Well, it happened. For the first time in its history, the European Union has proposed initiating economic sanctions against a member country under the excessive deficit procedure (EDP). What does that mean? Treaty provisions oblige a member state to keep its deficit below 3% of GDP and government debt below or sufficiently declining toward 60% of GDP.
Hungary is not the only country that is currently under this procedure. It shares the honors with five other countries. Then why the threat of economic sanctions only against Hungary? Because never since Hungary’s accession to the Union has its budget deficit been under 3% of GDP and because the European Commission didn’t see in the last two years any serious Hungarian resolve to remedy the situation. Although it is allegedly true that last year’s deficit will be just slightly over 3%, it was achieved by one-time measures: “nationalization” of private pension funds, extra levies on financial institutions and other selected economic sectors including telecommunication companies. Without these revenues the actual deficit would be well over 6 percent. And since no structural changes were introduced, it is unlikely that the Hungarian government will be able to sustain a deficit under the required 3%.
The European Union’s fiscal governance was lax to say the least in the past years. But then came the 2008 financial crisis. In its wake the rules changed drastically. As of December 13, 2011 financial sanctions will be applied to EU members that do not take adequate action against an excessive deficit.
According to these new rules a country that belongs to the euro-zone will be required to make a non-interest-bearing deposit worth 0.2% of its GDP. If it is a country, like Hungary, outside of the euro-zone, it can be deprived of its so-called “cohesion funds” amounting to no more than 0.5% of its GDP or no more than 50% of its cohesion funds.
What are the “cohesion funds”? These are infrastructure-development subsidies that are supposed to assist the less developed members of the EU in bringing their economies closer to the more prosperous western parts of the Union.
Although the Hungarian government tried to convince the population that such a procedure will not be launched against Hungary, apparently they strongly suspected the negative outcome for which they have been trying to prepare the ground. For example, only a few days ago the government introduced new austerity measures: fewer government subsidies on drugs and a cutback in subsidized public transportation travel.
Depending on final approval by the Economic and Financial Affairs Council (commonly known as Ecofin) that consists of the economic affairs and finance ministers of the member states, if Hungary doesn’t make major strides very quickly the suspension of funds will begin on January 1, 2013. According to most analysts of European affairs, it is very unlikely that Ecofin will go against the decision of the European Commission. Moreover, the weighting of Ecofin votes reflects the size of the country’s population, so if the large and prosperous countries that provide most of the subsidies to Hungary go along with the decision, Hungary is unlikely to be able to gather enough support to serve as a counterweight.
The “punishment” is severe: freezing 495 million euros ($656 million) worth of cohesion monies. That is exactly 0.5 percent of GDP–that is, the maximum amount of money that can be withheld according to the new rules. Although the suspension of funds will begin only on January 1, 2013, some projects that have not been approved but are under consideration must now be put on ice.
This is a very sizable chunk of the subsidies Hungary is slated to receive in 2013: 29% of infrastructure investment. The building of highway M43 and M3 or Metro4 in Budapest will not be affected because these projects have already been approved by Brussels. But some important Budapest development as well as the modernization of some railroad lines will not be able to go forward.
Ecofin meets once a month and the next meeting will take place on March 13. It is important to realize that even if Ecofin puts its stamp of approval on the Commission’s decision, Hungary still has until December to mend its ways. As Olli Rehn of the European Commission said, “Today’s proposal should be seen as a strong incentive for Hungary to conduct sound fiscal policies and put in place the right macro-economic and fiscal conditions to ensure an efficient use of Cohesion Fund resources. It is now for the Hungarian government to act before the suspension takes effect.”
And this means more than staying within the magic 3%. Brussels expects serious structural changes. Whether taking in more money by making pensioners pay their fare in the morning hours or taking away subsidies on drugs will be considered “structural changes” I very much doubt.
Not surprisingly, the Hungarian government finds the suspension proposal unfounded, unfair, and legally questionable. Orbán’s government claims that it has already taken prudent steps and therefore the decision is unfounded. An official from György Matolcsy’s ministry even claimed that there was no “practical chance” that the funds would be suspended. Lajos Kósa, one of the deputy chairmen of Fidesz, who likes to use strong words, said that the decision will lead to “bad blood” and that the commission made “an exceptionally bad and irresponsible decision.” Music to Brussels’ ears!
EU officials don’t consider their action a “punishment.” It is only a warning, and “if the country takes effective action in time it will not face this consequence,” Olli Rehn said today.
The markets immediately reacted to the news. Reuters reported that Hungarian assets fell after the EU threatened to suspend some funds to Budapest. The Reuters article also talked about “the disconnect between Brussels and Budapest.”
While we are dissecting the “excessive deficit procedure” we mustn’t forget about the other matters under consideration in Brussels: questions about the media, the judiciary, the new constitution itself and all those complaints coming from the European Parliament concerning the undemocratic spirit that casts a shadow over the Orbán regime’s efforts at establishing a different kind of democracy.
While the government is struggling over the deficit, another 1.5 billion forints was allocated for government communication. Unfortunately communication itself is no remedy for bad governance and an unrealistic economic policy.