This Selected Issues paper on Hungary reports that the public enterprises may pose significant fiscal risks on account of their quasi-fiscal activities and contingent liabilities. More than 85 percent of the economy is in private hands. According to the Privatization Act, assets may remain in long-term state ownership if they belong to a national public utility provider or are considered to be of strategic importance for the national economy or defense. Capital-intensive and labor-intensive enterprises remain as state property.

Abstract

This Selected Issues paper on Hungary reports that the public enterprises may pose significant fiscal risks on account of their quasi-fiscal activities and contingent liabilities. More than 85 percent of the economy is in private hands. According to the Privatization Act, assets may remain in long-term state ownership if they belong to a national public utility provider or are considered to be of strategic importance for the national economy or defense. Capital-intensive and labor-intensive enterprises remain as state property.

I. Hungary: Fiscal Risks from Public Transport Enterprises1

A. Introduction

1. Public enterprises (PEs) may pose significant fiscal risks on account of their quasi-fiscal activities (QFAs) and contingent liabilities. QFAs can lead to financial difficulties, unless they are adequately and transparently compensated by government budget transfers.2 Contingent liabilities can arise, for example, when there is political interference or mismanagement leading to excessive borrowing and poor profitability. These liabilities can be explicit, as in the case of guarantees, or implicit, if there is an expectation or precedent that PEs in financial distress will be eventually bailed out by the government.

2. Good practices in fiscal transparency call for the reporting on all activities of a fiscal nature and their associated risks. When PEs undertake QFAs, these operations are not captured in the conventional measures of the government fiscal balance, distorting the nature and extent of fiscal activities. This can lead to poor fiscal policy design. It also creates the incentive to move fiscal activities to PEs to make the reported government fiscal balances appear better than they truly are. At a minimum, therefore, the operations of PEs should be systematically monitored and transparently reported to the public. This requires adequate frequency and detail to enable a proper evaluation of fiscal risks.3

3. In 2005, the IMF’s Fiscal Affairs Department proposed a framework to assess fiscal risks from PEs and define the appropriate coverage of fiscal indicators. Quantifying QFAs and contingent liabilities can be methodologically challenging. Thus, identifying in first instance those enterprises that pose the most significant risks becomes important. The Fiscal Affairs Department (FAD) proposed an approach to the treatment of PEs in fiscal indicators and targets, focusing on the fiscal risks posed by the operations of PEs.4 The ultimate goal of this work is to assist authorities and Fund staff in defining the appropriate coverage of indicators and targets for the analysis of fiscal policy. Appropriate coverage is essential to allow an adequate and transparent assessment of the fiscal stance, mitigate incentives to move fiscal activities off budget, and reduce risks that unrecorded liabilities surface unexpectedly.

4. This paper assesses fiscal risks posed by two key public transport enterprises. These are the Hungarian State Railways (MAV) and the Budapest Transport Company (BKV). As noted by the IMF Report on Observance of Standards and Codes, Fiscal Transparency Module (fiscal ROSC), these PEs undertake QFAs on behalf of the government, but annual transfers from the budget have been ad hoc and insufficient to cover recurring operating losses. MAV and BKV have, as a result, resorted to borrowing, typically with government guarantees. This has resulted in the accumulation of contingent liabilities for the government. Since PEs are not covered by fiscal indicators and targets that apply to the general government, incentives exist to under-finance QFAs and report a lower headline fiscal balance until the PEs run into financial distress and have to be bailed out. In the past, these bailouts have been treated as “one-off operations, hampering fiscal transparency and contributing to overshooting of fiscal targets. Against this background, this paper applies FAD’s framework to assess fiscal risks posed by MAV and BKV and draws policy lessons for enhancing the transparency, quality, and predictability of fiscal policy in Hungary.

5. The rest of the paper is organized as follows. Section B provides a brief overview of the public sector enterprise in Hungary. Section C applies FAD’s approach to assess fiscal risks from MAV and BKV. The final section offers some concluding remarks.

