Research Dept. News
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Monthly Report, num 354 - February 2012
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European union - Emerging Europe
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Emerging Europe: Hungary causes concern
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Hungary suffers significant financial upset in the last few weeks.
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Hungary has grabbed public attention over the last few weeks. Between 6 December and 5 January, its country-risk premium shot up 176 basis points, going above 600 points, and the Hungarian florin lost 6% of its value against the euro. The Budapest stock market also fell by 9% in this period. What has been happening in the country? Although the immediate cause was the negative outcome of negotiations with the International Monetary Fund (IMF) and the European Union (EU) concerning the significant financial aid requested by the Hungarian government last November, it's also true that the country's problems come from further back in time. As can be seen in the graph above, since May 2010, when the new centre-right government led by Viktor Orban took over, the doubts regarding Hungary's public solvency have tended to grow, a dynamic that has become more exaggerated since last September, intensifying even further at the end of 2011.
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Investors are concerned not only about the state of its public finances...
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The essential factor underlying the stance taken by international investors is the government's inadequate response to problems with its national accounts. Although it's true that the situation inherited regarding public debt was complicated, with a cumulative public debt of around 80% of GDP (the highest in emerging Europe), what has caused most uncertainty is the perception that the budget adjustment policy followed was too short-term and lacked clear guidelines. First of all, the strategy employed to improve the fiscal balance in 2011 focused primarily on exceptional and not recurrent measures: transferring to the public system for pensions the system's private pillar (representing an extraordinary revenue of around 8% of GDP) and levying a series of duties to different sectors (banks, distribution chains, etc.) that generated an amount equivalent to approximately 2% of GDP.
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...but also the method used to improve the fiscal balance, excessively based on exceptional measures.
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Although this certainly helped to convert a public deficit that, in 2010, had reached the equivalent of 4.2% of GDP, into a surplus of 3.5% in 2011, the lack of any structural actions will mean that the country's accounts will become imbalanced again in 2012. The European Commission, for example, predicts a deficit of 3.2%. In addition to the harmful effects for long-term growth, the way in which these measures have been adopted (with a communication strategy that has tended to disconcert economic agents and with little predisposition to negotiate with the groups affected) has damaged the country's credibility.
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Also a cause for concern are the constitutional changes that might limit the central bank's independence.
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To complete the picture of rather unorthodox economic policy, the government decided to attack, not very aptly, another of its inherited problems namely the relative weight of private debt in foreign currencies (which totals 60% of the total mortgage credit, for example). Attempting to mitigate the effects of the florin's sharp depreciation since 2010 (greater than 14% against the euro), in September a plan was adopted for the early settlement of mortgages in foreign currencies at a subsidized exchange rate compared with the market rate, with financial institutions making up the shortfall.
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Within this context of diminishing credibility of economic policy, external developments have ended up making the financial situation tenser. The worsening of world's financial uncertainty associated with the euro area debt crisis since last November and the deterioration of economic activity in Hungary, linked to the weakness in the euro area, have resulted in a worrying financial dynamic since mid-November. Specifically, the unlikelihood of the economy being able to meet its significant external refinancing needs in 2012 forced the government, in November, to look to multilateral bodies in search of a loan of around 15 to 20 billion euros.
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This makes it more unlikely that the IMF will grant a loan and causes a reaction from the European Commission.
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However, the fact that these conversations coincided with constitutional changes that could damage the autonomy of Hungary's central bank has led to negotiations being suspended and a worsening of the financial tensions suffered by the country. Beyond its economic content, other aspects of the new constitution, such as the limitations to judicial independence or changes in the rights of minorities, have been considered as potentially incompatible with different aspects of European cultural heritage. All this has led to different actions on the part of EU institutions.
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Particularly relevant is the Report by the European Commission last 11 January, highly critical of the fiscal adjustment efforts carried out in 2011 and those planned in the budget for 2012. This means that the so-called «Excessive Deficit Procedure» will continue its course and, should no corrective measures be taken by the Hungarian government, it might end up with significant economic sanctions (such as the loss of structural funds). Similarly, on 17 January, the Commission filed three cases of European rights violations (related to the independence of the central bank and judiciary and also data protection). Although the most likely scenario is that Hungary, albeit reluctantly, will reverse the most controversial aspects and will end up accepting the terms under which the IMF and European Union will provide credit, the unorthodox bias of economic policy is more unlikely to be corrected completely.
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