Re-Positioning Public Utility Companies in Hungarian Public Finances after 2010

Written by:Lentner Csaba

Posted on:Dec 14,2019

Introduction

In Hungary, public utility companies have had an outstanding role since the second half or the 19th century, when the capitalist method of production was established. These economic participants attend to public duty functions. After the 1867 Compromise, the political leadership of the time established a developed system of state railways by obtaining shares in privately owned railway companies, and the powerful economy influencing activity of the state was also manifest in the market sector and other public services. As a result of the nationalisations performed after World War II, collective ownership became the norm all over the Hungarian economy, and although after the adoption of a New Economic Mechanism in 1968, market features also appeared, although moderately, in public utility companies (performance incentive relations and the rental of production equipment), the method applied by the socialist planned economy prevented the evolution of a genuine market structure (Lentner, 2020). The leadership in charge of the policy that led to a change of regime at the end of the 20th century aimed at the adoption of a modern system for attending to local government duties. Municipalities were in charge of public duties and provided public services, assisted by locally operating public utility companies, for the most part in their ownership. The systems of larger, nationwide public service providers were owned by the state up to the early 1990’s, and then they were gradually privatised.

The end of the 1970’s saw the emergence of the essential elements of the trend called New Public Management in western European countries. This meant that market hegemony came to the foreground, and consequently, the management kit of the business sector were applied in public organisations, decentralised structures were set up in the public sector and efficiency and efficacy were given priority in the public sector (Pollitt, van Thiel & Homburg, 2007; Drechsler, 2005; Drechsler & Kattel, 2008). Upon the appearance of the New Public Management approach in Hungary after the change of regime, public utility companies went into private, mainly foreign hands, and the new managements’ primary target was profit-making. This had an adverse impact on the population, as in order to make the highest possible profit, public service prices rose continuously. One of the main endeavours of the public finance reform launched after 2010 was therefore to improve the standard of living for the population. Thus New Public Management (NPM) and its economic philosophy was replaced by a public utility service provision practice aimed at the centralisation of public utility assets and procedures, the repurchase of public utility companies rather than their continued privatisation, the provision of public benefit in the widest possible circle, instead of profit made on public services (which is the objective generally set by the management, see the CNPG concept in Lentner, 2017).

Public utility business organisations are subject to both the regulation applicable to the central budget and public funds, and business management regulation. As these companies (irrespective of ownership, i.e. whether they are in state or local government ownership) are responsible for providing public services, they have a massive impact on the life and operation of companies, while they must also keep efficient and cost-conscious financial management in mind (Hegedûs & Zéman, 2016). Thus, in Hungarian public finances, reorganised after 2010, public utility companies are subject to tighter government regulation and closer proprietary control, and moreover, the government repurchased of the majority of public utility companies. In ten years, the worth of public assets rose by 50 per cent.

The re-regulated macro-economic background to the operation of public utility companies

Article 38 of the Fundamental Law, which entered into force on 1 January 2012, regulates assets in national ownership. The statutes stress that national assets must be managed efficiently, operation must be sustainable and the needs of future generations must be taken into account. In addition to Hungary’s Fundamental Law, Act CXCVI of 2011 on National Assets (hereinafter: National Assets Act) laid the foundations for a new structure of national property and regulated asset management. National assets may only be used for the specified tasks, i.e. for public duties. The Fundamental Law also emphasises that business organisations owned by the state or local governments must perform their duties autonomously and according to the requirements of lawfulness, expediency and efficiency. Public utility companies related to state assets are regulated in the National Assets Act, while those in local government ownership are also subject to Act CLXXXIX of 2011 on Local Governments (Local Government Act(. Local governments may attend to their duties through a budgetary organisation or through a business organisation in local government ownership. In Hungary the number of companies in local government ownership has increased significantly since 2006. In order to attend to their public duties, municipalities established businesses in especially large numbers between 2006 and 2008, but after 2011 this momentum subsided. This may be traced back to the fact that previously, the regulation of business organisations was more lenient than the rules governing public funds, and labour regulations were also less stringent than those applicable to employment in the public sector. Concerning regulation, in 2015 Act CXCIV of 2011 (on Stability) was completed to require approval for borrowing by business organisations in local government ownership. Local governments and their public utility companies were brought under tighter legislative control. After 2011, the State Audit Office was given powers to supervise local governments’ public utility companies in order to enhance the transparency of their business management. The new system of finances includes higher centralisation and tighter control over the business management of public utility companies.

Since 2013 price regulation has been applied Hungary to optimise solvent demand and the provision of public utility services. As a first step, the government reduced the consumer prices of electricity, natural gas and district heating, then went on to moderate the prices of water supply, waste disposal and chimney sweep public services. As a result of price regulation (termed as “reduction in overhead costs”), at the moment Hungarian families purchase the cheapest natural gas and electricity supply in Europe. The economic impact of mandatory reductions in utility bills is non-negligible, as the number of consumers in arrears with payment and the amounts outstanding have both declined considerably. Quantified data prove that in the wake of these actions, about HUF 85,000 (approx. EUR 300) less was paid for energy supply per household already back in 2014 than in 2012, prior to price regulation. The regulation of water supply, sewage, waste disposal, chimney sweeping and PB gas prices started on 1 July 2013 saves about HUF 100,000 per household annually. Energy suppliers’ total accounts outstanding by more than 30 days has dropped by 21 per cent, and the number of electricity, natural gas and district heating consumers in arrears with payment is 35, 38 and 22 per cent less, respectively. It can be said that these actions had a favourable impact on the population’s income position, and simultaneously, public utility companies’ overdue and unpaid claims also dropped, but the impacts of missed income on public utility service providers’ future operability and profitability is also worth assessing (Lentner, 2015). To offset missed revenues, the emphasis was shifted to more disciplined and cost-saving business management under the tighter control of the State Audit Office.

