Central Bank Profitability and Budget Deficit

 studies 

Zsuzsanna Novák – Imre Vámos Central Bank Profitability and Budget Deficit

Summary: This paper investigates central bank profitability primarily focusing on its impact on the government budget. It compares the accounting profit of the four euro area countries running the highest debt and three new EU Member States in the period 1999–2013 following the introduction of the euro. The analysis points out that despite autonomous monetary policy and higher seigniorage revenue, countries with higher levels of (external) government debt, such as Hungary, are often faced with central bank losses. The paper summarises and systematises the main findings of the 2013/I thematic issue of the Public Finance Quarterly titled “Monetary Policy” on the relationship between the National Bank of Hungary (MNB) and the budget. Furthermore, it delineates the European Union’s relevant recognition rules and evaluates the domestic processes in an international context by describing the profitability of the ECB and the selected European central banks.

Keywords: central bank, budget, government debt JEL codes: E58, M48

In their assessment of the advantages and banks of seven euro area countries over the 15 drawbacks of introducing the euro, Csajbók years since the introduction of the euro. Such and Csermely (2002) pointed out, similarly examination is justified by the fact that under to other Central European monetary policy certain conditions, central bank profits may professionals, that as a result of abandoning its also be used to reduce the government deficit autonomous monetary policy, a central bank indicator in an excessive deficit procedure, and Ijoining the euro area will incur losses by losing as such, they could generate savings for public the seigniorage from the issue of national finances, while guaranteeing the independence currency. A central bank with an autonomous of the central bank from the budget. currency may indeed earn a higher interest income on its operations relating to the monetary base than a euro area central bank, Approaches to seigniorage but ultimately this will not necessarily be reflected in its accounting profit. Seigniorage may be quantified in three ways: Following the identification of the key ubased on the annual real growth rate of factors determining the profitability of the monetary base; the ECB, and a brief explanation of the vin a fiscal approach to seigniorage, i.e. requirements for accounting and recognition as central bank revenue from the interest rate to be met by euro area central banks, we spread of central bank assets and liabilities examine the profitability of the National corresponding to the monetary base; Bank of Hungary as well as that of the central was profits made on the total asset holdings of the central bank (including Email address: [email protected] currency operations), which may be paid into

492 Public Finance Quarterly  2014/4  studies  the budget and is thus also quantifiable in ac- to reduce deficit, i.e. as general government counting terms (Walsh, 2010). revenue, to the extent that such dividends The first two approaches bear relevance and tax revenues result exclusively from to economics and are respectively referred financial transactions and are not generated by to in literature as the monetary and fiscal means of production or income distribution. approaches to seigniorage (Czeti ‒ Hoff- Otherwise the central bank might be inclined mann, 2006). For practical reasons, the start- to engage in such operations specifically for ing point of our paper is the statistics of the the purpose of reducing deficit. In turn, the third approach as the annual profits of central central bank may incur occasional losses by banks are publicly available data, but reference generating interest income or other capital is also made to the euro area’s approach to gains that provide insufficient coverage for its seigniorage. At the same time, we point out operating expenses. In such cases, the central why the Central Bank of Hungary, despite its bank may need to be recapitalised using autonomous monetary policy and seigniorage general government funds as opposed to the understood in the traditional sense (arising central bank contributing to public finances from the growth of the monetary base), failed through dividend payments. to improve the balance of the budget in the Within central bank profits, capital gains period under review. (e.g. foreign exchange gains) need to be treated separately by determining the net operating surplus, which does not include the Recognition of central bank former, being comprised only of the central profits in the budget under EU bank’s interest income and other operating regulations (ESA 95) revenues and expenses. In the euro area and in countries which are not members of the In a given year, the operations of a central bank monetary union but have adopted the euro may be profitable provided that the central area’s practice for the recognition of central bank, like any other financial institution, bank profits, this is done by deducting the manages the assets in its portfolio effectively. item “net result of financial operations, write- Naturally, in the case of a central bank, assets downs and risk provisions” from the net pro- and liabilities are primarily managed to meet fit or loss. Obviously, for compliance with monetary policy targets rather than to generate the practice of recognition adopted by the profit; however, successful management EU, each Member State must employ some could indeed have an impact on the balance method to deduct the estimated and actual of public finances. The extent to which the profit and loss of financial transactions for the profits may be recognised in statistical terms calculation of operating surplus. is relevant for our purposes in light of the ESA The profit transferred by the central bank, 95 methodology used across the EU, which is to which the state is eligible as a shareholder, the prescribed basis for the calculation of the is to be recognised as income on assets among Maastricht indicators of government deficit the items of public finances if it is equal to and government debt. or less than the net operating surplus. If it is The ESA 95 also contains strict provisions in greater, only the net operating surplus may be this respect. Its basic principle is that dividends recognised as income, while any additional and tax revenues paid by the central bank into dividends paid in are to be recognised as a the budget cannot be recognised as items withdrawal of equity. The same applies to

