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Hungary: Selected Issues

Author(s):
International Monetary Fund
Published Date:
November 1997
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II. Debt Dynamics in Hungary22

A. Introduction

24. The gross debt of the consolidated government23 rose from some 66 percent of GDP in 1990 to nearly 90 percent of GDP in 1993, before declining gradually to 85 percent of GDP in 1995.24 There has been a sharp decline in the debt-to-GDP ratio since 1995: 11 percentage points in 1996 alone (Figure 4, top panel). By the end of the century, the authorities intend to reduce this ratio to well below the 60 percent level specified in the Maastricht treaty as a condition for participating in the European Monetary Union. Indeed, on current policies, gross government debt is already projected to decline to some 64 percent of GDP by end-1997.

Figure 4.Hungary: Government Debt

Sources: Ministry of Finance and staff estimates.

1/ Excluding the cost of cleaning up the balance sheet of the NBH in 1997.

25. One factor behind the rise in the debt ratio in the early 1990s was undoubtedly the deteriorating fiscal position of the government: the consolidated balance turned from a surplus of some 1 percent of GDP in 1990 to a deficit of nearly 8 percent of GDP in 1993 (Figure 4, top panel). The primary balance also deteriorated by some 10 percentage points during this period (from a surplus of nearly 7 percent of GDP in 1990 to a deficit of 3 percent of GDP in 1993).

26. However, when analyzing government debt dynamics in Hungary, one has to take into consideration a number of special factors in addition to the government’s fiscal position. For example, during 1992–94 period the government issued substantial amounts of capitalization bonds, adding to the debt burden.25 On the other hand, since 1994 the government has benefitted from considerable privatization revenues which have mainly been used to reduce government debt.

27. Another important factor affecting debt dynamics in Hungary is the interest rate charged on the debt. A small component of the domestic debt, related to central bank credit to government prior to 1992, carries a below-market interest rate. More importantly, until this year, a very large part of the debt stock consisted of zero-interest bearing liabilities to the NBH arising from the devaluation losses associated with the foreign debt, contracted in the past by the central bank on behalf of the government (Figure 4, bottom panel). This portion of the debt did not bear any interest. On January 1, 1997, through a “securitization” operation, the government swapped the stock of the noninterest bearing valuation losses with foreign exchange denominated liabilities to the central bank.26 In fact, the operation was designed in a manner which ensured that the new stock of the NBH foreign exchange claims on the government was identical, in size and maturity, to the net foreign exchange position of the central bank. This chapter analyzes the above factors and quantifies their contribution to determining debt dynamics in Hungary. It then proceeds to draw conclusions regarding the conditions that need to be met in order to prevent an increase in the debt-to-GDP ratio.27

B. Determinants of Debt Dynamics in Hungary

28. The change in debt can be expressed in the following form:

where I is interest payments; P is the primary surplus; and A is other items besides the budget deficit that affect indebtedness, e.g., privatization receipts, devaluation losses, issuance of bonds for recapitalizing banks.

29. Table 1 provides the breakdown of the change in debt since 1992 according to (1). It also identifies the major components of A. The table confirms that the fiscal deficit has had a significant impact on debt, accounting for about half of the increase in debt during 1992–97 (see last column of Table 1). However, other items have also played an important role in explaining the movements in debt. For example, the issuance of consolidation bonds in 1992 and 1993 accounts for about one-third of the increase in debt during that period. Another critical element in explaining the increase in debt is the devaluation of the exchange rate: the contribution of this element has been of the same order of magnitude as the deficit.