B. Overview of the Public Enterprise Sector in Hungary

6. Key assets remain under government ownership and operation. Over 85 percent of the economy is in private hands.5 According to the Privatization Act (Act XXXIX of 1995), assets may remain in long-term state ownership if they belong to a national public utility provider or are considered to be of strategic importance for the national economy or defense. Capital intensive (MAV, BKV, electricity production) and labor intensive (Post) enterprises remain as state property. The Privatization Act also established the Hungarian Privatization and State Holding Company (ÁPV Rt) to oversee the privatization program.6

7. There is no centralized oversight and management of PEs. The organization of ownership rights follows a decentralized model.7 This is regulated by the Privatization Act, which assigns rights and oversight responsibilities between ÁPV Rt and line ministries.8 PEs under the supervision of ÁPV Rt aim to maintain an arms-length relationship with the government.9 Dividends and transfers between these PEs and the budget are set in business plans. Arrangements regulating transfers between PEs under line ministries and the budget are not transparent. Dividend and transfer policies have been ad hoc, and QFAs have not been fully compensated for by the government. QFAs are particularly significant in the cases of MAV and BKV, but are also present in the water, post, electricity, and gas sectors.10

8. Consolidated information on the PE sector is not available. The Hungarian budget covers the state budget sector, including central budget institutions, the health and pension funds, and other funds (e.g., Labor Market Fund; Cultural Fund). For the purpose of reporting on ESA95 basis, and setting targets for the Convergence Program, the state budget sector is consolidated with local government operations and certain central government units outside of the state budget sector.11 The government does not report on the consolidated position of the PE sector, either in budget documents or within-year reports. Budget documents also lack information on QFAs. And the discussion on fiscal risks is limited to loan guarantees of the central government. To assess the fiscal impulse, the Central Bank of Hungary compiles an augmented measure of the fiscal deficit (the “augmented SNA deficit”) that consolidates the general government sector with key QFAs, including those from public transport enterprises.

9. The operations of MAV and BKV are monitored closely by the government, but within-year data are not reported to the public. The Ministry of Economy and Transport (MET) exercises full ownership rights over MAV, while the Municipality of Budapest (MB) is the sole shareholder of BKV. Recognizing that these enterprises are in a difficult financial situation, their operations are monitored closely by the government. MAV reports to the MET on a monthly basis; and the amounts of capital injections and state guarantees are coordinated and approved by the MET and the Ministry of Finance. BKV also reports to the MB on a monthly basis. Its borrowing plans are approved by the MB, and by the state as well in the case of state-guaranteed loans. These within-year reports are not publicly available, although audited annual reports are.

C. Assessment of Fiscal Risks

10. This section reviews fiscal risks posed by MAV and BKV. Given precedents of financial difficulties and contingent liabilities, this section assesses fiscal risks from MAV and BKV against the criteria proposed by FAD. These criteria relate to: (i) managerial independence; (ii) relations with the government; (iii) financial conditions; (iv) governance structure; and (v) other risk factors (Box 1).

Assessment of fiscal risks posed by MAV

11. MAV does not comply with several of the FAD criteria on fiscal risks. As described in detail below, MAV does not meet many of the criteria in the areas of managerial independence, relations with the government, financial conditions, and other risk factors (Table 1). Regarding governance, MAV complies with the criteria on external audits, but reporting could be improved.

Table 1.

Hungarian State Railways: Summary of Compliance with IMF’s FAD Criteria on Fiscal Risks

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Sources: Hungarian authorities; and IMF staff estimates.

The enterprise has had negative profitability over the last years. In 2006, MAV’s net worth was also negative, requiring capitalization.

Debt level is defined as the ratio of total liabilities to total assets in most recent year in percent.

Debt cost is defined as the ratio of accrued 4-year financial costs to average total debt, including short and long-term debt, in percent.

Criterion 1: Managerial Independence—Pricing and Employment Policies

12. MAV does not enjoy managerial independence in employment and pricing policies. Employment and wage policies are determined in annual business plans, which have to be approved by the MET in compliance with the Labor Code. Passenger tariffs are set by the government, and these are not fully-aligned with cost-recovery levels. Prices for freight facilities have been set more freely since 1994 and better reflect market conditions. As noted by KPMG (2006), MAV has operated at a loss mainly due to services being priced at below operating costs and pricing policies being outside the control of the enterprise.

Criteria for Assessing Fiscal Risks of Public Enterprises

I. Managerial independence

Pricing policy: whether prices are in line with international benchmarks for traded goods and services; cover costs (for nontraded goods); and in regulated sectors, whether the tariff setting regime is compatible with the long-term sustainability of the PE.

