In Hungary the Financial Crisis has picked up a Second Wind

Hungarians are bracing for worse times ahead, some feel that a social explosion is imminent

At the beginning of this month the Hungarian parliament accepted the government's latest budget through a vote that more or less ran along party lines. In much the same way as the country is politically divided along two main rival camps, so too economists view the budget in either one of two ways: either the latest Hungarian budget is indicative of the government's commitment to reform and has brought the country back from the brink of disaster, or the budget seeks to sink the country further into the mire of recession by making an already bad situation worse. Indubitably, most investors and international institutions are of the former view; most Hungarians, on the other hand, fear the latter to be closer to the truth.

The bankruptcy last year in September of one of the world's largest financial institutions, Lehman Brothers, is taken by most to be the official start to the global financial crisis. Yet in Hungary the crisis was already well underway albeit not proclaimed publicly. Nevertheless, most financial experts at the time were quite aware of the state the country was in at the time. Likewise, although much has been made subsequently about how close Hungary had come to insolvency, the truth of the matter is that the country was already bankrupt; it was just not officially announced as such. Indeed, many consider Hungary to be still insolvent. The proof is in the fact that the country is unable to function without loans from the IMF and the EU.

Naturally, the government is trying to put a brave face on the situation. In fact, it had recently announced that it won't be drawing on the remainder of the IMF loan it had negotiated last year to pull the country “from the edge”. While for some this may seem to be a further indication that the country is really moving out of recession, others are more sceptical. They feel that Budapest is not drawing on the remainder of the loan because it doesn't want to, but rather because it is not allowed to.

If this is indeed the case then it won't be the first time that Hungary got into trouble with the IMF in this way. In 1989 Hungary was not allowed to draw on a final instalment of a loan because it had lied to the IMF about how large the state deficit was. Similarly, a year later the final instalment on another loan also couldn't be drawn because Hungary couldn't meet the necessary conditions. In fact, between 1982 (when Hungary first joined the IMF and immediately asked for a loan) and 1996 (the last major IMF loan prior to the current one) Hungary had negotiated a total of $5 billion USD in loans of which one third wasn't drawn on because the country for one reason or another had failed to meet the conditions set by the IMF.

A Taxing Issue

It is a well-known fact that IMF loans to countries come with strings attached. These strings make up a package known as structural adjustment, although the IMF is not fond of using this term nowadays because of the negative connotations it has to such programs in the past. In essence, structural adjustment forces a country to create an environment favourable to big business often at the expense of society as a whole. This is accomplished through massive cuts in public spending, especially in the areas of education and health. As a result, these sectors are left open to privatization and exploitation by big business since schools and hospitals are in desperate need of funding that governments no longer can or are willing to provide.

Although the Hungarian government has tried to fulfill the dictates of the IMF in this latest budget through a very drastic set of cuts in spending, it's obvious that it hasn't gone far enough. In particular, its failure to introduce a comprehensive form of property tax that would target the poor has once again irritated the IMF. For years Hungary has promised to introduce a comprehensive form of property tax but has always failed to do so, mainly because of the public backlash it would cause. The latest attempt this year had to be modified because of remarks made by the prime minister which upset many people. Basically these remarks amounted to that if a person can't pay the property tax because of the size of their home then they should move out and live in a smaller place.

It goes without saying that it won't be publicly acknowledged (and least not yet) by any of the parties concerned whether or not this is the real reason why Hungary isn't drawing on the remainder of its IMF loan. There are some, however, who argue that this isn't the problem at all. Rather, they see the government's refusal to draw on the outstanding amount in terms of political prudence. Since the present Hungarian government is extremely unpopular thanks to its economic policies of the past few years and that an election is set for the spring of next year in which it is almost certain to lose, the present government is doing as much as possible in order to make it difficult for the new government when it assumes office.

Political machinations aside, those in support of the government's latest budget attempt to justify its severe austerity measures by noting that Hungary will actually be in a better position than most countries within the EU because it is taking the bold step of swallowing the bitter pill of reform first. In other words, while other governments are increasing their budget spending, Hungary will have already gone through the worst and thus emerge in a much stronger position.

