction in the structural primary deficit from 4.4% to 2.2% of GDP. Looking ahead, further fiscal consolidation is needed to align fiscal policy with monetary policy efforts to curb inflation, strengthen public debt sustainability, and recreate fiscal space to finance ageing-related expenditures and the green transition (see below). Nevertheless, three factors are likely to complicate this task: rapidly increasing debt servicing costs, the sensitivity of the budget to fluctuations in international energy prices, and the uncertainty around the delivery of EU funds.
Debt servicing costs are increasing rapidly
With higher debt, higher inflation and higher interest rates, debt-servicing costs are expected to increase by 1.3pp of GDP between 2022 and 2024 (Figure 2.20, Panel A). The average debt maturity of 6.1 years in 2022 remains below the OECD average of 8.2 years, despite an increase from 4.1 in 2012 (OECD, 2023, pp. 37-38[16]). With the current levels of public debt and public debt maturity, a permanent interest rate increase of 1 percentage point translates into higher debt servicing costs by 0.8 percentage point of GDP after 6 years.
The share of foreign-currency denominated public debt has been adequately kept below 40% since 2016, which is much lower than in the early 2010s, but it has been trending upward since 2020 (Figure 2.20, Panel B). This share should be maintained low in order to limit the currency-risk exposure of public debt amid significant exchange rate volatility.
Figure 2.20. Debt servicing costs are rising, but debt is mostly in domestic currency
Note: 2023-2025 (dashed lines): OECD projections.
Panel A: The share of foreign-currency (FX) denominated debt in total public debt is calculated as an annual average for each year except 2023 where it is calculated as an average between January and October.
Source: OECD projections, Public debt management agency (AKK, https://akk.hu/statistics/public-debt-finance/central-government-gross-debt).
Winding down energy price caps to support the green transition and relieve public finances
As a landlocked country with a high dependence on fossil fuels imported from Russia, the energy price shock triggered by the war in Ukraine hit Hungary hard. Similarly to neighbouring countries, Hungary initially opted for large untargeted price caps to limit the increase in energy prices (Box 2.2). Vulnerable households without financial buffers might otherwise have been forced to take up high interest rate debt or reduce consumption in a way that would have durably affected their welfare (Hill, Skoufias and Maher, 2019[17]).
With an estimated cost of 2.5% of GDP in 2023, energy price caps have been very costly for the government budget, and one of the most expensive energy support measures implemented in OECD countries (Hemmerlé et al., 2023[18]). Looking ahead, the programme in place also exposes the budget to fluctuations in international energy prices in the coming years, even though the cost of subsidies is expected to decline in 2024.
Beyond any short-term fluctuations, a trend increase in energy prices is also required to curb CO2 emissions and master the transition towards greener growth. This is likely to require additional support for low-income households, while at the same time maintaining energy-saving price signals and minimising the budget impact. General energy price caps will not be an effective way to achieve these objectives. The recent easing of energy prices provides a window of opportunity to phase out existing utility price caps. Some targeting has already been achieved by restricting this cap to the part of household energy consumption that is below the national average, but more should be done.
Targeted cash transfers based on households’ exposure to rising energy prices can avoid creating incentives to consume energy and should become the preferred policy tool (Hemmerlé et al., 2023[18]). Only relying on household income to decide whether support is needed may be insufficient as vulnerability to high energy prices depends on different factors such as living in an energy-inefficient home, limited access to cheaper forms of energy, and having higher-than-average energy needs due to ageing, illness, or living in rural areas and having limited transport alternatives to driving a car. Such criteria can be used to estimate the energy needs of households and calculate support.
The availability and combination of different data sources was a key factor behind many countries’ efforts to implement targeted support measures during the recent energy crisis. For example, Denmark combined information on households’ heating systems available on the national real estate register with income data to identify the households that should be granted heating cheques. Moreover, the United Kingdom provided households with an automatic Cold Weather payment for each 7-day period of cold weather by linking postal code data to information from local weather stations (Hemmerlé et al., 2023[18]). These two examples highlight the need to put in place statistical information systems that are able to combine information from multiple data sources and identify the right set of beneficiaries and support levels. Well-targeted cash transfers to households can complement other policies to address households’ vulnerabilities in the long term, such as policies to support housing energy efficiency improvements (see Chapter 5).
