Since assuming power with an overwhelming parliamentary majority in May 2010, the Hungarian government of Prime Minister Viktor Orban has adopted a string of unpredictable economic policies. Ministers boasted about adopting an unorthodox strategy that would lead to at least 5% growth and trim the public debt ratio—in excess of 80% of GDP—inherited from the outgoing Socialist government.
Key elements of the strategy included so-called crisis taxes on selected activities, a hike in the standard VAT rate (to an international record of 27%), and forced transfer of defined-contribution private pensions into the defined-benefit public pension system. In addition, the government proceeded to weaken the courts and other independent institutions by appointing politically loyal heads or narrowing significantly their mandate.
The campaign to defang independent institutions peaked just before New Year's Day, when the parliament voted to amend the central-bank law. In the past, nearly every government has been critical of the National Bank of Hungary. Former Prime Minister Ferenc Gyurcsany attempted to influence the monetary council by packing it with four additional members. As it turned out, most of these members acted on the basis of professional judgment, disregarding the government's wishes.
But the most recent modification goes much further in paving the way for political interference—mainly through appointment of a new deputy governor—including in the management of foreign-exchange reserves. The purpose of these steps is clear. Senior government officials have criticized recent increases in the base interest rate—made necessary by the self-inflicted rise in risk premium—and proposed earmarking some of the central bank's reserves for off-budget public spending. (Personally, as a former member of the monetary council who for five years endeavored to bring Hungary's monetary policy making to international best practice, I am saddened by these developments.)
In Mr. Orban's words, the overall goal of his strategy was to secure fiscal sovereignty for Hungary. Stated plainly, this meant maximizing the scope for financing populist handouts and perpetuating the government's hold on power, while pretending to comply with the limits on public debt and deficits under the EU Stability and Growth Pact.
The new measures have undermined an already precarious business climate, as the credibility of economic policy deteriorated further from the low level that prevailed under the eight-year Socialist administration. Hungary has become the most vulnerable economy as the euro-zone crisis unfolds. Yet at the outset—contrary to the official view that Hungary is the victim of foreign speculators and of some sinister plot by politically motivated detractors—the new leadership was greeted with favorable expectations that it would clean Hungary's Augean stables. In fact, the risk premium on long-term government bonds declined by some 200 basis points in the run-up to the elections. However, this trend was quickly reversed, driven by disappointment with the new government's fitful measures and inadequate communication.
The systematic destruction of checks and balances resembles closely the institutional erosion that has taken place in Argentina and Venezuela, including nationalization of private pension funds, capricious taxation of the export sector, and political interference with the judiciary. The government's takeover of foreign-exchange reserves was the last blow to policy credibility in Argentina—well-documented by former central-bank governor Martin Redrado in his book "No Reserve."
While commodity prices remain high, both Argentina and Venezuela can stay afloat despite the enormous opportunity cost of these measures. For Hungary—lacking an abundant natural-resource endowment—amendment of the central bank law is severely damaging on two fronts.
First, Hungary can ill-afford to alienate financial markets much longer. This is already evident in the risk premium on government debt and the marked weakening of the forint. Indeed, the budgetary cost of interest payments above the average rate paid by the Visegrad neighbors (Czech Republic, Poland and Slovakia) is estimated to exceed €1 billion yearly and is rising. But this is small change compared to forgone real-money investment, stagnant growth performance and increasing risk of a full-fledged debt crisis this year.
Second, since joining the EU, Hungarian governments have not shied away from confrontation with EU institutions. But this has reached a new high with enactment of the new central-bank law. Besides derailing the prospects for EU and IMF financial support, Hungary could be subject to EU sanctions, including possible suspension of voting rights in these institutions if this move is interpreted as a violation of treaty obligations.
The time has arrived for Mr. Orban to reflect and draw some quick lessons from the recent past. It is not too late to step back from the collision course ahead. Specifically, he may want to consider reinstating the law passed a decade ago by his first government, which established central-bank independence.
Also, he would be well-advised to assign priority to implementing and strengthening a package of reforms announced last March but placed on the backburner, along with tangible steps to restore the integrity of the neutered institutions. Financial markets and EU member governments are ready to welcome such shift from a perilous experiment. Ironically, in the event, Hungary would soon enjoy the benefits of genuine fiscal sovereignty, much like the other Visegrad economies.
György Kopits; http://online.wsj.com/article/SB10001424052970204257504577148450196907834.html
Last Updated on Tuesday, 10 January 2012 08:44