Such reasoning is absurd, to say the least. The strategy adopted by some countries, including leading economies such as Germany, is that by increasing government spending they are investing in the economy in the hope that it would lead to a period of growth much sooner than it otherwise would. Thus, the increased government debt would be offset by an increase in revenue related to the growth generated by government spending. Along these lines, there would be no need for austerity measures in the first place since the economy would have moved out of recession before such measures would be necessary.

The fact that what Hungary is doing is the opposite of what other countries are doing has raised some eyebrows. This has led some to accuse the IMF of deliberately weakening the Hungarian economy for ulterior purposes. Critics point to the fact that the policies dictated by the IMF are contrary to the stimulus policies that the IMF recommends for rich countries, and directly contrary to the global stimulus objectives for the world economy as a whole. Also, as a recent paper from the Center for Economic and Policy Research published earlier this year makes clear that "the main purpose of providing balance of payments support to a developing country in a time of recession or approaching recession is to enable the government to pursue the expansionary fiscal and monetary policies necessary to stabilize the economy." Hence, the austerity measures being imposed on countries such as Hungary are clearly in conflict with the economic logic of providing loans in the context of an economic crisis.

For the vast majority of Hungarians, the effect such policies will have on their economy doesn't require a MBA or an in-depth of knowledge of economic theory. Over 100,000 jobs have been lost since the official start to the financial crisis last year. All these people were tax payers. The net loss of these jobs not only means that there will be less revenue for the government because of this shortfall, but these people will also be drawing on government expenditure in the form of welfare, early pensions, and unemployment benefits. Some will also incur an additional cost to society in terms of health care (alcoholism, suicide, and stress-related illnesses), vandalism, and petty crime.

To make matters worse, the government's austerity measures looks set to increase this number further. For example, government support for the physically and mentally handicapped has been cut back drastically to the extent that many programs which helped handicapped people integrate into the workforce will have to be scrapped, leaving many without support and, in effect, without a chance to work.

The same can be said for almost all key government programs. The country's network of ambulance services, for example, is in such an overloaded state that some feel that by the beginning of next year the entire system will collapse. Similarly, state-sponsored media have warned that because of a drastic cut in funding they will be unable to continue broadcasting at the level they are now. This means that programs geared primarily toward minorities and rural areas may soon be replaced by a blank screen.

Public transport, meanwhile, both on the local and national levels, are also facing bleak prospects. Budapest's transport authority, the BKV, is more or less bankrupt and was only saved at the last minute by an emergency cash injection, on the condition that ticket prices are raise by 4% in January. Still, many don't see how the company will be able operate in the future. The same goes for Hungarian State Railways (MAV) and even the recently reacquired Hungarian Airlines (MALEV), both of which are unable to function without extra government support. In the case of all three companies, their financial woes were primarily caused by extreme cases of corruption and poor management.

On the local level, municipalities which have already been struggling to survive over the years may themselves soon become bankrupt. A few have already become insolvent and the fear is that many more will follow suit as they are forced to take on debt in order to provide basic services. For some, even the provision of basic services is already such a burden that they have begun to cutback on such services altogether. The situation has reached such levels that some municipalities have resorted to drastic measures in order to raise cash. One village in Hungary, for instance, has offered to sell street names. Hence, anyone can have a street named after them if they are willing to pay for it.

All this has not only led the present government to be hugely unpopular, but has also led to a noticeable rise in anti-multinational sentiment. This was clearly expressed recently in the southern town of Pecs where the municipality took control of the city's water works, shutting out the French company Suez by force. As elsewhere, many have woken up to the realisation that not everything should be left in the hands of private enterprise. In the case of Suez, the high water rates had prompted the authorities to once again take control of their infrastructure. Not only this, Suez appears to have committed serious crimes while in charge of the water works -- including fraud, embezzlement, money laundering, forgery and the misappropriation of funds.

Thus, it seems that as economic conditions worsen in Hungary the battle lines are becoming ever clearer. Previously, few questioned the prevailing ideology of neo-liberalism: capitalism and the “logic of the market” was a universal axiom that all political parties adhered to; wherein they differed were minor points of emphasis, but the fundamentals remained the same.