Reaching a final agreement regarding the delivery of EU funds is key
EU funds, of which the currently blocked Cohesion and RRP funds represent the largest part, are expected to contribute 2.2% of GDP to public revenues in 2023 and 1.8% in 2024.
Hungary and the EU signed a Partnership Agreement on the delivery of EU Cohesion funds over the period 2021-27 and the EU approved Hungary’s Recovery and Resilience Plan (RRP) at the end of 2022. However, the agreement also imposed conditions before most funds can be delivered to Hungary. €21.2 billion of EU funds (12.7% of 2022 GDP) are subject to the implementation of reforms by Hungary (Box 2.5).To avoid that the negotiations with the EU delay important investments for Hungary, the government has decided to pre-finance some projects that are expected to be eventually covered by EU funds. Indeed, Cohesion and RRP funds are planned to finance key investments for Hungary in the context of the green and digital transitions (Figure 2.21).
An incomplete disbursement of EU funds would imply a higher fiscal deficit or reduced investment. By contrast, a simple delay in receiving these funds would not by itself contribute to increase the deficit because the fiscal balance is calculated on an accrual basis and not a cash basis. Nevertheless, there are limits to the expenditures that the government can prefinance in practice because this requires borrowing money and generates interest expenses.
As discussed above, a failure or a significant delay in finalising the negotiations with the EU may also affect investor confidence, and lead to negative economic consequences such as renewed pressures on the exchange rate that may significantly outweigh the direct accounting impact on public finances.
Box 2.5. The uncertainty around the delivery of EU funds to Hungary
Several parallel and interrelated strands of negotiations are currently underway regarding the delivery of EU funds to Hungary.
Negotiations about Hungary’s Recovery and Resilience Plan (RRP) concern €10.4 billion of grants and loans to be delivered in several disbursements by mid-2026. The first part of the RRP, covering €5.8 billion of grants, was approved in 2022. In December 2023, the Council of the European Union has approved an amendment introducing a RePowerEU chapter to the original RRP, covering €0.7 billion of grants and €3.9 billion of loans.
Separate negotiations concern Hungary’s Cohesion Funds for the period 2021-27. In December 2023, the EU agreed to unblock €10.2 billion following a positive assessment of the new legislation concerning the independence of justice. Nevertheless, €10.8 billion of Cohesion Funds remain blocked and their delivery is subject to different conditions.
Altogether, the currently blocked EU funds represent €21.2 billion, or 12.7% of Hungary’s 2022 GDP.
Two different parts of Cohesion Funds can be distinguished depending on the conditions preventing their delivery. A first part is subject to 17 conditions (also called “remedial measures”) related to the rule of law and a second part is subject to conditions related to academic freedom and child protection.
Even after the fulfilment of the conditions regarding the independence of justice, the delivery of RRP funds, including RePowerEU funds, is still subject to 23 remaining “super-milestones”. They include all conditions preventing the delivery of the first part of Cohesion Funds (i.e. 17 remedial measures reorganised into 21 milestones) and 2 RRP-specific milestones. Out of the initial 27 super-milestones, 4 have been fulfilled with the new legislation on the independence of justice. In December 2023, Hungary received €0.8 billion of the expected €0.9 billion to prefinance 20% of the expenditures covered in the RePowerEU chapter. While this prefinancing is not subject to any condition, it will be deducted from future regular payment requests which are conditional on the fulfilment of the remaining 23 super-milestones and of the respective measures in the updated RRP.
Figure 2.21. Hungary’s planned allocation of RRP grants over 2023-26
Source: (European Commission, 2022[19]).
Improving the tax system
Tax revenues in Hungary represented around 35% of GDP in 2021, which is close to the level observed in other Central and Eastern European (CEE) countries and the OECD as a whole (Figure 2.22). Compared to other CEE and OECD countries, a larger share of Hungary’s tax revenues comes from taxes on goods and services, while the share of income taxes is below the OECD average. Higher taxes on goods and services are largely related to a higher standard VAT tax rate (27%) and a relatively low VAT compliance gap, following significant improvements over the last decade (Figure 2.23, Panel A). Despite the progress made, there may be scope for making the tax system more conducive to growth and employment, through revenue-neutral tax reforms.
