Another austerity program introduced in Hungary, but they call it a “freeze”

It was not quite a month ago, on June 20, that Mihály Varga, minister of national economy, triumphantly announced that he “convinced the European Commission that no further austerity measures are necessary for Hungary to keep the 2.9% deficit target” that would ensure the receipt of investment funds from the European Union. Previously the Commission had expressed its misgivings about the feasibility of achieving the prescribed goal. According to Varga, the Commission was impressed by the recent positive results of the Hungarian economy: low inflation and rapidly decreasing unemployment figures.

So, great was the surprise that, after all, the government ordered a freeze of 110 billion forints worth of government expenditures in order to make sure that the deficit target is met. Varga tried to calm the nerves of Hungarians by saying that the freeze “will not affect families and businesses.” So, what will it affect? It looks as if Investment Fund expenditures will be substantially affected and several projects will be postponed. Across all ministries there will be an almost 40 billion forint spending freeze. Reserves for extraordinary measures, like floods, snowstorms and such, will be greatly reduced. The freeze will lower the GDP by .036%. He emphasized that these measures are not really necessary; they are only precautionary.

Yet Varga gave himself away once he began listing the reasons for the freeze. He explained that the favorable economic developments of late had actually had a negative effect on the state’s budget. For instance, a lower inflation rate than expected reduced excise tax and VAT revenues. Moreover, he added that “Hungary is facing some possible punitive measures from the European Union” which would affect certain funds coming from Brussels. Commentators judge that figure to be close to 100 billion forints. As for lower tax revenues, Varga could have added that due to the newly introduced state monopoly of tobacco the state lost about half of its former revenues from this source. Varga of course did not want to mention the substantial expenditures on the nationalization of several large private concerns. In addition, thirteen infringement procedures are currently underway, the latest being an impending fine to the tune of 60-90 billion forints over the tenders for the toll system introduced about a year and a half ago. All in all, the budget is not in great shape.

According to Levente Pápa, an Együtt-PM politician who deals with economic matters, the government has loosened the purse strings of late. The public works program was greatly expanded just before the national election. The same will be true in the coming months, this time because of the municipal elections in October. Sándor Burány of MSZP, who usually responds to issues connected to the economy, also called attention to the so-called “prestige projects” undertaken for the election year.

This morning Viktor Orbán explained the reason for the freeze. This year’s budget is tight, “at the very edge” of 3%, and thus it is a good idea to make it clear to the whole world that Hungary will hold the deficit under the maximum allowed. Then he tried to teach the Hungarian public, which is not too sophisticated when it comes to economics, that “Hungary must continually take up loans in order to finance its earlier loans and it is not immaterial under what terms the country gets these loans. Interest rates are greatly influenced by whether investors consider the budget stable.” Hence the freeze.

At this point the servile reporter who conducts these Friday morning interviews asked Orbán whether it hurts that the building of stadiums must be suspended. Naive man. Orbán announced that “luckily” one does not have to worry about these projects. There is always money for the prime minister’s pet projects. Moreover, he said that some of the expenses connected to stadium construction will occur only next year. Let’s worry about them then.

It is certainly worth taking a look at yesterday’s Magyar Közlöny (Official Gazette) which contains the details of this latest adjustment of the budget figures. The three ministries affected most are the Ministry of Human Resources (9,671.1 million), Ministry of National Economy (8,378.3 million), and Ministry of Agriculture (5,552.0 million). It is true that the Prime Minister’s Office will be able to spend less money from here on (1,446.5 million), but that is a relatively small cut, especially if we compare it to the 3,785.5 million taken away from projects financed by the European Union.

Even more interesting is appendix #2, which lists the exemptions. These are projects that the ministries cannot touch while adjusting their budget figures. One of the first is the prime minister’s protocol expenses. But no one can chip away at the enormous “government communication” budget either. Although I did not know that Viktor Orbán was keen on horses, the “development of the Horse Center in Szilvásvárad” is also exempt. The reconstruction work in the Castle District (Szent György tér, Mátyás templom) must go on. The Ludovika Campus reconstruction, including sports facilities, will continue uninterrupted. This is where military officers and civil servants will receive a proper Fidesz education. Monetary gifts for excellence in sports must remain the same as before. And then we have an incredibly long list of stadiums and sports facilities: Győr, Debrecen, Bozsik Stadium in Budapest,  Ferenc Szusza Stadium also in Budapest, Pécs, Nyíregyháza, Zalaegerszeg, Kaposvár, Kecskemét, Paks, Pápa, Békéscsaba, Mezőkövesd, Siófok, Dunaújváros, Gyirmót, Ajka, Balmazújváros, etc. etc. etc. Too long to list them all.