Table 1.Hungary: Decomposition of the Change in Debt, 1992–97
1992199319941995199619971992–97
In billions of forint
Change in debt (I+II)455.1842.3604.2981.9198.9526.83609.2
I. Consolidated deficit (1-2-3)213.0277.0311.2357.2212.4388.01758.8
1. Total interest payments162.7158.6289.3500.0566.3741.92418.8
2. Primary surplus exl interest revenue-60.8-121.7-27.7120.2325.0251.1486.1
3. Interest revenue10.53.35.822.628.9102.8173.9
II. Other items (1+…+6)242.1565.3293.0624.7-13.5138.81850.4
I. Consolidation bonds and other debt generating operatio129.7288.764.857.925.50.0566.5
Consolidation bonds129.7288.750.86.39.00.0484.4
Other0.00.014.151.616.50.082.1
2. Impact of devaluation126.1361.9351.0738.6137.8276.41991.8
3. Privatization receipts-12.0-22.2-60.6-153.6-214.4-50.0-512.7
4. Change in the treasury account27.0-63.3-8.555.4-83.9-73.2
5. Other debt reducing operations 1/0.0-75.00.00.00.00.0-75.0
6. Other-1.7-15.01.1-9.8-17.9-3.6-47.0
Contribution to change in debt, percent
Change in debt (I+II)100.0100.0100.0100.0100.0100.0100.0
I. Consolidated deficit (1-2-3)46.832.951.536.4106.873.648.7
1. Total interest payments35.818.847.950.9284.8140.867.0
2. Primary surplus exl interest revenue-13.4-14.4-4.612.2163.447.713.5
3. Interest revenue2.30.41.02.314.519.54.8
II. Other items (1+…+6)53.267.148.563.6-6.826.451.3
1. Consolidation bonds and other debt generating operatio28.534.310.75.912.80.015.7
Consolidation bonds28.534.38.40.64.50.013.4
Other0.00.02.35.30.00.02.3
2. Impact of devaluation27.743.058.175.269.352.555.2
3. Privatization receipts-2.6-2.6-10.0-15.6-107.8-9.5-14.2
4. Change in the treasury account3.2-10.5-0.927.9-15.9-2.0
5. Other debt reducing operations 1/0.0-8.90.00.00.00.0-2.1
6. Other-0.4-1.80.2-1.0-9.0-0.7-1.3
Source: Data provided by the authorities and staff calculations.

Import of military equipment using claims against Russia

Source: Data provided by the authorities and staff calculations.

Import of military equipment using claims against Russia

30. Privatization receipts have had a significant role in limiting the increase in debt. For 1992–97 as a whole, the rise in debt would have been some 14 percent higher in the absence of privatization. Finally, in some years, the change in government deposits has also been an important component of A. In 1994, for instance, government deposits were drawn down substantially while in 1996 there was a significant build up of these deposits.

31. Equation (1) is useful in helping to identify the key determinants of the change in nominal debt; however, to facilitate an analysis of debt dynamics and the sustainability of debt, it is useful to rewrite (1) in terms of ratios to GDP. Dividing both sides of (1) by Y, the nominal GDP, and defining:

where i is the nominal interest rate and g is the growth rate of nominal GDP, we obtain:

(3) can be rewritten as:

where d=D/Y, p=P/Y, and a=A/Y.

32. Table 2 provides the decomposition of Δd, the change in the debt-GDP ratio, according to equation (4). The primary surplus was in fact negative during 1992–94, contributing to the rise in the debt ratio. However, the fiscal adjustment process since 1995 has meant that the magnitude of the primary surplus has been one of the key factors explaining the decline in the debt ratio over the last three years. In fact, the size of the primary balance explains about half of the 20 percentage point drop in the debt-GDP ratio since 1994 (see the last column of Table 2).

Table 2.Hungary: Decomposition of the Change in Debt-GDP Ratio, 1992–97(Percentage points, unless indicated)
1992199319941995199619971994–97
Change in d (I+II+III)4.310.4-2.8-0.8-11.0-6.0-20.7
1.1 Primary surplus, p (excluding interest revenue)2.13.40.6-2.2-4.9-3.1-9.5
1.2 Interest revenue-0.4-0.1-0.1-0.4-0.4-1.3-2.3
II. (i-g)/(1+g)*d-1-1.41.3-1.93.8-3.50.1-1.5
III. a3.95.7-1.3-2.0-2.3-1.7-7.4
Consolidation bonds and other debt generating operations4.48.11.51.00.40.02.9
-Privatization revenue-0.4-0.6-1.4-2.8-3.2-0.6-8.0
Changes in Treasury account deposits0.8-1.5-0.20.8-1.0-1.8
Debt reducing operations 1/0.0-2.10.00.00.00.00.0
Other-0.1-0.40.0-0.2-0.30.0-0.5
Memorandum items:
Effective interest rate, i (percent)15.622.620.333.014.920.6
Growth rate of nominal GDP, g (percent)17.820.623.027.419.720.5
Source: Data provided by the authorities and staff calculations.