Figure 2.22. Hungary relies more on VAT and less on income taxes than OECD peers
Structure of tax revenues in 2021 (% of GDP)
Source: OECD Database on Revenue Statistics.
Turnover taxes should be phased out
In addition to VAT, taxes on goods and services also include business taxes levied on turnover rather than income (Figure 2.23, Panel B). Such taxes should be phased out over time, as they increase the price of intermediate consumption. This may lead companies to substitute untaxed imported inputs for domestic inputs, use other inputs that are less productive but less taxed, or vertically integrate to avoid paying the tax. Whenever firms along the value chain charge higher prices due to the turnover tax, cascading effects may occur because input prices are higher at each stage. Given their cumulative nature, turnover taxes may end up being much larger than their marginal rate in downstream sectors at the end of the production chain. Turnover taxes on products that are used at each stage of the production chain, such as taxes on telecommunication and financial services in Hungary, should be the first to be phased out because they are the most likely to cumulate. In France, turnover taxes have been found to increase production prices in downstream sectors by up to three times the marginal tax rate due to cascading effects. This has implications for productivity and competitiveness, and the survival of firms, especially during recessions (Martin and Trannoy, 2019[20]). By contrast, a VAT deducts intermediate inputs from the tax base and is neutral with respect to the organisation of value chains. In China, the 2012 reform that replaced turnover taxes with VAT for some services industries has been found to increase the sales of these industries by around 10%, driven by increased demand from downward industries (Xing, Bilicka and Hou, 2022[21]).
Figure 2.23. Both VAT and turnover taxes are high in Hungary
Note: Panel A: Contrary to turnover taxes in Hungary, sales taxes in Israel and the United States are not cumulative. They apply at only one stage of the production process. Panel B: The VAT compliance gap is the overall difference between the expected VAT revenue and the amount actually collected. It is expressed as a percentage of the VAT Total Tax Liability (VTTL).
Source: Panel A: OECD Database on Revenue Statistics, Panel B: (European Commission, 2022[22]).
Further reductions in social contributions for low-wage workers may raise employment
In the early 2010s, Hungary faced structurally low employment rates for some categories of workers in a context of high social contributions in international comparison. In response, the authorities started to reduce employers’ social contributions to boost labour demand. Relative to GDP, social contributions are now much closer to the OECD average. The reduction in employers’ social contributions started with the Job Protection Act (JPA) in 2013 and was initially targeted at younger, older, and lower-skilled workers. Employers’ social contributions were further reduced between 2017 and 2022 (Figure 2.24). The headline employer social contribution rate is now significantly lower than before 2017. Moreover, a reduced rate is applied to the agricultural sector and low-skilled professions, for the part of the salary falling below the minimum wage. Nevertheless, employee social contributions and the overall labour tax wedge remain above the OECD average.
Figure 2.24. Employer social contributions have fallen, but employee’ contributions remain high
Note: Panel A: The average rate of employer (employee) social contributions is the ratio of employer (employee) social contributions over gross wage earnings, expressed in percentage points, for a single person with average earnings and no child.
Panel B: The average labour tax wedge is the ratio of income tax, plus employee and employer social security contributions, minus cash transfers, over total labour costs, expressed in percentage points, for a single person with average earnings and no child.
Source: Taxing Wages 2023 (OECD, 2023[23]).
The reduction in employer social contributions was successful in raising the employment rate of younger, older, and lower-skilled workers immediately after the JPA entered into force in 2013 (Svraka, 2018[24]). Further progress was recorded after 2016, but at a slower pace. Employment rates for workers with upper-secondary and tertiary education were close to those observed in the best OECD performers in 2021. Only the employment rate for workers with below-upper-secondary education was still lagging behind (Figure 2.25).
A formal empirical assessment would be needed to assess the efficiency of the reduction in employer social contributions that started in 2017 and disentangle its effect from the impact of other factors such as minimum wage increases.
There may still be scope for further action to bring more low-skilled workers into the labour market, as employment, and in particular labour market participation, in this segment still have scope for improvement, while employment rates for higher-skilled workers are close to the highest levels recorded in OECD countries (Figure 2.25). The lower labour market participation of low-wage workers would particularly hint at the possibility of lowering employee social contributions for them, which would increase take-home pay for low-skilled workers in light of a comparatively high and binding minimum wage, and therefore encourage labour market participation and investments in skills. Moreover, it is mainly in employee social contributions where Hungary currently stands out in international comparison (Figure 2.24). In case employee social contributions are reduced, the increase in other taxes to ensure that the reform is revenue-neutral could be used to finance the social benefits currently related to social contributions.
