Tens of thousands of Hungarian protesters have gathered in Budapest since Jan. 1 to voice their opposition to Hungary's controversial new constitution. The ruling Fidesz party used its unprecedented two-thirds majority in parliament to rewrite the constitution, and the document is being criticized on the grounds that it serves only to further entrench Fidesz's rule, as well as that of Hungarian Prime Minister Viktor Orban. Jan. 1 also saw the enactment of a new set of regulations concerning Hungary's central bank, Magyar Nemzeti Bank (MNB). These new rules, which merge the MNB with a government financial regulator and give the government the power to appoint its vice president, have been lambasted by the International Monetary Fund (IMF), the European Union and the United States, which say they reduce the MNB's independence. Budapest has responded by claiming that it incorporated 90 percent of the European Central Bank's recommendations into its new laws and that changes to the structure of the MNB would only take place after the current bank governor's mandate expires in 2013.
The international criticism highlights Hungary's economic problems, in addition to its much-publicized political ones. Hungary's debt profile is among the most fragile in Europe. The country's credit rating was downgraded to junk status by Standard & Poor's and Moody's Investors Service in 2011 and by Fitch Ratings on Jan. 6, and its currency, the forint, has fallen by nearly 20 percent against the euro in the past six months. Hungary also holds the largest amount of government gross debt in Central Europe: 82.6 percent of its gross domestic product (GDP), up from 72.9 percent in 2008, the year it asked for an IMF loan.
Markets' confidence has deteriorated since the IMF broke off negotiations with Hungary over a possible new loan in mid-December. In a failed bond auction Dec. 29, the Hungarian government raised less than half the amount planned (it wanted $138 million but only received $63 million) due to concerns that Hungary might not receive financial assistance from the IMF.
Budapest has issued mixed messages throughout the IMF negotiations: It began by seeking an IMF credit line early in 2011, and then in September shifted to saying it would solve the crisis domestically. Budapest returned to dialogue with the IMF in November, only to shift its priorities back to controversial economic policies in December. These policy shifts can be traced back to two core problems in the Hungarian system, one financial and one political.
Financial Problems
Hungary's financial problems began outside of Hungary. Like many Central European countries, it binged on cheap credit in the heyday of the eurozone, and a large swath of the population sought favorably priced, foreign-denominated loans. Today, about 60 percent of outstanding mortgages in Hungary are denominated in Swiss francs, and Hungarian households' Swiss franc debt amounts to almost 20 percent of GDP. The government's own foreign-denominated debt amounts to 32 percent of GDP. Hungary's financial problems are in part explained by a sharp rise in the value of the Swiss franc, brought on by the European financial crisis: the franc currently trades for about 254 forints, up from 160 in 2008.
Moreover, Hungary does not have full control of its own banking sector. More than 80 percent of the banking sector in Hungary is foreign-owned, with Austria alone controlling 15 percent of its banks. Italy, Germany and Belgium are all major players in Hungary as well, exposing the Hungarian system to a massive credit crunch should Western banks pull lending capacity in the region.
With little to no control over the root cause of the foreign problem, Orban's government sought symptomatic remedies to the crisis at home. In mid-September, the Hungarian government passed legislation that allows full early repayment of foreign-currency denominated mortgages at a fixed exchange rate of 180 forints to the franc — forcing the banks to shoulder the losses. Several foreign banks reacted by slowly downsizing their operations, cutting lending and slowing recapitalization in their Hungarian subsidiaries.
Political Problems
Hungary's current political situation is also peculiar: Fidesz rode a wave of popular angst against the ruling Socialist government to a landslide electoral victory in 2010. The overwhelming parliamentary majority that resulted left Orban with broad legislative powers and a weak, divided opposition. However, his exercising those powers to push through unorthodox legislation has put him in conflict with both foreign creditors and benefactors, which has caused him to continually switch from a defiant, populist stance at home to a conciliatory tone with the IMF and European Union.
Hungary must reach an agreement with the IMF to avoid further rating downgrades, foreign capital outflows, higher bond yields and the severe consequences that being cut off from international credit would bring to the domestic economy. Hungary faces almost 30 billion euros in central government debt maturities in the next three years alone. Unless Budapest reaches an agreement with the IMF, it will struggle to repay maturing external sovereign debt, or to refinance the debt at a reasonable cost. According to a report by French bank BNP, higher borrowing costs could lead to a 3 percent contraction of Hungary's GDP in 2012. Since Hungary will try to concede as little as possible to the IMF to obtain the necessary loan — engaging in strong rhetoric with foreign banks and the IMF along the way — any agreement is likely to be preceded by escalating financial instability.
The Fidesz government is acutely aware that Hungarians will experience austerity measures and increased taxes before the next electoral cycle in 2014 — regardless of whether an IMF loan can be secured. The new constitution reflects this concern. Its core amendments entrench the government's power and reduce the strength of the opposition by extending the terms of Fidesz allies in key posts in the police, armed forces and judiciary by up to 12 years. These amendments also reduce and redraw electoral constituencies to further weaken the erstwhile ruling Socialist Party and strengthen nationalist parties that would portray IMF-mandated austerity measures as foreign interventions.
Orban will continue to capitalize on his political opportunity to entrench Fidesz in power, but eventually he will have to concede to IMF-mandated austerity and financial transparency measures if he hopes to avoid risking further deterioration of the Hungarian economy.