Operation of public utility companies in the new system of public finances

After the global economic crisis, public utility companies in Hungary also faced factors preventing efficient operation, operating risks and excessive debt. Price regulation, which was adopted in 2013, also had a considerable impact on the operability of public utility companies, as the net price revenue and other additional financing methods became more limited for these companies. As a result of the crisis, and especially the government reform of 2010, the accounting principle of going concern considerably appreciated both in business entities traditionally operating on market bases and in public sector organisations (Zéman and Lentner, 2018). In the case of public utility companies this may be of outstanding significance because they provide public services and also manage public funds, and most importantly, they constitute national assets. The eventual termination of business activity would affect the entire society and the standard of living. Thus, in addition to market relations, political decisions, economic policy interventions and legislative changes also have an impact on the enforcement of the accounting principle in the case of public utility companies (Lentner, 2013), and there is also a standard social demand for the uninterrupted and predictable provision of public services.

The statutory regulations enabling good governance and the efficient use of public funds are explained above. In addition to the establishment of a complex regulatory environment, the supervisory powers of the State Audit Office (hereinafter: SAO) were also enhanced. Act LXVI of 2011 (on SAO), which entered into force in 2011, added to the powers of the financial supervisory authority. Since this act entered into force, SAO can efficiently audit the operation of public utility service providers and judge whether their business management is sustainable and cost-efficient and they perform their public duties at a high standard. The reports of the State Audit Office published between 2011 and 2015 in relation to the renewal of the state management shed light on the deficiencies of public utility companies and on the inadequacy of asset registration (Domokos, 2016; Domokos et al., 2016). Zéman et al. (2018) analysed the creditability of local governments, and found that the information contained in the accounting reports compiled between 2013 and 2016 did not evidence deterioration in creditworthiness. However, research into the operability of local government-owned companies called the attention to the deficiencies in the profitability of these companies (Sisa et al., 2018; Molnár & Hegedûs, 2018; Molnár, 2019). In his study Boros (2019) examined the gaps in Hungarian regulation in the case of state-owned companies, and recommended the adoption of an independent statute on the system of internal control at state-owned companies. Legislation may only require the attitude to achieve financial results but not the financial output itself, this is exactly why the powers of regulatory bodies need to be reinforced (Kecskés, 2018).

Material and methodology

In the course of the research the 2013 and 2017 data of state and local government-owned public utility companies registered in Budapest were analysed. Thirty-two companies were analysed in each of the two periods. One of the selection criteria was the company’s being operative in both years. The key financial indicators of the 32 analysed companies were analysed in the aggregate, and interviews were made with the management of these 32 companies. They were requested to answer 6 questions, evaluating the optional responses on a Likert Scale of 5. It is important to note that the number of state and local government-owned companies registered in Budapest is 143, and 22.32 per cent of them were selected by the application of the following filters. In summary, the filter criteria were the following:

operation in both 2013 and 2017,
having a registered office in Budapest,
complex information suitable for evaluation should be available, and
the companies should qualify as public utility companies under the National Assets Act and the act on Hungary’s local governments.

Two objectives were set for the research: on the one hand, the evaluation of the financial procedures of the analysed companies, and on the other, the analysis of the impacts of public finance reforms performed within national competence.

Findings

Sample composition

The first table suggests that the companies in local government ownership typically operate as limited liability companies, while state-owned ones are typically joint stock companies. Twenty-two per cent of limited liability companies are non-profit organisations. Company types are selected partly for legislative reasons, as the National Assets Act prohibits local governments from undertaking unlimited responsibility, and this also applies to state-owned business organisations. In addition, operation in a non-profit form is a requirement for certain special tasks.

Table 2 shows the sectors of the national economy where the companies selected for the sample are operative. Most public utility companies operate in communication and transport, followed by companies active in state and local government asset management. Others include water utility companies and businesses engaged in electricity and natural gas supply.

Although the size categories used to characterise SME’s are usually not applied in the case of companies in local government and state ownership, a breakdown by size nevertheless provides interesting information. In a size grouping it can be established that the companies predominating this sector are large corporations and give approx. 37.7 per cent of this sample, while small and medium-sized companies represent 62.5 per cent, considerably below the corresponding ratio in the national economy, as SME’s share 99 per cent of all companies in Hungary.

Based on Table 4, most of the companies in the sample were in local government ownership, representing 75 per cent, and only 25 per cent of the reviewed companies are in state ownership.

Table 1: Breakdown by the legal status of the company