Exposé of Dr. László Windisch, President of the State Audit Office of Hungary (SAO), held before the National Assembly on 26 October 2022, on the audit of the 2022 final accounts.
Dear National Assembly,
Dear Mr. Speaker of the National Assembly,
Dear Mr. State Secretary,
Dear Members of the National Assembly,
According to the Fundamental Law of Hungary, the execution of the central budget is a key constitutional duty of the State Audit Office of Hungary. Accordingly, this year we carried out once again the audit of the report on the execution of the central budget, i.e. the SAO’s audit of the Final Accounts Act.
The SAO’s audit found that the bill is structured and presented in accordance with the relevant provisions of the Public Finances Act, and that the revenue and expenditure data give a true and fair view. The audit did not identify any material errors that would affect the accuracy of the data used in the preparation of the final accounts and the reliability of the final accounts bill. This is the most important concise conclusion of the SAO’s report, which I am now presenting to you; the most important conclusion, because it is the basis on which honourable Members can hold a meaningful debate on the many figures on the implementation of last year’s budget and the processes and content behind them. The reason I think it is important to emphasise this is because, in my experience gained during last year’s parliamentary debate on the final accounts, it is not known to everyone exactly for what purpose and according to what criteria the State Audit Office is examining the bill that is now before you.
This financial audit is the most important audit for the SAO, and the one to which we devote most of our resources each year. This year, a total of 75 auditors performed the task in about 2900 net audit days. The total number of sample items checked was 3030, involving a total of 110 organisations. The purpose of the audit is to establish if the budget has been implemented in accordance with the rules, if the content and structure of the final accounts bill comply with the legal requirements and that they present a true and fair view of the financial data and information relevant to the implementation of the budget. This work of the State Audit Office enables the National Assembly to have a meaningful debate on the final accounts bill, and also that there is no question about the reliability of the figures in the bill.
The State Audit Office carries out the audit using methods in line with international standards. To illustrate the essence of the method, allow me to use a simple analogy. Evaluating the reliability of the final accounts bill is similar to assessing whether the water in a large swimming pool is clean enough. This should be done in two ways. The first is to check whether the water flowing into the pool is clean enough, and whether the equipment for filtering out contaminants is working, because if not, it is pointless to continue the assessment, as it is almost certain that the water in the pool cannot be clean either. The second is to take a sufficient number of samples of water from different points throughout the pool and use their clarity to infer the clarity of the water in the pool as a whole.
For the audit of the final accounts, the first step is to assess the functioning of the internal control systems of budgetary institutions, managers of appropriations and fund managers preparing the partial accounts. Basically, we look at whether the design and operation of controls ensured regularity and compliance. In doing so, the SAO audited the controls in place in 15 organisations selected on a risk basis.
It also examined the operation of the basic control functions of 64 entities representing institutions of the central subsystem of public finances, as well as institutions managing social security and the separated funds of chapter-managed appropriations. In doing so, although minor deficiencies were found, we concluded that the controls worked and served well to prevent and eliminate errors. Sampling was carried out using a selection method and a sample size that ensured that the sample was evaluated to obtain objective assurance that the final accounts data were reliable. Given the small number of errors found by the auditors in the sample selected to ensure representativeness, we can conclude with reasonable assurance that the final accounts bill gives a reliable picture of the implementation of the budget and the financial situation of the central subsystem of public finances.
It is important to stress, however, that the State Audit Office is not responsible for evaluating budgetary policy as a whole, and it would be explicitly incompatible with its mandate to provide an assessment of the appropriateness or effectiveness of budget implementation. The SAO is in a position to contribute to this debate to the extent that its factual findings, ensuring the credibility and reliability of the final accounts data, can form the basis for a fact-based parliamentary debate.
In assessing the budgetary accounts, it is worth looking at the macroeconomic context that has had a major impact on the predictability and implementability of the budget. Our analysis on this subject, prepared in parallel with the audit, will be published on the website of the State Audit Office of Hungary at the same time as this exposé. On this basis, I will highlight some important factors.
Developments in 2022 have also shown that the fiscal year, the calendar year, is an artificially defined phase in the midst of a constantly changing and fluctuating economic process. Not only because the processes of real life do not end on 31 December and start fresh on 1 January, but also because significant changes can occur during the year that can change the course of events. This is what happened in 2022. At the beginning of 2022, the Hungarian economy continued to grow dynamically, and the forecast of a rapid rebound of the Hungarian economy after the COVID epidemic seemed realistic. Russia’s aggression against Ukraine and the sanctions in response to it have crossed this process. The momentum of the Hungarian economy continued for a few more months, but then the negative effects intensified. In 2022, the economic output, i.e. the volume of GDP exceeded the previous year’s GDP by 4.6%. The dynamic growth in the first two quarters was replaced by a decline in the following two quarters compared to the previous quarters, putting Hungary in a technical recession as GDP volume fell for two consecutive quarters. From the middle of the year, energy prices jumped and inflation increased significantly.
