Hungary is no Turkey

Somewhat unexpectedly, the European Commission concluded on 25 April, following the meeting of Hungarian Prime Minister Viktor Orbán and Commission President José Manual Barroso on 24 April, that negotiations for financial assistance for Hungary can begin, once the relevant legislation is adopted. On 23 April, just a day before the meeting of the two Heads, the exchange rate of the Hungarian forint reached a low of several weeks and government bonds yields were on the rise, suggesting that the Commission’s decision was indeed unexpected. Markets have reacted very positively: the exchange rate of the forint strengthened by four percent from 23 to 25 April, long term government bond yields have fallen from about 9 percent to 8 percent, and the stock market rose by four percent in a few hours.

Even though the Hungarian government continuously communicated its commitment to fulfilling the expectations for the start of such negotiations, the progress has been painfully slow since the first indication of financial assistance request in November 2011. Several observes concluded that Hungary may wish to play a Turkish strategy: Turkey started negotiations for financial assistance with the IMF in the height of the crisis, which boosted confidence, but as time passed and the situation improved, the negotiations were not concluded. But Hungary is no Turkey: public debt is about 80% of GDP in Hungary and 40% in Turkey, and Turkey has a great growth potential, as reflected by the 9.0 and 8.5 percent annual real growth rate in 2010 and 2011, respectively, in contrast to the 1.3 and 1.7 percent growth of Hungary during the same years. And there are several other important differences as well, such as net external debt, which is in Turkey only about one-third of the Hungarian figure as a percent of GDP.

What has changed the Commission’s view? One possible explanation is that budget anxieties of Spain and the Netherlands (eg the IMF forecasts 5.7 and 4.9 percent of GDP deficit in 2013, respectively for the two countries, way above the 3.0 percent target) underlined that the Commission cannot be equally tough for all EU countries and therefore it became more lenient. (Indeed, there are strong reasons not to enforce the 3.0 percent deficit target by 2013 for both Spain and the Netherlands.) But I continue to think that the Hungarian government has a very strong incentive to comply: market pressure earlier this year and the continued very high borrowing cost made it clear that without an agreement, Hungary is running a serious risk of insolvency. Borrowing at 9 percent per year in a country with weak growth outlook, high external debt, still high share of foreign currency loans and sinking trust is not just very expensive, but not really sustainable. Regaining market confidence without the support of the Commission and IMF is not a real option.

The negotiations will likely be tough, but will be helped by the new fiscal adjustment plan announced earlier this week, which was generally well received. The willingness to agree form the side of the Hungarian government is also helped by the result of some recent opinion polls, which suggested that the majority of voters, including voters of the current governing party, would favour such an agreement. An eventual conclusion of the negotiations would help to restore trust, thereby further lowering borrowing costs from the market, because the current 8 percent rate is still too high. But the country should also make use of the very low interest rate of official lending, even though current communication of the Hungarian government suggests that the programme is seen as precautionary. While maintaining market access certainly makes sense, not exploiting the borrowing opportunity at about 3 percent per year, when the market rate will likely be still much higher, would be unnecessarily costly. A fifty-fifty reliance on market and official funding would be a good benchmark. And we should never forget: Hungary is no Turkey