Fiscal revenue bonanza will not last forever

'Are CEE governments responsibly spending the increased revenues that stem from the cyclical economic upswing?'

Croatia: Once again, the budgetary performance exceeds expectations, given the announcement by the FinMin that Croatia would be running a modest budget surplus in 2017 (ESA2010), allowing public debt to approach 78% of GDP (down more than 7pp of GDP in the last two years). Consolidation has been driven by improving economic conditions and the related revenue boost (VAT, CIT, social security contributions). On the expenditure side, the government has remained fairly prudent and allowed for still modest wage and pension hikes (done in phases in 2017, i.e. the FY effect is expected in 2018), while debt servicing costs remained on a downward trajectory. Looking into 2018, the budget deficit target is set at 0.5% of GDP, while, given the better execution in 2017, we are expecting to see a balanced budget performance in 2018, alongside the closing of the output gap structural deficit below the MTO target (1.75% of GDP). The economic outlook remains supportive of the budget revenue performance, while hopefully the expenditure side will cope with the increasing appetite (wages and pensions) and the interest rate environment continues to favor declining pressures where debt servicing is concerned. Bottom line, we expect to see the fiscal position as comfortable in 2018, but see 2019 as a good test for the long-term commitment, with the announced VAT rate cut (presumably 1pp).

Czech Republic: The favorable development of the economy has been generating high revenues for the government to increase its spending. A significant 10-15% increase in wages of state employees from the end of last year is the most important example, but the government has been continuously raising financing in other areas as well (research, healthcare, etc.). However, the share of debt to GDP has been declining, as higher spending is covered by the cyclical development. In the coming years, we expect the government to focus more on government investment in infrastructure, which represents a slight risk in the direction of higher financing needs.

Hungary: Thanks to the cyclical economic upswing, major revenue items such as VAT and PIT increased significantly last year, by 7.1% y/y and 11.8% y/y, respectively, and this phenomenon continued in January. In spite of the increase in revenues, the government blew a huge hole in last year's budget from the cash flow point of view, due to the forced pre-financing of EU funds. As a consequence, there was a huge gap between the ESA (approx. 2.0-2.2% of GDP) and cash flow approaches (approx. 5.2% of GDP). We do not see any improvement in the efficiency of expenditure utilization, partly because of the lack of proper transparency. We continue to expect the ESA deficit to remain below the 3% of GDP threshold, while the gross public debt ratio may continue to slowly decrease.

Poland: In recent years, the total general government expenditure level was slightly above 40% of GDP. The biggest share (17% of GDP) is spent on social protection, but the level of social spending is 3pp lower compared to the EU15. General public services and the health sector are also underfinanced compared to the EU15, with expenditure at 4.7% and 4.6% of GDP, respectively (for the EU15 it is 6.6% and 7.2% of GDP). On the other hand, Poland performs better in terms of defense spending (1.6% of GDP) and education (5.0% of GDP). The recent dynamic increase in tax revenues (VAT revenues went up 20.3% y/y last year) is mostly used for financing the 500+ program and lower retirement age and helps to keep the fiscal balance well below the limit of 3% of GDP. In structural terms, however, the deficit has not improved visibly (it remains above 2% of GDP), making the fiscal position vulnerable in the case of an economic downturn.

Romania: In Romania, the effects of the cyclical economic upswing were counterbalanced by cuts in taxation in 2017 (VAT, excise taxes, special construction tax) and cash budget revenues remained virtually unchanged compared with the previous year at 29.4% of GDP (estimated nominal GDP for 2017). A look at the expenditure side of the state budget shows a higher share of personnel expenditure in GDP in 2017 (+0.6pp compared with 2016) and social assistance (+0.1pp), coupled with a decline in the relative importance of goods and services (-0.6pp) and locally-financed CAPEX (-0.2pp). Romania managed to comply with the 3% budget deficit target under local standards, but the structural deficit widened further and it is officially estimated by the government to begin to adjust only from 2019. Current trends for personnel and social expenditures will continue in 2018, according to official budgetary projections, so a key element in maintaining the budget deficit under control is improved tax collection.

Serbia: Budget execution in 2017 outstripped all expectations, as the general government recorded a surplus of 1.2% of (estimated) GDP. Such a notable improvement in the fiscal position was a result of stronger than expected revenue inflows, despite the disappointing growth figures. According to the budget plan and announcements from the government, the increased fiscal space will be used for a more expansionary fiscal policy stance in 2018. The government has already increased public wages (5-10%) and pensions (5%), while for the rest of the year we could see additional adjustment of pensions, while we also expect stronger public investment activity. In addition, we should see the introduction of various tax related subsidies for companies, especially SMEs. In our view, these measures will not impose a huge risk for mid-term public finance sustainability. However, we still do not see major steps on the structural reform agenda (pension and healthcare system), which represent key challenges for the mid-term and long-term sustainability of Serbia's fiscal system.

Slovakia: Fiscal revenues have been increasing steadily in recent few years, driven predominantly by the reinvigorated labor market and resulting higher tax and levy intakes. The effectiveness of VAT collection has also improved, adding to the total revenue stream. Even though fiscal deficits compared to GDP have decreased, consolidation was mainly achieved via the better revenue side. Public spending has increased, but few structural investments, which could be used for longer-term sustainable growth, are accounted for in this year's budget. According to the new forecast from the Ministry of Finance, this year could bring in EUR 150mn (0.2% of GDP) more in taxes and payroll levies than expected in the approved 2018 budget (mainly due to the stronger than expected labor market). PM Fico announced that he would like to distribute the proceeds in another social package, with details to be revealed later (holiday vouchers and lower VAT on baby food and diapers were mentioned).

Slovenia: The fiscal framework in Slovenia is determined by the Fiscal Compact implemented through the Constitution and the Fiscal Rule Act, so budgets for 2018 and 2019 are aimed at a gradual balancing of revenues and expenditure, with forecasted surpluses in both years vs. the milder deficit (estimated at -0.5% of GDP) in 2017. According to the MoF, the largest increases in expenditure are planned in the following areas: transport and transport infrastructure, science and the information society, healthcare, entrepreneurship and competitiveness, as well as EU fund related expenditures, which in our view can be labeled 'productive expenditures'. The strong fiscal performance recently has been supported by solid economic activity, which is to a large extent expected to remain supportive in the coming period as well, while the approaching elections, tight labor market conditions and low pressure from the market may imply some pressure on the expenditure side of the equation in the coming period.

 

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