Are Hungary’s Unorthodox Economic Policies working?

In 2010, Hungary elected the Fidesz party and its leader Viktor Orban into power. Since then the government has implemented a range of unorthodox economic reforms which have drawn criticism from economists and financial analysts alike. However recent reports indicate that the Hungarian economy may have finally exited a year long period of negative growth. The Hungarian Central Statistics Office estimates that the gross domestic product of Hungary ‘increased by 0.5% in the second quarter of 2013 compared to the corresponding period of the previous year’.  In addition the budget deficit now sits at 1.9% of GDP, well under EU mandated target of 3%. This means that Hungary now displays one of the lowest deficits among the EU 27 and is free from the EU’s Excessive Deficit Procedure monitoring procedures.

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Inflation has also dropped to a record low. The Hungarian Consumer Price Index now sits at the lowest level since Hungary’s transition to a market economy. In July it fell unexpectedly to a new low of 1.8% (year on year) compared to 1.9% in June.  When this drop is decomposed we can see that food prices declined by 1.4 percent from the previous month in July, whilst household energy costs fell by 0.4 percent.

Naturally the Fidesz government has claimed that its unorthodox policies are at the heart of this change. What I find interesting about such policies is that they could prove very popular in many European countries, such as my own, where there is a feeling that many banks ‘got let off the hook’.

Since coming to power Orban has introduced biggest tax in Europe on banks and financial companies and imposed large levies upon energy, retail and telecommunications companies. In addition Orban has announced plans to fix the exchange rate for loans taken by individuals in Swiss Francs. In particular, this attempt to lessen the debt burden for such individuals could lead to losses in the banking sector of up to 4.1 billion. In another popular move the government forced energy firms in January to slash their prices by 10% with the promise of another imposed 10% cut in October. Further unorthodox policies include interfering with central bank independence, nationalizing $14 billion in assets from private pensions and a steep 18% hike in the minimum wage.

However there are many who question whether such policies are sustainable in the long run.  Many economists are concerned that such policies will threaten foreign direct investment (FDI) into the country. The general argument is that the current regulatory unpredictability (i.e. high taxes on banks) may damage investor’s confidence and lead to large outflows of capital. This is significant because Hungary’s economy is heavily dependent upon foreign direct investment. For instance UNCTAD’s new inward FDI contribution index, which measures the importance of FDI to a country’s economy, ranks Hungary first among the 79 nations studied.

As discussed by the IMF, the large levies placed upon banks may place an additional drag upon growth. Hungary’s financial sector is heavily dependent upon foreign funding which is worth around €35–40 billion annually. To put this into perspective, foreign firms account for 90% and 70% of the insurance sector and investment banking sectors respectively. The deleveraging process now present in many financial institutions has meant that Hungary has experienced negative credit growth for the last several years and the IMF predicts this could further hinder economic growth.

In addition to this some economists are concerned that the new central bank chief Gyorgy Matolcsy (regarded as Orban’s ‘right hand man’) will opt for a plan of quantitative easing in order to stimulate the economy. This could be problematic because injecting money into the economy may increase imports and the debt burden whilst, at the same time, foreign capital is leaving the country. This could significantly affect Hungary’s ability to finance itself.

Despite these concerns there are still some positive signs for the economy. Germany, which accounts for 24.7% of Hungarian exports, has registered strong growth in the last quarter and now many expect the economy to return to a steady rate. The Hungarian economy will also receive a boost from the opening of a new Audi plant in Gyor which equates to €900 million in additional investment. Other investors have also expressed their desire to keep operating in the country despite regulatory pressures. In a recent interview with FDI Intelligience magazine,  Rhydian Pountney of the UK based engineering company Renishaw PLC stated that,

We are acutely aware of the political issues of the regime but we take the long view and we are not likely to be scared off by the ups and downs of politics,”

Could economists be wrong about the impending crash in FDI? Data from the OECD also suggests otherwise. According to preliminary estimates FDI inflows are now above pre-crisis levels at $13.5 billion. Conjointly the data shows that FDI outflows have also increased in 2012, to $10.6 billion – however this figure is still $2.9 billion below inflows.

Although I do not agree with many of the Fidesz party’s other policies, I believe it will be interesting to observe whether its economic policies will pay off in the long run. If so, it would be interesting to see how the economic community accounts for the success of a number of policies which have aimed to boost consumption at the expense of inward investment.

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4 thoughts on “Are Hungary’s Unorthodox Economic Policies working?

  1. Lucy says:

    Nice, Shaun! Enjoyed reading this article!

  2. […] Are Hungary’s Unorthodox Economic Policies working? (shaundacosta.wordpress.com) […]

  3. letomuaddib says:

    Some more developements have occured since you published your post:

    Massive upside surprise at GDP growth: http://politicsinhungary.wordpress.com/2013/11/14/massive-upside-surprise-at-gdp-growth/

    “The 0.9% year-on-year data in October marks a huge and unexpected decrease compared to 1.4% in September.”: http://politicsinhungary.wordpress.com/2013/11/13/record-low-inflation-rate-again/

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