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the euro area, where the profit of the ECB The operation has no impact on government may represent several governments’ revenue deficit and government debt. By contrast, at the same time; in such cases, the profit is pursuant to the provisions of the excessive to be split by each Member State, at the ratio deficit procedure, the coins remaining in specified by its central bank, between income circulation, while having no impact on defi- on assets and withdrawal of equity. Where cit, may influence government debt, but only owing to its capital loss, the central bank in the case of a coin replacement where the does not distribute the entire net operating old coins were recorded as the liability of the surplus as dividends, the difference cannot government (rather than that of the central be recognised in government statistics as an bank) and can still be exchanged to new coins increase in participating interest. Outside the (government debt will obviously increase by euro area, the practice of dividend payments the amount actually exchanged). varies by Member State: in some cases the The ESA 95 contains no specific provisions government is eligible to a certain percentage, concerning the recognition of loss payments while elsewhere national central banks to central banks, but dedicates a subchapter (NCBs) determine the rate of payments based to take account of the capital transactions on the levels of reserves and provisions. Where related to state-owned (public) undertakings, corporate income tax is paid on the profit including central banks. Pursuant to the of the central bank, such payments shall be provisions therein, as a general rule if a state- recognised as income tax or property tax. owned company receives a capital injection The transfer to the government of income from the government in the form of an from the sale of gold and foreign exchange unrequited non-financial capital transfer, the reserves cannot be used for the reduction of transaction will have a negative impact on deficit but, qualifies as a withdrawal of equity the balance of public finances. Such capital regardless of the form of payment (whether transfers occur when the government as tax or dividend). The separate treatment udoes not receive assets of equivalent value of this item is also justified by the fact that in exchange; it represents national assets and not simply vcannot expect an investment carried out those of the central bank. This also explains funded by government support to generate a the possibility that even if the government meaningful return (one that may be expected does not qualify as a shareholder of the central in the private sector from a similar investment, bank under the laws of the country concerned, or is at least equivalent to the interest on long- it may nevertheless be eligible to income from term bonds); the sale of foreign exchange reserves. wthe beneficiary has been making losses With banknotes remaining in circulation, for an extensive period (in which case bond the procedure is similar to that of gold and purchases by the government may also foreign exchange reserves. Where previously represent a capital transfer). issued banknotes are no longer valid, accepted Even then, the operation qualifies as a non- as legal tender or expected to be exchanged and financial transaction only if its sole purpose the central bank consequently writes off the is to cover the loss and its amount does not relevant liabilities, the item will be recorded exceed the loss covered (otherwise it will be as a positive entry on the government’s other recorded as a financial transaction). equity account, provided that it receives the Naturally, any loss payment to NCBs item in the form of a regular income transfer. mostly involves non-financial transactions,

494 Public Finance Quarterly  2014/4  studies  and as such it influences the (primary) balance two revaluation reserves provided that the of public finances. balance of the profit/loss for the year and retained earnings is negative, otherwise up to the amount above the positive balance of the Recognition of the MNB’s profit in former two items. the budget The dividend payments of the MNB also depend on the balance of the revaluation The national rules for settlements between reserves. Namely, the central bank may only the MNB and the budget are specified in pay dividends to its shareholder on the amount a government decree1, which requires the of the annual profits or retained earnings above accumulated profit reserve to include “the the negative balance of the reserves; however, amount transferred to cover the loss for the interim dividends are never paid. year and paid directly by the central budget, Consequently, similarly to the rest of the shareholder’s capital transfer credited to Europe’s central banks, foreign exchange gains retained earnings, as well as the amount of resulting from MNB’s operations cannot revenues from the fines imposed by the MNB generate budget revenues, while in Hungary, that has not been used for the purposes set foreign exchange losses incurred by the central out in the MNB Act.” [Article 5(8).] The bank typically add to the budget deficit. (See profit/loss for the year is the part of the Table 1) MNB’s annual profits that is not used for the payment of dividends. However, the budget does not only provide a capital transfer to The ECB’s profitability in the past cover the loss for the year (where it is not fifteen years covered by retained earnings), but covers essentially all components of the MNB’s The ECB’s operations to date have demonstrated equity in case their balance should become the consistent strength of the central bank of negative. The central budget is required to the euro area. credit retained earnings with the combined The three main drivers of the profitability negative balance of the separately calculated of the ECB and the Eurosystem controlled by Revaluation reserves due to exchange rate it have been portfolio management and the changes, which under the MNB Act include underlying financial market developments, the foreign exchange gain/loss resulting from the operations implemented during the the revaluation of the central bank’s claims global financial crisis, and banknote issuance and liabilities due in foreign currency at (Vergote et al., 2010). Throughout its the official rates applicable on the last day operations to date, the ECB has maintained of the year, and Revaluation reserves of its financial independence and its reserves (its foreign currency securities, which include provisions in particular) have been sufficient the difference resulting from the market to offset losses; it was forced to offset its losses valuation of claims on securities due in against Eurosystem monetary income only in foreign currency (MNB Act, Articles 146 1999 and 2004 (Vergote et al., 2010). In other and 147), or, before the effective date of years, there was no need to compensate for the 2011 Central Bank Act, their separate foreign exchange losses, which were prevented negative balances. Such a loss payment may by the strict accounting system of the Europe- be made up to the negative balance of the an System of Central Banks (ESCB); it could

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Table 1 MNB’s stylised balance sheet

ASSETS LIABILITIES

I. Claims in HUF VI. Liabilities in HUF 1. Claims on the central government (HUF government 1. Central government deposits securities) 2. Claims on credit institutions (O/N and longer-term loans, 2. Deposits by credit institutions (minimum and excess swaps, debentures, etc.) reserves, O/N deposits) 3. Other claims 3. Banknotes and coins in circulation II. Claims in foreign currency 4. Other deposits and liabilities (two-week MNB bill, swaps) 1. Gold and foreign currency reserves VII. Liabilities in foreign currency 2. Claims on the central government (foreign currency 1. Central government deposits government securities) 3. Claims on credit institutions 2. Deposits by credit institutions 4. Other claims in foreign currency 3. Other liabilities in foreign currency III. Banking assets VIII. Provisions IV. Prepaid expenses/accrued income IX. Other banking liabilities X. Accrued expenses/deferred income XI. Equity 1. Share capital 2. Retained earnings 3. Valuation reserves 4. Revaluation reserves due to exchange rate changes 5. Revaluation reserves of foreign currency securities 6. Profit/loss for the year V. Total assets XII. Total liabilities and equity