Employment policy: whether this is independent of civil service laws, and the government intervenes in wage setting and hiring.

II. Relations with the government

Subsidies and transfers: whether the government provides direct or indirect subsidies and/or explicit or implicit loan guarantees which go beyond those given to private enterprises; and whether the PE make any special transfers to the government

Quasi-fiscal activities: whether PEs perform uncompensated functions or absorb costs which are not directly related to their business objective and/or substitute for government spending.

Regulatory and tax regime: whether PEs are subject to the same regulations and taxes as private firms.

III. Financial conditions and sustainability

Market access: whether PEs can borrow without a government loan guarantee.

Less-than-full leveraging: whether PEs’ liability-to-asset ratio is comparable to industry averages.

Profitability: whether PEs perform compared to relevant industry.

Record of past investments: whether past investments had an appropriate average rate of return.

IV. Governance structure

Periodic outside audits: whether these are carried out by a reputable private accounting firm applying international standards and are published.

Publication of comprehensive annual reports: whether annual reports are published, and what type of information they include.

Shareholders’ rights: whether minority shareholders’ rights are protected.

V. Other risk factors

Vulnerability: whether PEs have sizeable contingent liabilities relative to their operating balance. Importance: whether PEs are large in some significant dimension (for example, debt service, employment, customer base).

Criterion 2: Relations with the Government—Transfers, Subsidies, and QFAs

13. MAV undertakes significant QFAs on behalf of the government, but these are not fully compensated by the budget. Subsidies or free tickets are provided for several population groups, including students, children, senior citizens, families, civil servants, pensioners, and others. About 25 percent of passengers do not pay for transport services. The government makes annual transfers to MAV under two concepts: consumer price supplements and public service obligations. These transfers have been insufficient to cover the cost of QFAs. The share of passenger operating costs covered by budget transfers has fallen since 2003, from 57 percent to about 47 percent in 2005 (Table 2). MAV also receives budget support for investment and other goals (Table 3).

Table 2.

Hungarian State Railways: Passenger Operations, 2000-05

(In billions of forint; unless otherwise indicated)

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Sources: KPMG (2006); and IMF staff estimates.
Table 3.

Budget Support to Hungarian State Railways, 2000-06

(In billions of forint, unless otherwise indicated)

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Sources: Hungarian authorities; and IMF staff estimates.

2006 data excludes freight operations.

14. The tax treatment of MAV is broadly in line with that of private enterprises. Since MAV does not use public roads, it receives a rebate from the government on paid excise taxes on fuel. The same treatment applies to water and air transportation enterprises. As MAV has been running losses, it has not paid dividends or corporate income taxes to the central government. MAV has also not paid the local business tax collected by municipalities.12 However, loss-making private enterprises, which do not provide public services, do not receive the latter favorable treatment.

Criterion 3: Financial Conditions and Sustainability

15. MAV is in poor financial health. The liability-to-asset ratio has increased from 25 percent in 2000 to over 100 percent in 2006 (Table 4). The company’s equity and reserve position has declined significantly over the past 5 years, reaching below capital adequacy levels in 2004 (KPMG, 2005). Liquidity indicators also show marked deterioration. Net operational losses before government transfers were close to 1 percent of GDP in 2006 (and about 0.5 percent of GDP after transfers). Investment levels have been compressed to under 0.5 percent of GDP in recent years.13

Table 4.

Hungarian State Railways: Summary of Financial Indicators, 2000-06

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Sources: Hungarian authorities; and IMF staff estimates.

2006 data excludes freight operations.

Current assets divided by current liabilities.

16. The government provides loan guarantees to MAV and has taken over MAV’s liabilities in several occasions in the past. The state took over MAV’s liabilities in 2000 and 2002. Despite these bailouts, liabilities have remained on the rise, reaching over 100 percent of assets in 2006. The cost of debt has been around 6 percent. This is close to government costs, arguably reflecting the state’s backing of MAV’s liabilities. State guarantees have averaged 0.3 percent of GDP in the past 6 years.

