Fiscal Consolidation, Public Debt Containment and Disinflation – (Hungary’s Experience in Transition)

The study analyses the relationship between public debt, external and internal disequilibrium and inflation in Hungary through changes in the public sector borrowing requirement and in the structure of budget financing. The analysis is based on data from the 1986-1997 period in order to put the changes in true perspective. Policy constraints stemming from high indebtedness and their macroeconomic consequences are analysed by comparing different measures of fiscal deficit, as well as by quantifying the factors determining the evolution of the public debt/GDP ratio. We focus on the operational deficit (which is derived from the nominal deficit by eliminating the inflation compensation component of interest payments) and on its financing. The study presents a detailed empirical analysis of the evolution of the financing structure (seigniorage - debt) as well as of the role and structural changes of debt financing. The calculations are based on net consolidated public debt, which includes the combined debt of the budget and the central bank to other sectors net of claims. The consolidation of budget and central bank balances is unavoidable in order to get reliable indicators of the fiscal stance since in Hungary the central bank has been responsible for borrowing abroad in its own name. We introduced the category of ?extended??consolidated public debt (including the stock of central bank’s sterilisation instruments) which enabled us to analyse the past eleven years in a consistent framework, and to reveal the trends as well as the dynamic relationships of the debt accumulation process. The analysis shows that the shift to a new regime of deficit financing based on issuing marketable government securities (in 1992) did not increase the fiscal burden, it merely revealed its true magnitude by separating monetary and fiscal functions and by increasing transparency. The analysis of consolidated debt revealed that throughout the last ten years the implicit real interest rates on public debt exceeded the growth rate of the economy, which led to the continuous increase of the debt ratio (the gross debt/GDP around 90% in the middle of nineties). This effect was mitigated only from 1995 by the fiscal adjustment resulting a primary surplus in the budget. The seigniorage did not play an important role in financing after 1992, it amounted to 1-2% of GDP. However, the major element in the significant (over 15 percentage points) reduction in the debt-to- GDP ratio over the last three years was the devotion of privatisation revenues to retire public debt. Analysing past developments, we came to the conclusion that despite the significant reduction in the debt-to-GDP ratio in the last few years, the debt burden is still significant and a further reduction of the debt to GDP ratio is inevitable in order to create the conditions for sustainable growth and to ensure the continuous convergence to developed countries. This requires a structural primary surplus of 1.5-2% of GDP in the medium run, if we take into account the requirement of sustainability, the goal of further reductions in the inflation rate and the fact that with the end of the privatisation process privatisation revenues will not provide additional sources for financing.