This is what the Ludovika Campus will look like

But there are other sacrosanct items worth mentioning: aid to art collections of churches, aid for the teaching of religion in schools, financial assistance to priests and ministers serving localities with populations of less than 5,000, financial support of priests and ministers serving abroad, aid for the Piarist order, aid to the Hungarian Reformed school in Debrecen, aid to religious organizations abroad, and finally financial aid for the organizations of ethnic minorities.

It is perhaps not surprising for those who are familiar with the Orbán government’s modus operandi that the largest amount is being taken away from the ministry that looks after healthcare, education, and culture. At the same time the government is spending billions and billions on at least three dozen stadiums all over the country. There is no question where this government’s priorities lie.

Banks versus the Hungarian government

Today was the last day for the legislators to get together before the summer recess. They marked the occasion by voting for a piece of legislation that is supposed to ease the hardship of those who took out loans in foreign currencies. Nobody seems to be satisfied with the result, with the exception of Hungary’s prime minister, Viktor Orbán, who announced that “this was a historic day that may be the start of a new era…. The era of fair banks may follow.” The debtors find the assistance insufficient. The banks consider it unfair and unconstitutional. And the Hungarian currency, the forint, has been ailing as more and more details of the proposed legislation have become known.

The loss the banks in Hungary face is at least $4 billion according to the estimates of Hungary’s central bank. Today OTP, Hungary’s largest lender, said it may have to refund borrowers $644 million, most of that sum due to the charge that banks were not transparent about unilateral changes to loan terms such as interest rate hikes and a smaller amount linked to exchange-rate margins. And this may not be the end of the banks’ troubles. Antal Rogán, whip of the Fidesz caucus, indicated that later in the year the government plans to force the banks to convert their forex loans to loans denominated in forints at a below-market exchange rate. That could cost the lending institutions an additional $16 billion.

The stock price of  OTP dropped as much as 4% during the course of the day, closing down 1.7% on the day and 4.1% on the week. The share price of Austrian Erste Group Bank AG, the second biggest lender in the country, plunged 16% after it was revealed that its loss in 2014 might be as large as 1.6 billion euros ($2.2 billion) because of its poor performance in Hungary and Romania.

London-based analysts see trouble ahead.  Peter Attard Montalto, an economist at Nomura International, thinks the market “is underestimating the disruptive impact the proposed path will have on the banks in the short to medium run.”

The forex loan legislation passed with an overwhelming majority. There was only one dissenting vote and two abstentions. The former came from Gábor Fodor, the sole MP of the Hungarian Liberal Party, and the two abstentions from DK members. Fodor argues that the legislation “will cause serious economic troubles.” He is also convinced that the Supreme Court’s (Kúria) decision regarding the currency bid/ask spread and the practice of unilateral changes in contracts is unconstitutional. In addition, there is the problem of the statute of limitations, which the bill retroactively changed in a bizarre way. The clock will start counting down only after the loan has been paid in full.

Naturally, the Banking Association (Bankszövetség) is up in arms. Taking advantage of the currency spread is an internationally accepted practice which covers the real cost to the banks. Like Fodor, the secretary of the association, Levente Kovács, considers the change in the statute of limitations unacceptable. He also objects to other retroactive changes incorporated into the legislation as “they violate the rule of law and cause uncertainty among investors.” He pointed out that the banking sector is one of the largest taxpayers in the country. The banks pay 220 billion forints yearly in taxes, and that does not include the extra tax levies they had to suffer in the last three years. The extra levies themselves amount to 1 trillion forints, which translates into 2 million forints per forex debtor. He predicted serious losses and, as a result, forced consolidation in the sector.

Everybody suspects that the banks will go to court over the issue of unilateral contract changes. It is also almost certain that there will be court battles over the legality of converting foreign currency loans into forint loans at below-market rates.

All this made no impression on Fidesz legislators. Antal Rogán claimed after the vote that parliament had at last meted out justice for the debtors and promised that within a few months all unfairly collected charges would be refunded. According to Rogán, the average debt holder may receive a refund of between 600,000 and 1 million forints before the end of the year.

This promised windfall did not satisfy those foreign exchange debt holders who had earlier organized several groups to battle for their “rights.” One of these groups, Otthonvédelmi Tanács (Council of Home Defense), demonstrated in front of the parliament building this afternoon. Figuring that an average loan is 7 million forints, they now demand 5.9 million back because in their estimation that 7 million forint debt has since doubled. They claim that the bill just passed will decrease their debt by only 1.2 million, which is not enough. They charged the banks with fraud, and some of the signs demanded jail sentences for bank managers.

Those who predicted court battles did not need to wait long. OTP shortly after the passing of the bill announced its decision to sue the government. And this is just the beginning.

