Abstract

Hungary’s public debt-to-GDP ratio, a key indicator of the state of public finances, has fluctuated widely during the 1990s. The gross debt of the consolidated central government1 rose from about 66 percent of GDP in 1990 to nearly 90 percent of GDP in 1993, before declining gradually to below 85 percent of GDP in 1995.2 There has been a sharp decline in the debt-to-GDP ratio since 1995 (Figure 4.1, 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.

Hungary’s public debt-to-GDP ratio, a key indicator of the state of public finances, has fluctuated widely during the 1990s. The gross debt of the consolidated central government1 rose from about 66 percent of GDP in 1990 to nearly 90 percent of GDP in 1993, before declining gradually to below 85 percent of GDP in 1995.2 There has been a sharp decline in the debt-to-GDP ratio since 1995 (Figure 4.1, 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.

Figure 4.1.
Figure 4.1.

Government Debt

Sources: Ministry of Finance; and IMF staff estimates.

One factor behind the rise in the debt ratio in the early 1990s was undoubtedly the deteriorating fiscal position of the government (Chapter II). However, when analyzing government debt dynamics in Hungary, a number of special factors have to be taken into account in addition to the government’s fiscal position. For example, during 1992–94, the government issued substantial amounts of bonds to recapitalize state banks and to cover losses from earlier housing loans, adding to the debt burden. Since 1994, the government has benefited from considerable privatization revenue, which has mainly been used to reduce government debt. Another important factor affecting debt dynamics in Hungary is the interest rate charged on debt. A small component of domestic debt, related to central bank credit to government prior to 1991, carries a below-market interest rate. More importantly, until this year, a large part of the debt stock consisted of zero-interest-bearing liabilities to the National Bank of Hungary arising from the devaluation losses associated with the foreign debt, contracted in the past by the central bank on behalf of the government (Figure 4.1, bottom panel). This portion of the debt did not bear any interest. On January 1, 1997, through a so-called securitization operation, the government swapped the stock of the non-interest-bearing valuation losses with foreign exchange denominated liabilities to the central bank.3 In fact, the operation was designed to ensure that the new stock of National Bank of Hungary 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 to prevent an increase in the debt-to-GDP ratio. This is important because a debt ratio that is not increasing is a condition for the solvency of public finances, that is, for the government to meet its intertemporal budget constraint.

Determinants of Debt Dynamics

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

ΔD=(IP)+A(1)

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

Table 4.1 provides the breakdown of the change in debt since 1992 according to equation (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 one-half of the increase in debt during 1992–97 (see last column of Table 4.1). 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 4.1.

Decomposition of the Change in Debt1

(Contribution to change in debt, in percent)

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Sources: Data provided by the Hungarian authorities; and IMF staff calculations.

’The calculations in this table are based on data provided to IMF staff in June 1997.

lmport of military equipment using claims against Russia. The 1993 deficit is inflated by the same amount with respect to the cash deficit figure.

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 about 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 buildup of these deposits.

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 equation (1) in terms of ratios to GDP. Dividing both sides of equation (1) by Y, the nominal GDP, and defining:

I=iD1;(2a)

and

Y=(1+g)Y1(2b)

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

D/YD1/[(1+g)Y1]P/Y+A/Y(3)

Equation (3) can be rewritten as:

Δd=p+(ig)d1/(1+g)+a(4)

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

Equation (4) decomposes the change in the debt-to-GDP ratio into the primary deficit (-p), a component reflecting the difference between interest rate and growth rate (i-g), and a component reflecting temporary factors (a).

Table 4.2 provides the decomposition of Δd, the change in the debt-to-GDP ratio, according to equation (4). The primary surplus was in fact negative during 1992–94, contributing to the rise in the debt ratio. 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 past three years. In fact, the size of the primary balance explains about one-half of the 20 percentage point drop in the debt-to-GDP ratio since 1994 (see the last column of Table 4.2).

Table 4.2.

Decomposition of the Change in Debt-to-GDP Ratio1

(Percentage points, unless otherwise indicated)

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Sources: Data provided by the Hungarian authorities; and IMF staff calculations.

This table is based on data provided to IMF staff in June 1997; more recent information reported in Figure 4.1 indicates that the fall in the debt-to-GDP ratio in 1997 was larger than reported in this table, owing to stronger GDP growthand higher privatization receipts. Because of revisions in the GDP series, the changes in the debt ratio reported in this table for 1992–96 may also differ from those reported in Figure 4.1, in Table 4.3, and in Chapter II.

A negative sign indicates a surplus. These figures differ from those reported in Box 2.1 of Chapter II because the primary balance here is defined as inclusive of the profit transfers from the National Bank of Hungary and of the transfers to the National Bank of Hungary to cover losses. Moreover, the figure in Chapter II refers to a broader definition of public sector and is adjusted for various factors (see Box 2.1 in Chapter II).

Interest revenues mostly reflect the remuneration of the treasury account held by the government at the National Bank of Hungary.

lmport of military equipment using claims against Russia.

The other component of equation (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.

