1. Lessons from the Hungarian “Exception” George Kopits ICGFM Winter Conference “PFM in the 21st Century” Washington, December 5-7, 2011

2. Outline Background Broad fiscal trends Exception 1.0 (in 2001-09) Paradigm change? Exception 2.0 (since 2010) Implications for sovereign risk Conclusion: Lessons

3. Background Mixed progress during the transition Reforms in the tradable sector –External liberalization –Domestic liberalization (incl. financial system) –Privatization (incl. effective bankruptcy procedures) Slow reforms in the non-tradable sector –Public administration: workforce remained bloated –Social security system partially reformed –Tax system partially restructured Monetary policy: broadly successful IT regime EU membership  moral hazard

4. Background Economic performance Foreign direct investment: first high, then low Swings in external performance Near crisis in mid-90s, and late 2008 Disinflation into single digits, but some persistence Marked deceleration in economic growth

5. Background Real GDP Growth Rate xxxxxxxxxxxxxxxxxxxxxx

6. Background

7. Broad fiscal trends Distinguishing characteristics – deficit bias – time inconsistency – procyclicality – debt sustainability problem – lack of transparency

8. Broad fiscal trends

12. Broad fiscal trends Public Debt

13. Broad fiscal trends Lack of transparency – inconsistent time-series data – overoptimistic macro-fiscal forecasts – abusive PPP practices – distorted accounting for SOEs – opacity in budgetary procedures – occasional arrears in expenditures and tax rebates

14. Exception 1.0 (2001- 09) Center-left government Expansionary stance during “Great Moderation” government wage hikes public pension hikes VAT rate cuts Contractionary stance during crisis (IMF-EU standby) wage and pension freeze VAT rate increase some streamlining of social entitlements rules-based fiscal framework

15. Paradigm change? Rules-based fiscal framework (FRL Nov. 2008) policy rules: expenditure limit real debt limit (  limit on discretionary deficit) procedural rules: pay-go rule MT budgetary planning transparency norms independent fiscal institution: Fiscal Council

16. Paradigm change? Fiscal Council Contribute to goals of fiscal framework – credibility in fiscal policymaking – transparency in public finances – public debt sustainability Basic characteristics, functions – independence (incl. election, tenure of members) – arm’s length relation, equal access – decisions by consensus – surveillance (evaluation, compliance)

17. Paradigm change? Fiscal Council: surveillance functions Evaluation at aggregate level Evaluation at disaggregate level Compliance with standards and procedures Compliance with fiscal rules Communication (government, press, etc.)

18. Paradigm change? Fiscal Council: performance – strong technical staff – early tail winds (during adjustment program) – favorable press coverage – positive feedback from civil society – no interference from government – first government complied, second did not – de facto abolition at end-2011

19. Exception 2.0 (since 2010) Center-right government Major policy (reform?) measures flat tax, without exempt threshold temporary taxes on selected activities record VAT rate (27%) nationalization of private pension funds Institutional changes limits on Constitutional Court, on fiscal matters political appointment as head of State Audit Office attempts at curtailing independence of NBH de facto abolition of Fiscal Council

20. Exception 2.0 (since 2010) Demise of the Fiscal Council Critical assessments by the Council – changes in accounting rules – effects of various changes in tax law, pension reform – forecasts of four-year macro-fiscal outlook Reactions by the government – limited access to information – proposal to drastically cut funding – disbandment of FC staff – narrowing remit of FC to opinion on budget bill – appointment of new FC chair (following resignation of former)

21. Implications for sovereign risk

22. Comparison with the UK Common features –fiscal sustainability problem –low policy credibility –contemporaneous election of center-right governments United Kingdom –clear medium-term fiscal target –front-loaded adjustment program –establishment of Office for Budget Responsibility Hungary –mixed and opaque policy signals –adoption of distortionary stop-gap measures –abolition of Fiscal Council

23. Implications: sovereign risk premium

24. Implications: sovereign default risk premium

25. Conclusion: Lessons “Exception” leads to stagnant activity, long-term sustainability problem, and vulnerability to crisis (lacking a natural resource base) Government should not succumb to populist instincts or to moral hazard Government ignores financial markets at its peril IMF can provide financial and technical assistance, but policy credibility must be home-grown New government must use opportunity to signal paradigm change and follow up with action

26. References Kopits, G., “Monetary and Fiscal Policy from Transition to EU Integration: A Comparative Assessment” in B.Y. Kim and C. H. Lim, eds., Financial Sector Reform in Transition Economies (Seoul National University, 2009), pp. 29- 61. Kopits, G., “Brussels Can’t Monitor 27 Budgets” The Wall Street Journal (October 11, 2010) Kopits, G., “Goulash Populism” The Wall Street Journal (February 25, 2011) Kopits, G., “Independent Fiscal Institutions: Developing Good Practices” OECD Journal on Budgeting (November 2011)