8th Annual European Seminar of ELIAMEP, Island of Poros, 7-10 July, - - PowerPoint PPT Presentation

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8th Annual European Seminar of ELIAMEP, Island of Poros, 7-10 July, 2011 Adjusting to the Crisis: Policy Choices and Politics in Europe.

Julius Horvath, Central European University, Budapest Crisis, Adjustment and the New Economic Policy: Case Study of Hungary 2008-2011

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Introduction

1980-1990s Hungary is Liebling of foreign investors; 2004 EU

member

From approximately 2001/2002 internal political conflicts led to

irresponsible economic policy which together with global factors brought increased vulnerabilities and financial crisis in fall 2008

A rescue package from the IMF and the EU

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Introduction

Crisis had clear political implications to the ruling socialist-liberal

coalition:

In April 2009 April Prime Minister Gyurcsany resigns; new

technocratic government, with socialist-liberal support, introduces austerity package

As a result of the overall dissatisfaction and disillusionment the

• pposition party strengthened significantly, won the election in April

2010 and began to introduce a fundamentally different type of economic policy

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October 2008 Hungarian Crisis

• As external factors to Hungary led markets to begin to re-assess perceived

risk investors started to appraise Hungarian assets as more risky:

• forint weakens, around 14% against euro in the most stressful period; 7%
• n October 15
• the stock market had fallen to a two-year low
• central bank used interest rate defense of the forint as it raised its

benchmark interest rate by 300 basis points to 11.5 percent

• the inter-bank market and government securities market experienced

serious stress; foreigners wanted to sell Hungarian bonds, and with buyers very slow to buy; auctions to issue new government bonds were not successful

• financial institutions shortages of liquidity
• the shares of OTP, the leading Hungarian bank, fell drastically

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Why Hungary? Vulnerabilities as Perceived in Fall 2008

• Excessive fiscal deficit
• Maturity and currency mismatches in the financial system, both within

households as well as corporate sector;

• As forint weakened, both the household and the corporate sectors’ net

foreign currency liabilities increased, indirect risk to the banking system

• Hungary sensitive to movements in international capital markets as a

considerable proportion of financing depends on flows to Hungarian daughter-banks from their western European parents

• External debt high
• Wide current account deficit

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Why Hungary? Vulnerabilities as Perceived in Fall 2008

• Hungarian performance worse than the typical point of reference, the V-3:
• Growth in Hungary below 2% while V-3 around 7%
• Inflation above 7% in Hungary, under 3% in V-3
• Current account deficit was under 7% in Hungary, 4% in V-3
• Debt to GDP around 65-70% while the debts of the CZ and SK were under

30% and PO 50%

• In Fall 2008 Hungary seemed the weakest country in the region
• However, no real estate bubble

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Euro/Forint Exchange Rate 2007-2009

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December 2008, Corporate and Household Currency Mismatches

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Sources of the currency mismatches

• interest rate differentials; the relatively lower interest rate on

foreign currency drives credit growth in foreign currency; make domestic savings more attractive; the expectation of a stable or appreciating domestic currency

• funding of banks in foreign currency; banks have had large inflows
• f foreign currency funding (often from foreign parents), which they

have passed onto their clients

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Government Securities Held by Non-Residents

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6 largest parents of foreign-owned banks in HU, Brussels, May 20 2009

• The parent banks of the foreign-owned Hungarian banks behaved responsibly
• They reconfirm their commitment to maintain our overall exposure to Hungary.
• We also acknowledge that our subsidiaries in Hungary have been and will continue to

adjust to the current challenging economic environment. A need for additional capital cannot be excluded, and will be met as necessary

• We demonstrate our long-term commitment to the development of the Hungarian

economy; and signal our willingness to contribute to the efforts of the international community to respond in a comprehensive and well-coordinated manner to the crisis

• Bayerische Landesbank(Hungarian subsidiary: MKB Bank Zrt);
• Erste Group Bank AG, (Hungarian subsidiary: Erste Bank Hungary Nyrt);
• Intesa SanPaolo, (Hungarian subsidiary: CIB Bank Zrt);
• KBC Group (Hungarian subsidiary: K & H Bank Zrt);
• Raiffeisen International Bank Holding, (Hungarian subsidiary: Raiffeisen Bank Zrt);
• UniCredit Bank Austria AG (Hungarian subsidiary: UniCredit Bank Hungary Zrt)

