 |
For a small country that many had assumed was well on its way to quiet obscurity as a minor eastern member of the European Union, Hungary has demonstrated a remarkable capacity to surprise over the past two years. With a population of only 10 million and unspectacular growth since at least the turn of the millennium, it was never the darling of the markets; nor was it a focus of investors’ fears. But since 2008, it has twice managed to roil global markets, and is now firmly on analysts’ watch lists as an economy to keep an eye on.
In autumn 2008, Hungary and Ukraine were the first east European countries to be forced to turn to the IMF and the EU for financial support, after twitchy investors declined to finance the countries’ sky-high budget deficits any longer. Barely a year later, Hungary appeared to be heading back towards a chastened stability, with its then finance minister proudly announcing that it was unlikely to need to draw down the remainder of its E20 billion stand-by loan.
And this spring, voters furious after years of austerity – Hungary’s fiscal troubles have been long in the making – and after eight years of stories of government corruption, turfed out the Socialist-Liberal coalition and awarded a landslide victory to Fidesz, a party of the centre-right that promised tax cuts, fiscal stimulus and a more painless economic recovery.
Within days of the election, Hungary was back on traders’ terminals, after Viktor Orbán, the newly elected prime minister, went to Brussels to be told that his election promises would have to be substantially modified. Orbán had wanted José Manuel Barroso, the president of the European Commission, to agree to budget deficits nearer to 7% than the 3% for 2010 and 3.8% for 2011 that Hungary had already signed up to under the terms of its IMF/EU deal. While Orbán was away, the deputy leader of his party told businessmen Hungary had a “slim chance” of avoiding Greece’s fate. His words wiped trillions off asset prices globally that day.
András Simor, the central bank governor who was appointed by the previous government and is now at loggerheads with Fidesz, has been closely involved with economic policy throughout this period. “When I was appointed in 2007, I thought my job would be to manage Hungary’s entry into the euro and maintain price stability,” he recalls in an interview with Emerging Markets.
Though proud of the way the central bank and the previous government handled the first phase of the crisis, he is now in the dark about government economic policy. By his own admission, the central bank and the government do not talk.
FORINT FALLS
Hungary was in fact nowhere near default, although the sharp falls in the forint since the spring have made its problems more difficult to manage. More than two-thirds of Hungary’s private debt is denominated in foreign currencies, and half of that is in Swiss francs. At the end of May, the Swiss franc was worth Ft185; today it is worth more than Ft210. Each fall in the forint costs holders of foreign currency-denominated mortgages money and so cuts consumer spending.
Nor, Simor concedes, are forint falls any better for the public debt situation. “Ultimately, our foreign currency holdings are precisely hedged, because when the government borrows euros, it deposits them in the central bank to get forints. But over a one or two year period, a sharp fall will cost more in debt repayments.”
The new government’s economic policy is being set by György Matolcsy, a neo-Keynesian economist, who rightly concluded that there was no democratic mandate for more austerity after years of sluggish growth and stagnant real wages. He believes fiscal stimulus, together with a targeted industrial policy concentrating on Hungary’s areas of comparative advantage and deep reform of state spending, was the only way to address Hungary’s woes.
When confronted with the impossibility of getting a more generous settlement from the multilateral lenders, the government hastily assembled an alternative plan which involved a windfall tax of Ft200 billion ($715 million) on banks to be paid for three, later reduced to two, years, which would be used to finance promised tax cuts.
Many doubt the viability of this plan. György Surányi, a former central bank governor who is now head of the Italian bank Intesa SanPaolo’s central and east European operations, argues that the tax cuts are the cause of the budget shortfall.
“The Ft200 billion won’t fill the budgetary gap. First of all, because it will decelerate the credit growth, which will have a negative impact on the output. Second, the reduction of the general corporate tax from 19% to 10 per cent will create a fiscal gap that is roughly equal to the banking tax,” he says.
He also questions whether, in a small, open economy, fiscal stimulus can have enough of an effect to make a difference.