Import of military equipment using claims against Russia

Source: Data provided by the authorities and staff calculations.

Import of military equipment using claims against Russia

33. The other component of (4) which has had a significant impact on the decline in the debt ratio since 1994 has been a. This component had a positive impact in 1992 and 1993, mainly because of the issuance of capitalization bonds; however, since 1994 a has been negative, thanks mainly to privatization receipts.

34. To calculate the contribution of the second term in (4), i.e. (i-g)d-1/(1+g), we have to calculate the effective interest rate on debt, i. To do this, we have added the devaluation losses to the actual domestic interest payments in equation (2a). Nonetheless, i-g turns out to be negative in a number of years, reflecting mainly the fact that the foreign exchange liabilities vis-à-vis the NBH did not bear any interest.28 Only in 1993 and 1995, when the forint depreciated sharply, does the contribution of (i-g)d-1/(1+g) become positive.29 This term is also positive in 1997, albeit very small in magnitude, reflecting the debt swap operation between the NBH and the government which replaced the zero-interest bearing debt with foreign exchange liabilities vis-à-vis the central bank. However, since part of the domestic debt still bears a below-market interest rate and the full impact of the securitization operation on interest payments will not be felt on the budget until 1998, the contribution of (i-g)d-1/(1+g) is small in 1997.

35. Of course, when looking at the solvency of the public sector and the long-term sustainability of the debt ratio one has to assume that i-g would be positive.30 Indeed, the proportion of below-market interest bearing debt in Hungary is rapidly declining and market interest rates, at which Treasury bills and government bonds are issued, are currently comfortably positive in real terms. Similarly, in the medium-term, one cannot expect any contribution from a.31 Therefore, any analysis of future debt dynamics and sustainability would have to focus on the first two right-hand terms in (4), namely, p and (i-g)d-1/(1+g).

C. Debt Sustainability

36. Equation (4) implies that for the debt-to-GDP ratio to stabilize the primary surplus has to be larger than (i-g)d-1(1+g), assuming no contribution from a. Although the debt-to-GDP ratio in Hungary began to decline in 1994, this was achieved by using privatization receipts and running down government deposits (Tables 1 and 2). The government was running a primary deficit and i-g was negative, not a sustainable situation in the long-run. In fact, in 1994, before the economic adjustment process began, Hungary was probably in a debt trap. This is illustrated by column 1 in Table 3.

Table 3.Hungary: Analysis of Debt Sustainability, 1994 and 1997(Percent, unless indicated otherwise)
19941997
Debt stock (billion forints)38005500
Domestic21003200
Foreign17002300
Debt/GDP8668
Domestic interest rate2822
Foreign interst rate88
Depreciation2013
Market interest rate, i2822
Nominal GDP growth rate, g2320
(i-g)5.02.0
Required primary surplus (i-g)d-1/(1+g)3.51.1
Actual primary surplus, p1/-0.63.1
Source: Data provided by the authorities and staff calculations.

Excludes interest revenues. With interest revenues and excluding some mis-classified items, the primary surplus would be -0.5 percent of GDP in 1994 and 4.1 percent of GDP in 1997.

Source: Data provided by the authorities and staff calculations.

Excludes interest revenues. With interest revenues and excluding some mis-classified items, the primary surplus would be -0.5 percent of GDP in 1994 and 4.1 percent of GDP in 1997.