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Additional Vulnerability: Low Fiscal Credibility of Policy Makers

Especially after 2006 election Policy Makers Credibility Problems Hungary’s 2002 election campaign heightened competition among

its political parties and propelled populism to such an extent that the subject of political litigation resulted in large monetary contributions from the state budget to various citizen groups

Examples include arranging for pensioners to receive a 13th

monthly payment or increasing the salary of public employees by 50% all in the hopes of securing votes.

Inefficient state monopolies, especially in transportation industry,

and fragmented and costly municipal systems added to it

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Additional Vulnerability: Low Fiscal Credibility of Policy Makers

Thus, government debt increase is not a result of mass

demonstrations but rather of political inter-elite conflicts

Changing the situation seems very difficult as those who receive

transfers feel that they are entitled to them

Tax evasion in Hungary is widespread; Till the new government flat tax introduced compared to the Czech

Republic, Slovakia, Hungarian taxes high

Vámosi-Nagy, the former vice-chair of the Hungarian tax authority

estimates that the non-official economy is around 20-25% of the GDP; this has tradition element, after 1848, 1948 form of society’s passive resistance against the power

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Government Expenditures as % of GDP, 2006-2008

1 2.1 1 1 .5 1 1 .3 9.0 8.8 8.8 1 0.6 1 0.5 1 0.5 1 0.7 9.6 9.2 1 0.1 9.7 9.2 1 0.2 1 0.1 1 0.3 1 4.9 1 5.2 1 5.4 1 4.2 1 3.6 1 3.5 1 5.6 1 5.3 1 5.4 4.4 3.6 3.3 4.0 4.0 4.0 2.4 2.4 2.5 4.0 4.0 4.0 2.2 2.0 1 .9 2.7 2.8 2.8 5.8 5.9 5.7 3.6 3.2 3.3 5.2 5.2 5.1

46.6 46.2 46.6 40.8 41.3 43.1 48.9 49.8 51.9 0.0 10.0 20.0 30.0 40.0 50.0 60.0 2006 2007 2008 2006 2007 2008 2006 2007 2008 HU VISE GRAD3 E U-15

Compensation of employees Purchase of goods and services Social benefits Investment Interest Other

% of GDP

Source: Kauffman (2008, p. 11)

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General Government Expenditures, 2009, % of GDP

Source: IMF (2011, p. 9)

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IMF Supported Program

A full-fledged crisis avoided with policy action from IMF and EU The IMF arrived when the first signs of a full-blown crisis had started

to emerge, and by trying to restore confidence

IMF a $15.7 billion loan 17-month Stand-By Agreement as part of a

program designed to ease financial market stress;

EU $8.4 and WB $1.3 billion The IMF immediately made available $6 billion, remainder to be

released in 5 installments subject to quarterly reviews

The Stand-By Arrangement was approved under the fast-track

Emergency Financing Mechanism of the IMF

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Bajnai Adjustment Program to Crisis

2009 new government with technocratic inclinations (Bajnai/Oszko)

turn away from the populist one; Gyurcsany/Veres

The IMF-supported program to implement a fiscal adjustment

package to ensure government’s financing needs decline; reductions in government wage and pension bill;

Also to maintain adequate liquidity and capital in the banking system Fiscal adjustment aim to provide confidence that the government’s

financing needs can be met in the short and possibly medium term

The stigma of IMF assistance helped to a frontal loss of the socialist-

liberal coalition in April 2010 election

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Bajnai Adjustment Program to Crisis

The Bajnai government efforts are illustrated in the ranking of

Hungary of European countries according to the size of their fiscal deficits

In 2007 Hungary had the highest fiscal deficit (as % of GDP) in

Europe followed by Greece, Romania, France and the UK.