The European Commission is not happy with Hungary’s economic performance

Yesterday the European Commission published a press release after the commission staff concluded its fifth Post-Program Surveillance mission to Hungary. After a few encouraging remarks that welcomed recent economic improvements, the authors of the memo delivered some bad news. The better economic indicators are mostly due to artificial one-off stimuli (a decrease in utility prices, the central bank’s low-interest loan program, the workfare program, and greater use of EU subsidies) and therefore one must be cautious when assessing the state of the Hungarian economy. The report also pointed out that “although the general government deficit has been kept below the 3% of GDP threshold, government debt is not yet on a firm downward path.” Furthermore, it warned that based on the Commission’s 2014 spring forecast, “the country appears at risk of breaching the requirements of the Stability and Growth Pact.” They suggested “additional fiscal consolidation efforts, in order to avoid that an inadequate pace of debt reduction could trigger the re-opening of an excessive deficit procedure in spring 2015.”

That was  not all. The mission stressed the “benefits of pursuing growth-friendly fiscal consolidation.” The mission also called for a  stable and more balanced corporate tax system, including “phasing out distortive sector-specific taxes.” They recommended an improvement of the banks’ operating environment, including a reduction in their tax burden. And finally, “the mission called for improving the business environment and emphasized the need to stabilize the regulatory framework and foster market competition, in particular by removing entry barriers in the service sector.”

All this sounds like reasonable advice. Hungarian economists who are more and more critical of Viktor Orbán’s unorthodox economic policies have been saying the same thing for a number of years, to no avail. And it is unlikely that the Orbán government will heed the European Commission’s advice, especially their call to reduce the tax burden on the banks. Viktor Orbán immediately charged the European Commission with serving the interests of banks and multinational corporations when it threatens Hungary with the excessive deficit procedure.

Banks have it hard in Hungary. Here is one example–András Hámori, a senior executive of the Russian Sberbank Europe AG, gave an interview to Reuters that was later picked up by the Moscow Times. Hámori sees good business opportunities in the Czech Republic and Slovakia as both are expanding markets where taxes on banks are contained. But not so in Hungary where the “regulatory environment posed many challenges, which warranted caution.” He continued: “So when a shareholder decides where to deploy capital he obviously has to look at the potential return, and Hungary here does not rank on top, more like the opposite side.”

In addition to exorbitant tax levies banks also have to cope with the forex-loan problem. Prior to 2008, during the tenure of Zsigmond Járai, the Fidesz appointed governor of the central bank, the interest rate on loans denominated in forints was very high; therefore most people took out loans in foreign currencies, primarily in Swiss francs and in euros. It was a great deal while it lasted, but in the last four or five years the Hungarian forint weakened considerably against both of these currencies, placing a heavy burden on the debtors.

The Hungarian government decided to ease the hardship of those people with foreign-currency loans. With the bill that was recently approved by parliament, the Hungarian government seems to put most of the burden on the banks. According to some estimates this piece of legislation will cost the Hungarian banking sector $4.85 billion. Moreover, it looks as if the banks will have to convert foreign-currency loans to loans in forints.

Over the past week or so the Hungarian forint has fallen from 305 to the euro to 312 today. This weakening stems primarily from the central bank’s cutting interest rates to what some consider “dangerous levels.” In the last two years the interest rate was lowered from 7% to 2.3%, and last week there was talk that the central bank is contemplating at least one further reduction. The forint’s decline only accelerated after the forex bill was submitted to parliament for discussion.

Source: Politics.hu

The EU is raising the possibility of reinstating the excessive deficit procedure against Hungary in 2015 because of Hungary’s very high national debt, which has been growing instead of shrinking as the Orbán government promised. This growth is especially glaring if we consider that the government could have reduced the national debt by 10% if it had earmarked for that purpose all of the money it expropriated from the private pension funds of millions of Hungarians. Today there is not one red cent left from this pension money, and it’s unclear what new sources the government can tap to bring down the growing national debt.

Reducing the national debt is especially difficult because the Orbán government is a profligate spender. They are especially keen on nationalizing private businesses. Moreover, beginning this year Hungary will have to pay interest on the 10 billion dollar loan from Russia although the actual building of the reactor will not begin for years. That will add considerably to the national debt.

All in all, I am almost certain that the country’s finances are in a shambles. However, Mihály Varga excludes any possibility of any excessive deficit procedure (szó sincs túlzottdefecit-eljárásról). He admitted that “Hungary probably will have to introduce further financial consolidation in order to lower the national debt.” I will be curious to see who’s next on the hit list.

The population hears only about the economic growth Hungary has achieved in the last few months and the higher GDP than earlier anticipated; they have no clue about how fragile the Hungarian economy really is. One could counter: “Well, just think how many times in the past four years critics of the Orbán government have predicted that the whole economic edifice Viktor Orbán and his right-hand man György Matolcsy built will collapse. And look, nothing of the sort happened.” Indeed, until now they were lucky, but how long will that luck last? There will be a day of reckoning, I believe. Mind you, they might manage to keep the country afloat just long enough to make the day of reckoning a problem for their successors.