The Stability and Growth Pact and its

Reform from the Perspective of the

New Member States

Gábor Orbán – György SzapáryMagyar Nemzeti BankMagyar Nemzeti Bank

11th Dubrovnik Economic Conference

30 June 2005

2

Outline

• Fiscal consolidation in the run-up to the euro

• A reformed SGP framework – a different challenge?

• Country-specific medium-term objectives

• The ageing problem and the SGP

• The introduction of fully funded pension pillars

3

Initial budgetary conditions: Distance from the 3% reference value

in the run-up to the euroDeviation from the deficit criterion 4 years prior to euro adoption

-1.9 -2-2.7 -2.5

0.6

-4.4

1

-6.3

5.7

-3.6 -3.6

-0.5-1.2

0

4.8

-2.4

2.2

0.5

-2.2

-3.8

-0.3

1.1

-8

-6

-4

-2

0

2

4

6

8

% o

f GD

P

4

Lower debt ratios: in 2004 and in the run-up to the euro

0 20 40 60 80 100 120 140

% of GDP

AustriaBelgiumFinlandFrance

GermanyGreeceIreland

ItalyLuxembourg

PortugalSpain

NetherlandsCyprusCzech

EstoniaHungary

LatviaLithuania

MaltaPoland

SlovakiaSlovenia

5 years prior to EMU

2004

5

As debt ratios are lower and yield convergence is at a more advanced

stage...

-2 -1 0 1 2 3 4 5 6 7

percentage points

AustriaBelgiumFinlandFrance

GermanyGreeceIreland

ItalyLuxembourg

PortugalSpainThe

CyprusCzech

EstoniaHungary

LatviaLithuania

MaltaPoland

SlovakiaSlovenia

The long term bond yield criterion 3 years prior to assessment (12-month averages)

6

…we may expect smaller fiscal gains from convergence…

-0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0

percent of GDP

Czech RepublicLuxembourg

EstoniaLatvia

LithuaniaSlovakia

MaltaCyprus

SloveniaFrance

The NetherlandsIrelandPolandAustria

GermanyHungaryFinland

SpainBelgium

ItalyGreece

Portugal

7

… so not even high debt countries may afford to rely on the reduction

in interest payments.

2.98 2.78

1.90 1.861.30

0.84 0.81 0.780.48 0.29 0.05 0.02

-0.26-0.67

-0.98-1.27

-1.59 -1.69 -1.78-2.34

-4.81

-5.69

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

perc

ent o

f GD

P

8

The reformed SGP

• Trade-off: transparency vs. soundness– New SGP: increases complexity but

risks softening up EDP– Changes not because of NMS but

reform affects them, too• Reforms affecting new member states

– Taking more account of country differences in the setting of MTO’s

– The treatment of systemic pension reforms

9

Cyclical effects on the budgets of new member

states• Higher output volatility + lower cyclical

sensitivity of budgets lower cyclical safety margins, potentially looser medium-term targets

in percent in percent in percent

EU-15 0.50 3.83 1.97 -1.03

CEE-8 0.41 4.26 1.68 -1.32

Czech Republic 0.40 4.20 1.70 -1.30Estonia 0.41 4.78 1.95 -1.05Hungary 0.44 3.65 1.62 -1.38Latvia 0.33 4.22 1.39 -1.61Lithuania 0.33 6.05 2.01 -0.99Poland 0.49 3.87 1.88 -1.12Slovakia 0.40 3.87 1.55 -1.45Slovenia 0.45 3.44 1.54 -1.46

Cyclical Safety Margin

Minimal Benchmark

Cyclical Budget Sensitivity

The Largest Value of Output Gap

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Ageing is a threat in NMS

2000 2050 2003EU-15 25.95 51.40 1.57

Austria 25.20 58.20 1.40Belgium 28.10 49.50 1.62Denmark 24.20 40.30 1.72Finland 25.90 50.60 1.72France 27.20 50.80 1.89Germany 26.60 53.20 1.31Greece n.a. n.a. 1.25Ireland 19.70 45.70 1.97Italy 28.80 66.80 1.26Luxembourg n.a. n.a. 1.63Netherlands 21.90 44.90 1.73Portugal 26.70 50.90 1.47Spain 27.10 65.70 1.25Sweden 29.40 46.30 1.65United Kingdom 26.60 45.30 1.64

Czech Republic 21.90 57.50 1.17Hungary 23.70 47.20 1.30Poland 20.40 55.20 1.24

Old-age Dependency Ratios (in percent)

Total Fertility Rate

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Ageing problem calls for higher present saving

1. This may take the form of lower government deficits/higher surpluses today – which reduces explicit debt

2. Or: saving may take place outside government (accumulated in private pension funds)– Only if tax-financing: sum of explicit + implicit is

reduced. – In case of debt-financing: explicit debt rises as

implicit liabilities are reduced

• „Costs” of pension reform are the savings necessary to cope with ageing

• Pressure to deduct these costs – compromise: new SGP allows for partial debt financing for 5 years to allow budgetary adjustment to reform

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Are fully funded pillars the solution for the ageing

problem?• How do these reforms improve

sustainability?– Increase savings today – IF transition is tax-

financed– Also reduce future deficits as introduction of

fully funded pillar partly transforms DB into DC

• Desirable features of a fully funded private pillar– Promotes intergenerational equity– Present savings for future pensions cannot be

spent elsewhere• Risks of a fully funded private pillar

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The Hungarian example: future balances of the pension

systemThe balance of the government pension fund 2004-2105

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

% of GDP

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

% of GDP

Single-pillar system Multi-pillar system

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Risks in the pension fund sector

• Unsatisfactory performance may generate implicit liabilities– Explicit legal guarantees, or– Political pressure from an interest group growing in

size to provide certain minimum replacement rates

• What is satisfactory?– A rate of return that sets multi-pillar replacement

rates equal to the replacement rate consistent with a sustainable full PAYG.

– Hungary: actual real net return is an annual 2% so far!

– Operating costs (total fees = 2.4% of total assets and 9.8% of contributions) and incentives/competition may be a problem

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Thank you for your attention!