This apparent awakening of the population to what capitalism really entails has been disquieting not only to the country's political establishment but many western governments as well. It goes without saying that the concern of the latter isn't for the plight of people subjected to the full force of the government's austerity measures, but to safeguard the investments made by companies and wealthy individuals that they indirectly represent. Along these lines, embassies from leading Euro-Atlantic countries recently issued a veiled warning to the government over a decline of investor confidence because of recent events. Although this warning made note of the problems of government corruption, there is no doubt as to where the emphasis of their message really lay.

A Corrupting Influence

The sudden interest by western embassies in government corruption in Hungary should come as little surprise considering that it comes on the heels of the water works dispute in Pecs, as well as the recent awarding of radio frequency licences to rival stations. This isn't to say that these and other cases aren't free of some form of corrupt influence. On the other hand, it's no coincidence that these recent events also run counter to the interests of certain governments within Europe and across the Atlantic.

In the case of the Pecs water dispute, France made clear that it was unhappy with what had transpired. Likewise, the government's pro-business stance was also made apparent by their commitment to helping out Suez in the dispute. For many, the government's position is a clear example of economic treason, something which it has engaged repeatedly over the years and which has, in effect, led the country's economy to the sorry state it is now in.

There are, however, forms of corrupt behaviour not unique to Hungary but which cut across the entire EU -- affecting old and new members alike. The most common is the issue of outrageous salaries paid to CEOs. Although in the eyes of the law such behaviour is not actually considered criminal, to the general public it is seen as such, and is regarded as the simple manifestation of a corrupt economic system in practice. Politicians in leading European countries have realised as much and in September of this year worked out a deal to force banks to link bonuses to long-term performance. It's widely acknowledged that the previous system encouraged short-term risk-taking, which helped trigger the banking crisis.

Yet in countries such as Hungary the problem of corruption is much more widespread. Salary and severance pay issues have permeated the BKV to such an extent that local politicians have also been caught in the line of fire. Presently the police are investigating over 800 BKV contracts for irregularities related to excessive pay.

The problem of outrageous salaries in Hungary isn't limited to just business enterprises but extends all the way through the civil service and even to the head of the national bank (MNB) who makes four times as much as his American counterpart. One may argue that the job by the head of the MNB, Andras Simor, is much more important and prestigious than that of the head of the Federal Reserve in the US, but very few would buy this argument.

Aside from this there is also the problem pertaining to the activities of offshore enterprises. Not only was Simon embroiled in a scandal in where he transferred a large portion of his wealth to an offshore account in Cyprus, but nearly everyone within the government is tainted in one way or another by an offshore scandal of sorts. This includes in Finance Minister, Peter Oszko (often dubbed as Peter Offshore) whose previous job was as a “tax optimization” consultant; in other words, he helped clients to avoid paying taxes in Hungary through various offshore schemes.

The effluence of offshore activities affecting the Hungarian economy in terms of lost tax revenue is such that it goes all the way to the very top, including the Prime Minister himself. His association with an offshore company called Wallis International was involved in the bankruptcy a few years ago of a major poultry processing plant that ruined the livelihood of hundreds of farmers, ultimately leading several to commit suicide. At the time his reaction was simply that they didn't understand the business they were in; ironically, this is the very same person who had since been entrusted to pull the country out of a crippling recession and financial crisis.

The Empire Strikes Back

Realising the growing backlash against multinationals, the government has gone on the offensive by trying to point out their intrinsic worth. Recently the Prime Minister, Gordon Bajnai, held a lecture at a university attempting to explain the virtues of his government's program and IMF-directed recommendations. He also stressed that foreign multinationals are important to the Hungarian economy, noting that they have created 300,000 new jobs in Hungary over the past twenty years. This message was similarly repeated on state media as well as commercial media outlets in support of the government agenda.

While such statistics may sound impressive, in actual fact they aren't. True, while multinationals have created 300,000 new jobs in the past 20 years, during this same time period over 1.5 million jobs had been lost due to privatization and restructuring the economy in order to benefit the operation of multinationals. In fact, 100,000 jobs were lost in the past year alone due to the financial crisis and some analysts believe an equal number will be unemployed in the coming year as well. Not only this, at the rate that multinationals have created new jobs over the past two decades, it will take them another 100 years or so to replace the jobs that were lost during that same time frame.