In 2009 the ranking was led by Greece followed by Spain, Ireland,

UK, Portugal, Lithuania and the Slovak Republic, while Hungary was ranked 19th;

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Fiscal Deficit, % of GDP, 2007

Source: Purfield and Rosenberg (2010, p. 15) Note that in 2006 fiscal deficit was 9,2%

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General Government Debt 2007 versus 2009

Source: Purfield and Rosenberg (2010, p. 15)

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Pre-2010 Political-Economic Trap

Hungarian policy makers opted for a welfare model which they

cannot afford;

However, during the period 2002-2010 the discourse of the

• pposition was as if the ruling coalition was too ‘neo-liberal’

representing foreign, finance and former communist elite interests

While socialist-liberal camp was fiscally incompetent, it clearly was

pro-western and followed ‘modern politically correct’ practices; however opposition was still able to label them as non-democratic,

Under Bajnai a decrease in the government deficit; the opposition

argued that the deficit was created by the socialist-liberal coalition and the costs were to be paid by the people …

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Fundamental Shifts in Hungarian Economic and Other Aspects of Policy

April 2010 election changed Hungarian policy landscape The socialist-liberal coalition which ruled in 1994-98 and 2002-2010

substantially weakened as the liberals were voted out of the Parliament

In addition, far-right movement entered the Parliament, and the

ruling party reached a two-third majority which would allow them introducing Constitutional changes

Figures nicely document the pre-election atmosphere in Hungary

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Opinions about Current Economic Situation

Source: Wike (2010); results are from Pew Fall 2009 survey

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Opinion of Hungarians Concerning Their Economic Situation, 2009

Source: Wike (2010); results are from Pew Fall 2009 survey

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A Perceived Democracy Gap

Source: Wike (2010); results are from Pew Fall 2009 survey

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New Government: Changes in Mentalité and Discourse

Mentalité of the policy makers, i.e. their social mind which shapes

the notion what is possible went through a significant shift

The transition is considered as discredited and corrupt; state is to be

in the centre; belief in meritocratic power centre as compared to checks and balances

Emphasis on national sovereignty in economic policy making as

compared to being part of the international community

Old policies which tried to comfort to what was expected by the

international community led to lagging behind, crisis, dissatisfaction

Government introduced a thorough control of institutions in Hungary,

and sees its role as a historic one

Prime Minister speaks not about the new reform steps but rather

about re-organization of the country

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Shift in Economic Policy: Introduction of Flat Income Tax

Tax Bill approved in November 2010 introduced a flat 16% personal

income tax rate

Expected to boost domestic demand; led to increased savings of the

middle and upper classes as uncertainty prevails;

Labor related tax was too high as compared to other neighboring

transition countries, competitors of Hungary

Bartha, Nagy and Palócz (2011, p. 13): 400 billion forints of

additional income for households, 250 billion due to flat tax and 150 billion due to substantially increased child allowances

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Shift in Economic Policy: Discretionary Taxes on Large Corporations

• Initially government unsure about its position on the deficit, however after

some initial exchanges with the IMF and the EC the government decided to narrow the budgetary gap to 3.8% in 2010 and below 3% in 2011

• In 2010 the authorities introduced a special levy on financial institutions,

foreign-owned retail chains, telecommunication and energy companies

• This had net deficit-reducing effect of around 2 percent of GDP; this was

counter-balanced by introducing a flat marginal tax rate and generous child allowances with the effect of 1.75 of GDP (IMF, 2011, p. 7,8)

• Commercial banks to pay 0.15% of their adjusted 2009 balance sheet totals

in case it is below 50 billion forints, and 0.5% when above the 50 billion forints limit

• Whether sectoral taxes may have distortionary effects and thus undermine

growth, as the IMF claims, or they are to be seen as a legitimate sharing of the burden of adjustment as is the opinion of the Hungarian government;

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Shift in Economic Policy: Abolishing the Second Pillar Private Pension System

• In late October 2010 Hungarian Parliament approved the suspension of mandatory

social-security payments to private pension funds, first till the end of 2010

• Later this payment was totally abandoned. Basically, the government eliminated the

second pillar, around 40 000 people remained in it out of the previous 3.1 million

• As pension system was used as an escape from real solution mechanism; devoting

contributions to the second pillar were seen as potentially increasing a deficit in the first pillar

