IMF-deal: the stress-test of the Orbán-government

Key Points

• Moody’s downgrade of Hungary’s sovereign debt to ‘junk’ status is a clear sign that the government’s eccentric and “unorthodox” economic policy has proved unsuccessful. As suggested by recent government statements, Prime Minister Viktor Orbán has realized the need for change and reaching an agreement with the IMF, which means that talks with the Fund could accelerate over a ‘stand-by’ agreement. Moreover, statements following a meeting with economists indicate that the government will adjust next year’s budget proposal and also plans to reach an agreement with the Bank Association.
• The government is left but with unpalatable political options: it either continues its “freedom fight” threatening the country’s financing, or performs a radical correction, which would be tantamount to acknowledging defeat in the domestic political arena. Therefore, the government will try various manoeuvres to make a half-turn in economic policy without obvious rhetorical and personal changes and simultaneously reap the benefits of an IMF agreement. However, it is yet to be seen whether increasingly apprehensive investors can be placated with such “compromise” solutions.
• While the replacement of economy minister György Matolcsy is unlikely this year (with such a move Viktor Orbán would acknowledge the defeat of his own economic policy) one can expect to see his gradual “withdrawal from the frontlines” and the waning of his economic influence. The presence of deputy Prime Minister, Mihály Varga at the recent meeting with economists shows that he may be given a leading role in managing future economic policies. As a compromise, the creation of an independent finance ministry cannot be ruled out either and in all likelihood the upcoming IMF talks will be conducted without György Matolcsy.
• The downgrade has increased the chances for a Central Bank rate increase, although opinions are divided as to its scale. The current crisis may be the first live testing of the Monetary Policy Council expanded by new members; from the point of credibility it will be important to see the positions taken by Central Bank representatives and external members delegated by the government. Also, an agreement with the IMF may result in the suspension of efforts to remove NBH governor, András Simor as the Fund will insist on cooperation with the Central Bank.

The government has manoeuvred itself into a corner

• Thanks to the ‘double-talk’ concerning the IMF as well, Moody’s downgrade indicates that due to its poor international perception Hungary finds itself in a negative spiral and the situation can no longer be remedied through minor adjustments, such as the Széll Kálmán Plan.
• The downgrade is tied to the following four factors:
  1. deepening crisis in Europe,
  2. poor fundamentals of the Hungarian economy (high external debt and low growth),
  3. effects of the country’s unorthodox economic policy, generating uncertainty and hampering growth,
  4.  government communication creating poor image and lost credibility, inability to ‘sell’ abroad its, in some areas, successful economic policy (for instance, pro rata the government implemented two thirds of the Széll Kálmán Plan’s cost-cutting measures, yet its effort has failed to improve investor confidence).
• To relieve the pressure it finds itself in, the government must meet three criteria: (1) a new economic policy team; (2) should implement ‘orthodox’ measures; (3) combined with new government communication. However, a 180 degree turnaround in substance, communication and leadership would lead to a domestic political crisis unacceptable to the Prime Minister and Fidesz, i.e., the government will continue to look for “compromise solutions”. As since the beginning of the governance the popularity of Fidesz has dramatically decreased, Orbán will try to do anything to avoid further popularity loss, even if it seems inevitable.

  

• The downgrade also means that Viktor Orbán will be denied the chance to follow the ‘Turkish model’. Had the Prime Minister contemplated playing a trick of ostensibly returning to the IMF as to reassure the markets without intending to reach an agreement, that option has already been lost. Failure to reach a quick agreement with the Monetary Fund carries serious consequences regarding the country’s economy, monetary and fiscal policies.
• Since the downgrade has undermined the government’s bargaining position at the upcoming negotiations, signing a stand-by agreement similar to the one in 2008 appears to be its only remaining option. The current impasse is attributed to the government’s failure to recognize some simple rules of logic: the more it keeps talking about “unorthodox” measures and the unfeasibility of cooperating with the IMF, eventually the more it will be forced to accept an IMF loan and adopt “orthodox” solutions.
• Potentially strict loan conditions may also mean that the government will have to abandon some of its measures symbolising its unorthodox economic policy (e.g., the final-payment scheme and special taxes). As a result, the implementation of the conditions set by the IMF will lead to an even greater defeat in the domestic political arena than the return to the IMF. It will become evident for all that the government is unable to deliver on its promises made in the past few days (claiming that an agreement with the Monetary Fund will have no effect on its economic policy).

Personal consequences?

• To prove his political “stamina” and avoid admitting the failure of his economic policy, Viktor Orbán has held on for too long to György Matolcsy, even as an increasing number of Fidesz politicians and government members have called for his departure. However, in the first round the Prime Minister will try to sideline György Matolcsy without dismissing him as to avoid the appearance of political defeat in the eyes of his domestic followers.
• However, by “keeping a tight grip” on György Matolcsy the Prime Minister runs the risk of becoming the target of both internal and external discontent. The Prime Minister’s position is also weakened by the fact that calls for his resignation have become more vociferous in the past two weeks. However, this should not lead to his imminent resignation, which may come only if (1) the decision to hold an early election or appoint a new prime minister is initiated by the Prime Minister himself or (2) if he finds himself in the minority within Fidesz.
• Currently none of the opposition parties are ready to govern and potentially the results of an early election would only strengthen Jobbik. This is also suggested by the fact that currently Jobbik is the only party demanding an early election, while the two other opposition parties merely demand the head of György Matolcsy or go only as far as calling for the replacement of the Prime Minister.