Even the European Commission concedes that the effect of multinationals on an economy is not that great and that it's micro, small and medium sized enterprises (SMEs) which are the important drivers of innovation and change in Europe. According to statistics compiled by Marta Kozak of the International Finance Corporation (IFC), micro, small and medium-sized enterprises represent 99 % of an estimated 23 million enterprises in the EU and provide around 75 million jobs representing two-thirds of all employment. Indeed, they contribute up to 80% of employment in some industrial sectors such as textiles, construction, and furniture.

In spite of the importance these enterprises have on the economy, little if anything is done in Hungary to serve their needs. Instead, emphasis has been on creating an environment catered to the interests of multinational corporations. As a result, it has been estimated that about one-sixth of the country's GDP flows directly towards multinationals in one form or another.

Accordingly, the biggest problem facing the Hungarian economy, and one which has been aggravated by successive government policies, is the country's over-reliance on imports. Most economists agree that a country that is dependent on imports is doomed to failure. And yet little has been done to wean the country off this self-destructive path.

This over-reliance on imports is reinfroced by an unusually (and unjustifiably) strong currency. In many ways, it is the converse to what goes on elsewhere. In China, for example, Beijing keeps its currency artificially weak in order to encourage exports, much to chagrin of other countries such as the US.

Because of generous tax breaks and other incentives, the “playing field” in Hungary is anything but level and Hungarian producers are unable to compete with their foreign counterparts. This situation is further exacerbated by the fact that the government has done its best to hinder its own farmers through red tape and by providing little or no form of support whatsoever. In addition to this, the payment of EU subsidies to farmers is often delayed. In other countries the situation is usually the opposite. To make matters worse, with falling real wages of 3-5% over the past few years Hungarian consumers actually seek out the cheap imports because they can't afford better quality, yet more expensive, local produce.

An equally enigmatic problem for the Hungarian economy is that of interest rates. Not only is the Hungarian economy unsustainable because of excessive imports, persistently high interest rates likewise makes the task of overcoming the country's economic crisis near to impossible. For one, the state debt is at a record high of about 80% of GDP. Most economists regard this is as an impossible hurdle to overcome. This is made all the worse by the fact that successive governments have tried to service much of this debt through treasury bills and government bonds.

While the government has repeatedly tried to bring interest rates down it has always failed. This is because when such attempts are made the currency usually begins to weaken at an alarming rate, forcing the national bank to raise rates once again. As with the unusually strong currency, some observers feel that Hungary's high interest rates serve an ulterior purpose and don't truly reflect market fundamentals. In essence, Hungary acts as a hedge fund for foreign investors trying to maintain high returns that can no longer be secured closer to home. Again, the IMF is seen as playing a pivotal role in all this.

One way in which countries such as Hungary can shield themselves from the devastating whirlwind of currency speculation and rising interest rates is to introduce capital controls so as to limit the ability of foreign funds to enter and flee a country easily. However the IMF is against such controls arguing that it restricts economic freedom. Because of this, the Hungarian economy is forced into a no-win situation. It has to adhere to IMF dictates otherwise it won't receive the cash it badly needs to avoid bankruptcy. In turn, concern over a looming currency attack provides a perfect excuse for why the government can't undertake genuine stimulus measures even if it wants to.

This no-win situation is compounded by the fact that a sudden devaluation of the Hungarian currency to more realistic levels would have a catastrophic effect on most people. Personal savings and property values would shrink, impoverishing many. Most Hungarians are quite aware of this: earlier this year when the Hungarian currency began to devalue at an alarming rate, people rushed to convert what they could into Euros and US dollars. The rush was such that many exchange offices ran out of hard currency.

This uneasy situation is also reflected in the fluid state of consumer prices. Prices in Hungary are anything but stable, and price stability is what lies at the heart of any properly functioning economy. Of most concern is the price of electricity and natural gas which have been increasing steadily throughout the year. With rising prices and falling real wages a growing number of people have begun to default on their utility bills. Some companies have responded by trying to make payment terms a little easier but this has been of little help.

