Hungary and the Euro[3]
Introduction
Hungary became EU member in May 2004. As part of the “acquis communautaire”, participation in the new version of the exchange rate mechanism (ERM II), and subsequently in the European Monetary Union (EMU) is obligatory for all new EU members (no opt-out clause is available). Therefore, the question since then for Hungary and other new member countries has been no longer whether or not to enter the eurozone but rather the time horizon when Hungary’s entry should happen. More specifically, as a condition for EMU membership, a country must be prepared to adopt the euro as the single currency and be able to meet the obligations arising from the Stability and Growth Pact. The formal condition for a country’s preparedness to adopt the single currency is the fulfilment of a set of nominal convergence criteria, the so-called Maastricht criteria.
A single currency offers many advantages: it makes it easier for companies to conduct cross-border trade, the economy becomes more stable, and consumers have more choice and opportunities. However, a variety of political and economic obstacles barred the way: weak political commitment, divisions over economic priorities, and turbulence in international markets. These all played their role in frustrating progress towards the Economic and Monetary Union. All EU member states are in principle obliged to introduce the euro once they fulfil the convergence criteria. The EU countries that have not negotiated a currency opt-out are Poland, the Czech Republic, Hungary, Romania and Sweden (Hampl, 2023). The only exception is Denmark, which has an ‘opt-out clause’ in the EU treaties, exempting the country from the obligation to adopt the euro. Denmark may nevertheless apply for membership of the euro area if it so decides.
There are not many polls that measure the levels of support of adopting the euro among Hungarians. But a Eurobarometer study puts the percentage of Hungarians who would like to replace the forint with the euro at 72% in 2023, in contrast to 56% in 2003 (Eurobarometer, 2023).
Hungary and the Euro – a literature review
The Hungarian political economy is conventionally approached in reference to (one of) several typologies seeking to capture the broader, systemic variations of capitalism that emerged in Central and Eastern Europe (CEE) (Sebők-Simmons, 2022). Most often grouped together with its Visegrád peers, Hungary’s post-transitional mode of capitalism and its institutional arrangements are seen as having equilibrated onto a specific capitalist type variously described as ‘embedded neoliberalism’ (Bohle-Greskovits, 2012), ‘dependent market economy’ (Nölke-Vliegenthart, 2009) or an ‘foreign direct investment (FDI)-based (second-rank) market economy’ (Myant-Drahokoupil, 2010). Hungary was thought to become a part and parcel member of the European Union and then that of the Economic and Monetary Union by building on the grounding conditions established along the years after the regime change. As is often the case, expectations and reality did not converge satisfactorily to each other since the country is now featured with eurolessness (Kovács, 2020). According to Bod et al (2020) in the Hungarian academic and analytical community, the first wave of discussions on this topic dates back to 1999. At that time, several research institutes prepared analyses on EU membership and subsequently on professional preparations for future eurozone entry, commissioned by the Ministry of Finance to support governmental positioning. Over time, the stance of the Hungarian National Bank (MNB) also emerged (Csajbók–Csermely, 2002). Due to various changes in the Hungarian government’s intentions, the topic temporarily fell off the agenda, resurfacing only occasionally (Darvas–Szapáry, 2008). The 2008 financial crisis and the political shift in 2010 created a new situation. The realities and the disturbances within the eurozone at that time were considered by those who participated in the debate initiated in Közgazdasági Szemle on rethinking the euro introduction (see the discussion starter by Neményi–Oblath, 2012), which was responded to by numerous experts in the same journal). After several justified years of absence (as there was no governmental intention for entry and the new order of the eurozone was still taking shape), in 2017, Portfolio.hu opened a debate on the timeliness of the Maastricht criteria and what should be done in the preparation process if political will emerged (see the discussion starters by Madár [2017a], [2017b]). In light of recent developments, the topic resurfaced in the November 2019 issue of Ellensúly (Dobozi (2019), Bod (2019). The staff and leadership of the Hungarian National Bank also took a stance on the issue of transitioning to the euro in several professional publications and commentaries (see Virág ed. (2020).
