Hungarian debt level has steadily increased since 2001, with the debt-to-GDP ratio reaching about 84% at end-2011. This high level combined with significant volatility of macroeconomic variable influencing potential future debt paths – GDP growth, exchange rate and interest spreads – put Hungarian debt sustainability at risk. To assess debt sustainability over a 5-year horizon, a stochastic debt simulation has been conducted by applying random shocks derived from historical volatility to a baseline scenario. These simulations are used to derive fan charts showing the distribution probability of debt under different sets of assumptions regarding i) the nature of shocks – temporary or permanent – and ii) fiscal policy reactions, i.e. either allowing automatic stabilizers to operate or not. Results indicate that the probability of a debt ratio going beyond 90% of GDP in the next five years – a level beyond which debt is likely to hurt growth – is non-negligible (at least 25% in the most favourable scenario), especially if volatility turns out to be higher than observed in the past. The main risks to debt sustainability lie in growth shocks, whose volatility is high in Hungary. This highlights the crucial role of growth for debt sustainability. The impact of exchange rate depreciation can also be important, especially if shocks are permanent, while the rise in interest spreads would have a much more limited impact as debt is only progressively rolled over. Finally, fiscal policy reaction matters. Offsetting the impact of automatic stabilizers significantly reduces the width of potential debt paths over the five-year horizons.
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