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.


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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