Figure 2.25. Employment rates are relatively low among low-skilled workers
Employments rates, %
Note: In 2012, the employment rates of workers with below-upper-secondary, upper-secondary, and tertiary education in Hungary were 38.8%, 67.9%, and 79.7%, respectively, as shown by the first histogram on the left. The best OECD performer in 2012 and 2016 was Iceland, for all education levels. In 2021, it was New Zealand for workers with below-upper-secondary education, Switzerland for workers with upper-secondary education, and Poland for workers with tertiary education.
Source: OECD Education at a Glance (2022[25]).
Corporate income taxes will need to align with Pillar 2
In 2017, Hungary reduced its statutory Corporate Income Tax (CIT) rate from 16% to 9%, the lowest level in the OECD. Since then, the Two-Pillar Solution to address the tax challenges arising from the digitalisation of the economy has been agreed by Hungary and 136 other jurisdictions of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS). The Pillar 2 Model Rules are designed to ensure that large multinational enterprises (MNEs) pay an effective CIT rate of at least 15% on the profits arising in each jurisdiction where they operate. These new rules do not apply to Hungarian companies that have no foreign presence or generate less than EUR 750 million in consolidated global revenues (OECD, 2023[26]). In response to these rules, Hungary will raise its statutory CIT rate to 15% for in-scope businesses from 2024 onwards. In order to avoid foregoing CIT revenues that would otherwise be collected by the jurisdiction where the parent company of the Hungarian subsidiary is tax resident, Hungary should ensure that all in-scope MNE subsidiaries are taxed at an effective CIT rate of 15% (i.e. after accounting for various tax allowances that may have been granted to attract foreign direct investments).
Raising additional revenues from property taxes and VAT
Considering future fiscal challenges related to population ageing and the green transition, any reductions in public revenues will need to be compensated by increasing revenues from other sources (Box 2.6). Scope for raising revenues may exist in recurrent taxes on immovable property, which at 0.4% of GDP raise less than the 1.0% OECD average. These taxes have also been found to be relatively growth-friendly and could help to shift some investment out of housing into higher-return economic activity (Arnold et al., 2011[27]). In Hungary however, immovable property taxes are optional and levied by municipalities. Introducing a minimum local tax rate or a national tax could raise more revenues from property taxes (OECD, 2019[28]).
There may also be room to reconsider some of the current VAT exemptions and reduced rates, which tend to be distortive and raise the administrative costs of the VAT. VAT exemptions include public services, financial and insurance services, and the rental of real estate. A reduced VAT rate of 18% is applied to selected food products, and a reduced rate of 5% is applied to a list of goods and services including new residential property, district heating, books, newspapers and other cultural services, accommodation services, and selected pharmaceutical and food products. Removing all reduced VAT rates and VAT exemptions, except on the use of owner-occupied dwellings, financial and insurance services, and public services, could potentially raise VAT revenues by up to 3.4% of GDP (European Commission, 2022[22]).
While implementing these property tax and VAT reforms, low-income households could be compensated by increasing targeted social benefits, or by introducing a threshold above which the increase in property taxation would apply, but that would be less costly for public finances than keeping housing taxation low or applying reduced VAT rates for all households, whatever their revenues.
Box 2.6. The fiscal impact of selected policy recommendations
The upper part of Table 2.4 presents the fiscal impact of phasing out turnover taxes and reducing labour taxes for low-income workers, while at the same time increasing recurrent taxes on immovable (residential) property and removing some VAT exemptions to ensure that this tax reform is fiscally neutral ex ante. The impact of removing some reduced VAT rates and exemptions is presented net of the cost of compensating low-income households with targeted cash transfers. While the cost of targeted cash transfers depends on how exactly they are designed, gross fiscal revenues from removing some VAT reduced rates and exemptions would need to increase by more than 1.7% of GDP to finance these transfers. This tax reform is expected to increase GDP in the medium to long term (Chapter 1) but the related fiscal revenues are not considered here.
