Hungary's reforms grind to a halt as coalition splits

By bne IntelliNews April 1, 2008

Michael Logan in Budapest -

When Prime Minister Ferenc Gyurcsany announced on Monday, March 31 the government was backing down over healthcare reform and sacked Health Minister Agnes Horvath - one of the scheme's key architects and an appointee of the junior coalition Alliance of Free Democrats - he not only provoked the junior party into leaving the coalition, but also effectively announced an end to all economic reforms.

What happens next politically is uncertain. Calls from the main opposition party Fidesz, riding high in the polls, for new elections will very likely be ignored, as the Hungarian Socialist Party would lose power and the Free Democrats would drop out of parliament altogether. Equally, few analysts believe the Socialists will dump Gyurcsany with no credible alternative available. The most likely scenario is that Gyurcsany will lead a minority government, with 190 MPs in the 386-seat parliament, until 2010.

Regardless of the political outcome, the consensus amongst analysts is that the reform window is closed. "Fiscal consolidation will not be reversed, but further tightening is unlikely," says Istvan Zsoldos, an analyst at Goldman Sachs in London.

The reforms, aimed at ultimately facilitating the adoption of the euro, were first introduced in the summer of 2006 to bring to an end Hungary's years of constantly missing its budget-deficit targets. The measures cut the deficit from 9.2% of GDP in 2006 to 5.5% in 2007. However, they also pushed up inflation, now at 6.9% after peaking at 9% last March, and cut 2007 economic growth to 1.3% - way below Hungary's regional peers.

The reforms and poor economic performance - a sharp contrast to the early post-communism years when Hungary was considered the shining example of a transition to a free market economy in the region - saw the government's popularity plunge. Gyurcsany's September 2006 admission that he had lied about the need for the measures prior to that year's elections also drove the process. The Socialists are currently polling as low as 15%, while the junior coalition partner Alliance of Free Democrats is at a meagre 1% - below the 5% threshold needed to enter parliament.

A recent crushing referendum defeat, when Hungarians voted to cancel fees for medical treatment and education introduced as part of the deficit reduction efforts, piled on further pressure. Most believed it was only a matter of time before the government caved in. It now appears to have done so.

Loosening signs

Even before the referendum and the coalition's collapse, the government was showing signs of loosening fiscal discipline. There was talk of tax cuts worth around €1bn - a proposal that worried those who had long warned the government would loosen the purse strings in the run-up the 2010 general elections in an attempt to regain popularity.

Following the referendum, credit rating agency Standard & Poor's downgraded Hungary's outlook from 'stable' to 'negative', saying that it expected the deficit to stall at 4.5% this year and in 2009. This is at odds with the government's predictions that the reforms will bring the deficit down to 3.2% in 2009. Following the events of the last few days, investors are unlikely to be reassured that the government will meet its targets.

However, there are those who believe that the crisis could be a good thing. "The chance of reforms in the last two years of an election cycle was almost zero anyway, but a minority government can avoid a pre-election spending spree," Gyorgy Barcza, chief economist at Hungary's K&H Bank, told bne.

Barcza said that previous experience showed Hungarian governments normally loosen the purse strings by several percent of GDP prior to elections. However, he pointed out that previous minority governments in Poland and the Czech Republic had refrained from splashing out.

Nonetheless, many believe that Hungary requires deeper and more structural reforms. Even though the economic reforms were welcomed internationally when they were first announced, there was still criticism that they were too focused on revenue-raising measures instead of expenditure cuts.

That criticism has not gone away and Christoph Rosenberg, who heads the International Monetary Fund's regional office for Central Europe and the Baltics, is one of many calling for more reforms. During a recent visit to Budapest, he said public finances were still bloated and that social spending - which he said was far too big in relation to the size of the economy - must be cut further to balance the budget.

Rosenberg's charge that spending is still too high is common, with many saying that it must be cut well below its current level of just over 50% of GDP. Government debt, at 65.6% of GDP in 2007 - on an upward trend from 54.2% in 2000 - also has to be addressed, many say.

Regardless of whether the coalition strikes a new deal or the government continues as a minority one, Hungary's chances of staying on track and finally adopting the euro around 2014 look increasingly slim.

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Hungary's reforms grind to a halt as coalition splits

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