Convergence process in numbers with respect of the reference value
Hungary does not fulfil the criterion on price stability. In May 2024, the reference value was 4.1%, calculated as the average of the 12-month average inflation rates in the Netherlands, Italy and Latvia, plus 1.5 percentage points. The corresponding inflation rate in Hungary was 8.4%, 4.3 percentage points above the reference value. Over the last two years, HICP inflation first increased substantially peaking at 26.2% in January 2023 before easing steadily to 3.9% in May 2024. Average annual HICP inflation rose to 15.3% in 2022 and 17.0% in 2023, and was significantly above that of the euro area in both years. This inflation differential was due to the higher HICP weight of energy and food in Hungary, a more positive output gap in Hungary in 2022 driven by expansionary policies, and significant currency depreciation in 2022. The inflation differential vis-à-vis the euro area narrowed until early 2022, then widened substantially until early 2023, and has narrowed again since then, mainly driven by energy price inflation that was influenced by measures aimed at reducing the effect of the inflation shock on households purchasing power.
Public finances
The general government deficit remained high over the 2022-2023 period, increasing from 6.2% in 2022 to 6.7% in 2023. Revenues as a share of GDP were below the pre-pandemic levels at 42.7% in 2022 and 42.4% in 2023. While personal income tax revenue grew robustly on the back of rapidly growing nominal wages, the growth in social security contributions was hampered by the tax cuts implemented in 2022. The VAT revenue and excise duties fell as a share of GDP in 2023, in the context of weak consumption. The introduction of windfall profit and sectoral taxes over 2022-2024, levied on companies in the energy, financial and retail sectors, has temporarily mitigated a steeper decline in the tax-to-GDP ratio. The expenditure-to-GDP ratio remained significantly above the pre-pandemic levels at 48.9% in 2022 and 49.1% in 2023, due to elevated discretionary spending, and the impact of high inflation and high energy prices. The elevated expenditure levels in 2022 and 2023 were driven in particular by a significant increase in interest burden in the context of high inflation and high nominal interest rates (from 2.8% of GDP in 2022 to 4.7% in 2023), and the introduction of measures adopted to mitigate the economic and social impact of the increase in energy prices, in particular the subsidies to utility companies for the losses incurred due to caps on residential energy prices and support schemes for energy-intensive companies. The fiscal impact of measures adopted to mitigate the economic and social impact of the increase in energy prices, net of the revenue from taxes on windfall profits of energy suppliers, was estimated at 1.0% of GDP in 2022 and 1.6% in 2023.
Debt sustainability risks appear medium over the medium run. Government debt is projected to slightly increase from around 74% in 2024 to around 78% of GDP in 2034. This projection assumes that the structural primary balance improves from a deficit of 1.3% of GDP in 2023 to a neutral position in 2024 and remains at that level (excluding changes in the cost of ageing) over the projection period.
Hungary does not fulfil the exchange rate criterion. Inflation targeting regime with the inflation target set at 3 percent with a tolerance band of +/-1 percentage point. Since 26 February 2008, the exchange rate band was abolished and a floating exchange rate regime was adopted that, however, allows foreign exchange interventions by the MNB. In 2022, the HUF/EUR exchange rate was on a steep depreciation path that started at the end of February following Russia’s full-scale invasion of Ukraine. Starting from a level of around 355, the forint fell to a low of 430 HUF/EUR in October 2022. The depreciation of the forint reflected general uncertainty related to the war, a deteriorating current account balance due to high energy prices, inflation rising much faster in Hungary than in the euro area and concerns about the future EU fund receipts for Hungary. Following the monetary policy measures of October 2022, the forint started appreciating, a reversal which was later supported further by favourable developments regarding Hungary’s receipt of EU funds. Inflation also started falling rapidly further contributing to the improvement of the risk assessment of the HUF/EUR exchange rate. The HUF/EUR appreciated to around 370 by May 2023. Since mid-2023 the forint was on depreciating path again while the central bank continued its monetary policy easing. In May, it traded against the euro on average at about 387 HUF/EUR. International reserves of the central bank that had already reached EUR 38.4 billion end-2021 rose to 38.7 billion by the end of 2022. Reserves increased more sharply in 2023 and reached EUR 41.4 billion by end 2023, which was around 21% of GDP. Reserves were increased by the issuance of foreign currency denominated government bonds and by inflows of EU funds, while debt servicing, foreign exchange expenditures of the Treasury, the change in the central bank’s forint liquidity providing FX swap holdings, and valuation effects of central bank assets mitigated the increase. International reserves increased to EUR 47.7 billion in May 2024. Short-term interest rate differentials measured by the 3-month interbank interest rate spread visà-vis the euro area increased sharply and peaked at 1400 basis points at the end of 2022. The increase reflected monetary tightening in view of rapidly rising inflation. Throughout 2023, the interest rate differential fell substantially reaching a level of around 570 basis points by end 2023, as inflation fell and monetary easing started in Hungary while the ECB was tightening its monetary policy. The spread stood at around 343 basis points in May 2024.