The lower part of Table 2.4 presents the fiscal impact of net investments related to the green transition (Chapter 5). Investment costs related to the water infrastructure and the Paks 2 nuclear plant are not included in this table as these investments are mainly expected to restore or replace existing infrastructures. The modernisation cost of the electricity grid is a mid-range estimate, while the cost of subsidies for dwelling insulation is the cost of improving the energy efficiency of 10% of the housing stock with new windows and modern boilers, taken as an indicative cost of necessary subsidies to support financially constrained households. In order to finance these investments, fiscal savings may be generated by restructuring the energy support scheme and moving from price caps to targeted cash transfers to vulnerable households, as advocated in this Survey. The cost of this scheme is 1.5% of GDP per year on average since the outbreak of the war in Ukraine. While the exact amount of savings from reforming it depends on how the replacing targeted cash transfers would be designed and on energy prices in the coming years, 1% of GDP is taken as an indicative estimate. Moreover, 2/3 of EU RRP grants are expected to be allocated to the green transition, which represents 2.3% of GDP of additional funding. Nevertheless, these two sources of financing fall short of the required investment expenditures, which shows the need to create additional fiscal space to finance the green transition. Launching spending reviews would be helpful to consider how the efficiency of public spending could be improved in the future.
Table 2.4. Indicative ex-ante fiscal costs (-) and revenues (+)
Source: OECD estimates.
Longer-term fiscal challenges relate to the financing of pensions and the green transition
Further reforms are needed to limit the projected increase in pension costs
According to the 2021 Ageing Report by the European Commission (European Commission, 2021[29]), ageing-related expenditures related to pensions, healthcare, long-term care, and education will rise from 17.1% of GDP in 2019 to 22.5% in 2070, mostly driven by a strong increase in pension costs. Hungary will face the fourth largest increase in pension-related expenditures in the EU (+4.1pp, from 8.3% to 12.4% of GDP). Most of this increase (+2.4pp of GDP) is projected to occur between 2030 and 2045, in line with the rise in the ratio of people aged 65 or above to people aged 20-64.
Debt simulations show that the absence of reforms to reduce ageing-related costs would lead public debt to reach 200% of GDP by 2060, in a scenario where the primary fiscal deficit would entirely be due to the increase in ageing-related costs (Figure 2.26). By contrast, ensuring that public debt reverts back to 50% of GDP by 2060 would require a primary fiscal surplus of 1.3% of GDP over 2024-2060. Achieving this objective would necessitate reforms to limit the increase in ageing-related costs, and raising the primary fiscal balance substantially above the 2023 level. Indeed, the structural primary position is estimated to be around -2.2% of GDP in 2023 (Figure 2.19). Reforming the pension system but failing to raise a primary fiscal surplus would lead public debt to exceed 100% of GDP by 2060. Replacing the current energy subsidies to households with targeted cash transfers, as recommended above, would significantly improve the fiscal balance, as their cost has been 1.5% of GDP per year on average since the outbreak of the war in Ukraine.
Figure 2.26. Addressing the fiscal effects of ageing is key to safeguard fiscal sustainability
Gross government debt (Maastricht definition), % of GDP
Source: OECD estimates.
In most EU countries, the increasing dependency ratio effect will be countered by a decline in the ratio of average pensions to average wages (benefit ratio), driven by reforms lowering replacement rates and limiting the increase in calculated pensions over time (Figure 2.27). By contrast, Hungary is one of only two EU countries where the benefit ratio is planned to increase between 2019 and 2070 (Figure 2.28). This increase is primarily related to the reintroduction of the 13th monthly pension payment in 2021, and the absence of other measures to contain entitlement increases, such as linking retirement age to gains in life expectancy (Hungarian State Treasury, 2021[30]). Moreover, saving effects of the 2009 pension reform, which raised the statutory retirement age from 62 in 2010 to 65 in 2022, are partially offset by generous accrual rates for long careers beyond 40 years, driving up the overall replacement rate.
To address these challenges, Hungary’s Recovery and Resilience Plan includes a reform roadmap to improve the sustainability of the pension system, while increasing lower-income pensioners’ entitlements (Government of Hungary, 2022[31]). The reform is expected to be introduced by 2025 and will need to consider a set of measures applicable to both current pensioners and contributors to the pension system (Box 2.7).