• Pension funds had high fees and low returns; result of investment to low-yielding and

low-risk securities, and also of low returns in recent financial crisis

• Under Bajnai those in the second pillar over 52 allowed to transfer into the first pillar
• Private pension funds in charge of the Pillar Two held government securities of an

approximate value of 10% of the GDP, of which around a half will be automatically cancelled and thus decreasing the overall debt, (IMF 2011b, p 15)

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Shift in Economic Policy: Dealing with the Currency Mismatches Effects

• n Households
• Parliament adopted a new law basically prohibiting foreign currency denominated

mortgage lending

• About 60% of the mortgage loans are denominated in Swiss Francs, “Stress tests

conducted by the Central Bank (MNB) suggest that the capital positions of most banks could absorb even a sharp additional forint depreciation.” (IMF, 2011, p. 12).

• Government introduced a moratorium on mortgage foreclosures and introduced a

support scheme to distressed mortgage borrowers; local government (through a national asset management fund) can acquire the property at foreclosure and may rent it back to the distressed borrower

• To decrease moral hazard only those low-income would be eligible who paid their

mortgage installments for at least 12 consecutive months. It is envisaged that around a one-third of distressed debtors might be eligible to participate in the scheme with estimated costs of around 0.5% of the GDP for the period of three years; (IMF, 2011)

• On average borrower had franc denominated mortgage debt at 160 forints per franc

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Currency Mismatches

Source: IMF (2011b, p.8)

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Shift in Economic Policy: Disabled and Early Pensioner Benefits, Low Labor Participation Ratio

• „The fact that Hungary's employment rate is just 56 per cent, the lowest in

Europe, is a disgrace.” Prime Minister suggested that the labor market participation rate should be increased to 75 per cent

• Government has opened a taboo question: in 2011 around 238 000 persons

receiving pensions and 338 000 receiving disabled benefits are below the retirement age

• After the fall of socialism the first non-socialist government has chosen the

‘weak confrontation’ approach, which is one of the sources of current economic troubles.

• For example, the highest number of job losers in 1992 was 663 000, about

340 000 of which were not registered as unemployed and joined the early retirement or the disability pension scheme (Ferge and Tausz 2002)

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Labor Participation Rates, Visegrad and EU-15

10 20 30 40 50 60 70 80 90 100 Hungary Poland Czech Republic Slovakia EU-15

Young workers (15-24) Prime age workers (25-54) Older workers (55-64)

Source: Flores (2008, p.7)

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Receiving Benefits before Retirement Age

Number of Persons January 2011, in billion forints Average per Person, forints Pensions 238 000 29 120 000 Miner’s Pension 16 000 2 135 000 Disabled Benefits 338 000 25 73 000 Widow’s Benefits 21 000 0.7 33 000 Total 613 000 56.7 ‐‐‐

Source: www.index.hu 2011 May 16 11:17

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Governance Issues

One of the first steps of the government was to introduce 98% tax

• n the severance payments in the public sphere; this tax was

introduced retroactively and was deemed unconstitutional by the Constitutional Court

The government arranged for a vote in Parliament in which the

rights of Constitutional Court were limited in budgetary matters, and afterwards introduced the measure

The ruling party when delegitimizing the socialist-liberal coalition

pointed to at times disarray by ‘too independent’ opinions of different political fractions

To prevent such a situation government from the beginning began to

curtail independent institutions’ opinion and activity (including the Fiscal Council, Constitutional Courts, and others)

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Relationship with the IMF

Disagreement with the IMF is seen from official IMF documents; for

example, IMF (2011) uses at times a harsh tone and critical remarks when evaluating the economic policy of the government

Minister of Economy speaks as if liberating Hungary from the IMF IMF also objects to changes introduced after April 2010, especially

tax cuts and discretionary taxes

IMF (2011, p. 19) from the approved amount 8.7 billion euros was

disbursed from the IMF and 5.5 billion euros from the EU

The new government decided in the summer of 2010 not to seek

completion of the remaining disbursements

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Situation in June 2011: Control of Vulnerabilities

Constitution sets a public debt ceiling of 50% of GDP, not clear how

to move there from the current level; local governments prohibited from issuing debt to finance current spending

