8 February 2013Budgetary risks of the monetary policy
It would be reasonable to reconsider the methods of calculating the public debt indicator – was one of the remarks made in the press conference where the SAO study titled ‘Budgetary risks of the monetary policy, with special regard to the debt rule’ was presented. SAO prepared the study primarily to assist the work of the Fiscal Council. The Fundamental Law of Hungary stipulates for the obligation to reduce public debt. Due to this constitutional obligation the State Audit Office of Hungary (SAO), as the supreme economic and financial audit institution of the National Assembly, needs to face new tasks. On one hand, when providing an opinion on the central budget appropriation bill, SAO pays special attention to whether the bill includes the criteria for reducing public debt; on the other hand, it also systematically examines and analyses those components of the public debt that are not directly linked to the central budget.

The public debt is to be raised by the allowance obligation that has to be paid by the central budget when one of the reserve funds of the National Bank of Hungary (NBH) is in deficit. In te recent years, under this legal title the payment obligations of the central budget amounted to the volume of ten billion forints. The actual risk is even higher. These payment obligations of the central budget result from the fulfilment of core tasks of NBH, in relation to which SAO does not have an audit mandate. In accordance with its advisory function stipulated by the Act on SAO, the State Audit Office of Hungary prepared a study to examine the related risks. The study titled ‘Budgetary risks of the monetary policy, with special regard to the debt rule’ uses only public data and information.

The aim of our study is to reveal – by means of analysing past years’ data and presenting correlations – which are the underlying reasons for the central budget’s obligation to replenish NBH’s reserves. According to our study, several factors are influencing the risk of generating a payment obligation. Thus, taking into account the international practice, we posed such questions whose answering can substantially reduce risks. At the end of our study we also point out that the more effective handling of the risk related to the obligation to replenish NBH’s reserves can make it advisable to amend also the so called public debt-rule as well.

In our analysis we discussed two basic functions that are correlated, namely the utilisation of monetary policy tools and the practice of building foreign exchange reserves. The utilisation of monetary policy tools might result in the increase of the central bank’s risk of incurring a deficit, as the only objective when using these tools is the achievement of monetary policy objectives and the aspects of the central bank incurring a deficit are neglected. Reserves – due to their nature – are supposed to be tied up in rather short-term, low-risk assets. The yield of such assets is however usually moderate, often less than the average cost of liabilities financing foreign exchange reserves.

The main monetary policy tool of NBH is the two-week-term NBH bond, whose interest rate equals the central bank’s base rate. With the help of the two-week bond the central bank can tie up the surplus liquidity of the banking system. According to the Hungarian regulation, the partners of the central bank can decide freely, without any restrictions on quantity, how many bonds they wish to buy in the framework of the auctions. Between the years 2008 and 2009 the two-week bond portfolio increased from HUF 782 billion to HUF 2681.5 billion. The increase continued in the following years as well, the portfolio amounted to HUF 3936.3 billion in 2012 and HUF 4227.3 billion in 2011. As a result of the increased portfolio, the central bank paid interests in the amount of HUF 695.7 billion between 2009 and 2011.

International comparison shows that the European Central Bank and the central banks of European countries included in the analysis use different methods when striving to use monetary policy tools in a way that keeps interest costs within reasonable limits and they are not completely subordinated to the aim of making short-term financial market profits follow the central bank’s guiding interest rate as closely as possible, that is, to the central banks’ profitability aspects.

Between the years 2007 and 2011 the foreign exchange reserves of Hungary increased each year by an amount exceeding HUF 1000 billion. In 2008 and 2010 a proportion of approximately 80 percent of this increase was financed by foreign resources. Contrary to that, in 2009 the expansion of foreign exchange reserves was financed by national resources in a proportion of 90 percent, while in 2011 national resources amounted to 100 percent. During the 4 years the proportion of national resources financing foreign exchange reserves increased altogether by HUF 4000 billion (which equals 14-15 percent of the GDP). In the financing of the 2011 increase in foreign exchange reserves several national resources were involved. An amount of 900 billion out of the 2300 billion increase in foreign exchange reserves calculated in forints is due to the decline of the forints’ rate of exchange. The increase in the portfolio of liquid forint amounts of commercial banks, tied up in monetary assets, financed the increase of foreign exchange reserves up to an amount of HUF 870 billion.

In 2011 households, enterprises and also the budget were on the savers’ side and eventually these savings resulted in increasing the funds of NBH. In relation to that, we examined the development of loans outstanding. We concluded that in case of commercial banks, instead of the expansion of granting credits, another real alternative was to permanently tie up their liquid forints in different monetary assets, above all in two-week central bank bonds.

The significant increase in foreign exchange reserves between 2009 and 2011 in itself intensifies the risk of NBH’s earnings becoming negative, as the greater the amount of foreign exchange reserves is, the greater difference can be between the interest revenues resulting from the placement of foreign exchange reserves and the interest costs of funds financing foreign exchange reserves. Our analysis identified other factors increasing risks as well.

Being aware of risks of incurring a deficit, it seems extremely important to consider, whether it would not be reasonable to urge solutions that reduce interest costs when using monetary policy tools, following the practice of the other central banks in Europe.

It would be also worth examining, how the utilisation of tools serving the purposes of financing public debt as well as monetary policy tools could be harmonised, in order to optimise the costs resulting from the simultaneous utilisation of both kinds of tools.

In consideration of the long-term sustainability of budgetary equilibrium, we have to pose the question, whether with the present, safe volume of foreign exchange reserves it is justified to give stronger priorities to cost-efficiency aspects on the national economy’s level when taking decisions on financing public debt.

The increase on the average acquisition rate of foreign exchange reserves poses an increasing risk also in terms of ‘the adjustment of forint exchange rate reserves’ becoming negative, as this way the reserve starts to lessen when the exchange rate of forints is higher. Here we have to deal with a significant budgetary risk, as in case the international opinion on the Hungarian economy improves and thus the exchange rate of forints is gradually increases, then within a few years the decrease in the value of considerable foreign exchange reserves expressed in forints might result in the fact that the central budget will have to replenish ‘the adjustment of forint exchange rate reserves’ of NBH with amount totalling 100 billions of forints. Due to the improvement of the forint’s exchange rate also the adjustment reserves of the securities in foreign currencies might shortly show a deficit and it cannot be expected either that NBH’s profit reserve will show a positive return counterbalancing the negative balances of the two other funds.

It has to be emphasised that in case of these factors, it is not the inappropriate management of NBH or the bad performance of the Hungarian economy that is under discussion. On the contrary, the significant payment obligation related to monetary policy and building foreign exchange reserves will be due when the Hungarian economy starts to grow. The problem is that these payment obligations worsen the debt indicator and thus force the Fiscal Council to approve the adoption of the budget appropriation bill only in case the balance of the current budget improves to an extent equalling the above mentioned payment obligations. However, this would result in further austerity measures hindering economic expansion.

Accordingly, there is a severe risk that in case the exchange rate of forints improves significantly and continuously, the debt rule in its present form can be observed only if in other areas of the economy savings amounting to hundred billions of forints are realised. This, of course, would slow down economic expansion. Thus, the question raises itself, whether it would be advisable to reconsider the calculation methods of the public debt indicator, taking into consideration also the above risks.