EU ratchets up pressure on Hungary with funding sanctions

By bne IntelliNews February 23, 2012

Tim Gosling in Prague -

As anticipated, the European Commission announced on February 22 that it has proposed suspending EU development funds to Hungary unless the country implements structural reforms and reins in its budget deficit. Hungary's response can be read as another test of its resolve to secure an IMF programme.

The move represents the first time the European Commission has proposed suspending development funds from one of its members over an excessive deficit. The Cohesion Funds target support for transport and environmental projects.

The Commission has long been pressuring Hungary to cut its budget deficit, which breaks the 3% limit in the Maastricht Treaty, ever since the country joined the bloc. However, given the plethora of other states that also missed the threshold in 2011, the penalty is another clear shot from Brussels in its ongoing tussle with Budapest over economic policy.

While the volume of funding under threat is lower than some expected, at €495m - or 0.5% of GDP - it will still hit home should it be withheld next year. Budapest has until January to avoid the funding cut by applying recommended reforms to reduce its 2012 budget deficit. In addition, the suspension would need to be endorsed by the EU's other 26 member states before it can be applied, AP reports.

On the one hand, a move from Hungary to implement the reforms looks unlikely, given that the EU first made the demands in 2004 and that the current Fidesz government has proved itself anything but ready to comply with the austerity economics currently preached in Brussels. On the other, if Budapest is serious about negotiating a loan programme with the IMF and EU, it will have to finally relent.

"This decision today is to be regarded as an incentive to correct a deviation, not as a punishment," said Olli Rehn, the EU's economic affairs commissioner. That's a claim that will likely be met with derision in Hungary. Satisfying the opposing forces represented by Brussels and the increasingly nationalist feelings amongst the domestic audience is a balancing act that Fidesz appears to have brought upon itself, but still needs to perform.

The heart of the matter is clearly not the country's deficit level per se - the EC has sent the recommendations under its excessive deficit procedures five times since 2004 - but the one-off measures that Hungary has been using to try to bring it under control over the last couple of years.

Those include several one-off revenue measures that have hit the country's banks hard - the nationalization of around €10.5bn of private pension assets, a stiff crisis tax, and forcing them to shoulder huge losses on foreign currency debt. Many of those banks are Western European, and they have made no bones about lobbying the issues in Brussels.

While greater fiscal discipline is in high fashion in Brussels right now, the EU is also using it as part of its arsenal to press Budapest to abide by a more orthodox economic policy. Since Hungary asked for the bailout, the Commission has threatened legal action against recent legislation passed by Budapest on the central bank and judiciary, and helped bring down national airline Malev by demanding it pay back state subsidies. Analysts at JP Morgan said, "we believe the EU will use the threat of suspension as leverage in upcoming negotiations [over the bailout], but will ultimately not apply the sanction."

What's unclear - as ever - is which way erratic Prime Minister Viktor Orban and his government will jump in the end. On the same day that the funding sanction was announced, he outlined new measures to fight the deficit, including a reduction of expenditure on drugs and public transport, as well as banning officials from the purchase of new cars and mobile phones. However, no figures on how these measues would affect the budget were attached. At the same time, a government statement queried the legality of the sanctions and suggested it is not in line with the spirit of the EU's basic treaties.

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