Economy improves but Hungarians' patience with govt wears thin

By bne IntelliNews February 29, 2008

Robert Smyth in Budapest -

With an improving economy and new plans to charge protesters for any damage they cause, a repeat of 2006's angry storming of the state television building seems unlikely. But Hungarians are almost certain to take to the streets again soon, using the anniversary of the 1848 uprising against Austrian rule on March 15 to target the current ruling power under Prime Minister Ferenc Gurcsany, because even though the economy may have bottomed, the unpopularity of the government has not.

Indeed, a number of Hungarians have already taken to protesting outside parliament, this time against the delayed referendum on the possible axing of controversial fees levied every time patients visit the health service. And more soon came out to protest the very fact the government re-erected the prohibitive cordon around the parliament to keep protestors at bay, which is exactly where they have remained since.

Yet this comes against a backdrop of a generally improving economy after the government imposed some shock therapy in order to rein in the budget deficit caused by the loose fiscal policy followed in the period of 2002-2006. The budget deficit at 9.2% of GDP was the biggest in the EU.

Hungary's trade deficit in 2007 declined significantly as the result of healthy exports and suppressed domestic demand due to the "austerity reforms" imposed by the government. While Hungary posted a bigger-than-expected trade deficit of €148.1m in December, the full-year figure was €443.5m, down from €2.38bn in 2006.

Janos Samu, an economist at Concorde Securities in Budapest, rates the government's and Gyurcsany's fiscal policies as very sturdy and better than expected. "The austerity measures have exceeded expectations and resulted in both an increase in revenues and reduction in expenses for the government," he says.

The PM has also begun to tackle Hungary's notoriously overpopulated and cash-devouring public sector. "We've seen a tendency to reduce headcount in the government, health and education sectors, which will put a cap on spending," says Samu, adding that the curbing of government financial contributions to energy, health and transport has led to a substantial improvement in the finances.

Samu also praised the PM's bid to get more people actually paying taxes, tempting many out of Hungary's large black economy and into the white. "This added meaningfully to the effect of increased tax rates," he says.

While these have been reassuring steps, additional taxes and increased tax rates may also have contributed to the improvements, but these will eventually be reversed as they are increasing the tax burden in an already tax-heavy state. "High taxes are still squeezing the economy, and a spectacular change is unlikely in 2008," says Gergely Hudecz, political analyst at Budapest Economics.

And the government's very unpopularity could threaten its ability to see the austerity reforms through. "There seems to be a consensus that the downturn is bottoming out, although the political uncertainties are getting worse," says Hudecz. "The tenability of the austerity measures is questionable considering the growing resistance to the [governing] Socialist Party."

Some backsliding is already evident. Gyurcsany and Co. could continue on the path of reducing expenditures, but have opted not to at risk of increasing their unpopularity further.

For his part, Gurcsany assured Parliament in February that the austerity measures are petering out and the budget deficit is on course to reach the desired of 3.2% of GDP in 2009. This is achievable even despite HUF200bn (€754m) in tax cuts expected for the same year, which should happen in the run-up to the next general election in 2110.

Gurcsany's comments appear based in truth, but shouldn't be taken as gospel.

The tortoise and the hare

According to the forecast prepared by GKI Economic Research in cooperation with Erste Bank, economic growth will accelerate considerably in 2008 from the snail's pace level of 2007, which was caused by extraordinary circumstances.

Hungary's GDP growth almost came screeching to a halt in 2007; rather worrying for any developed economy, let alone a fledgling one still supposedly on a rapid growth path. Raiffeisen Bank noted that Hungary's fourth-quarter GDP growth in 2007 came in at a disappointing 0.8% year-on-year and, more shockingly still, that the growth rate has been plummeting progressively throughout the whole year from 2.7% on year for the first quarter, 1.2% for the second quarter and 0.9% for the third quarter. Interestingly, the figure for the whole year stands at 1.3% on year, which comes in even lower than during the notorious "Bokros austerity package" from the Socialist government in the mid 1990s.

Despite positive signs such as a slight increase in real earnings after a 4.8% fall in 2007, perhaps worst of all for Hungarians is that they won't be able to reclaim the region's economic leadership anytime soon. "The expansion of the economy will be modest compared with the achievements of the neighbouring countries," according to the GKI/Erste research. GDP growth is to remain in a really poor position compared to regional rivals, confirmed Hudecz.

Fitch Ratings also recently observed that a ratings upgrade for Hungary is far from impending, warning against the unpopular government spending its way to popularity. The latter action could even prompt a ratings downgrade.

Further, according to the GKI/Erste research, a substantial part of the upswing will be nothing else than the automatic correction of the sharp decline in agricultural production in 2007. GKI/Erste argues that after the 10-15% drop in 2007, even an average year would mean 10% growth in 2008. Raiffeisen also mentioned that manufacturing exports turned out to be the only growth sector in 2007, but warned that in 2008 the improvement of net exports is limited due to global economic slowdown.

Regarding the overall reform of Hungary's overly complex and easy to manipulate tax system, Concorde's Samu feels that none of three package proposals that Gyurcsany announced in February would be put before parliament in the coming months goes far enough towards shaking up the whole tax regime for the long term good. Once again, the PM's fragile popularity means his hands are somewhat tied. Nevertheless, the measures taken should be more than enough to prevent a return to a budget deficit in excess of 4% of GDP. "While the eventual reduction of taxes is also consistent with this, it looks inconsistent with the convergence path requirement of 2.2% of GDP by 2011," says Samu, adding that 3% is more likely without the application of further measures."

Hungarians will no doubt take to the streets again. But while most Hungarians will opt not to join the protests, Gurcsany's grip on power nonetheless hangs by the finest of threads and even if Hungary has turned the corner, the path ahead remains a difficult one for this once buoyant economy.

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