Markets favour slim victory for Hungary's ruling Fidesz party

Markets favour slim victory for Hungary's ruling Fidesz party
By Levente Szilagyi in Budapest April 4, 2018

Hungarian Prime Minister Viktor Orban's conservative government looks set to win its third straight term at Sunday's election, an outcome favoured by the markets as it would ensure stability and the continuation of the current economic policy. 

Most economists give credit to the conservative government for successfully manoeuvring Hungary out of the economic crisis, paying back International Monetary Fund (IMF) and EU loans and creating an economic environment favourable to foreign investors. A stable win by Fidesz would be favoured by the markets as the government is likely to continue its prudent fiscal policy.

On the other hand, a supermajority for Fidesz would increase tensions with Hungary’s European partners and could lead to market sell-offs. Analysts say another supermajority would further erode democracy in Hungary, and may lead to a crackdown on democratic institutions. This in turn might trigger a response from the EU, which would be negative for Hungarian assets.

Hungarian asset manager Viktor Zsidai says Orban will continue with his state-capitalistic model and as long as the EU funds are flowing in, the economy will not falter for the next two to three years. 

Meanwhile, a victory for the small and fragmented opposition parties would lead to a fragile government and political instability. Questions over the future policy direction of a government comprising a mix of the new parties would likely cause some sell-off of the forint and bonds, as the central bank could be seen as less involved in the bond market. 

Economic achievements 

In recent years Hungary's economy has been growing strongly, led by EU-funded investments and rising consumption, yet the government has focused on immigration as its top campaign theme and has not released any governing programme for its next term.

Hungary avoided a Greek-style debt crisis in 2010, and with some unorthodox policies the government has turned around the economy, which grew 4% last year, the fastest pace in eight years. The jobless rate fell from 12% to 4%, although the actual figures may be higher due to public work programmes and the emigration of the skilled workforce. Employment has risen to record highs and wages have been increasing by double digits. Structural problems still remain, though, with a huge unskilled and uneducated population in rural areas, and abundant red tape hurting competitiveness. 

Hungary's budget has recorded primary surpluses since 2012, which helped the country to escape the excess budget procedure after nine years. The government overhauled its tax system, shifting the focus to the consumption tax. Hungary has one of the highest VAT rates, at 27%, and tax evasion remains a major problem, but has been reduced thanks to anti-fraud measures such as the launch of online cash registers and more stringent tax audits.

In line with its social policy goals, the Orban government has favoured middle and upper-middle-income households with the flat 15% personal income tax and generous tax allowance schemes and subsidies, while freezing welfare payments and cutting unemployment benefits after three months. 

Orban's economic patriotism

Since coming to power in 2010, Orban has promoted the idea of  "economic patriotism," stressing the importance of domestic ownership in key sectors of the economy. After taking office, the Orban cabinet levied huge sectoral taxes on multinational companies, which were later either phased out or reduced after infringement procedures were initiated by the EU.  

Orban has focused on the banking, retail, energy, and media sectors, industries that he wants to be dominated by the state or friendly local entrepreneurs. These sectors were profitable and therefore offered rich pickings, and his lack of influence there became a constant frustration. By expanding domestic control of the banks he could direct lending; influence over the energy sector would fix energy prices, while domination of the media would silence opposition voices. 

Orban’s Hungary has led the drive towards a new industrial model. His government has built up new state champions in the banking and electricity sectors by buying up assets from exiting foreign investors, in effect reversing the privatisations of the 1990s that his government argues went too far. 

The government has launched programmes to strengthen Hungary's major manufacturing sectors with the goal of increasing manufacturing’s contribution to GDP from 17% to 20%, the same level as in the most developed countries in the EU. 

It signed a number of strategic agreements with multinationals and gave hefty state subsidies and grants to them, as the economy heavily depends on foreign companies which account for more than three-quarters of industrial investments. Slashing the corporate tax rate to 9%, one of the lowest in Europe, has had a marginal impact on the budget, as it was offset by new taxes.  

Monetary policy crafted to stimulate growth 

With former economy minister Gyorgy Matolcsy taking the helm at the Magyar Nemzeti Bank (MNB), an economist revered by the prime minister was put in charge of reshaping monetary policy and working closely with the government on achieving its fiscal and economic goals with a string of unorthodox measures. 

The MNB began to loosen monetary policy in 2013, cutting the base rate to historic lows, pushing yields down, and helping meet the cabinet's goals of cutting back state debt. The loose monetary policy of the central bank resulted in HUF1.6 trillion savings for Hungary between 2013-2017. The MNB, which has become one of the most dovish central banks in Europe,  launched a number of unconventional monetary policy tools to push down yields on both the short- and the long-end of the curve. 

The MNB also launched programmes to kickstart lending. By converting and later phasing out Swiss franc loans, it reduced households' debt reduced by HUF1 trillion, a key measure of the government's economic policy as high debt stifled domestic consumption. The decline of foreign-currency debt has reduced the country's vulnerability, which in 2017 bore fruits as all three major credit rating agencies revised Hungary's ratings from junk to investment grade.

Hungary's state debt manager successfully managed to increase the share of domestic savings in its debt financing, and reduced the share of foreign-currency debt within the overall debt to 22% by the end of 2017 from 50% in 2010. The ratio could drop further to just 10% of the total in five years. 

Gross debt had come down to 72% of GDP by the end of 2017 from above 80% in 2009, but including liabilities of the state-owned bank, the figure is close to 74%. The Orban government in 2011 privatised HUF3 trillion worth of private pension money from the accounts of millions of Hungarians, which was never paid back and was used to pay back debt. The MNB has taken credit for stimulating growth with its measures, which accounted for 1% of the GDP last year.

