Elisabeth Dellinger
Capitalist Corner

Hungary’s Crossroads

By, 01/11/2012

Like many European nations, Hungary has struggled with fiscal issues the past few years. However, since 2008, Hungary’s financial crisis has driven the nation toward authoritarianism. Since Prime Minister Viktor Orban gained power in April 2010, his litany of questionable political and economic policies has eroded freedom and capitalism (not to mention economic growth and Hungary’s currency, the forint). The European Court of Justice has tried and failed to halt Hungary’s slide, but now a potential EU/IMF bailout may force the country back on a more democratic path. Hungary’s seeking assistance, and officials have said any loan will have huge strings attached.

Their main opening to force Hungarian change is a new law that effectively removes the central bank’s independence. The Orban-championed law merges the Hungarian National Bank (HNB) with the financial regulatory agency, which Orban will head—demoting HNB chief Andras Simor and giving Orban power to appoint monetary policymakers. Orban has long criticized Simor’s monetary tightening, which he says impedes Hungary’s economic growth. Agree or disagree with Simor’s monetary strategy—Orban’s real aim is to politicize the central bank. He’d likely stack the committee with his Fidesz party insiders—and a politicized bank, in our view, heightens risk of faulty monetary policy and could compound Hungary’s economic woes.

It also violates the Maastricht Treaty, so European Commission Chief Jose Manuel Barroso said Hungary won’t get assistance if the HNB loses independence. Officials seem set to demand reversals of other treaty-violating measures, like January 2010’s media reforms. These placed all media under government control, with “politically unbalanced” (i.e., opposition-friendly) outlets fined or yanked off the air. Also in jeopardy is a windfall tax on financial, telecom, energy and retail firms, which was ostensibly a tax on large foreign multinationals. And the commission may seek to unwind constitutional changes that effectively place the judiciary under party control.

EU officials previewed their negotiation strategy on Wednesday, with a double-whammy of threats. Hungary’s failure to meet deficit targets could mean losing €1 billion in aid, per the EU’s toughened rules on budget oversight. And if the government refuses to roll back the central bank, media and judicial reforms, which the European Commission again warned violate EU law, they’ll face legal action. Hungary’s set to receive official letters of warning on all three measures early next week—not coincidentally, when bailout negotiations commence.

Bailout terms will likely also include hefty economic changes, like the tough spending cuts and structural reforms Orban’s thus far avoided as he’s unsuccessfully tackled the deficit. The ill-advised stopgaps he chose instead, like the windfall tax, are largely anti-growth. He also hiked the VAT to 27%, raised small business taxes from 30% to 37% and nationalized €11 billion in private pension assets. And he’s required banks to accept foreign currency loan repayments at below-market exchange rates—helping ease the strain on homeowners suffering under the depressed forint, but forcing banks to accept heavy losses. That could freeze business investment lending, rippling throughout the economy—and if economic growth can’t boost state revenues, long-term debt reduction may be a pipe dream.

Whether the EU/IMF tactic works, though, is anyone’s guess. In 2010, Orban abandoned bailout negotiations because he didn’t want foreign bodies influencing domestic policy. His party lies just left of fascism, and his rhetoric at home is highly nationalistic, casting EU officials, capitalists and foreign investors as villains trying to impose their will on the “Holy Crown” of Hungary. Caving to officials’ contingencies runs counter to his philosophy. And as if on cue, he opened 2011’s final parliamentary session with a rousing speech proclaiming “no one in the world” can dictate Hungarian law. Minutes later, lawmakers passed the HNB reforms 293-4. 

But a reversal may still be possible. The stakes are higher today than in 2010, and EU/IMF assistance—and the strings attached—may be Hungary’s only option. The forint is near record lows, long-term sovereign yields spiked above 10%, and several debt auctions have met insufficient demand or been canceled altogether. Hungary didn’t meet 2009 and 2010’s deficit targets included in 2008’s bailout, and outstanding debt increased from 75% to 82% of GDP in Q3. With S&P and Moody’s downgrading Hungary to junk and the state’s heavy hand scaring off investors, affordable open-market financing may prove impossible.

Orban’s latest comments don’t give any clues on whether he’ll cave though. Last week, he said he’s committed to the central bank’s independence and open to “any kind” of loan agreement. But he also said he doesn’t see the need to re-write the central bank law, which he claims formalizes the bank’s independence (conveniently ignoring the checks and balances removed). And following the EU’s latest threats, he avowed Hungary’s “commitment to the rule of law,” but said nothing about Hungary’s commitment to “media freedom, democratic principles and fundamental rights”—the chief concerns laid out by the Commission. To me, it seems he’s trying to adopt a conciliatory tone without changing his actual stance—and that may be why he’s taken to barring foreign reporters from press conferences.  

Still, it’s entirely possible Orban’s softer tone is for real, and he may yet accept the EU IMF terms. But given his hard drive to consolidate power—Hungary’s new constitution brands one opposition party as a “criminal organization”—it makes sense to consider his alternatives. Also telling, another law passed December 30 allows the government to levy special taxes to pay for any fines imposed by the European Court of Justice—which seems a sign Orban is willing to thumb his nose at EU officials and make his people pay the price. If he chooses to remain defiant in his quest for aid, he could instead turn to Hungary’s former Soviet benefactor, Russia, where Vladimir Putin might be more willing to accommodate his authoritarian aims.

In our view, that would be a sad outcome for Hungary’s people. If the government were to follow the EU/IMF path, Hungarians would have a greater chance of thriving societally and economically. Who can debate the value of a free press? Central bank independence decreases politically motivated faulty policy. An independent judiciary can uphold the rule of law and protect civil and private property rights—key to sustainable economic growth. Easing the tax strain on businesses would allow them to channel more of their profits into growth—and job creation. Re-privatizing pensions would offer retirees greater financial security. In short, better, more capitalist policy would promote society’s well-being.

No doubt Hungary’s predicament is painful for the folks there, and resolving its debt crisis will likely force citizens to make some tough adjustments (globally, though, given Hungary’s small size there’s little chance of contagion). But just as the peripheral eurozone’s debt troubles prompted much-needed changes there, if Hungary takes the wise path, events today could help return it to the path of freedom and capitalism, making it stronger over time.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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