WAITING FOR THE OTHER SHOE TO DROP: THE IMPACT OF

C O N F I D E N T I A L SECTION 01 OF 02 BUDAPEST 001139

SIPDIS

DEPT FOR EUR/CE, EB/OMA, INR/EC; USDOC FOR SAVICH; TREASURY
FOR ERIC MEYER, JEFF BAKER, LARRY NORTON; USEU FOR HAARSAGER

E.O. 12958: DECL: 11/24/2013
TAGS: ECON EFIN PREL HU
SUBJECT: WAITING FOR THE OTHER SHOE TO DROP: THE IMPACT OF
THE FINANCIAL CRISIS ON THE REAL ECONOMY

REF: A. BUDAPEST 1059

B. BUDAPEST 1006

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


1. (C) Summary. Although there is little agreement among
experts regarding Hungary's growth rate for 2009, most
business leaders remain pessimistic about the future. Some
sectors in the real economy have already begun experiencing
the negative effects of Hungary's economic slowdown, while
others may not feel the impact until next year. Effects on
the real economy are likely to become clear in January, when
companies will begin producing flash reports that reflect
fourth quarter results. AmCham and other business
organizations are increasingly urging the government to use
the international stabilization program as an opportunity to
enact economic reforms, but they are pessimistic about their
chances for success. End summary.


2. (U) Given the large number of external variables, there is
little consensus among economists and macroeconomic analysts
regarding the length and severity of the economic downturn in
Hungary. A rapid return to growth in Western Europe and
assistance to European automakers could mean a speedier
recovery in Hungary, which depends on Germany and other
Western European markets as a destination for exports. But
continued low domestic consumption levels and a slow return
to normalcy for financial markets may mean longer term
problems for Hungary.


3. (U) The GOH currently estimates that output will contract
by about 1 percent in 2009. More pessimistic outlooks -
including the Central Bank in its latest inflation report -
estimate a 2 percent decline in GDP for 2009, while others
predict a smaller decline or even a slight increase in growth
next year. The IMF forecasts that growth will not return to
its estimated potential of 3 percent, however, until after

2011.


4. (U) Many businesses outside of the financial sector that
do not rely heavily on external credit have thus far only
experienced limited effects of the economic slowdown. That
said, most business leaders are pessimistic - even by
Hungarian standards - about their prospects for 2009.

SOME COMPANIES ALREADY HIT...


5. (SBU) Some elements of the real economy have already begun
to experience the economic downturn's negative effects. In
the expectation of difficult times ahead, companies have
begun cutting costs and reevaluating less profitable business
units. Media and advertising firms are losing business due
to slashed marketing budgets. Similarly, technology
companies report that orders are down as companies delay
equipment upgrades and postpone IT investment.
Manufacturers, particularly those supplying the auto
industry, have also experienced a large falloff in orders.


6. (C) The availability of credit and financing continues to
be a problem for businesses. Citigroup's Head of Corporate
Banking Laszlo Balassy notes that in both the corporate and
consumer banking sectors, "only the best borrowers" have
access to funds. In addition, M&A attorney Andre Mecs told
us that he is aware of at least two acquisitions that were
canceled because of financing problems. FCS reports an
increasing number of requests from U.S. companies (and/or
their suppliers) for assistance with financing. For example,
FCS is working to help the importer of Arizona Tea, which has
orders from Hungarian retailers, but is unable to obtain
financing locally to make its purchases from the U.S. source.
Other U.S. companies have asked for FCS assistance in
putting them in touch with the EBRD, as other forms of
investment financing have dried up.


7. (U) In recent weeks, the number of reported layoffs,
production line closures and temporary stoppages have
increased significantly. On November 25, Alcoa, which
operates four factories in Hungary, announced the layoff of
734 workers, due to falling demand for cars. Other U.S.
companies, including GE and Delphi have also recently
announced layoffs. A popular financial website has even
created a counter to track the number of people layed-off in
Hungary as a result of the global economic crisis. Since the
beginning of October, the site estimates 6,383 people have
been layed-off from 55 different companies. Opposition
FIDESZ Party President Viktor Orban has publicly raised the
prospect of layoffs ultimately reaching 250,000.

BUDAPEST 00001139 002 OF 002



...OTHERS EXPECT THE PAIN TO COME SOON


8. (SBU) Even those businesses not yet feeling the direct
impact of the economic slowdown are preparing for a difficult
2009, and many are developing contingency plans to prepare
for "worst case scenarios." In addition to cutting expenses,
we have heard for some time that many foreign manufacturers
and banks were no longer reinvesting profits in Hungary; that
trend is likely to accelerate unless the current environment
improves. Unemployment is also expected to continue to rise.
A legal consultant told us that a number of companies are
preparing to institute large-scale collective dismissals.


9. (C) The continued decline in domestic consumption is
expected to significantly impact consumer electronic and
other businesses that rely on consumer spending. For
example, mobile service provider T-Com has noted an increase
in the bad debt ratio of consumers, and expects a slowdown in
the mobile telephone handset replacement rate.

A CLEARER PICTURE IN JANUARY


10. (C) A number of companies have indicated that "we won't
know how bad things really are" until the end of January,
when companies begin releasing reports for the fourth quarter
of 2008. Some of the more pessimistic observers believe that
this is when "panic will begin" once these figures fully
quantify for the first time how far company revenues have
declined.


11. (C) Comment. Most businesses we have spoken to believe
that 2009 will be a "tough year." Many business leaders also
believe that if Hungary does not take meaningful steps to
reduce government expenditures, lower the tax burden on
labor, and reform the pension and social welfare system,
Hungary will face an even more difficult future. Hungarian
National Bank President Andras Simor tells us privately that
he is making these points to government decision-makers but
admits candidly "I'm failing." The sense of many major
investors is that at best Hungary will lose ground to other
countries in the region, and at worst it could face another
financial crisis as investors lose confidence in the country.
AmCham Hungary and other business chambers are increasing
efforts to urge the government to use the IMF/EU/World Bank
stabilization package as an opportunity to enact difficult
but necessary reforms. Former Finance Minister Lajos Bokros
has been pressing this point, but believes the governing
party is "unable to correctly diagnose the disease" and thus
"incapable of finding the right treatment." Many business
leaders remain similarly skeptical about the government's
willingness and ability to move forward on reform, and for
many Hungarians the past months have been a "foreign attack"
rather than the logical consequence of bad policy. Without a
sober recognition of what happened - and what could happen
again without corrective action - one business contact warns
that "the IMF package will be like giving alcohol to an
alcoholic." End comment.
Foley