8th Annual European Seminar of ELIAMEP, Island of Poros, 7-10 July, 2011 Adjusting to the Crisis: Policy Choices and Politics in Europe . Julius Horvath, Central European University, Budapest Crisis, Adjustment and the New Economic Policy: Case Study of Hungary 2008-2011 1
Introduction � 1980-1990s Hungary is Liebling of foreign investors; 2004 EU member � From approximately 2001/2002 internal political conflicts led to irresponsible economic policy which together with global factors brought increased vulnerabilities and financial crisis in fall 2008 � A rescue package from the IMF and the EU 2
Introduction � Crisis had clear political implications to the ruling socialist-liberal coalition: � In April 2009 April Prime Minister Gyurcsany resigns; new technocratic government, with socialist-liberal support, introduces austerity package � As a result of the overall dissatisfaction and disillusionment the opposition party strengthened significantly, won the election in April 2010 and began to introduce a fundamentally different type of economic policy 3
October 2008 Hungarian Crisis As external factors to Hungary led markets to begin to re-assess perceived � risk investors started to appraise Hungarian assets as more risky: - forint weakens, around 14% against euro in the most stressful period; 7% � on October 15 - the stock market had fallen to a two-year low � - central bank used interest rate defense of the forint as it raised its � benchmark interest rate by 300 basis points to 11.5 percent - the inter-bank market and government securities market experienced � serious stress; foreigners wanted to sell Hungarian bonds, and with buyers very slow to buy; auctions to issue new government bonds were not successful - financial institutions shortages of liquidity � - the shares of OTP, the leading Hungarian bank, fell drastically � 4
Why Hungary? Vulnerabilities as Perceived in Fall 2008 Excessive fiscal deficit � Maturity and currency mismatches in the financial system, both within � households as well as corporate sector; As forint weakened, both the household and the corporate sectors’ net � foreign currency liabilities increased, indirect risk to the banking system Hungary sensitive to movements in international capital markets as a � considerable proportion of financing depends on flows to Hungarian daughter-banks from their western European parents External debt high � Wide current account deficit � 5
Why Hungary? Vulnerabilities as Perceived in Fall 2008 Hungarian performance worse than the typical point of reference, the V-3: � Growth in Hungary below 2% while V-3 around 7% � Inflation above 7% in Hungary, under 3% in V-3 � Current account deficit was under 7% in Hungary, 4% in V-3 � Debt to GDP around 65-70% while the debts of the CZ and SK were under � 30% and PO 50% In Fall 2008 Hungary seemed the weakest country in the region � However, no real estate bubble � 6
Euro/Forint Exchange Rate 2007-2009 7
December 2008, Corporate and Household Currency Mismatches 8
Sources of the currency mismatches � - i nterest rate differentials; t he relatively lower interest rate on foreign currency drives credit growth in foreign currency; make domestic savings more attractive; the expectation of a stable or appreciating domestic currency � - f unding of banks in foreign currency; b anks have had large inflows of foreign currency funding (often from foreign parents), which they have passed onto their clients 9
Government Securities Held by Non-Residents 10
6 largest parents of foreign-owned banks in HU, Brussels, May 20 2009 The parent banks of the foreign-owned Hungarian banks behaved responsibly � They reconfirm their commitment to maintain our overall exposure to Hungary. � We also acknowledge that our subsidiaries in Hungary have been and will continue to � adjust to the current challenging economic environment. A need for additional capital cannot be excluded, and will be met as necessary We demonstrate our long-term commitment to the development of the Hungarian � economy; and signal our willingness to contribute to the efforts of the international community to respond in a comprehensive and well-coordinated manner to the crisis Bayerische Landesbank(Hungarian subsidiary: MKB Bank Zrt); � Erste Group Bank AG, (Hungarian subsidiary: Erste Bank Hungary Nyrt); � Intesa SanPaolo, (Hungarian subsidiary: CIB Bank Zrt); � KBC Group (Hungarian subsidiary: K & H Bank Zrt); � Raiffeisen International Bank Holding, (Hungarian subsidiary: Raiffeisen Bank Zrt); � UniCredit Bank Austria AG (Hungarian subsidiary: UniCredit Bank Hungary Zrt) � 11
