1. The Stability and Growth Pact and its Reform from the Perspective of the New Member States Gábor Orbán – György Szapáry Magyar Nemzeti Bank 11th Dubrovnik Economic Conference 30 June 2005

2. 2 Outline Fiscal consolidation in the run-up to the euro A reformed SGP framework – a different challenge? Country-specific medium-term objectives The ageing problem and the SGP The introduction of fully funded pension pillars

3. 3 Initial budgetary conditions: Distance from the 3% reference value in the run-up to the euro

4. 4 Lower debt ratios: in 2004 and in the run-up to the euro

5. 5 As debt ratios are lower and yield convergence is at a more advanced stage...

6. 6 …we may expect smaller fiscal gains from convergence…

7. 7 … so not even high debt countries may afford to rely on the reduction in interest payments.

8. 8 The reformed SGP Trade-off: transparency vs. soundness –New SGP: increases complexity but risks softening up EDP –Changes not because of NMS but reform affects them, too Reforms affecting new member states –Taking more account of country differences in the setting of MTO’s –The treatment of systemic pension reforms

9. 9 Cyclical effects on the budgets of new member states Higher output volatility + lower cyclical sensitivity of budgets  lower cyclical safety margins, potentially looser medium-term targets

10. 10 Ageing is a threat in NMS

11. 11 Ageing problem calls for higher present saving 1.This may take the form of lower government deficits/higher surpluses today – which reduces explicit debt 2.Or: saving may take place outside government (accumulated in private pension funds) –Only if tax-financing: sum of explicit + implicit is reduced. –In case of debt-financing: explicit debt rises as implicit liabilities are reduced „Costs” of pension reform are the savings necessary to cope with ageing Pressure to deduct these costs – compromise: new SGP allows for partial debt financing for 5 years to allow budgetary adjustment to reform

12. 12 Are fully funded pillars the solution for the ageing problem? How do these reforms improve sustainability? –Increase savings today – IF transition is tax-financed –Also reduce future deficits as introduction of fully funded pillar partly transforms DB into DC Desirable features of a fully funded private pillar –Promotes intergenerational equity –Present savings for future pensions cannot be spent elsewhere Risks of a fully funded private pillar

13. 13 The Hungarian example: future balances of the pension system

14. 14 Risks in the pension fund sector Unsatisfactory performance may generate implicit liabilities –Explicit legal guarantees, or –Political pressure from an interest group growing in size to provide certain minimum replacement rates What is satisfactory? –A rate of return that sets multi-pillar replacement rates equal to the replacement rate consistent with a sustainable full PAYG. –Hungary: actual real net return is an annual 2% so far! –Operating costs (total fees = 2.4% of total assets and 9.8% of contributions) and incentives/competition may be a problem

15. 15 Thank you for your attention!