In 2022, both gross and net average earnings were 17.4% higher than in the previous year. One-off benefits and wage increases at the beginning of the year also contributed to the strong growth for the year as a whole. Real wages grew by 2.6% on average in 2022, but the rate of increase in consumer prices has consistently outpaced the growth of wages since September 2022. Thus, in December, year-on-year inflation was already 24.5%, compared with a 17.9% rise in average wages, meaning that real wages had started to fall by the end of the year. The value of household financial assets grew by 8.1% in 2022, but this fell short of the growth of both wages and nominal GDP, meaning that the propensity to save declined.
How has fiscal policy been able to respond to a situation where the actual external conditions are radically different from those on which the forecast underpinning the budget was based? I should point out here that the Hungarian public finance rules give the government wide powers to reallocate and even exceed budget appropriations and to reorganise the budget headings. In the event of a sudden and significant change in the external political and economic environment, this regulation gives the government sufficient room to adjust the budget to the changed circumstances. This broad authority becomes almost unlimited in times of state of emergency legislation, as in such cases the government may, by government decree, lay down rules other than those in the Public Finances Act. There is no doubt that the government made frequent use of these legal powers during 2022 and took decisions that significantly modified both revenues and expenditures
However, it would be useful for the legislator to reflect on the optimal balance between budgetary flexibility and the effective exercise of the National Assembly’s budgetary powers. I consider this particularly important because I believe it is necessary to strengthen as much as possible the role of the Budget Act as a compass. The fact that the fiscal year is an artificially designated part of the economic continuum, which is also evident in 2022, also justifies a rethinking of whether it is appropriate to set the requirement to reduce the public debt ratio or to keep the government sector deficit below a certain level for each year separately, as is the case here in Hungary, according to EU requirements. There is a legal possibility and practice to give an EU Member State a grace period in case of non-compliance with the budget targets, but it could also work the other way around, so that actual savings made in one year can be spent above the annual limits in the following year. In other words: it would be useful and could reinforce the principle of good stewardship if compliance with the rules was not required annually, but on a kind of rolling average over several years.
Ladies and Gentlemen of the National Assembly,
Our analysis also records that planning of the 2022 budget was based on growth in domestic consumption and investment. Consumption has expanded even more than forecast, leading to a significant increase in revenues for the central budget, especially in VAT income. However, from mid-year onwards, energy prices increased sharply, leading to a significant increase in the fiscal expenditure needed to sustain the household consumption cuts and the need for fiscal compensation for the increase in energy prices in public services and in some areas of the private sector. In addition, the war situation justified the acceleration of the increase in defence spending. To finance these, new extra-profit taxes were imposed and existing taxes were increased.
In the middle of the year, the government took measures to improve fiscal balance, curbing expenditure growth in budgetary institutions and in chapter-managed appropriations, and above all affected investment. As a result, investment has been able to contribute to economic growth less than planned. All throughout 2022, the volume of investment in the national economy increased by 0.3% year-on-year, but fell by 6.3% in the fourth quarter compared with the same period of the previous year. At the same time, the cash deficit of the central budgetary subsystem reduced to 7.1 percent of GDP by the end of 2022, compared to 8.6 percent in the previous year. The general government sector’s deficit to GDP ratio fell to 6.2 percent compared to 7.2 percent in 2021, but was above the Maastricht criterion of 3 percent. As in the previous year, the exemption from the Maastricht criterion was made possible in 2022 both by EU regulations to address the negative effects of the Covid-19 pandemic and by the domestic legal provisions in the Stability Act.
The high deficit outturn of the central budgetary subsystem was mainly driven by unplanned expenditure in early 2022, as well as the impact of the mid-year pension increases necessitated by higher inflation and payments related to the protection of public utilities and compensation for energy prices. Additional expenditure was also due to higher interest payments related to debt servicing, as well as additional payments, allocations and capital increases related to public assets in December. Government debt ratio declined from 76.7% at the end of 2021 to 73.9% at the end of 2022, thus meeting the public debt rule of the Fundamental Law of Hungary and even improving by close to 3 percentage points. These figures also convincingly demonstrate that any communication expecting more criticism of the Fiscal Council, whose constitutional duty is to ensure compliance with the public debt rule, was completely unfounded. And the public debt indicator has fallen every year since it was introduced, with the exception of the year 2020 hit by the COVID-19 pandemic. Time has therefore proven that in each case the Council has taken an informed and professionally sound decision. Political statements calling for the Fiscal Council to take a critical stance that goes beyond its mandate are not professionally based.
In 2022, the tax revenue outturn exceeded the forecast, with the exception of a few taxes. Budgetary payments by businesses were 147.7% of the target while consumption-related taxes were of 120.4%. In 2022, the central budget’s VAT income exceeded the target by 25 percent.