17. The recent separation of freight and passenger branches has increased transparency. A new and legally-independent firm for freight transport was established in January, 2006. As noted earlier, prices for freight transport have been better aligned with market conditions, and freight operations are expected to post profits following the split in operations from passenger transport. This separation will increase transparency and will make it easier to define public transport services that are to be compensated by the state. However, unless passenger fares or budget transfers are increased, losses from passenger operations will continue and will cease to be cross-subsidized from freight operations. Following the separation of freight and passenger operations, MAV will also undergo a rationalization program (e.g., closure of underutilized branch lines).14

Criterion 4: Governance Structure: External Audits and Shareholders’ Rights

18. MAV’s accounts are audited externally on the basis of International Accounting Standards, and these reports are available to the public. Currently, the auditor is the KPMG Hungária Kft. (KPMG Hungária Limited Liability Co). Annual reports are not posted on-line and there is no within year reporting on MAV’s financial position. MAV is not listed in the stock exchange and has no minority shareholders.

Criterion 5: Other Risk Factors

19. MAV dominates railway transport in Hungary. MAV faces little competition in passenger rail transport, serving over 150 million passengers a year. Győr-Sopron-Ebenfurt Co., a joint Hungarian-Austrian enterprises, also offers rail transport but at much smaller scale. Five small private railway enterprises offer freight services. In terms of employment, the number of employees has gone down in recent years, but at about 45.000, MAV continues to be a large employer in need of further restructuring.

Assessment of fiscal risks posed by BKV

20. BKV also fails to meet many of the FAD criteria on fiscal risks, including in the areas of managerial independence, relations with the government, financial conditions, and other risk factors (Table 5). External audits are performed and publicly available, and BKV’s annual reports are also posted on-line.

Table 5.

Budapest Transport Company: Summary of Compliance with IMF’s FAD Criteria on Fiscal Risks

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Sources: Hungarian authorities; and IMF staff estimates.

Profitability is defined as the ratio of net profits to net worth in most recent years in percent.

Debt level is defined as the ratio of total liabilities to total assets in most recent year in percent.

Debt cost is defined as the ratio of accrued 4-year financial costs to average total debt, including short and long-term debt, in percent.

Criterion 1: Managerial Independence—Pricing and Employment Policies

21. BKV does not enjoy managerial independence in pricing and employment policies. Prices are set administratively by the MB and lag behind cost-recovery levels. Given the current tariff structure, operating revenues before government transfers cover less than 50 percent of operating expenditures.15 Employment and wage policies are set out in annual business plans, which have to be approved by the Budapest Municipal Owners’ and Municipal Operations’ Committees and comply with the Labor Code.

Criterion 2: Relations with the Government—Transfers, Subsidies, and QFAs

22. Budget transfers are not sufficient to make up for the cost of QFAs. Student, pensioners, and other groups receive discounted or free tickets. BKV receives subsidies to compensate for these QFAs under two concepts: price subsidies (linked to consumers) and normative subsides (linked to public service obligations). Both the central government budget and the MB provide financial assistance to the company (Table 6). Budget transfers are determined annually and cover about 40 percent of operating costs. In 2004, BKV and the MB signed an 8 year long public service contract the defines quality standards, volume of services to be provided, compensation schemes, etc.

Table 6.

Budget Support to Budapest Transport Company, 2000-06

(In billions of fortins, unless otherwise indicated)

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Sources: Hungarian authorities; and IMF staff estimates.

23. BKV is broadly subject to the same tax regulations as private firms. However, as noted below, BKV’s poor liquidity position prompted the enterprise to apply for deferred tax payments to the tax authority (APEH) in 2004.16 As BKV has been running losses, it has not paid dividends or corporate income taxes. Similarly to MAV, BKV has also not paid the local business tax.

Criterion 3: Financial Conditions and Sustainability

24. The government took over BKV’s liabilities in 2002 and provided loan guarantees in 2005. The central government provided special assistance to BKV in 2002, taking over debt obligations worth HUF 36 billion (about 0.2 percent of GDP). About 60 percent of these liabilities corresponded to short-term credits. Reflecting poor liquidity and difficult access to market financing in 2004 (see below), state loan guarantees in the amount of HUF 15 billion were provided for the first time in 2005.

