Transcript of a Conference Call with Mission Chief for Hungary Christoph Rosenberg on the First Post-Program Monitoring Discussion
June 15, 2011June 15, 2011
MS. NARDIN: Good morning and thank you for joining us on this conference call with Christoph Rosenberg, the Mission Chief for Hungary, to discuss the staff report of the first Post-Program Monitoring discussion with Hungary.
MR. ROSENBERG: Thank you, Simonetta, and good morning or good afternoon to everybody. Let me say a few words about the meaning of “post-program monitoring discussions,” which is a mouthful, because you may not be familiar with this particular IMF procedure. Whenever we have large outstanding amounts of credit to a country, we are required to conduct a somewhat more intensive policy dialogue even after the program has ended. In the case of Hungary, we expect this period to continue until Hungary pays down its debt to the IMF which I is going to be in 2014. We conduct these discussions every 6 months and prepare a report on them. We had these discussions this time in April jointly with our colleagues from the European Commission. The report that you have in your hands was finalized in May and there was an update which is also part of the package submitted to our board 2 weeks ago. The board meeting itself was on June 8, exactly a week ago, and that is going to be what I will be briefing you on.
I should say at the outset that our discussions with the Hungarian authorities have really been very constructive and very good. We all know that there were some difficult periods around the end of the program and around the last Article IV consultation, where we did not see eye to eye on a few policy issues. I think that a lot has happened in Hungary in the last few months and that has certainly made our policy dialogue at all levels from the Prime Minister, who we met in April, to the technical level and the Central Bank, very constructive.
On the economy itself, I think the general story is generally well known by now. Hungary is slowly emerging from the crisis, certainly not at the speed that we would like to see. The economy is heavily driven by exports especially to Germany, while domestic demand is very weak as we can see from the latest data coming in. Of course, this low domestic demand means also low imports so that we have a trade and current account surplus, which from an external financing point of view is a good thing. Budget implementation has been a longstanding issue in Hungary, and also last year the budget deficit despite big efforts by the government was not fully on target. On an ESA 95 basis, it was 4.3 percent of GDP. There were also some problems earlier this year, but our latest data suggests that implementation seems to be back on track.
The financial sector is also something we always look at very carefully. Here the credit growth has been and is very low due to a host of reasons that we can discuss later. This is also certainly contributing to low domestic demand. The consultation focused on three policy areas: the Szell Kalman plan obviously, the measures that the government has recently been taking in the financial sector, and finally issues of external vulnerability and reserve coverage.
To take those one by one, the Szell Kalman plan, which was published in March and then further specified in the convergence program in April, is a very welcome step in the right direction. In fact, it is very much in line with our recommendations in the January 2011 Article IV consultation. We think the size of this plan is appropriate and the focus on expenditures is appropriate. The focus on stimulating labor supply is also right. We think overall it strikes the right balance between bringing debt to GDP on a credibly downward path, but at the same time not withdrawing too much stimulus from the economy. So in that sense what we are projecting now for the next year, the deficit of 3.3 percent of GDP, is appropriate and would certainly achieve this goal. Of course, the plan could be improved and we have pointed to a few things in the report. There could be more focus on staffing issues in the government in general, means testing of social benefits would be useful to protect the vulnerable, the transport sector could have attracted more attention, and clearly, we also think that the elimination of sectoral levies, including on the banking sector, should proceed as fast as possible.
The key issue about the Szell Kalman plan is its implementation, and there of course some early steps have now been taken. But we think that the true test will really be the 2012 budget because that is where the numbers will actually have to enter a full fiscal framework. As you know, the Szell Kalman plan for this year does not really envisage much savings, so the 2012 budget will be the thing to watch.
In the financial sector, as I said, the key issue is that the banks are fundamentally solid, but that they are not lending for a number of reasons. A specific concern that the authorities have identified is the mortgage sector. There have been five measures that were now agreed with the banks. I think it goes in the right direction. Again, one can debate whether the scale of the problem actually requires any kind of government intervention, and the measures that have been now designed may be a bit over engineered in that they are very detailed. It will remain to be seen how effective they will be because there are many constraints included, for example on the lifting of the foreclosure moratorium or renewed lending in euro. But on the other hand, that limits the possibility of this risking too much moral hazard or having fiscal implications.
One can argue about some of the details that were negotiated. I do not want to get into that. But as a whole, we do not think that this scheme in itself will have a huge effect one way or the other at this point, but we will have to see how it will be implemented.
The other issue with the financial sector of course continues to be the bank levies. We do think that these have some negative implications: we see foreign banks directing their funding to other countries in the region because of this and because of other issues in the business environment in general. So we have urged the authorities to move quickly to replace these ad hoc levies with a more permanent, sustainable taxation model for banks. Obviously, we strongly believe that the banking sector needs to be properly brought into the tax loop. The variant that we have suggested to think about is a financial activity tax which is one that would levy the tax not on the size of the balance sheet but on profits plus remunerations, the value added. This would thus be akin to the value added tax which as you may know is not levied on the financial sector right now.