Szell Kalman Plan

• labor market and social benefit reform; put public debt on a

downward path schedule

• spending cuts concentrate on social benefits, eligibility for early

retirement, disability pensions

• plan revised corporate income tax from 19 to 10 percent in 2013;
• increase fees on un-healthy goods

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June 2011: Control of Vulnerabilities

Hungarian growth in 2010 1.2%; 3.8 or 4.0% Polish and Slovak Government budget deficit for 2011 envisaged under 3% of GDP Plans to cut around 30 000 public-sector jobs out of the 700 000 Strong demand from Germany leads the Hungarian export and

remains the biggest force behind the successful adjustment

Retail sales remain low as higher unemployment than before the

crisis, slow wage growth, almost no credit constrains consumption

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Hungary Main Macro Indicators, 2007-2012

Source: IMF (2011, June)

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Retail Sales

Source: IMF (2011, June)

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Credit to Private Sector

Source: IMF (2011, June)

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Trade Balance, Foreign Exchange Reserves

Source: IMF (2011, June)

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General Government Expenditures

Includes transfer of Pillar 2 pension assets to the state 2007 2008 2009 2010 2011 2012 Source: IMF (2011, June)

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Current Account, Reserves

Source: IMF (2011, June) 2007 2008 2009 2010 2011 2012

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Forint-Euro 2000-2011

Forint - Euro 2000-2011

220.0 240.0 260.0 280.0 300.0 320.0 M a r

• S

e p

• M

a r

• 1

S e p

• 1

M a r

• 2

S e p

• 2

M a r

• 3

S e p

• 3

M a r

• 4

S e p

• 4

M a r

• 5

S e p

• 5

M a r

• 6

S e p

• 6

M a r

• 7

S e p

• 7

M a r

• 8

S e p

• 8

M a r

• 9

S e p

• 9

M a r

• 1

S e p

• 1

M a r

• 1

1

Source: MNB

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Gross External Debt

Gross External Debt (% of GDP)

0% 20% 40% 60% 80% 100% 120% 140% 160% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Non‐financial institutions Banks MNB General government Intercompany debt

Source: MNB

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Maturity Structure of Gross External Debt, % GDP

Maturity Structure of Gross External Debt (% of GDP)

0% 20% 40% 60% 80% 100% 120% 140% 160% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Long term Short term Intercompany debt

Source: MNB

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Currency Structure of Gross External Debt, % of GDP

Currency Structure of Gross External Debt (% of GDP)

0% 20% 40% 60% 80% 100% 120% 140% 160% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 HUF‐denominated debt Foreign currency‐denominated debt

Source: MNB

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Central Government Bond Holdings by Secotrs

Central Government Bond Holdings by Sectors

(% of GDP)

0% 10% 20% 30% 40% 50% 60% 70% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Non‐financial corporations Financial corporations General government Households Foreign investors

Domestic financial corporations and foreign investors prevail Source: MNB

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Short-term HUF-denominated Central Government Bond Holdings by Sectors Short‐term HUF‐denominated CG Bond Holdings by Sectors

(% of GDP)

0% 2% 4% 6% 8% 10% 12% 14% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Foreign investors Households General government Financial corporations Non‐financial corporations

Domestic financial corporations and households prevail Source: MNB

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Long-Term HUF-denominated Central Government Bond Holdings by Sectors Long‐term HUF‐denominated CG Bond Holdings by Sectors

(% of GDP)

0% 5% 10% 15% 20% 25% 30% 35% 40% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Foreign investors Households General government Financial corporations Non‐financial corporations

Foreign investors and domestic financial corporations prevail Source: MNB

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Foreign Currency Denominated Central Government Bond Holdings by Sectors Foreign Currency‐denominated CG Bond Holdings by Sectors

(% of GDP)

0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Foreign investors Households General government Financial corporations Non‐financial corporations

Basically all holdings are by foreign investors Source: MNB

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Real Exchange Rate in Hungary, 1991 Jan = 100,

Source: MNB, Csonto (2011)

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References

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Debreceni Egyetem, Közgazdaságtudományi Iskola, 2001, June

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Külgazdaság 2011, 3-4, 4-8

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