As the end of the year approaches there is growing apprehension of what lies ahead. The Hungarian currency has once again begun on a slide downward, albeit not as quick as it was at the beginning of the year. Nevertheless, this unstable situation has many economists worried. In effect, while most countries have been cautiously optimistic that they are moving out of recession, in Hungary it appears that the financial crisis has picked up a second wind and will return with vengeance in 2010. Even the government doesn't appear too optimistic. At first the prognosis was the same as everyone else at the beginning of January that by the end of this year the economy would slowly but surely climb out of recession. By the summer the hope for a recovery had changed to the spring of next year, The latest forecasts now see hard times ahead until the fall of next year and even then the government warned that there will be challenges ahead and the recovery will be somewhat muted.

Future Uncertain

As people try to make ends meet the best they can, the government is clearly desperate for alternative sources of revenue. This can be seen in some of the legislation that was recently passed, For example, a tax on donations has meant that many enterprises have foregone giving to charities this year.

The desperation on the part of the government is such that it even results to trickery in order to secure funding for some of its programs. For example, when it was discovered earlier this year that electricity companies had overcharged customers and that a court ordered them to reimburse consumers, the government stepped in and instead of refunding customers the money was simply appropriated and put into a government program that gave financial assistance to those most affected by the financial crisis. This money, in turn, was primarily used by people to pay their outstanding utility bills, so that in the end most of the money found its way back in the coffers of the electricity companies.

These and other measures have raised fears that in its desperate search for cash the government will be soon eyeing private savings as a possible source of income. Previous administrations struggling with the debt problem indubitably looked at a variety of alternatives to taking out more foreign loans. One option, which was explored by the Medgyessy government (2004-6), was to raise funds by issuing special bonds or even paying civil servants or suppliers partly in “script” (a government IOU). Tibor Draskovics, who was Finance Minister at the time (and recently stepped down as Justice Minister) had then considered resurrecting enforced “investment” in government bonds, an approach often used in former communist times to plug holes in the state budget.

During the communist years employees were compelled to put their names down for 'peace” or “five-year-plan” bonds. At the demise of the totalitarian regime in 1989 billions of so-called socialist victory bonds amounting to billions of HUF at face value remained outstanding. In due course, all this fancy paper became worthless scrap overnight. Some people made use of the elaborately illustrated sheets as wallpaper for their bathrooms and toilets.

Although some economists argue that mandatory bond purchases or the acceptance of scripts could help bridge the chasm in government financing, the lack of public trust in the government, mostly due to past experience, would indubitably lead to capital flight from the country. Moreover, since only about 10% of the population has savings of more than 1 million HUF (about 3,500 Euros) and that most of these people have the wherewithal to park their money outside the country, it's hard to see how much the government could actually gain from such an action. On the other hand, desperate times frequently call for desperate measures.

With the pressure mounting on all sides, some feel that a social explosion is imminent. This doesn't mean, however, that people will suddenly mobilize and force the government to abandon the IMF dictates and introduce true forms of economic stimulus, including making multinationals pay their fair share of the tax burden. Indeed, it's far too simple to think that popular mobilization can defeat the IMF's extraordinary power; there are countless examples of governments imposing draconian IMF policies despite popular uprisings, riots, and insurrections. Moreover, the brutality of the Hungarian police in the recent past shows just how far the government will go in order to enforce the status quo.

Along these lines the future looks quite bleak for many Hungarians. Economic insecurity has given rise to political apathy on the one hand and extremism on the other. This, in turn, fuels the rise of radical movements, as exemplified by the rise of the right-wing Jobbik Party in Hungary.

While all this may seem to be a Hungarian problem, it's actually something which affects the entire EU. For one, it's not only Hungary which is going through this process, but many other countries within the region as well. Not only this, more established EU member states are also feeling the pressure. Greece is a case in point.

The economic failure of Hungary will no doubt have a lasting and negative impact on the rest Europe. This is not only in terms of economics, but politics as well. The Jobbik's uniformed paramilitary wing, the Hungarian Guard, has already been emulated elsewhere, such as in the Czech Republic, and in London a branch of the Jobbik has been established. Meanwhile, within the European parliament an alliance of nationalist parties was set up, among them the Jobbik, the British National Party, and the French National Front.

As long as Brussels prefers to look the other way while neo-liberalism wreaks havoc on the economies of Central and Eastern Europe, this situation will only get worse. Most Hungarians had high hopes when joining the EU, believing that membership would bring economic prosperity and a certain guarantee against government abuse. In both cases people have been disappointed to find out that they were wrong.