Figure 2.27. Without further reforms, pension expenditure will increase sharply
Note: The dependency ratio quantifies the impact of demographic changes, i.e. the relative change in the old-age (65+) versus working-age (20-64) population. The coverage ratio divides the number of pensioners of all ages by the population above 65. The benefit ratio is the ratio between the average pension and the average wage, both measured in gross terms. The labour market effect describes the labour market behaviour effect on pension expenditure. This effect accounts for developments in the employment rate, labour intensity (hours worked per person), and career shift (hours worked by the population aged 20-74 divided by hours worked by the population aged 20-64).
Source: 2021 Ageing Report (European Commission, 2021, p. 79[29]; European Commission, 2021[29])
Figure 2.28. The benefit ratio of Hungarian pensions is planned to increase between 2019 and 2070
Note: The benefit ratio is the ratio between the average pension and the average wage, both measured in gross terms.
Source: 2021 Ageing Report (European Commission, 2021, p. 84[29]).
Box 2.7. Improving the fiscal sustainability of the Hungarian pension system
The Hungarian pay-as-you-go public pension system performs well in maintaining the standard of living after retirement. The average disposable income of individuals older than 65 is on par with the rest of the population, relative old-age poverty is low, and new entrants to the labour market can expect high pension benefits. However, population ageing challenges the current system. Some reforms from the last decade – such as raising the statutory retirement age and cancelling the early retirement options – partially offset the adverse fiscal effects of population ageing. Nonetheless, other policy measures deepened the fiscal challenge. Since 2011, women who accumulate 40 years of rights have been allowed to retire with full benefits before reaching the statutory retirement age, and more than half of female retirees take advantage of this scheme and retire at relatively young ages. The 2021 reintroduction of the 13th monthly pension bonus has increased all pension benefits, including those of high earners, by 8.3%. Overall, spending on public pensions in Hungary is expected to rise by 4.1% of GDP by 2070, while pension contributions are expected to decline slightly as a share of GDP.
To put the current pension system on a more sustainable fiscal path, Hungary can tighten eligibility conditions, reduce benefit levels and/or increase social security contribution rates or other taxes to finance the expected increase in spending.
The different reform options have different effects on pension adequacy, vulnerable groups, and total pension-related spending which need to be carefully evaluated. The acceptability of a pension reform will also likely depend on the chosen reform option and the way of implementation.
Linking the retirement age to life expectancy, for example, is an automatic adjustment mechanism based on a relevant development in a crucial indicator. Relying on such a mechanism could help avoid the economic and social costs of changing the pension parameters in an ad-hoc and sudden manner when fiscal pressure becomes too tight.
It would be equally important to consider features of the current system that make it difficult for individuals to fully assess the optimal time to retire and make it hard for policymakers to adjust the system’s parameters. For example, the pension entitlements in Hungary are calculated based on non-linear accrual rates that vary with the length of the contribution period and net wages, and the accrued earnings are adjusted annually by the previous year’s average wage increase so that large fluctuations due to, for example, the business cycle can occur.
The financing of the green transition should be clarified
Reaching GHG emission reduction targets and achieving the green transition may also have a significant impact on public finances (see Chapter 5). Large public investments include the construction of a new nuclear power plant in Paks, with an estimated cost of 7% of GDP (International Energy Agency, 2022[32]) at this stage but significant risks of cost overruns; the modernisation of the electricity grid to accommodate electricity supply from renewable energy sources, with an estimated cost between 1 and 5% of GDP; the modernisation of the water infrastructure, with an estimated cost of at least 6% of GDP; and the support to households for improving the thermal insulation and the heating systems of their dwellings. While public support will mainly be needed to help financially-constrained households, illustrative estimates indicate that improving the energy efficiency of 10% of the housing stock with new windows and modern boilers will already cost around 3% of GDP. Taken together, the cost of these major green transition projects amounts to nearly 20% of GDP. Some of these investments may be covered by EU funds or higher carbon tax revenues. Nevertheless, both sources of financing are uncertain at this stage and should be clarified to ensure that green transition investments are consistent with fiscal sustainability.
Table 2.6. Policy recommendations from this chapter (key recommendations in bold)
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