Orban's obsession with Soros and migrants 

Despite all the economic achievements of the last few years, Fidesz has narrowed down its campaign message to the single issue of immigration. 

The governing parties focussed their campaign on dire warnings that future of the stable, growing and balanced economy is at stake in this election. 

This election campaign has been like none other, and the nastiest Hungary has ever seen. Orban has played on the fears of the electorate, painting apocalyptical views of a mass migrant invasion if his ruling Fidesz party loses. Seen as the strongman of Europe, he built his reputation in Hungary and across the continent by being the most vociferous opponent of the EU's mandatory resettlement quota. 

Debates on future policies and economic visions are overshadowed by the ruling party's aggressively negative campaign. Orban has repeatedly warned the public that Hungary will turn into an “immigrant country” if opposition parties, backed and financed by Hungarian billionaire George Soros in his view, win the election. 

Critics say the prime minister is trying to mask numerous corruption scandals with his openly xenophobic and racist rhetoric. Surveys show Hungary slipping in various corruption surveys. He has been blamed for building a state of crony capitalism where businesses close to the ruling party and the prime minister himself built up mass fortunes and business networks using EU and state funds. 

Ruling party with no election manifesto 

The ruling party has not disclosed its programme for the 2018-2022 period, but statements by ministers and the prime minister foreshadow the continuation of the existing prudent fiscal policy, more tax cuts and an increase in various tax benefits for the middle-class and those of state-financed programmes in areas such as tourism. Prior to the election, the government declared there will be no election budget in 2018. 

Stability and growth are the two main pillars of economic development, Hungary's Economy Minister Mihaly Varga said recently. In his speech to industry leaders in March, he promised more tax cuts to come. The personal income tax could be slashed to 10% if there is leeway in the budget. 

To improve the competitiveness of the corporate sector, in particular SMEs, the government aims to cut labour taxes to a level lower than the central European average by 2022, as these tax burdens are still among the highest in the EU. 

Economic growth should continue to exceed the EU’s average GDP growth in the coming four years, Varga forecast. The cabinet is targeting the reduction of state debt to 60% of GDP by 2022, and a zero-deficit budget on a cash-flow basis by 2020.

Varga also laid out plans for increasing employment, which is at a 25-year high, but the activity rate is lower than in the Czech Republic. The MNB governor said Hungary can catch up with the average development level of the European Union by 2030 and the Austrian level by 2050. 

A mixed bag of promises from the opposition

Meanwhile, opposition parties are caught up with their internal problems and have been forging agreements in local districts in the hope of staging an upset victory. 

Leftist opposition parties are focusing on restoring the checks and balances of Hungary's frail democratic institutions, including the creation of a separate Prosecutors' Office that would investigate corruption cases and the rewriting of the election laws, that clearly favour the incumbent Fidesz party. 

The Socialists and Dialogue party alliance, the third most popular party with 12%-15% in the polls, would host a referendum to quash the Basic Law and enact a new constitution. Its economic agenda is a mixed bag of promises ranging from increasing social transfers to raising taxes for upper-middle-income families. The Socialists and Dialogue are calling for the introduction of progressive tax as the flat tax is hurting lower income earners, they claim. 

The party alliance led by prime ministerial candidate Gergely Karacsony promised a comprehensive wage hike programme, a 13th-month pension, and utility rate cuts. Karacsony also pledged to levy taxes on offshore incomes and giant properties, and double the family allowances frozen under the Fidesz government. The party would make the minimum wage tax-free again.

Hungary's second largest party Jobbik, which has shifted to the centre leaving its racist and anti-EU rhetoric behind, is promising to restore democratic institutions and to hold government officials accountable for corruption-related crimes. It aims to strengthen local SME's with the aim of reducing Hungary's dual-structured economy that depends heavily on large foreign firms.

Its programme includes increasing spending on education and healthcare, which opposition parties claim were neglected under the Fidesz government. The party has lobbied consistently for foreign-currency mortgage debtors to have their loans converted at the exchange rates of the time they took out the loans. Other welfare measures include housing programmes for young people and allowing men to retire after 40 years in work.

Green opposition party LMP, which barely passed the 5% ceiling in 2014, has been the most vocal critic of the expansion of the Paks nuclear power plant, and the party has promised to halt the investment if it comes to power. Instead, it would use funding for renewable energy and for state-financed projects to boost the energy efficiency of residential homes.

The party would introduce a two-tier tax for businesses and individuals, abolish the controversial corporate sponsorship to sports clubs, commonly known as the TAO-scheme, and levy a tax on luxury properties and large farmlands. The LMP would phase out the MNB’s foundations, which manage huge volumes of public money, bonds and real estate and hold hundreds of billions of forints in government bonds and works of art. 

Opposition parties bet on high turnout

According to the polls, Fidesz enjoys the support of 40-45% of decided voters, but pollsters warned the actual figure may be lower as many respondents hide their party preferences out of fear. In the 2014 elections, Fidesz was polled at 50% but received only 44% of the popular vote, which still gave it a supermajority due to the single-round election system created by the ruling party in 2013.

The outcome of the election will be decided at the 106 constituencies and especially in those 25-30 districts where opposition parties could run a tight race with the incumbent if they agree to withdraw some of their candidates in favour of the strongest challenger to Fidesz. 

Voter turnout will also be key, as more than two-thirds of the more than 1mn undecided voters would favour a change of government, polls show. Opposition parties now see mobilisation of their supporters as critical to their chances of victory. Some pollsters say turnout of above 70% would be needed to push Fidesz into a majority.  

 

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