To calculate the contribution of the second term in equation (4), that is, (ig)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).4 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 National Bank of Hungary did not bear any interest.5 Only in 1993 and 1995, when the forint depreciated sharply, does the contribution of (ig)d–1/(1 + g) become positive.6 This term is also positive in 1997, albeit small in magnitude, reflecting the debt swap operation between the National Bank of Hungary and the government, which replaced the zero-interest-bearing debt with foreign exchange liabilities vis-à-vis the central bank. Since part of the forint debt vis-à-vis the National Bank of Hungary 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, and considering the low level of devaluation losses in 1997, the contribution of (ig)d–1/(1 + g) is small in 1997.

When looking at the solvency of the public sector and the long-term sustainability of the debt ratio in perspective, it is necessary to assume that i—g will be positive.7 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, any contribution from a should not be expected.8 Therefore, any analysis of future debt dynamics and sustainability would have to focus on the first two right-hand terms in equation (4), namely, p and (ig)d–1/(1 + g).

Debt Sustainability

Equation (4) implies that for the debt-to-GDP ratio to stabilize the primary surplus has to be larger than (i-g)d-1/(l+g), assuming no contribution from a. Although the debt-to-GDP ratio in Hungary declined in 1994, this was achieved by using privatization receipts and running down government deposits (Tables 4.1 and 4.2). 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 4.3. Using the actual debt stock and nominal GDP growth, and an interest rate in domestic currency close to those prevailing in the market on new debt issues in 1994, column 1 indicates that the government would have needed to run a primary surplus of at least 3½ percent of GDP to stabilize the debt ratio in 1994. In fact, the 1994 budget entailed a primary deficit of about ½ percent of GDP.

Table 4.3.

Analysis of Debt Sustainability

(In percent, unless otherwise indicated)

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Sources: Data provided by the Hungarian authorities; and IMF staff calculations.

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

A similar calculation for 1997 implies a required primary surplus of only just over 1 percent of GDP, against an actual primary surplus (excluding interest revenue) of about 3 percent of GDP.9

One other issue has to be taken into account in this analysis: seigniorage. In theory, seigniorage 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 seigniorage at about 3½ percent of GDP in 1994 and at about 2½ percent of GDP in 1996.10 Seigniorage is likely to decline further in 1997, and it is unlikely to exceed ½–1 percent of GDP in the medium term. If these estimates of seigniorage were included in Table 4.3, the basic results would remain unchanged. According to the table, 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 point as the medium-term value of seigniorage, the required primary surplus would have still been much higher than the actual primary deficit of ½ percent of GDP.11 Therefore, the situation was not sustainable even taking into account seigniorage. In 1997, the actual primary surplus is higher than that required for debt stabilization; therefore, the magnitude of seigniorage is immaterial in terms of debt sustainability.

Conclusion

The analysis of the debt dynamics presented here indicates that:

  • (1) the debt-to-GDP ratio was not on a sustainable trajectory in 1994;

  • (2) the fiscal consolidation undertaken since 1995 has played a key role in reducing the debt ratio in Hungary; nonetheless, a sizable decline in the debt ratio over the last three years can be attributed to other items, in particular, privatization; and

  • (3) 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 about 1½ percent of GDP in the primary surplus in 1998 and maintaining the surplus in the following four years. Despite this decline, the magnitude of the primary surplus should be sufficient to keep the debt-to-GDP ratio on a downward trajectory, even ignoring seigniorage 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.

References

  • Buiter, Willem, H., 1997, “Aspects of Fiscal Performance in Some Transition Economies Under Fund-Supported Programs,IMF Working Paper No. 97/31 (Washington: International Monetary Fund).

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  • International Monetary Fund, 1996, HungarySelected Issues, IMF Staff Country Report No. 96/109 (Washington: International Monetary Fund).

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1

Including the non-interest-bearing liabilities vis-à-vis the National Bank of Hungary for valuation losses (see below). These liabilities were roughly of the same magnitude as the net foreign debt position of the central bank.

2

Consolidated central government excludes the local governments (see Chapter V for further details). References to government in this section refer only to the consolidated government.

3

See International Monetary Fund (1996), Chapter IV. The term “securitization” is the literal translation of the Hungarian expression to describe this operation. It is somewhat misleading as there was no actual transfer of securities between the central bank and the government.

4

In contrast to Table 4.1, devaluation losses are not included as a separate item in the presentation in Table 4.2.

5

Also, as mentioned above, part of the forint debt vis-à-vis the National Bank of Hungary carries a below-market interest rate.

6

Interest payments on consolidation bonds also increased sharply in 1995.

7

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 Buiter, 1997). The fact that (i–g) was negative in Hungary for most of the 1990s reflects primarily the below-market interest rate paid by the government to the National Bank of Hungary.

8

The government, however, has recently amended the privatization law to facilitate the sale of the remaining minority shareholding in a number of enterprises.

9

The primary surplus is somewhat lower in the more comprehensive definition used in Chapter II.

10

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

11

Moreover, the primary balance reported in the table already includes part of seigniorage revenues (those consisting of transfers of central bank profits to the government). The component of seigniorage that was not included corresponds to those transfers that took the form of interest payments on the treasury account held by the government at the central bank (the bulk of the interest revenues in item I.2 of Table 4.2).