The third big issue that we discussed is external vulnerability. There I think one should not be deceived by the lately very positive investor perception of Hungary. I think that is of course very positive and rewards the government for making announcements in the right direction, but we should not forget that Hungary remains highly exposed to external shocks. In the report, we have a box which compares vulnerabilities before the crisis and now. On a number of metrics, the buffers are higher and there are new policy instruments to deal with possible external shocks. But on the other hand, the country is just as exposed as it was before to foreign investors who can quickly change their minds, as you know. Let’s not forget, we're living in a dangerous environment in Europe right now. Many things can happen and Hungary would certainly with its high debt to GDP ratio be one country that could quickly be affected by something going wrong elsewhere in Europe.
In that context, we did suggest that it's important to look at reserve coverage because that is the buffer that the central bank and government have at their disposal to deal with any kind of unexpected events of the kind seen in late 2008. Of course, there is a large academic debate over what is adequate and what is not for reserve coverage. We think that one should not lose sight of short-term debt reserves which is a classic metric used for countries with very open capital accounts. And we think that in that context one should take for granted the large part of funding from parent banks. It is true that during the crisis, parent bank funding was a stable source of funding but it is not clear that that will always be the case in the future, given the goodwill lost in the last year. Moreover, there are large repayment due to external creditors in the next few years. Against this background, we've suggested that it would be prudent to increase the reserve coverage and we discussed a few mechanisms that do not interfere with the monetary framework in the report. I should say that at the board meeting last week a number of Executive Directors from around the world in this context expressed concern about the recent decision to use some of these reserves to buy a share in the gas company MOL. With that, I'll turn the floor back to Simonetta and to questions.
QUESTION: I have three different questions. The first is about the public information notice. Let me quote a sentence, "Directors regretted that much of the fiscal achievements under the program have been unwound since the program lapsed.” How do you mean that? The second is about the social benefits. You stress that social benefits should be strictly means tested to avoid placing a disproportionate burden of adjustment on the most vulnerable. Do you think that these programs under the Szell Kalman plan are a bit too arrogant to most vulnerable people? My third question is that the Prime Minister, Mr. Orban, will announce the 1st of July that he will cut state debt from 82 percent to 77 percent by using the private pension funds -- the bonds on the private pension funds. How would you comment on these steps?
MR. ROSENBERG: Let me take them in turn. First, the statement by the directors which is reflected in the PIN refers to a concept that we use when we analyze fiscal policy”: the primary structural deficit. That is the change in the fiscal stance corrected for what's happening in the economy (the cyclical stance) and one-off measures. Under the program, there was a substantial structural fiscal adjustment. If you look at Table 9, you see this improvement in the primary structural balance by 2.3 percent of GDP in 2009. But in 2010 and 2011, this was largely undone because in 2010 we have a structural fiscal loosening of 1.8 percent and in 2011 another minus 0.4. What's behind this is that the government at that time lowered taxes, personal income tax and corporate income taxes. There was an increase also in expenditures. To get to the headline deficit agreed with the EU, the government then introduced a number of one-off tax measures. So basically, what has happened is that maybe the headline deficit didn't change so much, but the underlying deficit, the deficit that corrects for these one-offs, did weaken substantially. That's why the Szell Kalman plan is so important, because it aims to correct this underlying fiscal weakening.
The second question was about the social benefits. Indeed, what we were missing in the Szell Kalman plan is that we have, which is appropriate, some adjustments to social benefits because some of them are by international comparison a bit generous and don't give the right incentives to work. But at the same time, the benefits are not means-tested, meaning they do not differentiate between rich and poor. Certain benefits are just cut across the board, and we think it is important especially against the background of the income tax reform which already makes the tax system more regressive, that the truly poor and vulnerable are less affected by these cuts than those who can afford them.
The third question was about the reduction of debt. Yes, with the transfer of these pension assets back to the government, there will also be government securities that will be coming back and those will be automatically cancelled out. This is something that we show also in our tables. It is a one-off reduction in government debt. The question is not so much what happens with these returning government bonds that are automatically cancelled, but what is happening with the other 5-6 percent of GDP that are being transferred back. As we write in the report, not all of the assets that are being transferred back to the government are being used to reduce government debt. In fact, only about half of it is being used to reduce government debt. The rest is being used for various other purposes, including current spending.
QUESTION I have three questions. The first one is on FX reserves. Basically, you mentioned three possible tools which the government or the central bank could use to increase fixed reserves. Am I right in reading between the lines that your ideas were not received very positively by the Hungarian authorities? Is there any willingness on the Hungarian authorities' side to actually carry out any of these measures to increased fixed reserves? My second question is that the European Commission statement which came out recently mentioned the need for additional fiscal measures to achieve the budget deficit targets and your forecast actually exceeds the government forecast in each of the next 3 years. The budget doesn't mention the need for further measures, only the implementation. Would you comment on that?
The third question is you say very little about the tax system in this report and there is some criticism of the Hungarian government's measures which cut the personal income tax but basically for a certain income group. Do you believe that the government should possibly reconsider its plan to phase out the super grossing in the next 2 years in order to achieve deficit targets?
