SCENE-SETTER FOR TREASURY ACTING DAS ERIC MEYER

UNCLAS SECTION 01 OF 02 BUDAPEST 000681 SENSITIVE SIPDIS DEPARTMENT FOR EUR/NCE AND EB/IFD,OMA, AND INR/EC TREASURY FOR DAS ERIC MEYER, JEFF BAKER, AND LARRY NORTON E.O. 12958: N/A TAGS: PREL ECON EFIN HU SUBJECT: SCENE-SETTER FOR TREASURY ACTING DAS ERIC MEYER VISIT TO BUDAPEST ¶1. (SBU) Your visit comes as the Parliament has recessed for the long summer "cucumber season." With the dissolution of the MSzP-SzDSz coalition following the national referendum on elements of Prime Minister Gyurcsany's reform agenda this spring, the government is now feeling its way forward without a Parliamentary majority. ¶2. (SBU) Despite continued progress since your last visit in March on deficit reduction, growth remains stagnant, transparency suspect, and unemployment slowly inching toward eight percent. Higher fuel and food costs have kept inflation over 6 percent, and there is the constant risk that the government will revert to form and increase spending as the 2009 European Parliamentary and 2010 Hungarian national elections approach. Economic uncertainty and political gridlock, in turn, have contributed to a climate where extreme "solutions" have gained currency and frustration with the system itself has gained traction. As one AmCham executive stated, "Hungary is running out of time." ¶3. (SBU) Your visit is on the heels of the recent IMF Article IV consultations, which concluded with a "favorable" assessment of Hungary's short-term, macro-economic indicators tempered by concerns over long-term sustainability. The IMF team emphasized the country has made a good start in its deficit reduction plans but must continue with stalled structural reforms. The country is also in the midst of celebrating the unexpected news of its recent selection over other countries in the region for a new Daimler car plant, expected to add another 1 to 1.5 percent to Hungary's GDP. We are, however, concerned that this perhaps undeserved vote of confidence, given the government's record on competitiveness, may heighten their aversion to reforms which could further damage their standing in the polls. ¶4. (SBU) While the GoH has not set a target date for the Euro, the country's Euro Coordination Committee (co-chaired by the Finance Minister and National Bank Governor) recently released a plan stating that Hungary could join the ERM-2 in 2009 with the possibility of setting a date for Euro entry at that time. ¶5. (SBU) Your schedule begins with Ministry of Finance Director for International Relations Zsuzsanna Varga and Deputy Director Economic Policy Toth Laszlo. Finance Minister Janos Veres has underscored his commitment to expediting resolution of the outstanding issues in our bilateral tax treaty. He confirmed that the GoH will resume negotiations on July 7. You may want to take the opportunity to ask for a status on the progress of these negotiations and to remind the Ministry of Finance of its end of 2008 deadline. Veres has also recently announced promised tax cuts for 2009 coupled with reduced spending and a further whitening of the economy. Foreign businesses would particularly welcome the elimination of the 4 percent "solidarity tax," but we are concerned that the government's emphasis on "revenue neutral" measures indicates an intention to simply move to another tax category. ¶6. (U) KOPINT TARKI Research Insitute Senior Researcher Attila Bartha will provide you with a general overview of macroeconomic issues in Hungary and the region. ¶7. (SBU) We have invited former Finance Minister and Central European University Professor Lajos Bokros to lunch with you and Ambassador Foley. His famous "Bokros Package" of austerity measures in the 1990s gives him great credibility on economic issues, and he has been a vocal and vigorous proponent of continued structural reform. ¶8. (U) You will meet with Hungarian Debt Management Agency Director Andras Rez. Rez will provide you an overview of the country's ability to maintain reductions in its current debt as a percentage of GDP, still the highest for the region. ¶9. (U) Your meeting with Hungarian National Bank Deputy Director for Economic Analysis Agnes Csermely, comes at a time as the Forint strengthens against the Euro, breaking records at its highest level since the Euro was introduced. The National Bank also recently surprised the market by keeping the benchmark interest rate at 8.5 percent at its last session in June, which ran counter to its recent practice of increasing the prime rate. ¶10. (U) Your schedule allows for some down time before early evening drinks and dinner. BUDAPEST 00000681 002 OF 002 ¶11. (SBU) We've arranged for you to have early evening drinks with Krisztian Orban, Oriens Investment Management Founder and Managing Partner. Orban makes the rather compelling argument that high state expenditures, a high tax burden on labor, and the low labor supply creates a vicious cycle of low economic growth in Hungary. His presentation has been provided to you separately by email and includes a proposal for reform to break this cycle. This presentation was briefed to the leadership of the governing party, but we understand their emphasis on avoiding "social instability" led to the rejection of his recommendations. ¶12. (U) You will have dinner with AmCham member and Deloitte Hungary partner Dr. Attila Kovesdy to conclude the day. An expert on Hungarian taxes, Kovesdy can explain the mysteries of the country's cumbersome tax system and the tax reform plans being considered by the GoH. ¶13. (U) We look forward to welcoming you in person. Foley