On Monday Hungary was “standing on its own feet.” By Thursday it wanted a “new type of co-operation with the IMF.” The abrupt change of heart is only partial. The first central European casualty of the euro zone crisis is still trying to avoid conventional Western medicine. But if Hungary is to avert a crisis it needs both the IMF’s money and its cruel-to-be-kind prescriptions.
Hungary’s fundamental weakness and policy mistakes are being exposed. Last month the central bank forecast just 0.6 percent GDP growth in 2012. Since then there has been a further worsening on the Western front, with bond yields rising in almost all zone countries except Germany. That’s bad news for central European growth.
The pressures on euro zone banks are another reason to be fearful. Foreign banks dominate the Hungarian financial sector, with Austrian, Italian, German and Belgian institutions prominent. As these banks address their intra-zone problems, they are likely to reduce their risk outside. Hungary, whose debt has been put on watch for downgrade to junk status by Fitch and Standard & Poor’s, is particularly vulnerable.
The risks are made worse by the handling of the Hungary’s difficult problem with Swiss franc and euro mortgages. A government law in September forced banks to swallow exchange rate losses on these unwise loans. The banks protest this is unfair.
Nor is this the only unorthodox step the Fidesz government in Budapest has taken. It reduced Hungary’s debt-to-GDP ratio slightly to an estimated 77 percent of GDP this year, and the fiscal deficit to an estimated 2.5 percent of GDP. But it achieved these things largely through a dubious one-off transfer of private pension assets to the public sector in December 2010.
Another vital relationship broke last year. In July 2010 the IMF and EU suspended the support they had been giving since 2008 because of concerns over the government’s fiscal plans. But it is becoming more and more expensive for Budapest to issue debt. Yields now exceed 8 percent and the forint is hovering close to all-time lows.
Fresh agreement with the IMF is needed, with financial support coming alongside tighter economic policies and greater respect for investors. Otherwise a balance of payments crisis may ensue. Hungary is the first of central Europe’s euro crisis victims. It won’t be the last.