THE FORECAST CALLS FOR PAIN: GLOOMIER THAN

C O N F I D E N T I A L SECTION 01 OF 02 BUDAPEST 000053 SIPDIS DEPARTMENT FOR EUR/CE, EB/OMA, INR/EC TREASURY FOR ERIC MEYER, JEFF BAKER, LARRY NORTON E.O. 12958: DECL: 01/20/2014 TAGS: EFIN ECON PREL HU SUBJECT: THE FORECAST CALLS FOR PAIN: GLOOMIER THAN EXPECTED GROWTH TO RESULT IN BUDGET REVISION REF: 08 BUDAPEST 1201 Classified By: P/E COUNSELOR ERIC V. GAUDIOSI; REASONS 1.4 (B) AND (D) ¶1. (U) Summary. Worse than expected economic forecasts for 2009 mean that Hungary will not meet its budget deficit target of 2.6 percent without cutting expenditures or raising taxes. The GoH is in the process of reviewing possible new measures, which are expected to be announced within the next two weeks. In addition to new taxes and spending cuts, the government is also reportedly considering needs-based testing for social programs. The GoH is likely to allow the 2009 budget deficit to be higher than the planned 2.6 percent, but still below the 3 percent limit established by the Maastricht criteria. More substantial reforms, however, remain unlikely. End Summary. FOUL WINDS BLOW IN FROM BRUSSELS ¶2. (SBU) Although less severe than many analysts expected, in its revised forecasts issued Monday, the EU now projects that the Hungarian economy will contract by 1.6 percent in 2009. The EU also projects a lower inflation rate of 2.8 percent. The forecast for Hungary was impacted by the EU's downward revision of forecasts for the German, Austrian, and other Western European economies, which receive a majority of Hungarian exports. The EU's forecast for Hungary is optimistic compared with the consensus position of local analysts, however, who now predict a 2.5 contraction in the Hungarian economy in 2009. ANOTHER BUDGETARY DO-OVER ¶3. (SBU) Hungary's current budget is based on estimates of a 1 percent economic contraction in 2009, and an inflation rate of 4.5 percent. As a result of worsening economic growth forecasts and a lower than expected rate of inflation, it appears unlikely that the GoH expenditure cuts enacted to meet the IMF's 2.6 percent deficit reduction target for 2009 will be sufficient. Analysts predict a shortfall of approximately HUF 200-300 billion (USD 1-1.5 billion) in order for the government to meet its 2.6 percent deficit goal, and Prime Minister Gyurcsany has called the economic situation "Hungary's worst crisis since 1945." ¶4. (SBU) As a result, the GoH announced it will introduce new measures in the next two weeks to cover the anticipated budgetary shortfall - the fourth set of changes required for the 2009 budget, confirming for many that the government failed to adequately predict the impact of the global financial crisis on Hungary. As Parliament prepares to return in emergency session on January 29, there is considerable speculation as to what steps the government will take to ensure Hungary achieves its budget deficit target, including the possibility of new tax increases and spending cuts. There is also speculation that the government will allow the 2009 budget deficit to exceed its former deficit target of 2.6 percent. TAX, SNIP OR GET OFF THE SPOT? ¶5. (SBU) Many believe that the government will cover the majority of the anticipated shortfall by raising taxes. Analysts predict the government might impose additional excise taxes, or possibly raise the VAT rate by as much as 2-3 percent over its current level of 20 percent. One analyst estimates that this could increase revenues by approximately HUF 250-300 (USD 1.25-1.5 billion) in 2009, and points out that lower inflationary pressures provide scope for a possible tax increase. The major opposition FIDESZ party and former coalition partner Free Democrat party, however, both oppose increasing the VAT rate. Finance Minister Veres told the media that in order to partially offset the loss of budget revenues, "we do not want to rule out the possibility of tax hikes" but commented that "certain types of taxes may be lowered to improve Hungary's competitiveness, necessitating other types of tax hikes." Some analysts speculate that this might mean that the government will lower income taxes or social welfare contributions. Economists and international financial institutions have been urging the Hungarian government to move away from its high reliance on labor and employment taxes (REFTEL) and to move increasingly toward consumption-based taxation. ¶6. (SBU) The government may also try to make up some of the difference through additional spending cuts. Some observers BUDAPEST 00000053 002 OF 002 believe the GoH might introduce means testing and additional work incentives for social benefit recipients in order to reduce government spending on social assistance programs. On January 19, Social Affairs and Labor Minister Erika Szucs announced that high income individuals might no longer be eligible for certain social benefits like family allowances. ¶7. (SBU) But tax increases and spending cuts may not be all the government has in mind. Before the release of the revised forecasts, Finance Minister Veres hinted to the Ambassador that if growth rate figures are much worse than originally expected, the IMF may not hold Hungary to its 2.6 percent deficit commitment. On January 13, visiting IMF director Strauss-Kahn made the point even more directly, noting that the IMF might accept a revision to the deficit reduction target, stating that "economic circumstances have changed" and that "we may need to modify our original deficit target - we do not wish to have a dogmatic standpoint." THE PATH OF LEAST RESENTMENT ¶8. (C) Comment. Given its track record, we expect the GoH will likely choose the path of least resentment, preferring to rely primarily on tax increases to generate additional revenue rather than undertake politically difficult reforms. At a party event on January 16, FIDESZ Party President Viktor Orban commented derisively that the government had become "a weatherman - making bad predictions but not hard decisions." We expect the government's revised budget will include tax increases - possibly in the form of excise tax and VAT increases - along with some modest expenditure cuts to meet a less ambitious deficit reduction target for 2009. The Government appears committed, however, to ensuring any new budget target remains below the 3 percent Maastricht criteria level. Having already succumbed to trade union pressure to roll-back some of the expenditure cuts affecting Hungary's bloated public sector, we do not expect the government to undertake substantial new austerity measures in its forthcoming budget revisions, despite the Prime Minister's call for a "return to reform." Gyurcsany remains ambivalent at best on the issue, however, and Minister of Economy and Development Gordon Bajnai tells us that "reform is not yet the policy of the governing party." This may still leave room for some limited reform of the social benefit system to introduce some needs-based criteria, but it seems likely that the government will do as little as possible even as the prognosis for 2009 worsens. End comment. Foley