Source: MNB

rely on its revaluation accounts as a buffer where the losses exceed the previous valuation against losses on foreign reserve holdings. In gains, and consequently the item is recorded accordance with the accounting rules of the as a realised loss. In such cases, the market euro area, the ECB also uses its revaluation value of each item is compared to its “average accounts to record revaluation arising from cost”, i.e. average purchase price. exchange rate developments, the net value of Over the past fifteen years, the ECB which is recorded separately for each asset, i.e. realised a profit on euro-denominated items not netted against the valuation gains or losses due to the reinvestment of their provisions or on other assets. This does not involve the previously generated income. The portfolio realisation of any actual gains or losses except created from the ECB’s own assets derives

496 Public Finance Quarterly  2014/4  studies  its funds from provisions (for exchange The foreign reserve holdings of the NCBs rate, interest rate and gold price risks), the with the ECB create interest exposure as a general reserve and previously accumulated result of the interest rate spread between in- central bank surpluses. Overall, the ECB terest on asset side items (mainly USD) and aims to use these to outperform a bench- EUR liabilities on liability side items. The mark return (such as the interest on the ECB’s foreign currency reserves accounted for MRO, its main refinancing operation and 66 per cent of its balance sheet in 2002, which policy instrument). Such items are invested dropped to 35 per cent by 2006 owing to the in euro-denominated assets and recorded as increase in banknote issuance (Vergote et al., other assets. (In the frames of its securities 2010). markets programme and its two programmes For up to 20 per cent of its profits for the for the purchase of covered bonds, the ECB given year, the ECB makes payments into the engaged in the intense purchasing of euro- general reserve fund (limited to 100 per cent denominated assets during the crisis). As part of the subscribed capital), and pays dividends of its extra liquidity operations, the ECB to member banks (NCBs) in proportion to tripled the size of its balance sheet during the their paid up shares, while its losses may be crisis. The ECB coordinates the monetary po- offset against Eurosystem monetary income in licy of the euro area, to be implemented by addition to the general reserve (ESCB Statute, the NCBs, which also announce open market Article 33). (This occurred in 1999 due to and credit operations mostly through tender- losses incurred on securities and in 2004, ing. Nevertheless, the ECB participates in when subscribed capital was at risk in the auxiliary operations that help the NCBs to absence of adequate reserves.) The Statute of access foreign-denominated liquid funds. In the ESCB and of the ECB refers to monetary this way, it intermediated between the FED income as “annual income derived from its and the NCBs by means of a swap transaction, assets held against notes in circulation and which affected its balance sheet in the form of deposit liabilities to credit institutions” (ESCB claims on the NCBs on the asset side, and in Statute, Article 32). The sum of the national the form of EUR liabilities to the FED. central banks’ monetary income is allocated The ECB is responsible for 8 per cent of to the national central banks in proportion to all banknote issuance (until 2001 banknotes their paid up shares in the capital of the ECB. were issued only by the NCBs), the stock of The clearing and settlement of the balances which has approximately quadrupled in the arising from the allocation of monetary Eurosystem since the EMU was established. income is carried out by the ECB. This is The ECB first realised a profit on banknote subject to authorisation by the Governing issuance in 2002. TheE CB charges the inte- Council. Each Member State subscribes rest rate of the MRO (its policy interest rate) capital weighted by a key equal to the sum of on its main lending operation, and it pays the 50 per cent of the share of the Member State in same interest on minimum reserves (as do the population of the Union and 50 per cent euro area NCBs). It pays no interest on excess of its share in the EU GDP at market prices, reserves (and, obviously, on banknotes), which as recorded preceding the establishment of the is the source of its seigniorage revenue in the ESCB (ESCB Statute, Article 29). The ECB’s economic sense. Between 2005 and 2007, the subscribed capital is automatically increased ECB allocated its income from seigniorage for when the central bank of a new Member State its risk provision and general reserve. joins the ESCB. (Non-member banks paid 5

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per cent originally and 7 per cent as of 2004.) euro area central banks pay the interest of The ECB’s losses may be offset against its MRO, the ECB’s policy instrument, on subscribed capital as a final buffer. the minimum reserves held by commercial The purpose of the ECB’s risk provision banks. Outside the euro area, the range of is to safeguard against losses arising from underlying instruments is wide. Before the exchange rate, interest rate and gold introduction of the euro, the instrument used price risks. Its advantage over revaluation for this purpose was the interest rate ceiling accounts is that it can be allocated faster. of the two-week repo tender in Slovakia and In 2010, in connection with its programme the price of the currency swap in Slovenia. In for the purchase of covered bonds, the ECB Hungary, the policy instrument was the two- also made such allocations for credit risk. week MNB bill until the middle of the year (The Governing Council adopted a decision (converted into a two-week MNB deposit as on the extension of the reserve.) The sum of August, its original function before 2007), of the general reserve and the risk provision the interest of which is also paid by the central may not exceed 100 per cent of the capital bank on the minimum reserve. The minimum subscribed by the euro area NCBs unless reserve rate is 1 per cent across the euro area dividends are to be distributed to the NCBs (2 per cent before 2012), whereas in Hunga- (ECB, 2013). ry it varies between 2 and 5 per cent subject Euro area NCBs make transfers to their to the decision of the credit institution own revaluation accounts and general reserves concerned. Thirdly, euro area Member States (and obviously, retained earnings) in a similar are less exposed to exchange risk and exchange manner; however, no restrictions apply to rate volatility partly because of their weak other reserves and provisions (except for credit dependence on non-euro area economies and counterparty risk) or dividend payments and currencies for the financing of their against own profits (Guideline, 2010). government debt, as opposed to economies in Central Europe, which have a major part of both private and public debt denominated Factors determining the profit- in foreign currencies. Additionally, euro area making capacity of euro area central banks deposit a part of their foreign NCBs and MNB reserve holdings with the ECB in proportion to their participating interests, and are also In addition to the differences in the rules paid the MRO interest rate on their balances. of accounting and recognition applied in The MRO interest rate fluctuates around the the euro area (arising primarily from the rate at which the banks otherwise record in- different treatment of revaluation reserves terest revenues on foreign reserve holdings in comparison with Hungarian regulations), (USD or JPY). In the case of non-euro area the profitability of NCBs outside and within economies, the interest on foreign reserve the euro area is influenced in various ways holdings obviously falls short of the interest by another three key factors. Firstly, the euro rate levels of domestic assets and liabilities. area NCBs are responsible for the issuance Moreover, in addition to the dividends of banknotes but not that of coins, unlike collected from the ECB, euro area central most non-euro area countries (such as Hun- banks generate interest income from their gary, where the National Bank of Hungary is claims on the euro area (such as TARGET 2 also responsible for coin issuance). Secondly, balances). (See Table 2)

