Identifier
Created
Classification
Origin
08BUDAPEST1059
2008-11-06 13:38:00
CONFIDENTIAL
Embassy Budapest
Cable title:  

THE WOLF FROM THE DOOR...AND THE ELEPHANT IN THE

Tags:  ECON EFIN PREL HU 
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VZCZCXRO4609
RR RUEHAG RUEHROV
DE RUEHUP #1059/01 3111338
ZNY CCCCC ZZH
R 061338Z NOV 08
FM AMEMBASSY BUDAPEST
TO RUEHC/SECSTATE WASHDC 3544
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE
C O N F I D E N T I A L SECTION 01 OF 03 BUDAPEST 001059 

SIPDIS

DEPARTMENT FOR EUR/CE, EB/OMA, INR/EC
TREASURY FOR ERIC MEYER, JEFF BAKER, LARRY NORTON

E.O. 12958: DECL: 11/05/2013
TAGS: ECON EFIN PREL HU
SUBJECT: THE WOLF FROM THE DOOR...AND THE ELEPHANT IN THE
LIVING ROOM: FROM FINANCIAL STABILIZATION TO ECONOMIC REFORM

REF: BUDAPEST 954

Classified By: P/E COUNSELOR ERIC V. GAUDIOSI; REASONS 1.4 (B) AND (D)

C O N F I D E N T I A L SECTION 01 OF 03 BUDAPEST 001059

SIPDIS

DEPARTMENT FOR EUR/CE, EB/OMA, INR/EC
TREASURY FOR ERIC MEYER, JEFF BAKER, LARRY NORTON

E.O. 12958: DECL: 11/05/2013
TAGS: ECON EFIN PREL HU
SUBJECT: THE WOLF FROM THE DOOR...AND THE ELEPHANT IN THE
LIVING ROOM: FROM FINANCIAL STABILIZATION TO ECONOMIC REFORM

REF: BUDAPEST 954

Classified By: P/E COUNSELOR ERIC V. GAUDIOSI; REASONS 1.4 (B) AND (D)


1. (C) Summary. With the immediate crisis seemingly averted
and with discussions underway with the IMF, EU, and the World
Bank on the details of the international stabilization
package, the economic debate in Hungary is beginning to shift
toward a closer examination of the steps the government is
proposing to meet the terms of the agreement, and to a
broader discussion of economic reforms needed in Hungary.
Given the minority government's relatively weak position and
the return to politics as usual in Hungary, it is uncertain
whether deeper economic reforms beyond steps required to meet
stabilization package requirements will be achieved in the
near term. End summary.

A BAD MOON RISING


2. (SBU) Most economists and analysts believe the financial
stabilization package for Hungary is large enough to help
Hungary meet its public and private financing needs through
the end of 2009, and that the size of the package and speed
of its negotiation have sent a positive signal to help
restore a degree of investor confidence. Indeed, market
reactions over the past week have been largely positive, with
both the forint and the stock exchange showing signs of
stabilizing and recovering some of the value lost in recent
weeks.


3. (C) Many caution, however, that Hungary's acute
vulnerability reflects much deeper economic problems that, if
not addressed, could lead the country back to the precipice
of significant capital flight. Throughout our recent and
extensive survey of economic analysts and business contacts,
most have argued that the stabilization package should not be
seen as a safety net, but rather a springboard for reform.
Furthermore, they believe that Hungary only has a limited
window in which to address these issues.

LOOKS LIKE WE'RE IN FOR NASTY WEATHER


4. (C) As economic analysts begin looking beyond disaster
aversion to the effects of the global financial crisis on the

real economy, many believe Hungary faces a difficult road
ahead. Although the EU currently forecasts growth for Europe
resuming as early as the third and fourth quarters of 2009,
even the government considers this to be optimistic, and many
predict that Western Europe's demand for Hungarian exports
will not recover so quickly. October exports declined 7
percent year-on-year, the largest drop in over five years.
Lower domestic consumption is also expected as a result of
austerity program measures reducing real incomes. Together
with shrinking export markets, this could cause a sharp
increase in unemployment, with some estimating as many as
300,000 newly unemployed.


5. (U) Indeed, manufacturing has already been affected, with
a number of factories and businesses announcing layoffs,
production line interruptions, and closures. Industrial
output fell 2.4 percent in September. Recent layoffs
contributed to a 0.2 percent increase in unemployment, and
this trend is expected to continue. Moreover, the reduced
availability of credit will continue to affect businesses,
and new construction continues to slow. Retail sales figures
are also down as domestic consumption levels drop, along with
consumer confidence and the purchasing index.


6. (C) Although the government is proposing new measures to
help SME's and to increase public works projects, there is
increasing concern that austerity measures and growing
economic dislocation could cause greater levels of labor
unrest. The presumption that the crisis was "created" in
foreign countries to benefit foreign companies is already in
the air, and political analysts caution that it may give rise
to an increase in right-wing extremism.

I HEAR HURRICANES A BLOWING


7. (U) In order to meet deficit reduction requirements in the
IMF package, the government has announced a series of
measures, including the institution of a freeze on public
sector wages, eliminating next year's 13th month bonus, and
limiting the amount of 13th month pensions, as well as the
number of people who qualify for it. In addition, the
government announced plans to dedicate existing EU
development funds to support SMEs (1,000 billion HUF) and to

BUDAPEST 00001059 002 OF 003


promote a major public works campaign (1,800 billion HUF).


