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

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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