498 Public Finance Quarterly  2014/4  studies 

Table 2 Stylised balance sheet of NCBs (euro area central banks)

ASSETS LIABILITIES

1. Gold and foreign currency reserves 1. Banknotes in circulation 2. Claims on non-euro-area residents denominated in foreign 2. Liabilities to euro-area credit institutions related to monetary currency policy operations denominated in euro (O/N deposit facility, other deposits) 3. Claims on euro-area residents denominated in foreign 3. Other liabilities to euro-area credit institutions denominated currency in euro 4. Claims on non-euro-area residents denominated in foreign 4. Liabilities to other euro-area residents denominated in euro currency (general government deposits, other liabilities) 5. Lending to euro-area credit institutions related to monetary 5. Liabilities to non-euro-area residents denominated in euro policy operations denominated in euro [MRO, longer-term refinancing, marginal (O/N) lending facility] 6. Other claims on euro-area credit institutions denominated 6. Liabilities to euro-area residents denominated in foreign in euro currency 7. Securities of euro-area residents denominated in euro 7. Liabilities to euro-area residents denominated in foreign (government securities, covered bonds) currency 8. Claims on the Federal Government 8. Counterpart of special drawing rights allocated by the IMF 9. Intra-Eurosystem claims (participating interest in the ECB, 9. Intra-Eurosystem liabilities (ECB debt certificates, other) transfer of foreign reserves to the ECB, TARGET 2 balances) 10. Items in course of settlement 10. Items in course of settlement 11. Other assets (coins, fixed assets, other financial assets, 11. Other liabilities (accruals and income collected in accruals and prepaid expenses etc.) advance, off-balance-sheet instruments revaluation differences) 12. Provisions (for exchange rate, interest rate and gold price risks) 14. Equity and reserves (capital, statutory reserves) 15. Profit/loss for the year V. Total assets XII. Total liabilities and equity

Source: Bundesbank

The profitability of seven euro adopted the euro recently) based on the area central banks and the MNB reports of the past fifteen years (see Tables since the introduction of the euro 3 and 4) shows that in terms of data as a percentage of GDP, Ireland and Spain have An overview of the accounting profits of the fared the best. Owing to the positive result central banks under review (the four euro achieved each year, they have been able area Member States running the highest to make significant contributions to their debt as well as Slovenia and Slovakia, which respective budget balances, resulting in

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average balance improvements equivalent to Central and Eastern Europe to join the euro about 0.3 per cent of GDP. Additionally, in area. Then, in the first years following the recent years they have continuously improved adoption of the single currency, its profits their profitability. Interestingly, the profit deteriorated significantly, due primarily to the of Ireland’s central bank shows the closest requirements of the euro area for revaluation correlation with the dividends collected from and provisions, and the exchange of the the ECB (r=0.646). The financially least previous national currency (tolar). In the past successful NCB has been that of Portugal, five years, its profitability has already been the profits of which have been out of step improving, but the central bank’s accounting with ECB results, and where the distribution profit as a percentage of GDP is still at a mere of income to the budget is subject to highly third (half, at best) of the levels seen before complex regulations. While the Irish and 2001. However, as the Slovenian central Spanish central banks pay their entire profits bank paid only a fraction of its profit into the into their respective budgets (following budget even before the adoption of the euro, transfers to reserves) and the Spanish central the revenues of the budget have essentially bank also pays interim dividends during the remained unaffected by EMU membership. year, Portugal imposes an income tax on Since the general reserve provided sufficient central bank profits, but then only 50–60 per coverage to finance its deficit even in the years cent of the profits after tax are paid into the of losses, there has been no need to recapitalise budget (Tables 3 and 4 show the aggregate Banka Slovenije. balances of all taxes and dividend payments). During the crisis, euro area NCBs made Among the new EU Member States under a profit on the excess liquidity provided to review (Slovakia, Slovenia, and Hungary), the commercial banks. This is because commercial performance of Slovakia has been the most banks mostly borrow at MRO rates, while volatile. However, its central bank profits did frequently holding the surplus in O/N deposits, not fall in the aftermath of adopting the euro: which pays interest at a lower rate. The extra after 2001, the first positive results were posted liquidity generated higher profits, but also in 2009, the first year of the country’s EMU involved a higher level of risk. Consequently, membership. This was followed by two years the overall effect of the crisis on central banks’ of losses, then the National Bank of Slovakia income was not unambiguously positive or closed 2012 and 2013 again as a winner of the negative. In addition to the general reserves, euro area. Despite the recent years’ positive risk provisions and revaluation accounts, accounting profits, it has not paid dividends which are also allocated by the ECB, the NCBs to the government since 2001 (other than also set up a joint risk provision fund during paying a nominal amount as tax on profit), the crisis, because the bankruptcy of some but it has not placed a burden on public commercial banks caused the central banks to finances either, because instead of relying on incur losses on refinancing operations. the central budget, it used its own retained In the period under review, the profitability earnings to top up its revaluation accounts. of the MNB was rather diverse, which is Over the past 15 years, the Slovenian NCB, primarily owed to the volatility of the forint. Banka Slovenije has also shown a highly As explained later in more detail, foreign- imbalanced financial performance. Thanks to denominated low-interest assets were set its strict and committed fiscal and monetary against the central bank’s liquidity-absorbing policy, it was the first among the countries of operations with returns equivalent to the base

