Hungary’s new government faces an unenviable task. If the new Socialist-led administration doesn’t come up with a credible plan to balance its books, the country is on course for crisis.
The ruling party managed to hang onto power in April’s elections but prime minister Ferenc Gyurcsany has got off to a gruelling start. Reckless spending over the last five years has ruined public finances. As a result, the country already has the biggest budget deficit in the EU at $560 million by the end of April – more than half of what it planned to spend in the whole year.
Most observers are confident that change is in the wind. Ironically, the Socialist party’s slim majority could be the economy’s saviour. It was forced into a coalition with the liberal Free Democrats (SzDSz), a fact which some analysts suggest will translate into a more reform-minded government.
“If the Socialists had won a clear majority, resistance to change would have been greater, as the party is not committed to the idea of reform,” says Sandor Richter of the Vienna Institute for International Economic Studies. “The Free Democrats ... will only enter the coalition if there is a reform programme on the table. I am expecting to see the start of deep reforms,” he adds.
difficulties ahead
It won’t be easy. Last year the government posted a deficit of 6.1% of GDP and this year’s official target is 6.7%, although there is even disagreement over just how big the overspend really is.
Eurostat, the EU’s statistics office, caught Hungary trying to mask the true size of its budget deficit through a bit of accounting trickery last year. The body is still rowing with the state over what spending should be counted in.
The general confusion is made worse by the fact that the Hungarian National Bank (MNB) is politically opposed to the government and has made even more pessimistic forecasts, saying the deficit will hit 8.8% of GDP. This is partly because it includes this year’s $1.5 billion spending on motorway construction – equal to 0.5% of GDP – which Eurostat insists should also be included in the calculation.
“The important thing is not the figures, but if the new government will initiate a new policy in the coming weeks and start to prepare reforms,” says Richter. “The worst thing the government could do now is do nothing. Then a crisis will be unavoidable.”
As Emerging Markets went to press, the Socialists and the Free Democrats were still hammering out a concrete plan of action, which they say will be released at the end of May. However, the first hints on policy are encouraging.
The government has been looking for some time for ways to get extra spending – especially the $1.5 billion on motorways – off its books. On May 9, it struck a compromise. Economy minister Janos Koka announced that motorway company Allami Autopalyakezelo (AAK) would issue k1.2 billion of bonds by the end of 2006 and take a k320 million loan from the European Investment Bank to pay for the work. It will also float 20 to 40% of AAK on the Budapest Stock Exchange, a move which will class some of the spending as “private” and so move it off the state’s accounts.
“Based on consultations [started in September 2005], we are convinced that Eurostat will not have any objections to this financing construction,” Koka says.
benefit of the doubt
So far ratings agencies and investors are giving the new government the benefit of the doubt. The government says it will cut spending by at least $1.5 billion, or 0.5% of GDP by the end of the year – enough to stick to the original budget deficit target of 6.7% of GDP.
Many strategies are available, but the problem boils down to cutting spending and raising taxes, which all Hungary’s governments of the last five years have been reluctant to do.
While the details are still being finalized, experts widely expect the state to hike the middle range VAT rate in the three-tiered tax from 15% to 20%, which will provide some relief in the short term.
Other measures being discussed are reducing ministry budgets by 5%, freezing public sector wages, as well as reducing the subsidies on medicine and mortgages. However, most of these will not have much impact on this year’s deficit.
“A lot of money could be saved on mortgages, which up to Ft216 billion ($1.1 billion) had to be spent from the 2006 budget, although the austerity will probably not apply to the loans already granted,” says Piet Lammens, an economist with CSOB.
No news, analysts agree, would be bad news. Despite encouraging early signs, ratings agencies are watching closely to see if the new team follows through with concrete action. While most countries in the region are on the path to steady upgrades, Hungary is bucking the trend. Fitch has already downgraded Hungary’s ratings in December 2005 to BBB+, while S&P (A-; January) and Moody’s (A1; March) have changed the country’s rating outlook to negative.
the euro dilemma
The government faces an early test this autumn when it embarks on fresh convergence negotiation with the EU to pave the way for adopting the euro. Hungary is still paying lip service to the 2010 entry date to European Monetary Union (EMU), but as the deficit needs to be brought under the 3% Maastricht cap by 2008 – if Hungary is to have a shot at meeting the deadline – few believe the forint will disappear before 2013 at the earliest.
To complicate matters, the central bank failed to act quickly when concerns over the deficit pushed the national currency to a new low against the euro, at Ft260. Still, economists expect the forint to strengthen again in coming months and then to stay in the MNB’s trading band.
“EMU entry is not a priority, as attention is focused more on growth, the rise in living standards and the fight against unemployment. These objectives don’t fit well with the need to lower the budget deficit, which is the key for Hungary,” says Lammens.