25. BKV’s financial conditions are weak. Following the government’s bail out in 2002, the ratio of total liabilities to assets continued to increase from 8 percent to close to 30 percent in 2006. Liquidity indicators have also worsened (Table 7), rendering the financial position critical in 2004, in part due to shortfalls in expected price subsidies. At that point, BKV was granted deferred payments of tax liabilities to APEH and was authorized to issue new debt. The issuance was undersubscribed as banks regarded BKV’s creditworthiness as less favorable compared to previous years. Net operating losses after transfers have remained at around 0.1 percent of GDP in recent years. Weak financial conditions have constrained investment at 0.2 percent of GDP, and equity levels have been on the decline.

Table 7.

Budapest Transport Company: Summary of Financial Indicators, 2000-06

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Sources: Hungarian authorities; and IMF staff estimates.

Current assets divided by current liabilities.

Criterion 4: Governance Structure: External Audits and Shareholders’ Rights

26. BKV’s accounts are audited externally on the basis of International Accounting Standards, and annual reports are published on-line. Currently, the auditor is Deloitte & Touch, and audited reports are publicly available. BKV also publishes annual reports on its website, with useful and clearly presented financial information. As in the case of MAV, there is no public within-year reporting. BKV is not listed in the stock exchange, has no minority shareholders, and is not rated by any credit rating agency.

Criterion 5: Other Risk Factors

27. BKV is the largest local public transport enterprise in Hungary. BKV provides transport services to 1.4 billion passengers a year and does not face meaningful competition. It employs close to 13.000 people and its orders are significant in the local input markets.

D. Concluding Remarks

28. MAV and BKV pose important fiscal risks. Both enterprises fail to meet key FAD criteria. In particular, financial arrangements with the budget are not transparent, and QFAs are not fully compensated by the government. The enterprises financial conditions have been weak, and despite bailouts in recent years, liabilities have continued to rise. Some part of these liabilities are backed by government guarantees and, absent improvement in financial conditions, could impact the government accounts in the near future. Externally audited reports are publicly available, but the assessment and disclosure of fiscal risks from PEs in budget documents is lacking. This hampers fiscal transparency and increases uncertainty regarding the true extent of fiscal activities.

29. While these PEs pose risks to the government budget, government policies also entail risks for these PEs. Pricing policies are set by the government and tariffs have lagged behind cost-recovery levels. The enterprises’ dependence on budget transfers pose risks to their operations. Incentives to under-finance QFAs and bail out the enterprises every few years will remain, until transparent financial arrangements between the budget and these enterprises are set out, and consistent pricing policies are determined.

30. The government is taking steps to improve transparency and governance. Over the past few years, the government has been discussing a public service contract with MAV. In the most recent Convergence Program, the government has reaffirmed its commitment to increase the transparency of financial arrangements. The goal is to clearly define the principles governing operating subsidies in public service contracts that would be concluded with the relevant enterprises. Under these contracts, subsidies would reflect the entire cost of efficient delivery of the service that the government requires the enterprise to undertake. Timely and proper completion of these contracts is essential to provide stability and transparency to funding arrangements. The government has also increased budget support to MAV in 2007 and provided a capital injection.

31. The assessment in this paper suggests that additional efforts could enhance the quality, transparency, and predictability of fiscal policy. While the general government balance on ESA95 basis is the key fiscal policy indicator and target, the extent of QFAs in these public transport enterprises, the history of bailouts, and incentives to under finance QFAs, support the view that the existing coverage does not reflect the true extent of fiscal activities.17 Best practices in fiscal transparency suggests that the government should include an analysis of these PE operations in budget documents, present a statement on QFAs, and report on the consolidated position of these PEs with the general government on a frequent basis. The budget should also provide a medium-term perspective of financial support to these PEs. Consideration could also be given to applying the criteria on fiscal risks to other sectors to identify other loss-making or vulnerable enterprises that may need closer monitoring.

Appendix 1

Business associations operating with company shares in long-term state ownership, percentage of state ownership, and agencies exercising the state’s membership (shareholder’s) rights according to the Privatization Act

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Appendix 2.

Hungarian State Railways: Income Statement and Balance Sheet, 2000-06

(In millions of forints)

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Source: Hungarian authorities based on data provided by Hungarian State Railways.

2006 data excludes freight operations.

Appendix 3.

Budapest Transport Company: Income Statement and Balance Sheet, 2000-06

(In million of forints)

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Source: Hungarian authorities.

References

  • Báger, Gusztáv, and Árpád Kovács, 2004, “Certain Lessons in Privatisation in Hungary,Development & Finance 2004/4, pages 2737.