500 Public Finance Quarterly  2014/4  studies 

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

B EC from ividends D Table 3

0 0 0 0 0 0

ransfer to budget to ransfer T 77,342 –4,419 108,079 139,273 –11,136 –77,954 –59,730

–105,786 –245,201 H ungary

entral bank profit bank entral C 88,574 48,674 55,139 14,194 55,695 233,803 309,376 139,858 –21,725 –65,972 –86,358 –20,110 –137,635 –150,926 –169,936

0 0 0 0 0 0 0 0 0 0

B EC from ividends D 6,449 8,158 7,821 17,746 14,565

0 0 0 1 2 0 0 0 5

16 17

ransfer to budget to ransfer T 1,374 46,212 172,457 956,161

S lovakia

entral bank profit bank entral C 70,588 53,718 489,846 199,439 173,443 963,260 –76,734 –17,177 –525,173 –576,284 –906,721 –757,654 –581,722 –1,182,778 –1,211,876

0 0 0 0 0 0 0 0 0

B EC from ividends D 6,400 2,700 3,100 3,700 6,000 7,000*

ransfer to budget to ransfer T 4,300 9,500 3,229 9,666 1,234 27,413 32,978 25,900 11,600 10,409 16,112 11,845 17,958 16,025

S lovenia

entral bank profit bank entral C 50,390 17,105 38,184 21,373 82,123 131,910 103,566 161,136 159,638 219,943 206,677 –29,719 –36,443 –85,319 –93,351

0 0 0 0 0 0

B EC from ividends D 4,800 16,100 20,400 63,500 34,500 31,000 37,000 38,365* –36,095

ransfer to budget to ransfer T 80,000

817,800 305,300 126,804 147,093 180,878 160,725 150,121 153,345 172,418 155,993 457,900 451,534 306,051

Greece

entral bank profit bank entral C 96,637 831,150 318,650 190,452 228,161 225,084 284,684 244,635 228,459 205,605 218,260 213,236 506,300 496,688 337,976

0 0 0 0

B EC from ividends D 77,230 97,710 67,470

162,520 174,430 106,290 130,600 226,580 179,370 –24,750 -147,920

ransfer to budget to ransfer T

808,950 S pain

3,147,580 3,845,230 2,400,130 2,570,000 2,673,180 2,090,190 2,004,980 1,447,570 1,265,260 1,947,470 2,196,250 4,793,490 5,758,700 4,063,830

entral bank profit bank entral C 791,130 3,186,330 3,871,560 2,415,660 2,577,730 2,749,070 2,126,840 2,026,930 1,955,830 2,894,600 1,995,000 2,371,680 4,841,550 5,855,260 4,153,530 0 0

C e n tral b a ks’ profits (+) d losses (–) 1999–2013 B EC from ividends D 495

45,320 16,280 20,596 36,769 22,608 29,645 14,590 14,389

34,714* 39,380* –4,566* –33,582

ransfer to budget to ransfer T 60,676 61,920 69,896 58,053 38,755 28,189 27,596 277,035 359,649 219,467 239,125 255,693 371,660 240,857 165,476

P ortugal

entral bank profit bank entral C 31,165 70,033 69,043 89,886 77,397 56,229 55,144 253,013 449,154 198,373 254,033 349,230 281,790 188,476 120,294

0 0 0 0

B EC from ividends D 2,719

28,600 10,330 10,350 35,858 16,857 12,775 15,230 17,222 –1,988

–17,500

ransfer to budget to ransfer T 98,496

958,343 671,029 745,496 290,054 192,816 109,181 103,022 321,725 823,719 530,639 451,303 213,400

I reland 1,212,110 1,147,628

entral bank profit bank entral C 69,041 24,800 840,885 933,805 364,212 228,001 110,155 121,971 122,474 828,557 563,027 520,507 1,518,137 1,437,392 1,200,247 Y ear 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 ungarian forint were converted to euro based Note: *estimated values based on participating interests in the EC B’s registered capital (original data not available). D ata available S lovak koruna, lovenian tolar and H ungarian forint were converted to euro on the official E urostat exchange rates. Source: annual reports of the central banks under review, 1999–2013 [in E U R thousands]

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 studies  finances –3 –9

4.3

–5.5 –4.1 –7.3 –6.5 –7.9 –9.4 –5.1 –3.7 –4.6 –4.3 Balance of public public of Balance –2.1 –2.2

Table 4

ransfer to budget to ransfer T 0.3076 0.1537 0.1836 0.1362 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 -0.0054 -0.0673 -0.0870 -0.0112 -0.1099

H ungary

entral bank profit bank entral C

0.3089 0.1106 0.0241 0.4187 0.0615 0.2558 0.0492 0.0904

-0.0285 -0.2069 -0.0973 -0.0664 -0.0206 -0.1568 -0.1419 finances –8

–7.4 –6.5 –8.2 –2.8 –2.4 –2.8 –3.2 –1.8 –2.1 –7.5 –4.8 –4.5 –2.8

Balance of public public of Balance –12.3

ransfer to budget to ransfer T 4.9820 0.7822 0.1960 0.0001 0.0001 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0019

S lovakia

entral bank profit bank entral C 5.0190 0.7867 0.2279

0.1124 0.2805 0.6791

–2.2398 –2,5693 –2.6673 –0.0446 –2.7232 –1.0514 –1.8362 –0.7970 –0.1113 finances 0 -4 –3 –4

–3.7 –2.4 –2,7 –2.3 –1.5 –1.4 –1.9 –6.3 –5.9 –6.4

Balance of public public of Balance –14.7

ransfer to budget to ransfer T 0.0059 0.0744 0.0423 0.0730 0.0125 0.0435 0.0561 0.0335 0.0335 0.0000 0.0731 0.0268 0.0119 0.0934 0.0777

