THE SICK MAN ... AND THE SICK COUNTRY

C O N F I D E N T I A L SECTION 01 OF 02 BUDAPEST 000373 SIPDIS SIPDIS DEPARTMENT FOR EUR/NCE; PLEASE PASS TO NSC FOR ADAM STERLING E.O. 12958: DECL: 04/07/2018 TAGS: PGOV PREL ECON KDEM HU SUBJECT: THE SICK MAN ... AND THE SICK COUNTRY Classified By: P/E COUNSELOR ERIC V. GAUDIOSI; REASONS 1.4 (B) AND (D) ¶1. (C) Hungary's political institutions risk grinding to a halt just as leading economic indicators reflect the realities of a stagnant economy. This correlation of public opposition to reform, continued gridlock in Parliament, growing concerns on the economic front, and the prospect of deepr social tensions have Hungary vying for the title of the new Sick Man of Europe. NOTHING TO SEE HERE ( ¶2. (C) Although the government will be eager to move past the wreckage of the referendum and the subsequent schism within the coalition, there are few roads left open. Faced by the prospect of ruling in a minority government ) if at all - Prime Minister Gyurcsany's attention will likely remain consumed by tactical considerations in the coming months. ¶3. (C) This will likely limit the GoH's activism on reform as well as its interest in foreign affairs. It will not, however, eliminate completely the prospect that the GoH will make the wrong choices for the wrong reasons. They might be predictable in this regard, but their oscillation on energy and even on NATO enlargement give the opposition ammunition to charge that the Gyurcsany government is not "reliable." Our contacts believe that the GoH will engage on foreign affairs only episodically given the low level of public interest; critics believe they will do so with a strong preference for easy solutions and short-term gains. In sum, we cannot rely on a common strategic vision that will motivate this government ) or the public - to make hard choices much less hard sacrifices. Rather, pragmatism will likely guide a minority government away from "radical reforms" that would run the risk of antagonizing any of its fragile bases of support. THE FORECAST CALLS FOR RAIN ¶4. (C) The Gyurcsany government will also be ill-equipped to deal with bad ) or worse ) news on the economic front. The nearly evaporated bond market in early March proved an unwelcome wake-up call for a high borrowing government, particularly as the rising cost of borrowing has eliminated their budget flexibility. Moreover, with political initiatives constrained, the government is left with no major likely response to anemic growth, declining foreign direct investment, and a contraction in the bond market. These factors have combined with record unemployment, steady inflation, and continued concerns re transparency. In sum, Hungary has minimal insulation from broader international financial trends and few tools to employ in attempting to ameliorate their impact. ¶5. (C) Confidence is questionable at all levels of society. Opinion polls indicate that a near-majority of Hungarians live paycheck-to-paycheck, and one of the richest men in Hungary has publicly ruled out additional investments here in favor of opportunities further east. National Bank President Simor ) himself a dark horse candidate if theparties turn to a technocrat to take the reins ) believes the business community needs to press the political class for some resolution to the present political impasse. PAIN MANAGEMENT ¶6. (C) Economic stagnation would, in turn, further undermine Gyurcsany's "light at the end of the tunnel" rhetoric regarding "the end of austerity." Although he is clearly putting reforms in neutral, both his party and the public may not be content with anything less than movement in reverse. If recent history is any guide, the party may turn to spending increases as a way to at least minimize their losses in the European Parliamentary elections of 2009 and the national elections of 2010. We understand, for example, that the government is considering legislation that would allow local governments and enforcement agencies broader rights ) and a lower bar ) to raise revenue by fining corporations; this could pave the way for more spending simply by further increasing revenue. ¶7. (C) Falling off the wagon on spending could derail progress on deficit reduction, but given the current siege mentality within the MSzP the party will be tempted to choose its political ambitions over practical but unpopular accomplishment. Finance Minister Veres, a seasoned survivor as one of Hungary,s longest-running ministers of finance, has staked his reputation within the government and within the European Union as a deficit fighting fiscal hawk. National Bank Governor Simor believes that the government will retain his focus on this issue as it begins to prepare BUDAPEST 00000373 002 OF 002 the 2009 budget. He believes that the current international risk environment promises swift, and potentially costly, market response to any slippage, but many in the business community fear that the government has made deficit reduction the only measure of success, failing to take into account broader issues of competitiveness and macroeconomic performance. GOVERNMENT IN SLOW MOTION ¶8. (C) If economic risks are expanding, the political system is contracting. Should the MSzP and the SzDSz prove unable to bridge their differences before April 30 (reftel),we will likely see a (further) slowdown in Parliament. Sources across the political spectrum predict that a minority government would move very selectively on legislation, focusing on areas where the MSzP and the SzDSz can agree. Under the present leadership of both parties, few such measures leap to mind. ¶9. (C) Minister Veres further narrowed the scope in a September 3 speech, saying that his preference was for as few as 4 pieces of legislation narrowly tailored to meet shared MSzP, SzDSz and large portion of Fidesz support, such as a disciplined 2009 budget. For its part, a public strongly attached to public services might welcome a government that governs less with respect to reform ( as long as it provides more with respect to benefits. SICK TO DEATH? ¶10. (C) These factors leave the country ill-equipped for bad news. However much he has come to epitomize the problems here ) and his impulsive, impolitic governing style has certainly compounded the problems - Gyurcsany may not be the sick man: Hungary might be. Although Gyurcsany is a weakened Prime Minister, leading a divided party within a fractured coalition, Hungary's institutions may be weaker still. ¶11. (C) As the March 9 referendum demonstrated, voters are united against elements of the Prime Minister's policies. But they are not united on a way forward, often prompting observers to conclude that Hungarians live in one country but two realities. As commentator Zsolt Balla noted, Hungarians continue to question the value of profit, the importance of private ownership, and the vitality of their own democracy. Business leaders and others question when Hungarians will be spurred to do more than complain about falling behind their neighbors in incomes and job prospects. If stagnation is the illness, then the first task is finding a willing patient. EXTREME SOLUTIONS; MODERATE EXPECTATIONS ¶12. (C) Whoever succeeds Gyurcsany will likely find a high degree of gridlock and a low level of support for reform. Surveying the economic risks, the legal sclerosis, and political divisions, former Minister of Justice and Law Enforcement Albert Takacs does not rule out a "Weimar Hungary" in which the government cannot govern, the economy cannot recover, and the public cannot resist the temptation of easy and extreme solutions. Former SzDSz President Gabor Kuncze commented wryly that through a combination of ambition, improvisation, and miscalculation, Hungary's parties had managed to "build a rock that's too heavy for us to lift." He fears that "the nation's political elite has divided the country and disqualified itself in the eyes of the public." As the government works to convince the public that there is "a coalition crisis but not a government crisis," Kuncze believes a national crisis is looming. ¶13. (C) This means our expectations for Hungary's level of attention ) and commitment - should remain modest in the medium-term. Our vigilance on the internal dynamic, meanwhile, should increase. There is a sense among many Hungarians that its membership in NATO and the EU ) and its relationship with the United States ) has decreased Hungary's sovereignty and increased both its responsibilities and its risk. Any new government will have to address Hungary's internal ills ) real and imagined ) before it can realistically increase its constructive engagement in international affairs and reasonably expect to wield the moral authority to unite a divided public. FOLEY