Additional Vulnerability: Low Fiscal Credibility of Policy Makers � Especially after 2006 election Policy Makers Credibility Problems � Hungary’s 2002 election campaign heightened competition among its political parties and propelled populism to such an extent that the subject of political litigation resulted in large monetary contributions from the state budget to various citizen groups � Examples include arranging for pensioners to receive a 13th monthly payment or increasing the salary of public employees by 50% all in the hopes of securing votes. � Inefficient state monopolies, especially in transportation industry, and fragmented and costly municipal systems added to it 12
Additional Vulnerability: Low Fiscal Credibility of Policy Makers � Thus, government debt increase is not a result of mass demonstrations but rather of political inter-elite conflicts � Changing the situation seems very difficult as those who receive transfers feel that they are entitled to them � Tax evasion in Hungary is widespread; � Till the new government flat tax introduced compared to the Czech Republic, Slovakia, Hungarian taxes high � Vámosi-Nagy, the former vice-chair of the Hungarian tax authority estimates that the non-official economy is around 20-25% of the GDP; this has tradition element, after 1848, 1948 form of society’s passive resistance against the power 13
Government Expenditures as % of GDP, 2006-2008 % of GDP 60.0 51.9 49.8 48.9 40.8 46.6 46.2 46.6 43.1 41.3 50.0 5.8 5.9 5.7 4.0 5.2 5.1 5.2 4.0 4.0 3.6 40.0 2.7 2.8 4.4 3.2 2.8 3.3 2.2 3.6 3.3 2.4 2.5 2.0 2.4 1 .9 4.0 4.0 4.0 1 4.9 30.0 1 5.2 1 5.6 1 5.4 1 5.4 1 5.3 1 4.2 1 3.6 1 3.5 20.0 1 0.7 9.6 9.2 1 0.2 1 0.1 1 0.3 1 0.1 9.7 9.2 10.0 1 2.1 1 1 .5 1 1 .3 1 0.6 1 0.5 1 0.5 9.0 8.8 8.8 0.0 2006 2007 2008 2006 2007 2008 2006 2007 2008 HU VISE GRAD3 E U-15 Compensation of employees Purchase of goods and services Social benefits Investment Interest Other Source: Kauffman (2008, p. 11) 14
General Government Expenditures, 2009, % of GDP Source: IMF (2011, p. 9) 15
IMF Supported Program � A full-fledged crisis avoided with policy action from IMF and EU � The IMF arrived when the first signs of a full-blown crisis had started to emerge, and by trying to restore confidence � IMF a $15.7 billion loan 17-month Stand-By Agreement as part of a program designed to ease financial market stress; � EU $8.4 and WB $1.3 billion � The IMF immediately made available $6 billion, remainder to be released in 5 installments subject to quarterly reviews � The Stand-By Arrangement was approved under the fast-track Emergency Financing Mechanism of the IMF 16
Bajnai Adjustment Program to Crisis � 2009 new government with technocratic inclinations (Bajnai/Oszko) turn away from the populist one; Gyurcsany/Veres � The IMF-supported program to implement a fiscal adjustment package to ensure government’s financing needs decline; reductions in government wage and pension bill; � Also to maintain adequate liquidity and capital in the banking system � Fiscal adjustment aim to provide confidence that the government’s financing needs can be met in the short and possibly medium term � The stigma of IMF assistance helped to a frontal loss of the socialist- liberal coalition in April 2010 election 17
Bajnai Adjustment Program to Crisis � The Bajnai government efforts are illustrated in the ranking of Hungary of European countries according to the size of their fiscal deficits � In 2007 Hungary had the highest fiscal deficit (as % of GDP) in Europe followed by Greece, Romania, France and the UK. � In 2009 the ranking was led by Greece followed by Spain, Ireland, UK, Portugal, Lithuania and the Slovak Republic, while Hungary was ranked 19th; 18
Fiscal Deficit, % of GDP, 2007 Note that in 2006 fiscal deficit was 9,2% Source: Purfield and Rosenberg (2010, p. 15) 19
General Government Debt 2007 versus 2009 Source: Purfield and Rosenberg (2010, p. 15) 20
Pre-2010 Political-Economic Trap � Hungarian policy makers opted for a welfare model which they cannot afford; � However, during the period 2002-2010 the discourse of the opposition was as if the ruling coalition was too ‘neo-liberal’ representing foreign, finance and former communist elite interests � While socialist-liberal camp was fiscally incompetent, it clearly was pro-western and followed ‘modern politically correct’ practices; however opposition was still able to label them as non-democratic, � Under Bajnai a decrease in the government deficit; the opposition argued that the deficit was created by the socialist-liberal coalition and the costs were to be paid by the people … 21
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