S lovenia

entral bank profit bank entral C

0.9911 1.0214 0.6993 0.3339 0.0785 0.5608 0.2924 0.1076 0.0473

0.3735 0.1428 -0.3616 -0.2748 -0.1053 -0.0798 finances n/a

–3.7 –4.5 –4.8 –5.6 –7.5 –5.2 –5.7 –6.5 –9.8 –9.6 –8.9

Balance of public public of Balance –15.7 –10.9 –12.7

ransfer to budget to ransfer T 0.2597 0.3274 0.3127 0.0996 0.1000 0.0828 0.0778 0.0770 0.0811 0.0000 0.0637 0.0571 0.0384 0.1579 0.4492

Greece

entral bank profit bank entral C

0.2868 0.3601 0.3458 0.1362 0.1266 0.1110 0.1183 0.1173 0.1276 0.0965 0.0987 0.0857 0.0463 0.1648 0.4565 finances 2 1.3 2.4

–1.3 –0.9 –0.5 –0.3 –0.3 –0.1 –4.5 –9.6 –9.6 –7.1

Balance of public public of Balance –11.1 –10.6

ransfer to budget to ransfer T

0.7007 0.9142 0.7045 0.3012 0.2487 0.0962 0.1391 0.1469 0.1904 0.1922 0.2553 0.2458 0.2294 0.3737 0.3077

S pain

entral bank profit bank entral C

0.7162 0.9295 0.7116 0.3252 0.2548 0.0940 0.3183 0.1985 0.1925 0.1955 0.2626 0.2465 0.2309 0.3762 0.3115 finances –4

–3.1 –3.3 –4.8 –3.4 –3.7 –6.5 –4.6 –3.1 –3.6 –9.8 –4.3 –6.4 –4.9 Balance of public public of Balance –10.2

a n d the b ala ce of g e eral ud et, 1999–2013, 2013

ransfer to budget to ransfer T C e n tral b a ks’ profits (+) d losses (–) as perce ta g of G DP , 0.0233 0.0221 0.0288 0.0413 0.0487 0.0415 0.0393 0.1029 0.1423 0.2161 0.1517 0.1383 0.1282 0.2178 0.1672

P ortugal

entral bank profit bank entral C

0.0465 0.0442 0.0576 0.0639 0.0481 0.0469 0.0780 0.1172 0.1664 0.2031 0.1507 0.1148 0.0182 0.2720 0.1527 finances 2.6 4.9 0.9 0.4 1.4 1.6 2.9 0.2

–0.4 –7.4 –8.2 –7.2

Balance of public public of Balance –13.7 –30.6 –13.1

ransfer to budget to ransfer T 0.2354 0.4272 0.4515 0.6302 0.2288 0.0687 0.0670 0.0555 0.1017 0.1609 0.4594 0.4244 0.5894 0.7000 0.7389

I reland

entral bank profit bank entral C 0.0274 0.4927 0.4791 0.6339 0.0491 0.0816 0.0749 0.0620 0.1202 0.2021 0.5754 0.5319 0.7382 0.8768 0.9254 Y ear 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: annual reports of the central banks under review, 1999–2013, and E urostat, 2014, percentages

502 Public Finance Quarterly  2014/4  studies  rate on the liability side, which had a negative bank dividends amounting to 0.5 per cent of impact on its profitability. GDP could significantly improve the budget, Over the past years, the Central Bank as the deficit figures ofT able 4 clearly show. of Hungary posted alternating profits and Obviously, the central bank profits for a given losses in its profit and loss accounts. Hun- year (apart from interim dividends) can only gary remained outside the euro area, but its lift the burdens of the following year’s budget. autonomous monetary policy has failed to produce spectacular benefits in this respect. Once the Hungarian economy beat double- Central bank financial strength digit inflation by 2000, the central bank has rarely made a profit from its annual According to Stella (2008, p. 7) central banks’ operations. This is despite the fact that it may financial strength is reflected by the extent to expect a higher seigniorage income than euro which their financial position helps them to area NCBs for two reasons: it is an issuer of achieve key strategic goals and to overcome coins in addition to banknotes, and its interest attendant risks. Central banks have no revenues from core lending operations (O/N profitability objectives, their operations being loans, longer-term covered lending facilities) governed by a primary objective in the broad are generally 50 to 100 basis points higher sense. In EU Member States, price stability than the interest which it pays on commercial tops the hierarchy of central bank objectives, bank deposits. The central bank, which in whereas in other countries, the primary spite of the fact that it has often incurred objective may be full employment or stable in- losses, has not made any transfers to the terest rate levels (see Fed). While making efforts budget since 2002; indeed, in the past twelve to provide macroeconomic stability, a central years, it often needed recapitalisation as a bank is often forced to forego its own financial result of the negative balance of its revaluation interests. (For example, when under pressure reserves. (Tables 3 and 4 show net payments.) to intervene on the foreign exchange market The possible causes of this phenomenon are to defend the exchange rate.) Nevertheless, discussed in more detail in the following the central bank’s long-term financial per- chapter. formance is a clear indication of its ability to The importance of the profitable financial maintain its financial independence, that it management of a central bank is best does not require government assistance, and illustrated by the government debt figures that it can manage its finances independently of the countries concerned as a percentage and thereby avoid political interference with of GDP, which, based on Eurostat, were the its operations, i.e. maintain its independence following in 2013: Ireland 123.7 per cent, (Vergote et al., 2010). Portugal 129 per cent, Spain 93.9 per cent, Quoting the former German central bank Greece 175.1 per cent, Slovakia 55.4 per cent, governor2, Stella (2008) proposes that central Slovenia 71.7 per cent, Hungary 79.2 per bank profitability is at most a concern at the cent. In a situation like this, also taking ac- level of microeconomic efficiency, and does count of the interest burden as a percentage of not have a material impact on monetary po- GDP (in 2013, Ireland 4.5 per cent, Portugal licy formulation with the world’s leading 4.3 per cent, Spain 3.4 per cent, Greece 4 central banks (the Fed, the ECB and per cent, Slovakia 2 per cent, Slovenia 2.6 Canada’s NCB). A leader in terms of central per cent, Hungary 4.4 per cent), even central bank independence among Central Euro-