MR. ROSENBERG: Very good questions. On the first one on the FX, yes, you're right. We mentioned these three measures that on the margin would help. None of them is in and of themselves powerful tools. And I think you're right. You're not reading it only between the lines, on all of these there were arguments why this didn't fit with the government priorities. I guess on this one we look at the issue from different perspectives and we can only recommend this. One thing we're also very clear on and I mentioned it earlier is that the recent drawing-down of reserves further to purchase the share in MOL--more than 2 billion Euros--is certainly not in the direction that we suggest here in the report. There I think the government should quickly find a way of compensating for this loss of reserves. For example, they could try to issue more FX long-term debt, but that of course again goes against the overarching goal of reducing debt. I think there's a tension here between on the one hand one needs to have strong buffers, on the other hand one wants to reduce debt, and sometimes they don't very well mesh together.
On additional measures for 2012, 2013 and 2014, as I've said, the Commission looks at it very much from the excessive deficit procedure and from Hungary's commitment to get the deficit below 3 percent of GDP. We look at it a bit more from the pure economic point of view, and from that point of view, what's important is that the debt to GDP ratio declines, and it also declines with 3.3 percent of GDP as you see in the report. In that sense we think that with fully implementation of the plan and the additional measures that the authorities have shared with us for 2012, we don't see any need for further measures at this juncture. It's probably likely that some of the measures in the plan will be modified and maybe not fully be implemented. Then of course, it will be important to find measures to substitute for those.
On your third question about the tax system, we discussed this earlier. If you go back to the last report in January we did analyze this tax change and we did show also in a chart that it is of course quite regressive, that the average tax rate declines much more for the higher-income groups than for the lower-income groups. At the IMF we don't usually get into distributional questions of which group in the society should be more or less taxed, but we do point out that it has macroeconomic implications. Of course, there is a large revenue loss with this tax cut which needs to be taken into account and that's where your super- grossing question comes in. It would be good to phase this change a bit over time to not have the tax revenue loss quickly compound over the next few years. Then there's the question of what is the overall effect on already weak domestic demand of this? The government has partly motivated this tax cut by the need to stimulate domestic demand. Our concern has always been that if you cut taxes for the higher-income groups, their propensity to consume is much less and it will maybe not have the effect on growth that is hoped for. And that's also the reason why our GDP forecast is a bit more modest than that of the government.
QUESTION: Just on what you said a few moments ago, I think I heard you saying that the no additional measures may be needed if everything that's in the plan is implemented. But you also say in the recent report that steps that are more ambitious are needed and you even mention a few areas where you would welcome more steps. If you could clarify that, please.
MR. ROSENBERG: That is true, but I think those additional measures should be compensating for an earlier reversal of these temporary levies which we think are detrimental to the business environment and to growth. As you note, we suggest giving more attention on the areas that we identified, for example, the public transport companies. But then reduce the temporary levies earlier or more forcefully because as I said they are problematic. For example, to give you one area where we think that they are not having a very good effect is in the retail sector which is a rather labor-intensive sector. To tax that sector quite heavily means that there may be job losses or less demand for labor, at the same time, as there are all these measures to increase the supply of labor. This may contribute to higher unemployment than is desired.QUESTION: My question would also regard Hungary's foreign currency buffers. You've also mentioned securing international backup facilities as one option for Hungary to increase its foreign currency buffers. Would you enter talks with Hungary in case it's implemented its fiscal problem well, and when do you think such talks could commence once Hungary becomes more open toward the IMF? Thanks.
MR. ROSENBERG: At the IMF we have created over the last few years a range of instruments including precautionary instruments for countries that like Hungary are exposed to external shocks but are pursuing the right policies. As I said, I think the last few months have seen policies go in a direction that we could support. That doesn't mean that we're quite at that point yet. To enter into any of these kinds of discussions the authorities themselves would have to express an interest in doing so. We didn't discuss these kinds of issues at any detail during the mission. I think when the time comes we are always ready to entertain any kind of initiative in this direction but it has to obviously come from the authorities.
QUESTION: You mentioned in the report that basically you are suggesting that the government is assuming the debt of railway company MAV and the other transport company without having a proper, credible researching plan first in place. Or the other way around, basically you're suggesting that the government should first have this plan and only assume the debt later. What is your view on the current state of affairs on that? The government has to draw up a plan for restructuring these two companies by the end of the year and we haven't seen any of this.
MR. ROSENBERG: Nor have we. I'm not an expert in railway restructuring, but as you know, this has been a longstanding issue in Hungary and it was also one that we tried to tackle under the program. Our suggestion to the government is simply to not risk moral hazard by these state-owned transport companies by assuming their debt without a precondition on getting from them a credible plan. I haven't seen such a plan and we would suggest that before one bails MAV and BKV out, one should ask them to put on the table a plan that once and for all restructures them because otherwise the problems will reappear and reappear as it has done for the last decade. Again, I can't tell you where such a plan stands. I think that would be a good question to pose to the ministry. But all we are saying is that before you do something like this, before you assume these debts, it would be useful to have a credible new structure.