Thursday, 19 January 2012

Hungary: Political Economy, the Calculus of EU-IMF support and Prognosis

Would Hungary make the cut for EU entry today? This question in many ways encapsulates the political-economy questions facing both the recent CEE entrant into the EU and the fate of the Union itself amidst the on-going Euro crisis that has yet to be played out.

The blueprint for EU Accession was/is the so-called Copenhagen criteria set out at the European Council there in 1993 that set out the joint pre-conditions of a State being a market economy able to survive the rigours of the Single Market and a democracy with institutions that guarantee rule of law, human rights and protection of minorities.

And the country met the conditions and duly joined the EU Club in the Big Bang of May 2004.

Fast forward to 2010/11 …and…Hungary finds itself subject to infringement procedures by the Commission, the EU’s Executive for constitutional measures, freedom of the press, judiciary and the central bank; and a dressing down of its PM, Victor Orban, by the European Parliament that has threatened today, Jan 19th, to escalate punitive measures last taken against Austria in 2000 when it dallied with the far-right party of Jorg Haider.

Victor Orban, Hungary's prime minister, has come in for a lot of flak. Here is a man who started off on the left-of-centre at the beginning of transition and is now occupying a nationalistic banner firmly on the right wing of domestic and European politics amid an overwhelming mandate from the electorate in 2010. His nationalistic go-alone model has been compared to the Putin-model followed in Russia of centralisation of power and politics.

Alas Mr Putin has had economic independence through Russia’s hydrocarbon endowment…as well as a black belt in Judo to boot …

The economic crisis globally and within the EU partly propelled Mr Orban back into power. History is rife with examples of economic collapse and rise of nationalism and there are signs of this across the EU from the rise of the Finnish People’s Movement, through Holland, France and - with the extension of the EU eastwards - into geographies last understood in the West in the pre-communist area of the collapsing Austian-Hungarian territories.

Yes, the Euro crisis has seen a domino effect of collapsing right-of-centre governments affected by the sovereign debt crisis from Ireland, Iberia via Italy through Greece by left-of-centre ones but with the exception of Spain, the jury is still out if these technocratic governments have sufficient traction and political experience to sustain the argument to austerity-fed electorates.


  • Hungary is a small open-ish economy and has neither the political or economic clout to be an outlier – within or outside the EU.
  • Forget the shenanigans of the Euro crisis, Hungary is dependent on the EU for internal transfers (yes they exist ..look up Cohesion Fund) and for pending EU-IMF financial support. The diplomatic upsurge in Hungary’s efforts to mollify Brussels and the visit to the IMF to seek external support will have brought home to Mr Orban that he will have to play by the EU rule-book. Expect a rapid vole-face and repeal of the conditions outlined by the EC last week regarding the new Central Bank Act passed at the end of 2011 and the explicit and implicit erosion of the central bank’s independence.
  • The European Parliament’s tough stance will not be followed up by the European Council but expect the EC to keep up the pressure to ensure that the  4th pillar of an open civic society and plurality of views is kept up...this can only be good for both Hungary's democracy but also for those waiting in the wings to join like the Croats in 2013.
  • The economic crisis is also having the effect of galvanising the EC’s approach to enforcement EU law - and frankly this too can only be a good thing if the Copenhagen criteria are to survive -  be it the preservation and deepening cross-country economic and commercial links with the EU through freedoms of capital, labour and goods moving about (ie the UK position in the last 2 decades) …or thorough guarantees of civil liberty, freedom of thought and voice.
  • In the economic space, the EC’s leverage is likely to expand in two ways in the EU:
i)              Greater focus generally on fiscal co-ordination and surveillance (already under way through Excess Deficit  Procedures) even if the Fiscal Compact will be a watered-down version
ii)           For the new EU CEE economies who are net recipients of EU transfers far greater impact of implicit or explicit conditionality – through existing aid and soft loans but…also through the EC’s effective control of any IMF assistance in the offing.
  • This is not the place to discuss the possible modalities of EU-IMF assistance that the joint mission is currently reviewing in Budapest. From a sovereign perspective, the key points are that Hungary is an EU member state and it will get assistance in the same way that Latvia and Romania did– a localised financial collapse in Hungary will not be allowed to happen and that could have unintended spillovers into the region or the Eurozone, not mentioning the highly vulnerable banking sectors in the region (as rightly picked up by both the World Bank's recent report and by Eric Berglof at the EBRD...a blog for another time).
  • Any budget or Balance of Payments support will require of Hungary conditionality - both pre-conditionality and programme compliance ie. interim benchmarks/policy conditions. With the IMF on board, this means that Hungary will sign-up to roll-back of some heterodox economic policies such as the flat tax although it’ll be interesting to see what the outcome is as regards the Hungarian version of financial repression of its banking system - used by the government to try and put a ceiling on FX exposures on a large swathe of the household mortgage sector that had taken a punt on the "carry trade" on the then cheaper CHF but which is now a curse on private sector balance sheets.
  • In the medium-term the increased monitoring of Hungarian economic policy will be + for both FDI and porfolio flows. 
  • In the short-term - and for the reasons outlined above - I am bullish on Hungary. I expect CDS spreads to narrow and the forint to strengthen. 


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