After Triggering Market Instability, Hungarian Government Scrambles to Reassure Investors

On Friday, 4 June, Hungarian markets tumbled in response to remarks from top government officials that government finances were in dire straits. The previous day, Fidesz party vice-chairman Lajos Kosa publicly commented that Hungary only had a slim hope of avoiding a Greek-like crisis in the near future. Kosa stated that public finances were far worse than his government had anticipated they would be when they came into office. Government spokesperson Peter Szijjarto, when queried about Kosa's comments, confirmed this feeling, citing a statement a year and a half earlier from then-prime minister Ferenc Gyurcsány that the government would indeed be in default without International Monetary Fund (IMF) support. Citing this statement, Szijarto claimed that Hungary's government had been on the brink of disaster for quite some time, and was only able to stave off financial ruin through heavy outside borrowing. Also on Thursday, 3 June, State Secretary Mihaly Varga estimated that the 2010 fiscal deficit could rise to 7.0-7.5% of GDP, soaring past the current, official budgetary target of 3.8% of GDP gap, due to what he claimed was falsified data from the previous government. This whirlwind of dismal fiscal prognostications sent markets tumbling. The forint fell to 288.80 per euro on 4 June, a nominal loss of nearly 5% over the course of one day. Meanwhile, interest rates surged and yields jumped.

Following the Friday instability, the government, over the weekend, moved to try to calm markets and amend what it had said at the end of the week. Specifically, Varga said that the dire warnings of a Greek-crisis were an "exaggeration" and that, despite the Socialist's fiscal irresponsibility, the Fidesz government would make all necessary cuts in order to reach the 3.8%-of-GDP deficit target for 2010. Varga nor any other top official gave any further details as to what the government's plans would be. The Secretary also tried to distance Hungary from other countries of Europe that face severe public debt risk problems. Varga promised that Fidesz would have an action plan by the end of meetings today.

Outlook and Implications

The new government is walking an extremely dangerous line. The conflicting information coming out of the government is likely indicative of a deep division on how policy should be pursued over the remainder of 2010—a division that would cause most investors some concern. In IHS Global Insight's view, the Friday, worst-case-scenario statements were aimed at providing the Fidesz government domestic political cover to break election promises of expansionary fiscal policy and, instead, to enact even more severe austerity measures than the Socialists had put in place for 2010. However, in expressing such worrisome expectations, the government—or at least the elements of the leadership that advocated for this policy—seems to have severely underestimated the risks surrounding such dire proclamations given the state of international investor markets in the wake of the Greek crisis. While official confirmation that the government would aim to meet the 3.8%-of-GDP target is actually even more austere than most analysts would have hoped for from Fidesz, the commitment to such a goal remains very much in question by markets. While we expect the forint and other markets to stabilise in the near future, they will remain extremely nervous, worried that the government may not stick to its promises.

During the election campaign earlier this year, Fidesz made grand proclamations about how it was going to stimulate growth through more expansionary fiscal policy, and that it was not beholden to the International Monetary Fund (IMF) or the European Union (EU) when formulating its economic policy. However, once in power, these promises have become nearly impossible to meet given the country's reliance upon IMF financing to meet public debt obligations and maintaining financial stability. This reliance is heightened even further in light of the Greek crisis, which has focused investor attention on public debt and finances, a focus that does not behove Hungary.

With these proclamations of doom, Fidesz can put the blame of the hardships of continued fiscal austerity squarely on the previous government, as well as, to some degree, the IMF. Fidesz's story line is that if they had been given a healthy budget, they would have been able to follow through on their promises, and cut taxes and increase spending. However, because the previous government handed them such high debt problems and fiscal irresponsibility, they instead had to submit to IMF pressures. What they have omitted is their own complacency in allowing public debts to begin to grow during their previous term in office, as well as their hostility as opposition members in parliament to austerity measures since 2006 that were designed to stem the rise in debt.

Ultimately, despite the difficulties in the markets in the short-term, and the negative ramifications that may arise from them—interest rates and inflation in June will likely be higher because of the forint's slide and the uncertainty surrounding fiscal policy—the last few days actually offer increasing hope that the country will indeed avoid a Greek-like scenario. By creating the political cover for their retreat from expansionary promises, and now by publicly proclaiming their intent to abide by the 3.8%-of-GDP deficit carte, Fidesz should soon be implementing enough fiscal cuts to help the country tighten the fiscal balance in the near future. Previously, one of our biggest downside risks for the Hungarian economy had been that Fidesz would try to ram through more expansionary policy in spite of global conditions, severely undermining stability at home. Reportedly, the government had a working agreement with the IMF that the Fund would accept a deficit of 5-6% of GDP in 2010 in return for fiscal changes that would limit deficits in the longer term.