Hungary: against the wall

Summary

• In recent weeks Hungary’s long-term financing has become doubtful for a number of reasons:
  1. Contrary to the government’s claims, it is evident that Hungary will be unable to finance itself from the market.
     • Both Moody’s and S&P downgraded Hungary to junk category.
     • Wednesday’s government securities auction was a failure (only fifty percent of a total offer of EUR 100 million were sold at extremely high yields approaching 10%).
  2. Negotiations between the EU, the IMF and the government have broken off, and with its latest moves (the adoption of the central bank and the stability acts) the government has openly challenged conditions set by the EU and the IMF for resuming the talks, i.e., terms of a potential agreement have dramatically deteriorated.
  3. The government’s previous plans have been dashed when it failed to find alternative financing sources in the East (in China, Russia and Saudi Arabia).
• The government could achieve a loan agreement offering security only with a radical shift in its economic policy, although hopes for such an outcome are fading fast. As suggested by the Prime Minister before Christmas in an interview, in recent weeks the cabinet may have generated conflict with the EU guided by tactical considerations . However, these tactics have backfired, and with passing the stability act and the act on the central bank, the government seems to cement its position, rejecting the most crucial preconditions for the loan package. With this move, the government has cut off its own route to retreat, making an agreement extremely difficult for both sides.
• A failure to reach a loan agreement may trigger the following short-term crisis management measures:
  1. The government may integrate the Central Bank and PSZÁF (Hungarian Financial Supervisory Authority) in order to finance budget expenses by using the central bank’s EUR 35 billion foreign currency reserve. Since the total expenses budgeted for 2012 come to EUR 50 billion, this represents a sizeable reserve.
  2. The government can hope to be relieved of some loan-payment obligations through an orderly default.
• The foundering of loan negotiations would definitely leave the Hungarian economy in a catastrophic state with potentially serious domestic political consequences. In such circumstances it cannot be ruled out that developments bearing down on the governing party will eventually lead to Mr. Orbán’s departure. Opposition to Viktor Orbán may intensify within Fidesz and after some time business interests affiliated with the prime minister will also have a vested interest in his removal from power. As the prime minister undermines his own position and his chances for re-election with his current policies, his recent moves must be considered irrational from the point of the economy and domestic politics alike.
• Over the past 12 months the governing party lost over 50% of its supporters and thanks to its unorthodox economic policy and centralizing efforts relations with the European Union and the United States have been seriously compromised. In the absence of a strong and united opposition and in the light of the date of the next election (2014) this does not represent an imminent threat for the government. In the short-term the government faces the bigger threat that in the middle of the European crisis and increasingly acute financing difficulties it has become more isolated than ever in the international arena. In addition, since Hungary is not a member of the euro zone, its rescue is not as urgent for Europe as it had been in the case of Greece.

Political and economic environment

In the past 12 months the government’s economic and political standing has seen a spectacular decline:

1. Since the election the government has suffered a dramatic decline in popular support.
   • The governing party lost 1.5 million supporters (compared to opinion polls following the election), while the number of undecided voters has grown dramatically. Of all opposition parties Jobbik has been the most successful in attracting new voters.
   • 
   • 
   • The rejection of the governing party has increased drastically. Today Fidesz is detested as much as the far-right Jobbik.
   • 
   • According to recent opinion polls, today two thirds of the electorate believe that things are heading in the wrong direction in Hungary. When the government took office the number of optimists and pessimists was roughly equal.
   • The Prime Minister’s personal popularity has steadily declined in 2011 and by April his rating (on a scale of 0 to 100) stood below 41 points, the lowest rating measured during his first term in office. In December this year his popularity index stood at a paltry 32 points.
   • 
   • Gazdaságkutató Intézet’s (an economic research institute, GKI) monthly consumer-confidence index shows a significant and steady decline for the year behind us. During the Orbán cabinet’s second term in office the index reached its peak in October and November 2010, following local elections, and has declined steadily ever since.
   • 
2. Government politicians explain political errors and unfulfilled promises with an adverse external environment (“crisis”) and a difficult legacy (“the previous eight years”). However, pointing “outside” and “backward” is wearing thin and is less and less effective in serving as a cover for the internal causes of failed policies.
3. Thanks to essentially unpredictable policy decisions, the foreign-policy environment has been significantly eroded in the past 18 months. At the end of the year the government finds itself under strong pressure from practically all quarters (EU member states, the EU and the United States). While political (and economic) relations with Western countries have deteriorated in the past year, the policy of ’opening to the East’ has not been a success either: relations hoped to be developed by the government with Russia, China and Saudi Arabia have not reached the level as to offer solutions for Hungary’s growth and financing problems. With its foreign policy the government has become isolated and, in the midst of a deepening European economic crisis and in light of Hungary’s extensive need for external financing, this may prove fatal.
4. While apparently the government fails to recognize these warning signs, its economic policy position, assessment and financing options have been seriously undermined in the past year, reflected by a weaker forint exchange rate, rising default risk premium, failed government-bond auctions and downgrades. As Hungary’s downturn is the steepest in the region, this is due only in part to the deepening EU crisis and must be attributed mainly to the government’s misguided measures (e.g., the final payment scheme, arbitrary tax increases, harmful economic policy statements). As things stand today, the country’s safe financing guaranteed by an IMF loan and the resulting security would require an economic policy U-turn. Such a move would mean a huge political setback for the government and personally for Viktor Orbán, while the adoption of such a policy shift cannot be taken for granted by any means.

IMF-EU negotiations on the loan package: dead end?

• The joint delegation representing the IMF and the European Union broke off negotiations ahead of schedule with the Hungarian government before Christmas. The decision to leave the negotiation table early is a clear signal the the European Union – and the IMF – are willing to confront the government directly. Hence an agreement between the parties is now only possible if a clear change in the policy line of the Fidesz-led government is introduced.
• José Manuel Barroso, the head of the European Commission (in his letter to Orbán that was leaked to the public and via his spokesperson) laid down some clear preconditions:
  1. The government should adjourn passing the new Central Bank Act, and the remarks of the European Central Bank should be considered while designing the final version of the act.
  2. The government should postpone passing the Stability Act as well, a supermajority law which would cement the flat tax introduced by the government.
• According to IMF’s Christopher Rosenberg negotiations will be conducted with the aim of reaching an agreement on a Stand-by Agreement, similar to the one granted to Hungary in 2008; and not a precautionary loan that the government prefers.
  1. The pressure from the European Commission on Hungary is unprecedented: Olli Rehn, European Commissioner for Economic and Financial Affairs, openly took responsibility through his speaker for the decision to break off negotiations with the Hungarian government. Meanwhile, a letter by Viviane Reding, European Commissioner for Justice, Fundamental Rights and Citizenship criticizing the reforms concerning the judiciary and the system of parliamentary commissioners (ombudsmen) was published in the media. José Manuel Barroso demanded in a letter that Viktor Orbán accept the conditions listed above.
  2. The organizational changes put forth by the new Bill on the National Bank proposed by the government can further narrow Andras Simor’s elbow-room and curtail the independence of the National Bank. These changes include appointing a new Vice President and concern the appointment of the members of the Monetary Council. Another proposal handed in simultaneously (but is not approved yet) would integrate the National Bank of Hungary with the Hungarian Fiscal Supervisory Authority. The new organization would be headed by a new executive. The measures were seriously criticized by both the ECB and Simor itself.

For example, the decision of PM Orbán to initially side with the British standpoint at the recent EU-summit was presumably motivated by tactical incentives: the PM was probably expecting that his unorthodox attitude would create more favourable conditions ahead of the negotiations on the necessary credit line.