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

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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