Hungary sentiment improves but damage may already have been done

By bne IntelliNews February 11, 2011

Kester Eddy in Budapest -

The Central Hungarian Pensions Office - located in a decidedly un-des-res area near Budapest's Keleti railway station - had never been so busy; on the last day of January, several thousand Magyars passed through its doors before the midnight deadline to register and continue paying into their private pension funds - despite what critics called "government blackmail" to switch, by default, to the state system.

Among them was Krisztina - she declined to give her surname - a horticulturalist from Budapest: "I'm staying out of pride. I don't trust the state system. I'm 24 years from retirement, but nobody knows what's going to happen in those years," she tells bne.

In future, Krisztina, along with her employer, will pay 10% of her salary into the private fund, with 24% channelled into the state fund as a tax - with no personal benefit whatsoever in return for the later contribution. Yet despite the onerous conditions, more than 102,000 of her fellow citizens also defied government exhortations to opt for the "security" of the state system. However, these represented but 3% of the 3m workers who had, until November, been paying into the mandatory second pillar since 1998.

The effective elimination of the mandatory pension pillar is just one of a raft of controversial laws passed by the government of Viktor Orban, the Hungarian prime minister, since his sweeping election victory last spring, when his centre-right Fidesz party (along with its nominally independent ally, the KDNP) won 53% of the vote. With an unprecedented parliamentary majority of 68%, Orban declared a "revolution" at the polls and vowed to rebuild the country in a spirit of "national cooperation."

In the political sphere, government has passed laws that include granting ethnic Hungarians citizenship (affecting, primarily, populations in neighbouring countries) and, most controversially, a media law which critics say muzzles and intimidates the free press. But it is in the economic and business sphere where new legislation has caused most concern.

Crisis management

In a campaign tinged with nationalism, Orban promised to create 1m jobs in 10 years through stimulating growth via tax cuts to both the population, particularly families, and small business. But, once in power and with the EU enforcing a strict budget deficit target of 3.8% for 2010 - followed by 3.0% this year - the prime minister had to find cash to plug the hole, caused in part by the lower tax income.

Rather than making further cuts in state expenditure, the government introduced punitive "temporary crisis" taxes on the retail, telecommunications, energy, financial and banking sectors - all largely dominated by foreign investors. Further, these taxes were not on profits, but on revenues, and they were made retroactive, ie. valid from the beginning of the year.

And when the budget gap for 2011 still yawned wider, the government denounced the mandatory second pillar of the pension system as "on the brink of collapse," and sought to grab both the accumulated assets and future income.

Adding to the turmoil, most of the associated legislation was initiated by individual MPs - a method of fast-tracking bills by avoiding the mandatory consultation procedures with affected parties under regular government-sponsored bills. The result was a raft of fast-changing, often badly drafted legislation, leaving many top managers wringing their hands in frustration as they sought to understand how to re-write their annual business plans well into the year. "To me, this shows [the government] does not really understand how business works," says Dirk Woelfer, spokesman for the German Chamber of Commerce in Hungary.

In December, 13 large investors, including E.On, RWE and Deutsche Telekom, appealed to the European Commission, accusing the Hungarian government of "using selected sectors and foreign companies in particular, to balance the state budget." Meanwhile, two ratings agencies, Moody's Investors Service and Fitch Ratings, downgraded Hungary's to just above junk status.

Yet, despite the international furore over the media law as Hungary took over the rotating presidency of the EU and the less-well publicised news of the pensions grab, investor sentiment toward Hungary in late January actually began to improve. "A number of underlying positives [have emerged] which perhaps now warrants more positive view on [Hungarian] credit, at least in the near term," Timothy Ash, head of emerging markets at RBS in London, said at the end of the month. He noted, for example, that the nationalisation of pension funds "should see the transfer of the equivalent of 11% of GDP in assets to the state's coffers," part of which will be used to cut the worryingly high public sector debt from the current 80% of GDP by some 5.5 percentage points.

Meanwhile the German recovery has been boosting exports - up 21% in 2010 - to yield a record trade surplus of €5.55bn last year, compared with €3.74bn in 2009. And analysts are hopeful that an economic package, to be published mid-February, will cut the budget deficit by some HUF600bn (€2.2bn) over the next three years by focusing on expenditure cuts, further restoring trust.

Even so, serious worries remain; domestic demand is weak, credit is shrinking and the government largely ignores the central bank - and is moving to ensure its nominees replace all four members of the monetary council when their terms expire from March.

Many believe the damage has already been done. At the individual level, while the government may describe the pension move as "reform," Krisztina scathingly retorts: "They didn't have the right to take this off us. I'm hoping for some legal redress for this arbitrary measure."

On the corporate level, a similar mood persists. "I know of companies withholding investment, and one that has struck Hungary off its list altogether," says Woelfer.

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