CONFIDENT VERES AGAINST OMV-MOL MERGER; BULLISH ON

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E.O. 12958: DECL: 07/12/2017
TAGS: PREL EFIN ENRG HU
SUBJECT: CONFIDENT VERES AGAINST OMV-MOL MERGER; BULLISH ON

REFORMS

REF: A. A) BUDAPEST 1137

B. B) BUDAPEST 72

Classified By: Political-Economic Counselor Eric Gaudiosi for reason 1.
4 (d).


1. (U) This message contains an action request. See
paragraph 4.

2.(C) Summary: In a relaxed lunch meeting with Ambassador
Foley, Finance Minister Janos Veres and State Secretary Almos
Kovacs frankly discussed their desire to sidetrack the
OMV/MOL merger and their interest in developing a system to
protect strategic industries. Veres described a GOH basking
in EU approval of Hungary's deficit reduction measures, and
he maintains that the PM has been sobered by low poll numbers
and strengthened his position within his party to see the
reforms through. Despite recent higher inflation figures,
Veres sees a full recovery by 2009. End Summary.

Looking to Block the OMV/MOL Merger

3.(C) Veres called concerns about increasing Russian control
over energy supplies in Central Europe "music to my ears."
Despite this, he discounted a MOL official's suspicion of a
Gazprom connection with Megdet Rahimkulov, because Rahimkulov
supported Gazprom's prior CEO and has an openly hostile
relationship with their new leader. In fact, if one rumor
Veres mentioned comes true, then it is, in fact, a U.S. major
that ultimately wants to buy OMV and MOL shared assets,
because it would give them a near-monopoly in refining and
distribution in five countries. In his travels to Austria,
Veres reported his discomfort upon hearing several Austrians
talk about the OMV-MOL merger as a foregone conclusion in
light of the historical Austro-Hungarian Empire. Veres
expressed concern about EU regulations that prohibit
U.S.-style restrictions on investment in strategic industries.

4.(C) In this light, Veres welcomed and requests USG
technical assistance to help develop a Hungarian framework to
address these concerns. We strongly support Hungary's
request in this area and encourage a State/EB or Treasury
team to visit Hungary and provide this support as soon as
practical.

EU Deficit Concerns

5.(C) Veres beamed when discussing the July 10 European Union
Council, Economic and Financial Affairs (ECOFIN) decision to
accept actions Hungary has taken to reduce its budget deficit
(Ref A; Ref B),as Hungary remains subject to the European
Union Excessive Deficit Procedure. In a mix of fraternal
concern and national pride, he described a somber Czech
Minister of Finance, whose government supports the reforms
necessary to reduce their budget deficit, after ECOFIN at the
same July 10 meeting found that the Czech Republic failed to
comply with a Council recommendation to reduce their deficit.
According to Veres, the Czech minority government will
likely not be able to pass measures to fulfill
deficit-cutting requests, so the Czech Minister of Finance is
likely to resign in protest this fall.

Tax and Health Reforms Highlight Coalition Differences

6.(C) Going into fall, which Veres describes as a sensitive
final period of implementing "painful" reforms, he sees tax
and health insurance reforms as flashpoints in discussions
between ruling MSZP and junior coalition partner SzDSz. On
health insurance, although the main budget targets are not
likely to change, the details of how the system will be
implemented are still under discussion, with SzDSz pushing
for greater privatization than their Socialist partners. On
taxation, SzDSz is pushing for business-friendly tax
simplification and reduction while MSZP is taking a more
measured approach. Veres expects a comprehensive tax reform
roadmap to be ready by January 1, 2008; and for tax cuts to
be implemented January 1, 2009 and January 1, 2010. On
repeal of the very unpopular with business solidarity tax,
State Secretary Almos Kovacs tellingly joked this would
happen only "in the promised land." Rather, tax
simplification could result in rate reduction or even
elimination of more complex taxation categories; the
solidarity tax itself would not be repealed, but reduced in

2010. Veres and Kovacs both support a multi-year predictable
tax scheme for business, and that is why they are using 2008

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as a planning year. This extends to property tax, where they
plan to conduct assessments during 2008 before a 2009 rollout.

Pain: Education and Local Government Reforms; Subsidy Cuts

7.(C) On perceptions that Hungary's reforms have been overly
revenue-oriented, Veres insisted that their deficit reduction
program relied two-thirds on spending cuts and one-third on
revenue measures. This will become clear, perhaps alarmingly
so, as teachers will begin to assume a higher course load
this fall, and local governments grapple with sharply reduced
central government funding for their programs. In this way,
the government can shrink spending on local government
without cutting positions or institutions, both of which
would require a nearly impossible two-thirds majority vote in
a highly divided Parliament. Against this backdrop, the
coalition would like to reduce the income ceiling for receipt
of natural gas subsidies by twenty to thirty thousand forints
a month, down from the current 94,000 ceiling, which covers
roughly two-thirds of households in Hungary (Veres asked that
we specifically keep this proposal close hold). Aware of
negative polling numbers, Veres commented that MSZP and SzDSz
are united in one thing: they don't want to do anything
further that is "unpopular with the population."

Reports of MSZP Infighting are Overstated

8.(C) Veres chuckled when discussing the suggestion that a
government reshuffle that elevated erstwhile PM Gyurscany
rival Peter Kiss to Cabinet Minister, asserting that PM
Gyurscany has cannily developed a consensus in the Socialist
party. MSZP county leaders consulted on the government
changes and broader reforms, and they "know how to handle the
situation" from the top on down. Rather than being a rival,
Veres recalls Kiss as being right "in the kitchen with
Gyurscany" as the current reforms were being developed. As
Veres put it, only Gyurscany knows what intrigues lurk in the
government, but from his eye-witness perspective as Socialist
insider, he saw the recent reshuffle as the product of a
unified party rather than an attempt to coopt rivals.

Inflation; Growth; Transparency Affects of Tax Enforcement

9.(C) One of the stunning and unexpectedly positive aspects
of the reform program has been an increase in tax revenues,
and Veres supported his claim that this has "whitened" the
economy through dramatic increases in the rolls of taxpaying
workers in construction, catering, and other specialties
associated with side payments and off-the-books employment.
For this reason, both Veres and Kovacs discounted wage growth
as inflationary - the pay is just now becoming official.
Veres discounted market-surprising reports of a jump to 8.6
per cent year-on-year inflation in June (Ref A),saying that
inflation pressures through August were part of the
government's projections, but that everyone has already
become comfortable with the truly surprising fact, the speed
of the deficit reduction, particularly its growth-limiting
aspects. Recent Constitutional Court decisions forcing the
government to pay up to a half percent of GDP in additional
pension payments make Veres reluctant to speculate on a
deficit figure better than 6.5 per cent of GDP this year
(despite optimistic comments by SzDSz president and Economy
Minister Koka). He will let Gyurcsany speculate about GDP
growth as high as three per cent this year, but officially
expects it to reach at least 2.5 per cent. This early
recovery towards growth leads Veres to optimism about a sharp
decline in inflation this August, and a complete recovery
from the negative affects of the fiscal adjustment by the end
of 2008, with growth around four per cent in 2009.
FOLEY