37. Using the actual debt stock and nominal GDP growth, the actual depreciation rate, and a notional foreign interest rate together with a domestic interest rate close to those prevailing in the market in 1994, column (1) indicates that the government would have needed to run a primary surplus of at least 3½ percent of GDP in order to stabilize the debt ratio in 1994. In fact, the 1994 budget entailed a primary deficit of about ½ percent of GDP.

38. A similar calculation for 1997 implies a required primary surplus of only just over one percent of GDP, against an actual primary surplus (excluding interest revenue) of some 3 percent of GDP.

39. One other issue, however, has to be taken into account in this analysis: seignorage. In theory, seignorage would reduce the primary balance needed for the debt-to-GDP ratio to decline. Estimates based on the forint-denominated component of reserve money, prevailing, market interest rates, and interest rates on the required reserves, put the magnitude of seignorage at some 3½ percent of GDP in 1994 and at some 2½ percent of GDP in 1996.32 Seignorage is likely to decline further in 1997, and in the medium-term it is unlikely to exceed ½-1 percent of GDP. If one was to include these estimates of seignorage in Table 3, the basic results remain unchanged. According to Table 3, Hungary would have needed a primary surplus of 3½ percent of GDP in 1994 to stabilize its debt ratio; even if we subtract ½-1 percentage points as the medium-term value of seignorage, the required primary surplus would have still been much higher than the actual primary deficit of ½ percent of GDP. Therefore, the situation was not sustainable even taking into account seignorage.33 In 1997, on the other hand, the actual primary surplus is higher than that required for debt stabilization, so the magnitude of seignorage is immaterial in terms of debt sustainability.

D. Conclusion

40. The analysis of the debt dynamics presented here indicates that:

  • (i) the debt-to-GDP ratio was not on a sustainable trajectory in 1994;
  • (ii) the fiscal consolidation undertaken since 1995 has played a key role in reducing the debt ratio in Hungary;
  • (iii) nonetheless, a sizable decline in the debt ratio over the last three years can be attributed to other items, in particular, privatization; and
  • (iv) the primary surplus in 1997 is adequate to ensure a downward trend in the debt ratio. The authorities’ medium-term strategy envisages a drop of some 1¼ percent of GDP in the primary surplus in 1998 and a further decline of 1 percent of GDP in the following four years. Despite this decline, the magnitude of the primary surplus should be sufficient to keep the debt-to-GDP on a downward trajectory, even ignoring seignorage and the privatization revenues which are likely to materialize in the next few years. Indeed, as the debt-to-GDP ratio drops, the primary surplus needed to ensure its continued decline becomes smaller than the value calculated here for 1997.
22

Prepared by Reza Moghadam.

23

Including the noninterest bearing liabilities vis-à-vis the National Bank of Hungary (NBH) for valuation losses. These liabilities are roughly the same magnitude as the net foreign debt position of the central bank.

24

Consolidated government excludes the local governments. References to government in this section refer only to the consolidated government.

25

These were mainly for recapitalization of state banks and to cover losses from earlier housing loans.

26

See EBS/97/61 (4/4/97), and Chapter IV of the 1996 Selected Issues (SM/96/207, 8/7/96).

27

A debt ratio that is not increasing is a condition for the solvency of public finances, i.e., for the government to meet its intertemporal budget constraint.

28

Also, as mentioned above, part of the domestic debt carries a below-market interest rate.

29

Interest payments on consolidation bonds also increased sharply in 1995.

30

If i-g is negative then the government debt can grow faster than the real resource base of the economy. More formally, if i-g is negative then the economy would be “dynamically inefficient”, i.e., the return to capital in each period would be less than the amount of resources devoted to capital formation (see IMF Working Paper WP/97/31 by Willem Buiter).

31

The government, however, has recently amended the privatization law in order to facilitate the sale of the remaining minority shareholding in a number of enterprises. The new wave of privatization is expected to yield revenues amounting to some 3 percent of GDP over the next few years.

32

The decline in seignorage can be attributed to lower inflation, the drop in interest rates, and lower demand for base money.

33

This result remains unchanged even if one were to deduct the entire amount of seignorage in 1994, i.e., 3½ percentage points, from the required primary surplus.

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