The IMF and the EU appeared to agree when they came in mid-July to review Hungary’s stand-by agreement and start talks on a second stand-by agreement to follow the expiry of the first. When they arrived for a round of meetings with ministry officials, it was reported that they were frustrated at being unable to get clear commitments on measures that Hungary was going to take. Orbán, once a junior professional footballer, who had the final say, was in South Africa at the time watching the World Cup.
The multilateral lenders worried about the absence of specific commitments on spending reform – in particular, they wanted to see more detail about plans to rationalize loss-making state companies like the railways – and they also worried about the sustainability of a budget based on a temporary bank levy.
UNEXPECTED OUTCOME
The outcome, when Orbán returned from South Africa, was the one least expected. Without even agreeing on a polite communiqué, the two parties broke off talks, and the delegations returned to Washington and Brussels, leaving IMF officials, in the weeks that followed, to scratch their heads and make discreet inquiries of carefully chosen experts into why the government had reacted so unexpectedly to their unexceptional demands.
The outcome was not what either party had desired. Hungary had, after all, been seeking a second stand-by agreement.
Public spending accounts for 49.2% of Hungary’s GDP, compared to an average of 40.3% for neighbouring countries. Well before the political changes of 1989/90, the country had some of the highest standards of living in the eastern bloc following the decision after the 1956 Hungarian Uprising to buy social peace with deficit spending.
Orbán ran a relatively disciplined fiscal policy during his previous stint as prime minister during 1998 and 2002, before losing to an opponent who promised that after the “regime change” that brought Hungary’s political and economic system in line with western Europe’s, he would bring about an equivalent “welfare change”. His insistence on keeping his promise – by doubling the salaries of many public-sector workers overnight – was the beginning of the slide that led to Hungary’s 2008 fiscal crunch. Orbán, of whom even admirers say that he treats everything as a political question, would be unwilling to pay the high political price of cutting social lifelines like loss-making rural railways.
The irony, according to Surányi, is that Hungary’s economic fundamentals now look rather good. Spectacular clashes between the government, the banks – most of them from neighbouring EU countries with their own deficit concerns – and the multilateral lenders who thought they were helping, are just serving to obscure a fundamentally optimistic picture.
“The fundamentals of Hungary are more stable than the perception. But if the perception lasts for a long time, it will turn into a self-fulfilling prophecy.” Though the picture is not “rosy”, he lists many reasons for optimism.
“The current account balance will deliver a significant surplus for two years in a row for the first time in 30 years, while import growth is 5% slower than export growth. Hungary’s gross external debt is dropping fast. And public finance – after many years of fiscal deterioration, it has to be said that it is now very reasonable, even though I have many criticisms. We have moved from a position of irresponsibility in 2006 to having one of the most responsible fiscal balances in the OECD [Organization for Economic Cooperating and Development],” says Surányi, adding that Hungary alone in the EU is now running a primary surplus.
In mid-September, after receiving a dressing-down from EU finance ministers, and after a renewed deterioration in the forint/Swiss franc exchange rate put added pressure on mortgage payers, the government announced that it would bow to IMF and EU demands and meet the agreed budget deficit target of 3% for 2011. Though Matolcsy said the bank tax would be “essential” to meeting this target, he added that the government would not seek any further support from the IMF.
Simor says the announcement that the target will be met is “very welcome”. But few can find a good explanation for the decision not to seek a new IMF safety net.
“We only drew on the stand-by loan for nine months. Then for one and a half years it was there as a safety net. Its real value was to increase the credibility of our budgetary policies,” says Simor. “It was a deal: on one side we agreed our policies with the lenders, and in return they reduced our risk premium. If we don’t extend it, we’ll have more freedom to set policy, but we will pay much more to borrow. It’s a political decision whether that’s a price worth paying.”
Many expect the government to announce a more disciplined fiscal policy, perhaps including painful spending cuts, after local elections on October 3. There is also speculation that Matolcsy might be replaced. But others detect wishful thinking on the part of market participants in these rumours.
Krisztián Orbán, an investment banker who has advised this, and previous, governments on economic policy, points out that there may be a silver lining. “If Hungary does it like this, then we know we have to get it exactly right.”