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  • International Monetary Fund, 2001, Government Finance Statistics Manual (Washington).

  • International Monetary Fund, 2005, “Public Investment and Fiscal Policy: Lessons from the Pilot Case Studies,available via the internet at http://www.imf.org/external/np/sec/pn/2005/pn0568.htm.

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  • International Monetary Fund, 2007, Hungary: Report on the Observance of Standards and Codes, Fiscal Transparency Module (Washington).

  • International Monetary Fund, 2007, Manual on Fiscal Transparency (Washington).

  • KPMG, 2005, “Independent Auditor’s Report for the Owner of the Hungarian State Railways Corporation.

  • KPMG, 2006, “Independent Auditor’s Report for the Owner of the Hungarian State Railways Corporation.

  • OECD, 2005a, OECD Guidelines on Corporate Governance of State-Owned Enterprises (Paris).

  • OECD, 2005b, Corporate Governance of State-Owned Enterprises: a Survey of OECD Countries (Paris).

  • OECD, 2007, 2007 Economic Review: Hungary (Paris).

1

Prepared by Ana Corbacho (FAD).

2

QFAs may be conducted by financial institutions (e.g., subsidized lending; credit ceilings; exchange rate guarantees), or by nonfinancial public enterprises (e.g., charging less than commercial prices; provision of social services; pricing for budget revenue purposes; paying above commercial prices to suppliers).

3

For instance, the IMF Manual on Fiscal Transparency recommends that budget documents include statements on QFAs and fiscal risks, and that the consolidated position of the government and nongovernmental public sector agencies that undertake significant QFAs be reported. Similarly, the 2001 Government Finance Statistics Manual (GFSM 2001) recommends the compilation of accrual-based statistics on the operations of PEs and the nonfinancial public sector.

4

In 2004, FAD conducted several pilot studies to identify “commercially oriented” PEs, which could be considered candidates for exclusion from fiscal targets and indicators. Very few PEs were found to be commercially oriented; but, more importantly, the pilot studies also suggested various changes in the approach to the fiscal coverage of PEs. See IMF (2005) for further details.

5

See Báger and Kovács (2004) for a survey of privatization in Hungary.

6

The government recently submitted to Parliament a new Act on State Asset Management, which will set up a new state asset management company. This company will assume the responsibilities currently assigned to the ÁPV Rt., the Treasury Property Directorate, and the National Land Fund, and will be directed by a national asset management council.

7

See OECD (2005a) and OECD (2005b) for a survey on ownership function models for PEs.

8

ÁPV Rt. exercises ownership rights over several important public enterprises, including the long-distance bus company VOLANBUSZ and certain power enterprises. The Ministry of Economy and Transport exercises ownership rights over MAV, the National Road Construction Company, and the State Motorway Company. The Municipality of Budapest is the sole shareholder of BKV. See Appendix 1 for a full list of enterprises under long-term state property as dictated by the Privatization Act.

9

As part of its asset management duties, ÁPV Rt. defines and approves the enterprises’ strategies and business plans, continuously tracks enterprises’ financial management and liquidity, has enterprises’ annual reports compiled, and decides on dividend payments.

10

See fiscal ROSC for further details.

11

These include, for example, ÁPV Rt; the National Road Construction Company; and the State Motorway Company. The budget documents include an appendix that explains the relationship between fiscal targets of the state budget sector and general government consistent with ESA95.

12

Act C of 1990 on Local Taxes exempts public service enterprises from the local business tax when these enterprises do not incur corporate tax liabilities.

13

See Appendix 2 for full details on the income statement and balance sheet of MAV.

14

The OECD (2007) notes that the returns on this program for 2007 and 2008 are uncertain, and that even with EU funds financing, the level of government support for this project is estimated to be large. These costs have to be incorporated in the Convergence Program.

15

Tariffs would need to increase by 134% to fully finance operations without any budgetary compensation.

16

A similar situation arose in 2000.

17

As recommended in the fiscal ROSC, a first priority should be to align the coverage of the budget with the ESA95 definition of government. This requires extending the coverage of the state budget to certain central government units (including the National Road Construction Company, the APV Rt., the State Motorway Company, the State Debt Management Company, the State Treasury Company, public media enterprises, and certain nonprofit institutions and enterprises).