Energy prices and the economy

One of the most important positive aspects of Hungary’s transformation and switch to a market economy has been a significant decrease in its hunger for energy. Although Hungary’s GDP is roughly 30% higher in 2005 than it was at the start of transition, its total energy consumption is still just 87% of its level at that time. Energy consumption per unit of GDP is now nearly 50% of its level before transition. Both a clear change in economic structure and dramatic increases in energy prices have played a role in these developments. The output of manufacturing industries is now two and a half times its former level, but manufacturing now consumes about the same amount of total energy. The relative weight of high-tech sectors in Hungary is now above the EU average. Energy prices are about 12-13 times higher in Hungary in 2005 than they were in 1990, although prices on average are just nine times higher.
Two-thirds of total energy consumption comes from imports, and this proportion is steadily rising. Looking at the key oil and natural gas segments alone, imports equal 80% of domestic consumption. The dramatic oil price increases of 2004 and 2005 have meant a 1–2% deterioration in Hungary’s overall terms of trade, and add about $1 billion to the country’s import bill each year. Despite higher oil prices, however, the growth of the Hungarian economy has continued to accelerate, due to more efficient energy consumption. Moreover, a trend toward lower inflation has continued, and even appears to be strengthening.
Like in some other European countries, the recent surge in motor fuel prices, which are now approaching Ft 300 per liter, has inspired protests from certain enterprises and a portion of the population. While their reactions may be understandable, it is nevertheless a fact even including the recent upsurge, fuel prices have risen only about 25% since 2000, while average inflation in the same period has been 40%. Excise tax on motor fuel has not risen since 2003, and in 2001–2002 fuel prices decreased even in nominal terms.
The government recently decided to bring forward a decrease in the standard VAT rate from 25% to 20%, previously scheduled for 2006, to later this year in the case of motor fuel. This step is aimed to calm the public outcry. With the approach of the elections next year, this can be seen as a political gesture – its effect on the 2005 budget will be no more than Ft 4–5 billion. But there are real problems with the decision. On the one the hand, the state budget deficit remains very high and the situation has not improved substantially in the last two or three years. On the other hand, the move calls into question the government’s often-repeated dedication to put the budget in order, and this further undermines predictability, which is a very important element for investors.
Furthermore, the government’s decision does not fit well with either the logic of a market economy, or the requirements of social justice. It uses taxpayers’ money to finance part of the increased costs of energy consumers among the population and the business sector, and thus helps block needed rationalizations and the adjustment of economic actors to the new situation of high oil prices.  Since about 50% of total fuel consumption in Hungary is among social strata with much higher than average incomes, the decision also tends to contribute to, rather than reduce, the already high income differentials between rich and poor.
There is a significant risk that in 2006, like in 2002, there will be an “election year economic policy” which will make it impossible to put the already teetering state budget in order.