8. (C) Many analysts believe that these measures do little,
however, to address underlying causes of anemic growth in
Hungary. Despite assurances by Minister of Economy Gordon
Bajnai that the government is ready to pursue reforms in
areas including party finance and public administration, many
remain skeptical of both the minority government's ability as
well as its intentions. Although his poll numbers have
recovered slightly over the past two weeks of crisis
management, Prime Minister Gyurcsany still lacks the personal
credibility and the political capital to marshal the
two-thirds majority in Parliament required by most structural
reforms. With the 2010 national elections just 18 months
away, betting here is that the government will walk back on
additional austerity measures now under discussion by next
year.


9. (SBU) There is a surprising amount of agreement among
policymakers and economic analysts about why Hungary has been
Central Europe's slowest economic performer in recent years.
They note that the country's high taxes on labor and one of
the highest redistribution rates in Europe continue to stifle
economic growth. The current tax, pension, and social
benefit systems do not incentivize employment, and contribute
to Hungary having one of the lowest labor participation rates
in the EU. An oversized bureaucracy and high levels of tax
avoidance burden the government budget and make spending cuts
and the reduction of Hungary's large national debt more
difficult. Finally, many believe that the political party
finance system contributes to corruption and a lack of trust
in public institutions (reftel).


10. (SBU) Many believe that Hungry must address these issues
now, or else risk falling further behind other countries in
the region. FIDESZ-era Finance Minister and former Central
Bank Governor Zsigmond Jarai maintains that the economic
policies of the current government are causing foreign
investors to seek opportunities elsewhere, and leads foreign
companies already in Hungary to repatriate a higher
percentage of their profits. He notes that foreign companies
in Hungary only reinvest around 30 percent of profits, which
is significantly lower than Slovakia (over 50 percent),or
the Czech Republic (approximately 60 percent). Analyst Tamas
Vojnits also notes that FDI levels in Hungary have begun
decreasing, and prominent development mogul Sandor Demjan -
who now focuses solely on investments abroad - predicts that
Hungary will become "the poorest European nation in 15 years
without structural reform."

...THE VOICE OF RAGE AND RUIN


11. (C) Despite initial hopes, the financial crisis failed to
lead to a new national consensus on the way forward. During
negotiations with the IMF, government attempts at achieving
buy-in from other parties appeared limited to achieving
enough support to be assured successful passage of
stabilization package-related measures in Parliament. Major
opposition party FIDESZ, after initially limiting its
criticism of the IMF deal, has resumed its criticism of the
MSzP for both the specifics of the package as well as the
secrecy in which it was negotiated. To date, the opposition
has criticized the stabilization package on several grounds,
denouncing it variously as a "shameful loss of sovereignty"
and as an "insufficient impetus for reform."


12. (SBU) Although FIDESZ Parliament Budget and Finance
Director Mihaly Varga agrees that the IMF package was
necessary in order to halt a possible contagion effect in the
region, he is doubtful that the government will enact
structural reforms that will help economic growth in Hungary.
He said that the IMF has been misled into believing this is
a financial crisis only, and everything else is OK. But when
welfare expenditures increased to 25 percent of the budget,
and pensions are 11 percent of GDP, and it is more attractive
to be on welfare than to work, the economic problems run alot
deeper than the financial crisis. Former FIDESZ Finance
Minister Jarai also expressed doubt that the government will
take on reforms with a year and a half remaining prior to
elections, and cautioned that "unless Hungary solves the
underlying economic crisis, we will face another financial
crisis."


13. (C) But FIDESZ has stopped short of offering a detailed
and comprehensive alternative. Last week Mr. Varga told the
Ambassador that Hungary should seek even greater reductions
in the deficit, and identified local and community

BUDAPEST 00001059 003 OF 003


governments as an opportunity for cost reductions, but at the
same meeting indicated his party "can't support freezing
wages." Mr. Jarai went even further, commenting that the
government should not just reduce the size of the deficit,
but should work toward a budget surplus in order to reduce
the level of government debt. At the same time, however, a
growing chorus of FIDESZ MP's like Debrecen Major Lajos Kosa
criticize the cuts the government is proposing as taking away
money from families, pensions, and healthcare. Still others
tell us privately that the party would have been amenable to
supporting the package in exchange for the government's
commitment to call early elections or replace the prime
minister.

PAIN WITHOUT GAIN


14. (C) Comment. By Hungarian standards, the government
acted quickly and decisively in reaching an agreement with
international financial institutions to address Hungary's
immediate financing problems. As the opposition readily
points out, however, the underlying causes of the problems
are largely of the government's own making. Although the PM
has made reference to austerity measures as being "the first
phase" of a "long crisis," now that the country appears to be
out of immediate danger, many in the diplomatic community
fear the government may content itself with doing the bare
minimum on austerity measures in keeping with the
stabilization package requirements. But further reforms are
necessary - and even convenient with the International
Community as the logical scapegoat. A course of inaction
from the GOH could be the last straw for foreign investors
who fear that the government has not recognized the origins
or the extent of the problem. As one senior AmCham official
cautioned, the GoH risks appearing foolish - or of taking
investors for fools. Even with foreign aid available in the
near-term, it can ill afford to further alienate foreign
investment by continuing what FIDESZ Parliamentary Faction
Leader Tibor Navracsics describes as a pattern of "wasting
one day at a time." End comment.
Foley