Ferenc Gyurcsany is in pensive mood. When Emerging Markets arrives for a meeting at the Orszaghaz, the Gothic-style parliament building on the bank of the Danube, the billionaire ex-businessman is found pacing his office staring at the floor and sighing heavily. It takes him several drawn-out moments to look up. This is perhaps not the image one would have of a man who has just become Hungary’s first post-communist prime minister to win re-election.
But then not all is well in new Europe. Fiscal profligacy has cast a shadow over this country of 10 million, whose spiralling budget deficit has made it the most troubled economy among new EU states, and one of the most vulnerable in emerging markets. Public discontent is mounting at what many see as the government’s cover-up of the true extent of Hungary’s fiscal woes in the run-up to the May elections – and Gyurcsany’s attempts to rebuild confidence since.
But Gyurcsany, who led his socialist-liberal coalition to a first-round victory, is adamant that he has his country’s interests at heart. When he sits down to talk, the 45 year old promises the most intensive period of reform in Hungary since it embraced the market economy in the early 1990s. He says he is determined to implement a programme of swingeing cuts to the budget deficit and restore fiscal discipline, despite growing scepticism from the markets.
Gyurcsany has been heavily criticized for relying too heavily on tax increases, rather than spending cuts, to achieve fiscal targets. But he tells Emerging Markets that he will focus on spending. “The target is very clear,” he says. “We will achieve a budget deficit of 3-3.5% of GDP by 2008.”
The revenue-increasing measures have been used “in the very short term”, but “we are aware that if our reform is to have a long-term impact, we have to cut back state spending.”
Gyurcsany adds: “In the short term, there needs to be adjustment, and in the long term, reform – these are the two pillars by which I will lead this government. If I can be honest, I can tell you that we are struggling much more from overspending than from over-projecting on the [tax] revenue side.”
The expenditure side is “the real challenge”, Gyurcsany acknowledges. “The main character of the reforms is to reshape private and public responsibilities. The most important measures [will be] in healthcare, education and pensions, together with specific measures in restructuring public transport.”
Nevertheless, Gyurcsany faces criticism from the highest levels of the Hungarian establishment for this two-stage approach.
Cutting expenditure
Zsigmond Jarai, governor of the Magyar Nemzeti Bank, the central bank of Hungary, warns in an interview with Emerging Markets that the tax increases already announced could negatively impact the economy and that more attention should be paid to cutting expenditure. “The various tax increases announced in recent months increase further the already high tax burden on the Hungarian economy,” he says.
“This will have a negative impact on competitiveness and hence real convergence in the longer run.
“In line with theoretical considerations and international experience, structural reforms of the expenditure side, particularly in the area of education, healthcare, local municipalities and the pension system are essentials to successful convergence.”
Hungary’s foreign debt and currency were both hit hard by the general sell-off of emerging markets in the spring. They took a new hit in August, when the index.hu (Hungary’s most popular internet news site) published a leaked copy of the government’s convergence plan, which was presented to the European Central Bank on September 1.
Part of the problem was that the document – which forecast an increase in public debt from 67.3% of GDP to 70.9%, 72.2% and 70.4% respectively in 2007, 2008 and 2009 – employed different calculation methods from those used previously. But these figures spooked the market; so did its prediction that the deficit, 8.5% of GDP this year, would only fall to 3.2% in 2009.
All the figures in the document miss targets set by the government – and that strengthened opinion among analysts that the tasks the government has set itself may be very tough to achieve in the medium term.
Defence
Prime minister Gyurcsany defends the delay in adopting spending cuts on the grounds that it could have engendered significant public opposition. “It turned out [after the elections in April] that we really need a very deep turnaround programme – a radical change in macro and social policy,” he says.
“We started real moderate change in social policy over the last 18 months, but we needed pro-reform public sentiments. A more radical reform has to be embedded in the right public atmosphere.”
Such reassurances have been received with concern by the markets, though. Investors will take more convincing before rebuilding positions in Hungarian paper, analysts believe.
Gillian Edgeworth, an economist at Deutsche Bank, tells Emerging Markets: “Once the genie [of loose fiscal policy] is out of the bottle, it’s hard to put it back.
“In 2002-03, election promises were made, and delivering on them was expensive.” Spending on items such as public-sector wages, and generous housing subsidies, rose steeply. “Now public finance has to be adjusted in the other direction, it’s much more difficult,” she says.
The government is “unlikely to implement any fiscal reforms, other than tax increases, before the local government elections in October,” Moody’s vice-president Jonathan Schiffer said this month, after the release of the agency’s annual report on Hungary. He points out that the market judged that the reform package rests too heavily on raising taxes.
Schiffer adds: “It has long been the medium-term plan of the Socialist Party to enact reforms and expenditure cuts in education and local administration; however, it is probable that such structural reforms will not occur until 2007, if at all.”
One upshot of Hungary’s problems is that the country’s entry into the euro is likely to be postponed. Prime minister Gyurcsany says Hungary could adopt the euro “the second half of 2010, or 2011, very soon after the next election”. But bank governor Jarai has publicly suggested later dates, such as 2012-14.
Jarai told Emerging Markets: “The major challenge in Hungary is to return to a sustainable macroeconomic path, to restore external and internal equilibrium. At the moment we are certainly far from fulfilling the Maastricht criteria, and the greatest efforts are needed on the fiscal side.
“Fiscal policy has to adopt adequate measures to prove that the budget deficit can be cut in a sustainable manner from the projected 10.2% of GDP this year to 3% in the coming years. Without a very strict and credible fiscal consolidation, Hungary will have no chance to meet the convergence criteria anytime soon.”
The country that for so long seemed to be eastern Europe’s favourite convergence play suddenly looks very tricky.