Public Finance Quarterly  2014/4 503  studies 

pean central banks, and indeed worldwide positive balance of retained earnings, the defi- according to some researchers (Beblavy, 2003; cit of the revaluation reserves (and in particular, Alpanda – Honig, 2007), the Czech National that of Revaluation reserves of foreign currency Bank incurred repeated losses between 2001 securities) drained approximately 150 billion and 2007 except for one year, and turned HUF worth of funds from the budget. profitable only in 2008. The lack of profitability is primarily That is, while remaining committed to its explained by the MNB’s high foreign reserve monetary policy objectives, a central bank holdings, as interest and similar income may certainly focus on considerations of on foreign-denominated assets was by far economic efficiency as well when economic exceeded by interest paid on items on the developments are favourable. In countries liability side. Over the past years, the National with high external debt, it will face serious Bank of Hungary was only able to avoid losses difficulties if it wants to manage its own by selling a significant amount of foreign- finances at the same time as maintaining the denominated assets over their purchase financial stability of the country; yet, it should price (Pulay et al., 2013). Of its asset-side by all means make such efforts in order to operations during the crisis, the central bank reduce the burdens on the budget. However, made a profit on its purchase programmes Hungary’s example shows that unfortunately, for government securities and mortgage the income of public finances and that of debentures, while after 2011, the two-year the central bank can often be increased only loan offered at the base rate and loans granted at each other’s expense, as a result of which to commercial banks at a 0 per cent interest the central bank’s considerations of economic rate as part of the Funding for Growth scheme efficiency may be overshadowed by monetary to stimulate real economy lending obviously policy objectives as well as government debt. hurt the profitability of its assets. On the liability side, as a result of the crisis, in late 2008 the Central Bank of Hun- The effect of the profitability of gary reduced the minimum reserve rate from the Central Bank of Hungary on 5 to 2 per cent (the rate applied across the the budget euro area at the time), granting the option to allocate reserves above the minimum up to 5 Pulay et al. (2013) point out the high risk to the per cent. Regulating the reserve requirement Hungarian budget arising from the balances apparently enabled savings for the central of MNB’s reserve accounts turning negative. bank (disregarding the interest paid on Namely, as a result of the central bank’s the deposits of banks maintaining higher institutional independence, the government reserves); however, financing the government and Parliament have no means to influence debt in foreign currency caused the stock of the liability of payments. Based on their central bank bills outstanding to increase examination of the central bank’s profitability significantly, resulting in substantial inte- between 2002 and 2011, they found that the rest expenses. The stock of central bank bills Hungarian central bank incurred losses in six outstanding increased from HUF 687 billion years during that period, and the budget was in January 2008 to HUF 5,501 billion in forced to recapitalise the central bank on six January 2014. Additionally, in 2008 the occasions. While loss for the year in itself did stock of overnight deposits also increased not require a budget transfer owing to the from below HUF 20 billion at the beginning

504 Public Finance Quarterly  2014/4  studies  of the year to more than HUF 900 billion the reasons for the criticism in Pulay et al. at year-end (currently fluctuating between (2013) concerning the absence of quantitative HUF 50 to 200 billion). These liability- constraints and the payment of a fixed rate of side items caused the central bank to incur interest (the base rate). substantial interest expenses. Owing to sovereign borrowing in foreign In addition to the changes in stock which currency and the inflow of foreign capital were detrimental to profitability, Pulay et al. (e.g. EU transfers), the Hungarian bank- (2013) also point out that while raising the ing sector is mostly characterised by an base rate suddenly in October 2008 (above abundance of liquidity. In such a banking 10 per cent in order to attract investors to system, it would obviously be appropriate to a government securities market that was use a liability-side central bank instrument drying up), the MNB narrowed the interest capable of absorbing a comparable amount rate corridor, as did other central banks, to of liquidity. By contrast, the euro area is stimulate the interbank market (from the dominated by a shortage of liquidity, as a usual one per cent around the base rate to half result of which the policy instrument is an per cent). This hurt its profitability further, asset-side central bank operation (the ECB’s bringing the interest rate of the overnight main refinancing operation). Nevertheless, deposit facility closer to that of the policy where required, the ECB also offers liability- instrument. Moreover, this happened in an side operations to commercial banks in interest rate environment where most central addition to the overnight deposit facility. banks across the European Union (except in During the crisis, in connection with its Romania and Bulgaria) were cutting rates. securities markets programme (SMP), the Frequently voiced criticisms concerning the ECB announced a weekly deposit facility, two-week bill introduced in 2007 included the subject to quantity constraints and variable absence of limitations on subscribed quantities interest rates determined by market demand. (Pulay et al., 2013), and the possibility for In surrounding countries such as the Czech foreign banks and non-monetary financial Republic, Poland and Romania, central institutions (insurers, investment funds, banks typically sterilise by means of repos etc.) to buy it on the secondary market, or by selling central bank securities (e.g. making it much more costly than the central the one-week bill of Polish NCB Narodowy bank’s sterilisation by selling government Bank Polski). In each auction, the Czech and bonds (Bánfi et al., 2013). Given the central Polish central banks absorb only a limited bank’s increased interest burden, it was an amount of liquidity, while the Romanian unfavourable circumstance for banks not to central bank normally conducts auctions have been provided with incentives in the at variable interest rates by sorting bids, in utilisation of excess liquidity to grant loans, quantities aligned with its monetary policy or invest their liquid assets into treasury bills objectives. and government bonds, failing which they In Hungary, the consequence of the possibility used the central bank bill to absorb liquidity. to subscribe the central bank bill in unlimited While MNB (2009) refers to the central quantities is that when new government bond bank bill as its most important monetary issues are used to repay existing debt or pay in- policy instrument, it also states that the size terest, the excess liquidity of commercial banks of its stock is not of primary significance in ends up with the central bank. Borrowing in terms of monetary policy. This was one of foreign currency, which is occasionally cheaper

