Analysis: Hungary's Ever Closer Union

By SAM VAKNIN, UPI Senior Business Correspondent

SKOPJE, Macedonia, March 21 (UPI) -- Russian mobsters love Budapest -- and not only for its views and cosmopolitan atmosphere. They can easily obtain a Hungarian passport posing as "investors" by laundering the proceeds of their illicit activities. The CIA labels Hungary a "major transshipment point for Southwest Asian heroin and cannabis and transit point for South American cocaine destined for Western Europe."

It is also a "limited producer of precursor chemicals, particularly for amphetamine and methamphetamine." This is why Hungary made it into the visa regimes of many Western countries in the last few months.


The opposition Hungarian Socialist Party, known as MSZ, harps on Hungary's tarnished image. It accuses the government of opaqueness in tax collection and budget spending. The current legal codes threaten the rule of law, they thunder.

Two years ago, Hungary was considered less suitable to join the European Union than the likes of the Czech Republic, Malta, and Slovenia.


Today, its youthful and nationalistic prime minister, Viktor Orban, feels comfortable to state on Hungarian Radio: "It is not us who will join the EU -- but the EU will come to us".

The abolition of borders within the EU will make Hungary a "nation of 15 million", he boasts, referring to Hungarian minorities in neighboring countries, mainly in Romania and Slovakia. Hungary is the top performer of the LEGSI index that monitors the stability of countries.

Many consider 38-year old Orban to be his country's main liability. His fiery speeches, provocative statements, and controversial policies often pit Hungary against other European countries, near and far. But this is hypocrisy. Orban's policies are typical of the countries of Central and Eastern Europe and many have emulated them.

Even his "Status Law" which grants employment, education, and social welfare benefits to minority Hungarians elsewhere has equivalents in Germany, Russia, and Slovakia, among others. It is little known that Romanians enjoy much the same economic benefits in Hungary as their Hungarian compatriots.

As opposed to other countries in transition, Hungary has not had a single bad year since 1994. Orban's reign since 1998 has been characterized by rapid growth of 5 percent per annum, low inflation at 7 percent, and even lower unemployment -- 6 percent nationwide and less than 3 percent in the Budapest area. The minimum wage has doubled and real wages are up 17 percent, in line with sustained increases in labor productivity.


Taxes were cut and much deeper cuts are planned after the April 2002 elections. Employer participation in social security contributions was reduced from 33 percent to 29 percent in January.

Net external debt is half its level seven years ago -- although gross external debt, at 60 percent of gross domestic product, is high. External debt growth is currently driven by the private sector, mainly by multinationals.

This achievement was the result of a strange mixture of forceful government interference and the introduction of competition almost everywhere.

Orban's government seems to have accomplished the impossible: micromanaging a free market economy.

Despite the presence of most multinationals, Hungary is surprisingly xenophobic. Cumulative foreign direct investment -- though often offset by outflows of portfolio capital -- stands at $26 billion, and $2.8 billion last year alone, most of it from Germany and the Netherlands. It will likely grow considerably as accession beckons. But foreigners still find it fiendishly difficult to buy land, trade protectionism in growing, and ministers regularly denounce foreign domination and multinational encroachment upon the local economy.

Vaclav Klaus, the Czech Republic's outspoken elder statesman, warned against an emerging "Munich-Vienna-Budapest" axis of evil directed against other Central and Eastern European nations. Jewish leaders accuse Fidesz, the ruling party, of latent anti-Semitism.


In reports published by consulting firms Lehman Brothers and Dresdner, Kleinwort, Wasserstein, foreign investors felt that EU accession will be retarded and new FDI discouraged should a minority government team up with the ultra rightwing Justice and Life Party, known as MIEP. Another concern was the loss of control over budget spending.

Hungary reneged on agreements it signed during the heyday of privatization from 1993-7, when it raised more than $6 billion by selling stakes in its banking, media, and telecom sectors. The American power utility, AES, sued both the government and the Hungarian power grid for breach of contract for refusing to purchase generated power, admittedly at inflated prices. It grudgingly settled out of court last December.

The government of Canada protests the nationalization without compensation of a Canadian business running Budapest's airport terminals. The Canadians, according to the Financial Times, accuse Hungary of appearing to "violate the obligations" of the Canadian-Hungarian investment protection agreement.

There are other worrying reversals -- neatly embodied by the Szechenyi Plan for national economic development.

Hungary's budget deficit in the first two months of the year -- at half a billion dollars -- is four times the deficit in the corresponding period last year. Revenues are expected to deteriorate further as customs and duties are lowered -- for instance on American cars.


Agricultural producer prices collapsed by one eighth in January alone, forcing the government to dole out supplementary subsidies. The western and eastern parts of Hungary, heavily dependent as they are on agriculture and basic manufacturing, do not share in the prosperity enjoyed by Budapest.

