Friday, April 21, 2006

Hungary – heading for trouble?

A recent declaration from the governor of the National Bank of Hungary (NBH) on the forint being in “serious danger”(FT 20/04/2006) initiated some discussion on the situation in the Central European state. Although the timing of the statement sparked accusations of political interference of the governor, yet is hard to contest its sheer content. Additionally, The Economist of April 15th (“Lynx economies”) summarizes a report by WIIW which praises the performance of the CEE NMS but cautions that “Hungary with its big current-account and budget deficits looks vulnerable”. Voices on Hungary’s exposure have been louder recently and the country has been given a closer look after the deterioration of the situation in Iceland where the krona plummeted by over 25% (against the EUR) in the last 2 months. The similarity of the situations the two countries should not be overestimated.

Overall the Hungarian economy, despite having one of the lower growth rates among the CEE NMS, is still expanding at a rate above 4%. Inflation has been brought down to a low of 2.3%, Short and long term interest rates, despite a recent surge, are at an acceptable, though relatively high, in comparison with other CEECs, level. During the last 12 months the forint has depreciated against the USD by 14%, EUR 7.3% (of which 5 % points in the last two months). This does not seem alarming, but certainly distinguishes Hungary from Poland, Czech Republic and Slovakia whos’ currencies moved in a similar magnitude but in the opposite direction.
On the other hand with a current account deficit of around 8% of GDP (IMF), by far the highest and most persistent among the big NMS (but still smaller than that of the Baltics), the imbalances and thus vulnerabilities are significant.
Moreover it is Hungary who has by far the highest public debt of all the CEE NMS, standing close to the Maastricht 60% of GDP reference value, sees the government spending much more than collecting thus looking towards further borrowing. The fiscal deficit has been over 8% GDP in the past years and the budget target at 6.6% this year, already a hefty sum, was exceeded in the first quarter of 2006, with estimates of a possible blow-up again to the vicinity of 8% by the end of the year. Lending is increasing, but there does not seem a credit boom, at least not of the pace of the one in the Baltic States.

Elections have a lot to do with the persistance of the situation, and they certainly contributed to the government sticking to its spending spree. The outcome can be expected to follow one of at least two basic scenarios.
On one hand, perhaps not seeming an obvious outcome of the April elections, a strong government with political will to push reforms and reduce spending could turn the situation around.
On the other however, if the newly elected government lacks will or political power to reform public finances, especially to push through cuts in spending - the country could face problems. If the election results in an unstable government, and prospects of a close upcoming election rerun, this would possibly inflate the deficit even more, through populist pre-campaign maneuvers and put pressure on the interest and exchange rates, raising the question how would the financial markets react?
Hungary had already postponed its euro adoption target date from 2008 to 2010, and there are even talks of shifting it past 2011 or even 2013 which are reflected in Reuters polls( see article by T.Fisher and D. Freeman) and estimates of the perception of the financial markets expectations (see interesting paper from the NBH ). Overall, a strong depreciation of the forint and a following interest rate hike could push the Magyar economy into crisis. Moreover if the new parliament is not dismissed ahead of schedule, 2010 will be the next election year. Thus if the new entry date will be set 2011/2012 in the next election campaign the euro may be at play.
Both major parties competing in the election campaign seem to agree on the reform of public finances and the need to curb fiscal deficit, but at the same time promise tax cuts and pension and other expenditure increases. How much of the latter is campaign rhetoric may be crucial…

Data: Eurostat, NBH, IMF Country reports, The Economist, FT.


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