Public Finance Quarterly  2014/4 505  studies 

(IMF loan), will ultimately make it more Through the gradual reduction of the expensive to finance the central bank (Dedák, foreign currency debt further accumulated 2013). This is because when the government during the crisis, the central bank could issues bonds or takes a loan in foreign currency, improve the position of the budget by a few the balance sheet total of the central bank will tenths of a per cent each year, which cannot be also increase, with the low-interest new assets the central bank’s macroeconomic objective, being offset on the liability side by the policy but would certainly indicate a favourable turn instrument offering a return equivalent to the in taxation terms. In 2014, the tax revenues central bank base rate. expected to be collected from the transaction Given the fact that in the Central European levy (approx. 0.9 per cent) and the special tax region, Hungary runs the highest government on banks (approx. 0.5 per cent) amount to debt (currently over 80 per cent of GDP), just below 1.4 per cent of GDP. If the central there is absolutely no need for a potential bank could generate at least a fraction of the central bank loss to add to the burdens on the same revenues through its operating pro- budget. According to MNB’s 2013 forecast (in fit and thus partly by imposing an implicit keeping with baseline assumptions), Hungary tax on banks, this would presumably create is not expected to meet the Maastricht criteria conditions which are more acceptable to until 2027, and central bank profits will act as both the society and the system of financial a positive driver on the budget balance only institutions. Therefore, within the confines from 2018 onwards (MNB, 2013). of its monetary policy objectives, the central

Chart 1 Cash in circulation, HUF (%) (1 January 1999 = 100%)

Source: MNB

506 Public Finance Quarterly  2014/4  studies 

Chart 2 Cash in circulation, EUR (%) (1 January 1999 = 100%)

Source: MNB bank should make efforts to adjust the price increase in the amount of cash in circulation conditions and quantitative constraints of its in Hungary between 2008 and 2011). instruments to restrict liquidity and facilitate The gradual reduction of foreign reserve lending so as to incur the least possible holdings entails a reduction in the central amount of losses. bank policy instrument, which improves In principle, autonomous monetary po- profitability. With the forint appreciating, licy offers higher profitability to the central the situation was made worse by the fact bank than euro area membership, because that a significant part of the foreign reserve such a policy does not require the interest holdings was entered on the central bank’s rate of refinancing loans to equal the rates balance sheet at less favourable exchange paid on commercial bank deposits. In terms rates, hurting the central bank’s account- of seigniorage from the issuance of currency, ing profit in the case of sales in the face of the advantage of autonomous monetary po- an appreciating forint, causing retained licy is already less obvious, as illustrated by earnings to be reduced. (The average book the example of Hungary and the euro area entry exchange rate of foreign currency (see Charts 1 and 2). Although from 1999 reserves /expressed in Hungarian forint/ is onwards, the amount of cash issued in HUF lower than the current market rate by now.) grew at a faster rate than the amount issued in In turn, unrealised foreign exchange losses EUR, the picture varies by country and even could lead to negative balances of revaluation by period (for example, there was virtually no reserves. Consequently, considering central

Public Finance Quarterly  2014/4 507  studies 

bank profitability as a whole, also taking ac- the European Union suggests the general count of factors other than seigniorage, it is rule that central banks may only reduce the questionable whether Hungary’s autonomous budget deficit against their own income by monetary policy does in fact add more to the making transfers to public finances from their budget than euro area membership would. operating income in the form of dividends or In April 2014, the Monetary Council of taxes. Since inflation is low across the euro MNB adopted a decision on the introduction area, and indeed the purchasing power of of new instruments to reduce the external debt money is decreasing at a very moderate rate in of the Hungarian economy and to stimulate all EU Member States, such transfers remain the internal financing of government debt. It below 1 per cent of GDP. In the case of major also decided to replace the two-week MNB fiscal imbalances that characterised the crisis, bill with a deposit facility as of August, even such low percentages could be highly which, in the same manner as the bill, would instrumental in avoiding an excessive defi- continue to serve as the central bank’s main cit procedure, and can spare the imposition policy instrument to absorb liquidity, except of taxes that might lead to severe economic that it may not be acquired by foreign and distortions in society. The examples of euro non-monetary financial institutions. These area Member States running the highest changes are aimed at reducing the external debts and those of the new Member States vulnerability of the Hungarian economy in Central Europe demonstrate that euro (Kolozsi, 2014). Additionally, through area membership does not necessarily hurt a reduction in the stock of instruments central bank profitability despite lower inte- restricting liquidity (as a result of some excess rest income from seigniorage. Faced with the liquidity being channelled into government highest gross government debt, the case of securities), they may also improve the central Hungary highlights the fact that central bank bank’s profitability, potentially creating a income is largely dependent on government positive side effect on the budget. debt financing, and that despite the autonomy of money issuance (and the monetary base), a central bank incurring greater losses on Summary foreign currency operations could make the situation of the budget even worse. Where Apart from some country-specific rules for required, the MNB’s new instruments settlements between the central bank and introduced in 2014 enable the central bank to the budget, the methodology used in the align its own microeconomic efficiency with course of the excessive deficit procedure of macroeconomic objectives.

Notes

1 Government Decree 221/2000 on the special and my colleagues... I don’t enter into any strategic reporting and accounting requirements applicable considerations about Bundesbank profits, neither to the Magyar Nemzeti Bank in the morning, afternoon or evening.” Stella (2008, p. 11) quotes Weber’s interview to Reuters 2 “The Bundesbank profit is a residual issue for me (15 March 2005).

508 Public Finance Quarterly  2014/4  studies 

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