The government also decided to raise gas prices by less than inflation -- all part of a new regulatory regime, replete with hidden, pre-election, subsidies. It has cancelled plans to privatize Postabank, opting instead to merge it with other state entities. It has re-nationalized a few motorways and all future motorways will be financed by the state-owned Hungarian Development Bank.

Hungary is also a graying country -- 15 percent of its population are older than 65. Its workforce is contracting, as its net population growth rate has turned negative. It partially privatized pensions but its un-revamped health care system masks enormous contingent obligations. Corruption is rife and the informal economy large.

Still, Hungary is flourishing.

Though its annual budget deficit and trade deficit, at $2 billion each, are about 4 percent of GDP, its sovereign debt is the second highest rated among all the economies in transition. Government consumption is a mere 10 percent of GDP. Hungary is an open economy -- trade constitutes two-thirds of GDP.


Services make up more than 60 percent of Hungary's GDP -- compared to half as much in manufacturing industry. But Hungary is fast becoming an important components manufacturing and assembly zone for richer EU countries. Its industrial sector is likely to grow. Its energy monopoly, MOL, is consolidating with other oil companies in Central Europe. Its current account deficit is a mere 2 percent of a vigorous and expanding economy. More than three-quarters of its exports are to EU destinations.

Interestingly, almost 40 percent of Hungary's population lives in rural areas -- although agriculture accounts for only 5 percent of GDP and 6 percent of the workforce. Only 16 years ago, more than one-fifth of Hungary's population worked in agriculture.

Hungary's financial system is advanced and sophisticated. Interest rates are on a prolonged downward trend. The National Bank of Hungary has cut interest rates 7 times since September. Both gross national savings and gross domestic investment equal more than 25 percent of GDP. Less than 9 percent of the population is under the official poverty line.

Hungary has become a major supplier of car parts to the British motor industry. It is linking up to the hinterland of Eastern Europe and the Balkan by rail and road. The private sector accounts for 80 percent of GDP.


The Danube -- Hungary's primary sea access -- was re-opened for traffic four months ago, for the first time since the Kosovo war. This saves Hungary tens of thousands of dollars in excess shipping costs -- daily. Moreover, a Romanian-led consortium is promoting the idea of opening an alternative oil-shipping lane cum pipeline through Hungary to ease the pressure on the Turkish straits.

Stratfor, the U.S.-based strategic forecasting firm, has this to say about the re-opening of this vital transport route:

"The river's reopening will have several important effects ... It will promote trade and integration among European Union members and applicants alike ... To keep shipping costs under control, the European Union will facilitate the construction of alternate shipping infrastructure bypassing those straits. All of these circumstances necessitate closer cooperation, both economic and political, among the EU states fast-tracked for membership and other powers in the region. Ultimately, that could help smooth the EU expansion process and aid the economies of several riparian states ...

"The Danube reopening comes at a fortuitous time. The European Union is accelerating expansion efforts, and all of the riparian states are either EU members or potential members. Although the EU does fund numerous infrastructure projects to promote trade, the Danube provides an instant avenue for economic integration. The EU's decision last year to shoulder most of the cost of clearing the river served as a nice political push for closer relations with applicant nations as well."


Orban's assertive comments notwithstanding, Hungary's economic future is pivotally dependent on a smooth accession to the EU, probably in 2004-5. Despite its polished, Western, image, it must invest heavily to comply with EU environmental standards and to overhaul its tax administration and legal system. Such budgetary outlays, especially in an election year, will strain Hungary's compromised fiscal discipline even further. Hungary, and the IMF, is discovering that EU accession may be incompatible with macro-economic stability.

Still, Hungary is a regular favorite of multilateral institutions.

Although often accompanied by monetary loosening due to massive capital inflows, Hungary's 15 percent band exchange rate regime -- since its crawling peg was abandoned in October -- and inflation targeting are often lauded by the OECD.

The World Bank has committed to Hungary $2 billion in projects since 1991, mostly for structural and institutional reforms and macro-economic support. Hungary is a recipient of Japan's Exim bank's co-financing facilities. As Hungary's transformation progressed, lending by these institutions dried up lately and Hungary owes the World Bank a meager $550 million.

By June 2001, the EBRD has invested $1.2 billion in Hungary in 64 projects worth $4.9 billion -- most of them in the private sector, in telecommunication, transportation, and banking.


Hungary's elections may result in a hung parliament. If so, fiscal rectitude will be the chief victim. Hungary's monetary policy is strained to its limits. Labor shortages are likely, especially in the cities. Expect more populism, nationalistic fervor, and glitches on the path to the EU.

But Hungary was among the first communist countries to introduce a free market system in the 1960s. It became a member of the World Bank in 1982. It withdrew from the Warsaw Pact in 1956. It has always been a pioneer.

"The Hungarian model" -- state interventionism coupled with a thriving private sector -- is working. No amount of political tinkering can bring it down.

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