Hungary: impact of stabilization package
Hungary's premier, Ferenc Gyurcsány, has on Saturday announced the details of his coalition government's fiscal stabilisation package, which targets to cut this year's public sector deficit by HUF 350 bn and by some HUF 1,000 bn each year in 2007 and 2008.
The measures are expected to boost inflation to 5% next year (well above analysts’ estimates of 3-4%) and push down the public sector gap to 3.0-3.5% of GDP by 2008.
Prime Minister set the Eurozone accession date between the middle of 2010 and the middle or the end of 2011 in an interview to Reuters. The Prime Minister practically acknowledged that the January 2010 euro zone accession target might not be achieved by any means and that a year of delay was most probable.
Overall, we are mixed about the potential market impacts of the measures. The government's strong commitment to implement fiscal tightening should definitely be welcomed. Moreover, equity market already priced in the negative impact of higher corporate taxes, which is the major negative impact on future earnings of the listed companies.
Although, we expect some negative reaction to the announcement of the detailed measures on the bond market. Prime Minister comments on higher inflation next year (5% versus market consensus of 3.5%) and lower GDP growth (2.5% versus this year’s 4.3%) might imply rate increase speculation and thus are definitely negative for bond prices and thus for the equity market too.
Please find below the detailed fiscal adjustment measures presented by Prime Minister Ferenc Gyurcsány on Saturday:
ELECTRICITY AND GAS PRICE HIKES
• Gas prices in Hungary will be raised by 30% on average in August, then by 30% in November and a third time in early 2007. Government said, gas prices could be 94% higher by the first half of 2007 than today. Although, 1.1 million families would be granted allowances, whom burdens would as a result rise less
• The price of electricity would be increased by 10-14% in August
• Introduction of solidarity tax for private individuals: equals to the creation of a new personal income tax (PIT) bracket of 40% for private individuals earning more than HUF 6m annually. This rate is 4 percentage points higher than the previous highest bracket of 36%. (Gov’t expects HUF 24bn more revenue in 2007 from the introduction of the solidarity tax, and expects HUF 32bn savings from narrowing tax break opportunities)
• Solidarity tax for businesses: applicable on every subject of corporate tax for profitable public and private businesses from September 2006. The tax base is the pre-tax profit of the business, which cannot be reduced by allowances. The rate of the solidarity tax for businesses is 4% of the tax base. This represents an increase of corporate tax rate from 16% to 20% (Solidarity tax for businesses is expected to result in HUF 40bn further revenues in 2006 and HUF 170 bn in 2007.)
• Continuation of banking tax: This tax was levied on financial institutions’ Hungarian operations, promised to be in force for two year until the end of this year. Although the Government will not abolish it, in contrast to their earlier promise according to their announcement. (Government expects HUF 50bn savings from the banking tax in 2007)
• Hiking Simplified Entrepreneurial Tax (EVA): From October rate of EVA will be increased from current 15% to 25%. (This measure is expected to generate HUF 10bn for the budget this year and HUF 53bn in 2007.)
• Increasing middle bracket VAT: From the beginning of September 2006, the middle bracket VAT will be increased to 20% from the current 15%. (This measure is expected to generate HUF 60bn for the budget this year and HUF 170bn in 2007.)
• Hike of excise tax: In a first step, the excise tax on cigarettes and alcoholic beverages (except for wines) will be increased, and the second step will further increase excise tax on tobacco. (HUF 3bn revenue increase annually in 2006 and in 2007)
• Introduction of interest and capital gain tax: Government plans to impose 20% tax on capital gains of domestic private investors. However, long-term government securities and investment notes will be exempt from this tax. (Planned revenues for this year is HUF 2bn and HUF 26bn in 2007.)
• Vehicle tax: Weight-based payment will be replaced by power-based payment as of 2007, duties will be increased from next year. (HUF 9bn revenues are expected)
• Employer’s contribution to social security will be extended: the Government prolonged the abolishment of this tax. (HUF 7bn revenues in 2006 and HUF 298bn in 2007)
• Increasing employee social security contribution (HUF 38bn revenues in 2006 and HUF 220bn in 2007)
• Flat tax rate form 2009: Government says that all changes made public on Saturday point towards a flat tax rate of 20% to be introduced in 2009 according to the agreement of coalition partners.
PUBLIC SECTOR SAVING
• Cut staff of ministries by 23%, ministry workers will be moved to smaller offices, their car fleet will be cut to half (HUF 57bn saving until 2008)
We see the following stock impacts to the austerity measures announced:
• MOL: Some 60% of MOL's corporate tax payment is paid in Hungary. Assuming a broadly unchanged ratio for the future and that 4% solidarity tax remains forever (or would be converted to corporate tax), it decreases the fair value of MOL's free cash flow by some 3%. Previously MOL was fairly positive on receiving a corporate tax holiday for the mother company for 2006, but it is now questionable. The company told us last week that it is better not to calculate with this. (2006 EPS impact minus HUF 160 or some 6%) Other indirect impact should be that rising personnel income tax and social contribution put further pressure on wage costs. However, it would likely have an impact from 2007 only, given that MOL already signed an agreement with trade unions for 2006. Planned energy price increases only affects households and not MOL, which purchases energy on the free market (we have already calculated with the rising energy prices in our MOL model). Excise tax also not an issue, major products (fuels, other refined goods but also filling station services are already taxed in the higher, 20% level). Overall, total negative impact of the austerity measures on our MOL valuation should be in the 4-5%range (3% from solidarity tax, 0.5% one-off losing tax holiday for 2006 and 0.5-1.5% on somewhat higher wage costs from 2007).
• BorsodChem: Rising natural gas and electricity prices are already factored into our BorsodChem model. Introduction of the solidarity tax on BorsodChem's Hungarian operations decreased net profit by some 3% for each forecasted years. Calculating with additional wage increase from 2007, total negative impact should be in the 3.5-4.5%, we believe. Good news is, that despite earlier concerns on the market that government is going to fully abolish corporate tax holidays, these (investments driven) tax allowances will remain. This is important for BorsodChem given their full corporate tax holiday in Hungary in the following years.
• Richter and Egis: While only hardly affected by energy price increases, pharmas are hit by 4% solidarity tax. According to our calculation this would lower net profit by some 3.8% (assuming that Richter and Egis has little room to lower corporate tax payment, since tax rate is still higher in other countries). Indirect impacts should be 0.5-1.0%, mainly due to increasing pressure on wages. Altogether, we see 4.5-5.0% negative impact on fair value for both companies.
Good news for Richter that despite earlier concerns on the market that government is going to fully abolish corporate tax holidays, these (investments driven) tax allowances will remain. In case of Egis, the measures do not affect R&D expenditure based tax allowances.