Hungary does not fulfil the criterion on the convergence of long-term interest rates. The long-term interest rate in Hungary used for the convergence assessment reflects the secondary market yields on a single benchmark bond with a residual maturity of about 10 years. The Hungarian 12-month moving average long-term interest rate relevant for the assessment of the Treaty criterion was above the reference value at the time of the 2022 convergence assessment of Hungary. It increased from the 4.4% of May 2022 to reach 8.5% in June 2023 and then started to decrease. In May 2024, the latest month for which data are available, the reference value, given by the average of long-term interest rates in the Netherlands, Italy, and Latvia, plus 2 percentage points, stood at 5.5%. In that month, the 12-month moving average of the yield on the Hungarian benchmark bond stood at 6.8%, i.e. 1.3 percentage points above the reference value. The long-term interest in Hungary rose steeply in 2022 reflecting rapidly rising inflation, monetary policy tightening and heightened risk aversion due to Russia’s full-scale invasion of Ukraine. It peaked at 10.2% in October 2022 but then started declining on the back of falling inflation and monetary easing. In May 2024, the long-term interest rate of Hungary was 6.8%. The long-term interest rate spread vis-à-vis the German benchmark bond widened substantially in 2022 and peaked at around 800 basis points in October, reflecting markedly higher inflation and central bank policy rates in Hungary as well as higher sovereign risk in a context of emerging macroeconomic imbalances, as evidenced by a widening of credit default swaps spreads. As inflation started falling steeply, the Hungarian central bank started easing at the end of 2022, while German short-term rates edged upwards and then declined in 2023. The long-term interest rate spread narrowed to around 427 basis point by May 2024.
Conclusion
All things considered, the impression that not entering the Eurozone in case of Hungary is more like a political choice rather than an economic determinism (Kovács, 2020: pp. 6). In the light of its assessment on legal compatibility and on the fulfilment of the convergence criteria, and taking into account the additional relevant factors, the Commission considers that Hungary does not fulfil the conditions for the adoption of the euro. Legislation in Hungary – in particular the Law on the Magyar Nemzeti Bank (the MNB Law) – is not fully compatible with the requirements of Article 131 TFEU. Incompatibilities notably concern the independence of the MNB, the prohibition of monetary financing and central bank integration into the ESCB at the time of euro adoption with regard to the ESCB tasks laid down in Article 127(2) TFEU and Article 3 of the ESCB/ECB Statute. In addition, the MNB Law also contains further imperfections relating to central bank independence and the MNB’s integration into the ESCB. Hungary does not fulfil the criterion on price stability. The average inflation rate in Hungary during the 12 months to May 2024 was 8.4%, well above the reference value of 4.1%. It is projected to remain above the reference value in the coming months. Hungary does not fulfil the exchange rate criterion. The Hungarian forint does not participate in ERM II.
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[1] Adam Kerenyi, research fellow, Centre for Economic and Regional Studies – Institute of World Economics
[2] Some part of this article was published by the Institutul European din România in 2024 with the following title: „Benefits and challenges of the euro”
[3] The author would like to express his gratitude to Professor Andras Inotai for his valuable input and discussions on the present topic.
