Identifier
Created
Classification
Origin
08BUDAPEST593
2008-06-13 13:25:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Budapest
Cable title:  

IMF ON HUNGARY'S ECONOMY: STABLE NOW BUT WARY

Tags:  PREL ECON EFIN HU 
pdf how-to read a cable
VZCZCXRO8744
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHUP #0593/01 1651325
ZNR UUUUU ZZH
R 131325Z JUN 08
FM AMEMBASSY BUDAPEST
TO RUEHC/SECSTATE WASHDC 3056
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE
UNCLAS SECTION 01 OF 02 BUDAPEST 000593 

SENSITIVE
SIPDIS

DEPARTMENT FOR EUR/NCE AND EB/IFD,OMA, AND INR/EC
TREASURY FOR JEFF BAKER AND LARRY NORTON

E.O. 12958: N/A
TAGS: PREL ECON EFIN HU
SUBJECT: IMF ON HUNGARY'S ECONOMY: STABLE NOW BUT WARY
ABOUT GROWTH AND SUSTAINABILITY

Summary
-------
UNCLAS SECTION 01 OF 02 BUDAPEST 000593

SENSITIVE
SIPDIS

DEPARTMENT FOR EUR/NCE AND EB/IFD,OMA, AND INR/EC
TREASURY FOR JEFF BAKER AND LARRY NORTON

E.O. 12958: N/A
TAGS: PREL ECON EFIN HU
SUBJECT: IMF ON HUNGARY'S ECONOMY: STABLE NOW BUT WARY
ABOUT GROWTH AND SUSTAINABILITY

Summary
--------------

1. (U) Growing concerns regarding Hungary's current growth
indicators and long-term sustainability have tempered an IMF
assessment team's "favorable" assessment of Hungary's
short-term, macro-economic indicators. The country has made
a good start in its deficit reduction plans but must continue
with stalled structural reforms. Its deficit remains the
highest in the region, and while it has been able to rein
this in since 2006 through revenue enhancements rather then
spending cuts, its ability to continue this as elections
approach is questionable. Hungary's bond market needs reform
as well to increase access for foreign banks to decrease
volatility. IMF analysts believe monetary policy decisions
have been grounded in sound judgment, noting the recent
removal of the exchange rate band and the recent increases in
the benchmark interest rate. But caution regarding fiscal
practices is still the order of the day, with a continued
focus on wages and inflation in the years ahead. End Summary.

A "Start"...But "A Long Way to Go"
--------------

2. (U) Assessing Hungary's macro-economic situation during
its regular Article IV consultations, IMF European Department
Assistant Director James Morsink privately briefed Ambassador
Foley on June 9. Morsink recently met with senior officials
in key government agencies and the Central Bank, as well as
with Prime Minister Gyurcsany and FIDESZ opposition leader
Viktor Orban. Morsink concludes that while current
short-term, macro-economic indicators are trending positively
and are "favorable" given the cyclical upturn, he is also
concerned about weak growth prospects for the long-term,
especially when compared to the regional average.


3. (U) Morsink believes indicators including positive GDP
growth, declining inflation, a narrowing current account
deficit, an improved trade balance due to weak domestic
demand, an upturn in private and public investment, and
higher labor productivity (output per worker) will be stable
in the short-term. He acknowledged, however, that these
figures are still weak when compared to other countries in
the region and recognized that labor participation is also

important. (Note: At 56 percent, Hungary's labor
participation rate is among the lowest in the EU countries.
End Note.) Morsink said that Hungary has made a "start" in
fiscal consolidation, but has "a long way to go" and faces
risks ahead.


4. (SBU) Morsink believes there is agreement among senior
government "technocrats" on what needs to be done -
significant structural reforms to cut government expenditures
and then lower taxes - but the lack of political will to do
so. On macro-economic vulnerability, he said that compared
to 2006, when the IMF was very concerned about this, Hungary
moved in the right direction last year. But he said there is
concern this year that the fiscal adjustments needed to make
further progress have "stalled."

Debt, Debt, and More Debt
--------------

5. (SBU) Concerning talk of tax cuts, Morsink said the IMF
view is that there is no "room for maneuver." He underscored
that tax cuts would be possible only if combined with cuts in
government expenditures. In a press conference on June 10,
Morsink elaborated further that tax cuts must be
deficit-neutral and cuts in labor taxes should be balanced
with increases in other taxes such as for consumption or
property. He also suggested potential expenditure reductions
through a combination of reforming welfare programs, health
care, education, and the pension system. Commenting that
Hungary has the largest debt in the region with high public
debt, high net external debt, and high gross external debt;
Morsink cautioned that Hungary must continue with macro
fiscal consolidation by reducing its fiscal deficit. While
the IMF believes Hungary may do even better than its 4
percent of GDP deficit target this year, it is concerned
about whether it can achieve its goal of 3.2 percent in 2009
with elections on the horizon.


6. (U) Hungary's government bond spreads are wider than
others in the region due to its high deficit, according to
Morsink. He gave the example of Hungary's recent floating of
a Euro bond issue worth 1.5 million Euros at 98 basis points.
The day before, the Czech Republic did something similar on
the same order of magnitude for 25 basis points. Morsink
predicted a major negative impact for Hungary if risk
appetite declines.

BUDAPEST 00000593 002 OF 002



Liquidity in the Bond Market: Increase Access
--------------

7. (SBU) Morsink explained that the factors contributing to a
freeze in the bond market earlier this year arose from global
financial markets being unsettled and the pension fund shift
towards equities. He believes these factors were largely
beyond the GoH's control, but implied that the pension fund
shift could have been better managed as they had been given
three years to do this. Morsink believes increasing access
for foreign banks to serve as bond dealers is the most
important change needed to increase liquidity in the domestic
bond market. The Central Bank has told Morsink that it will
take action on this proposal in January 2009. He explained
that foreign investors interested in the primary market would
play a stabilizing role since they would be more willing to
take the risk of investing in a small country like Hungary.
Morsink also said deepening the repurchase "repo" operations
market with the Debt Management Agency and commercial private
banks would help liquidity since people would be more willing
to take possession of bonds if they know they can get
liquidity given a deeper repo market.

Monetary Policy On The Right Track
--------------

8. (SBU) Commenting that the Monetary Council's decision to
remove the exchange rate band was a good thing, Morsink said
its subsequent decision to increase the benchmark interest
rate to 8.5 percent was also appropriate. He believes there
may be a need for further interest rate increases. But
Morsink also expressed concerns about the growing number of
foreign currency loans being taken by households (estimated
at up to 30 percent of outstanding loans) and cautioned that
inflation should be down to 3 percent on a 2-year horizon.
Emphasizing that nominal wage growth needs to come down,
Morsink said reduction in this will bring down core
inflation. He explained that with inflation turning out to
be higher than expected, the GoH could and may decide to
raise wages by 1 percent. The IMF was "surprised" by the
small uptick in GDP growth for the first quarter and believes
this is what may have contributed to the turnaround this year
in private sector wages, which he said was due mainly to the
increase in the minimum wage by sector.

Comment: Economists vs. Investors
--------------

9. (SBU) Economists and investors continue to look for ) and
to see ) different things as they examine the Hungarian
economy. Although the IMF team noted reduced concerns
regarding a prospective economic meltdown here, investors
continue to focus on growth, transparency, and
competitiveness indicators. In tempering its recognition of
progress on deficit reduction with a strong public message on
the importance of continued fiscal discipline, the IMF team
helped ensure that their assessment of macroeconomic
stability is not used to further stave off the structural
reforms that economists and investors agree are needed.
Foley