By combining these revenue ratios with the rapid rise in inflation, some have wrongly concluded that inflation has a positive impact on the balance of the budget. On the one hand, even the figures for 2022 do not support this conclusion, as not only have revenues increased as an indirect effect of inflation, but, as I explained earlier, the government has also been forced to increase a number of expenditures. On the other hand, the VAT income, which is significantly higher than forecast, is a direct consequence of the dynamic increase in consumption expenditure.
Our analysis has revealed that accelerating inflation has indeed encouraged a significant number of households to spend their income, and even their planned and actual savings, as soon as possible, preventing a loss of purchasing power. At the same time, the figures for the end of 2022 already show that inflation has risen faster than wages and consumption. The negative impacts will be felt most strongly in 2023, when households will be forced to reduce their consumption as their reserves are depleted and their real income falls. As a result, VAT income in 2023 will already be significantly below the target on a pro-rata temporis basis. This also illustrates that the fiscal year is an artificially constructed period and that, consequently, negative and positive trends in the same process, which are organically linked, can occur in two consecutive fiscal years.
The key lesson for 2022 and 2023 is that inflation is the enemy of the budget, so it is more than justified that fiscal policy and monetary policy should work together in a coordinated effort to suppress inflation.
Among the processes that negatively affected the budget, it should be mentioned that the EU budget revenues were 41.1% below the revenues planned for 2022, at HUF 972.3 billion. The appropriations for the cohesion operational programmes and the Instrument for Recovery and Resilience for the years 2021-27 have not generated any revenue in 2022. In comparison, EU spending in 2022 was in line with the initial estimate, with the Hungarian budget advancing more than HUF 500 billion to support the operational of the cohesion policy operational programs for 2021-27.
The balance of the budget deteriorated as interest expenditure was 53.5 percent higher than budgeted, due to accelerating inflation during the year, and in response the increase in the Hungarian National Bank’s policy rate, and rising market interest rates.
Expenditure of the Pension Insurance Fund in 2022 exceeded the statutory appropriation by 15.3%. Expenditure exceeded revenue in every month of the second half of the year, except December, driven by pension increases of 3.9% in July and 4.5% in November, retroactive to 1 January. In addition to the pension increase, a pension premium of HUF 21.4 billion was paid to pensioners and to the recipients of benefits to be increased in the same way as pensions based on the rate of GDP growth.
Ladies and Gentlemen of the National Assembly,
As I mentioned in the introduction, the macroeconomic environment outlined has had a profound impact on the implementability of the budget. However, the most important finding of the audit carried out and the resulting report is that the SAO’s audit did not reveal any material error affecting the regularity of the implementation of the budget as a whole.
The compliance audit covered the year 2022, and the first and third quarters of 2023 for the preparation of the final accounts bill. The audit of the cash revenue and expenditure performance of the 2022 final accounts bill was based on the assessment of sample items selected using a representativity procedure, the testing of data and processes against sample items and the application of analytical procedures in specific areas.
In its assessment of the sample items, the State Audit Office classified the errors detected into two main categories: regularity errors, i.e. cases of non-compliance with legal requirements, and reliability errors, which could affect the reliability of the data in the final accounts bill.
In connection with the bill on the implementation of Hungary’s 2022 central budget prepared by the Ministry of Finance, the audit of the State Audit Office of Hungary covered centrally managed appropriations, chapter-managed appropriations, budget support financed from EU and related domestic sources, organisations belonging to the central budgetary subsystem, separated state funds and social security funds. In our opinion, the proposed final accounts on the implementation of the budget are presented in accordance with the structure and content of the relevant provisions of the Public Finances Act and give a true and fair view of the revenue and expenditure data.
As a result of the audit, we concluded that the performance data of the central and chapter-managed budget support appropriations belonging to the central budgetary subsystem, EU and nationally financed budget support appropriations, entities of the central budgetary subsystem, estimates of revenue and expenditure of social security funds and of separated state funds are reliable in the proposed 2022 final accounts bill. The audit did not identify any material errors that would affect the accuracy of the data used to prepare the final accounts and the reliability of the proposed final accounts.
Both central budget revenue and expenditure and the cash deficit of the central budgetary subsystem of general government are over-performing compared to the original amounts set in the Budget Act for 2022. The SAO reported to the heads of the audited entities the individual deficiencies detected in the accounting of economic events, as well as in the controls preceding the execution of payments and in internal rules.
As I have explained in detail in this exposé, it is clear from the report and the related analysis that the implementation of the 2022 central budget was affected by a number of mainly external factors that, in addition to the predictability of the budget, also made implementation difficult, and it cannot be ignored that the processes referred to did not stop at the end of the period under review. It is already apparent that lower-than-estimated VAT income, higher-than-estimated interest expenditure and the shortfall in EU revenue will have a profound impact on the budgetary processes in 2023.
Based on all this, it is particularly important for the implementation of the budget, including any necessary corrections, to be traceable, reliable and regular, and in this respect the State Audit Office found no material error for the year 2022.
Thank you very much for your kind attention!
Dr. László Windisch
State Audit Office of Hungary