VISEGRAD BLOG: Governments battle central banks in Poland and Hungary

VISEGRAD BLOG: Governments battle central banks in Poland and Hungary
Even though Governor Gyorgy Matolcsy (left) was a Fidesz minister and his term anyway finishes next year, Prime Minister Viktor Orban (right) appears to believe he has to be brought into line now. / bne IntelliNews
By Robert Anderson in Prague March 14, 2024

Central banks and governments have often had a rocky relationship in the (not so new) democracies and market economies of Central Europe. Partly this reflected the struggle to build independent central banks in countries where this was a novelty; partly it reflected the strains of transforming Communist economies and converging with Western Europe.

Usually the battles have revolved around policy on interest rates, the currency and sometimes bank supervision, where politicians and business lobbies often have divergent views on what course should be followed.

But typically there are also fights over personnel, with presidents, prime ministers and political parties vying to get their candidates onto the bank board. Where there is a revolving door between politics and the central bank, this can make the relationship especially toxic when the government changes.

This year the delicate relationship between these key monetary and fiscal authorities has turned ugly in Poland and Hungary. The apparent threats to central bank independence are now worrying markets and the European Central Bank (ECB), the EU’s overarching banking supervisor.

In Poland, the incoming centrist government of Donald Tusk has accused National Bank of Poland (NBP) Governor Adam Glapinski of blatantly trying to help the then Law and Justice (PiS) cabinet before last October’s election, by making two unwarranted 100bp cuts in interest rates and also by issuing a false prediction of a PLN6bn (€1.38bn) central bank windfall profit (the NBP actually made a PLN20bn loss). The government also says that Glapinski had violated the Polish Constitution by buying government bonds and failing to react in time to the country’s high inflation rate.

The government now wants to drag Glapinski, a long-time PiS loyalist, before a special tribunal to explain his actions, a move seen as an attempt to put pressure on him to resign and then install its own candidate.

In Hungary, a furious row has erupted within the ruling Fidesz elite between Governor Gyorgy Matolcsy and Economy Minister Marton Nagy over cabinet proposals to tighten supervision over the central bank’s well-funded (and controversial) foundations.  

The bank fears this will be used as a tool to influence its monetary policy. "If passed, the new law could be used to build narratives against the Hungarian economy and hurt our financial stability," the Hungarian National Bank (MNB) said this week.

The relationship between the MNB and government had already deteriorated markedly since the end of the pandemic, as inflation rocketed and growth flatlined.

Both have blamed the other for Hungary having had the worst inflation in the EU – peaking at close to 26% in January 2022 – and they have often appeared to be talking and working at cross-purposes. The central bank has regularly attacked the government’s fiscal flatulence, while the cabinet has accused it of keeping interest rates too high – Hungarian rates are the highest in the EU, peaking at 18% before cuts began last May. 

The bank also argues that the government’s caps on prices and bank interest rates affect monetary transmission and reduce the effectiveness of its own monetary policy, which could force it to maintain tight monetary conditions for longer.

Pandemic populism

The Hungarian and Polish cases are very different but they share two features in common. The Central European economic environment has been especially difficult since the pandemic and the Russian invasion of Ukraine, leading to the highest inflation rates in Europe, as well as recession or stagnation. This difficult environment heightens differences of opinion over interest rates and currency policies.

The region’s three independent central banks (Slovakia and the Baltic states are in the Eurozone) were the first in the EU to raise rates – and to much higher levels than in Western Europe – and have come under fire for being too slow to bring them down again. Often central banks have found themselves working at cross-purposes to governments, as their tight monetary policies hurt the companies and consumers that politicians were trying to support with generous subsidy programmes.

Today, with the ECB still holding off cutting rates, the Central European independent central banks have little room to reduce rates further in the short term without risking currency turbulence.  

They are also cautious about the return of inflation. Although inflation has recently fallen sharply, analysts predict that in Poland and Hungary it may revive later in the year. Consequently Erste Bank this week forecast that the Polish central bank will continue to keep rates on hold until Q4, while the Hungarian central bank will stop cutting after this quarter.

Source: Erste Bank research

The second feature both countries share is populist authoritarianism, with Poland just emerging from PiS’s eight-year rule, while Hungary remains very much under Viktor Orban’s radical right-wing regime, which has so hollowed out the country’s democracy that it is difficult to see it ever losing power. Such populist regimes abhor pluralism and want to control all levers of the state, and therefore brook no opposition, even from a supposedly independent central bank.

In Hungary, the highly centralised Fidesz regime now appears to have tired of the central bank’s independence. There is also some personal history between Matolcsy and Nagy, whom the governor sacked from the bank board. Even though Matolcsy was a Fidesz minister and his term anyway finishes next year, Orban appears to believe he has to be brought into line now.

“Orban possibly wants to bring the central bank and banking supervision closer to his semi-oligarchic economic regime,” Gunter Deuber, chief economist of RBI, told bne IntelliNews.

In Poland, Law and Justice arguably captured the central bank (appointing six of its nine board members) in a way that no previous government had tried to do. The new government believes that paradoxically (and conveniently) it has to remove the governor to restore its independence. For its part, the six PiS appointees on the bank board accuse the new government of threatening the central bank’s independence.

Cases apart

So far, the markets have distinguished between the two cases. The erratic and highly unorthodox policies of the Hungarian government and central bank have long unsettled investors. The forint is now close to 400 to the euro, while the Polish zloty has remained largely unaffected by the dispute.

Both countries had EU funds frozen because of their radical right-wing governments’ violations of the rule of law but, unlike Poland, which is expecting its funds to be released over the coming year, some €21bn of Hungary’s EU funds remains frozen and are likely to remain so.

This leaves Hungary’s capital account dependent on portfolio inflows. And harming central bank independence is exactly the kind of thing that scares portfolio investors, points out Deuber. “Attacking the central bank, this is not the best combination,” he deadpans.

Consequently even Varga admitted to Bloomberg this week that the pressure on the forint is making the cabinet think twice about going ahead with the proposals. A closing of Fidesz ranks now looks more likely.

Like the markets, the ECB also appears to be treating the two cases differently. Deuber argues that the ECB is more worried by the Hungarian case because the MNB is the banking sector regulator at a time when the Orban regime is building a new state-owned superbank, MBH.

In Poland, the NBP has tried to involve the ECB on its side but has only received tepid support so far. This, however, may change if the Tusk government presses ahead with dragging Glapinski, 73, before a tribunal.

But some analysts doubt it will come to that. “If Tusk sees there is no sound legal basis [for removing Glapinski] he will not do it, but he wants to keep up the pressure,” says Deuber. “This could really backfire,” he says, adding: “I don’t believe Tusk will escalate it”.

The Polish government may hope that they can bully the governor into quitting before the tribunal meets, but so far he looks made of sterner stuff than that. Glapinski may remain a thorn in the cabinet’s side until his term ends in 2028.

A shorter version of this blog  first appeared on bne IntelliNews' Editor's Picks. To sign up for the daily Editor's Picks newsletter, please click here.