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Cbank: Hungary’s growth potential less than generally thought

Hungary’s potential GDP growth -- or the growth rate the country’s economy is expected to return to after the current slowdown -- is most probably less than the generally accepted 4% estimate, experts of the National Bank of Hungary (MNB) warned in a study of the effects of the fiscal expansion Hungary experienced between 2001 and 2006.

The expansive fiscal policy followed by Hungarian governments between 2001 and 2006 added about half a percentage point to Hungary’s GDP growth rate, bringing it to an average annual 4.1% for the period, Zoltán M. Jakab, one of the authors of the study, published in the latest issue of the bank’s periodical MNB Szemle, said on Monday.

Under a neutral fiscal policy, Hungary’s growth rate would have been one percentage point below the actual rate between 2001-2003, it would have been slightly higher in 2004 and it would have been around the actual growth rate in 2005 and 2006, the experts calculated. Fluctuations in the growth rate would have been bigger and would have followed more closely the fluctuations in the business cycle of eurozone countries, the study found.

The experts did not analyze the effects of the tax system or the structure and efficiency of fiscal expenditures on growth. They noted, however, that these, in fact could reduce potential growth, as evidenced by falling investments, flat employment and slowing growth of corporate-level total factor productivity. Potential growth would have slowed from 2001 even without the fiscal expansion, as favorable changes experienced on the Hungarian labor market from 1996 faded, Jakab said when asked by Econews. One effect of the fiscal expansion was that the usually close link between the Hungarian business cycle and that of the EU -- its largest export market -- loosened during the period. (Hungary posted relatively stable GDP growth of around 4% even in 2001-2003 when EU countries experienced a slowdown.)

The contribution of net exports to growth was low up to 2005. Growth was fuelled rather by booming domestic consumption. In 2001 and 2002, both the number and the wages of state employees jumped parallel with a reduction of the personal income tax rate, higher state income transfers and bigger state investments -- results of looser fiscal policies. Private sector wages also rose, partly due to big increases in the minimum wage during the two years. The fiscal expansion significantly boosted inflation during the period, the study found. Even assuming an unchanged monetary policy at the time, a neutral fiscal policy would have brought the inflation rate down 1-2 percentage points, especially from 2004 on, Jakab said.

Part of the higher inflation resulted from the VAT increase in 2004 and again in 2006 -- measures that could have been avoided without the expansive fiscal policies. Nominal wages would have risen less over the period, but real wages would have risen almost as much, because, from 2004, lower inflation would have partly offset the effect of lower nominal wage growth.

A neutral policy would have resulted in different monetary policy conditions: the forint would have firmed 8-10% and the central bank base rate would have been lower by 2006. A stronger currency would have allowed room to partly offset a 2001-2002 slowdown in growth through rate cuts without endangering the inflation target. Under the neutral fiscal policy scenario, inflation would have fallen to as low as 2.2% in 2005 (instead of 3.6%, as it did) before rising again in 2006 on higher food and regulated energy prices. (MTI-Econews)