Budapest's failure to meet deficit targets was the European Commission's official reason for freezing 495 million euros ($618 million) in cohesion funds. Hungary's 2.7 percent budget deficit in 2011 actually fell within the EU standard of 3 percent and was significantly lower than the deficits of countries such as France, the United Kingdom and the Netherlands. But the commission determined that Hungary reached the figure by using several one-off measures, such as nationalization of the pension system and the creation of "crisis taxes" levied on selected business sectors.
Though the commission's move has some economic basis, the decision to freeze cohesion funds must be seen in the context of the wider dispute between the European Union and Hungary's ruling Fidesz party. Since coming to power in 2010, Prime Minister Viktor Orban's government has proposed or instituted a number of highly controversial measures, including rewriting the country's constitution, nationalizing pensions and implementing measures against foreign banks operating in Hungary.
Brussels and Budapest also clashed over a proposed reform of the MNB that critics charged would undermine the bank's independence. Unveiled in late 2011, the reform would have required the MNB to merge with Hungary's financial regulatory body and allowed a politically appointed government representative to participate in the bank's meetings on interest rate policy. The reform would also have required the MNB to notify the government about its agenda.
Budapest capitulated in April when the Hungarian parliament presented changes to some of the controversial provisions. However, the ECB deemed the revisions insufficient to meet the requirements for central bank independence. This prompted the government's June 4 announcement that it would introduce additional changes in the law to meet the ECB's conditions.
The European Union's disputes with Hungary extend beyond economic matters. In May, the Hungarian parliament reformed a media law that had received criticism across the Continent. Under international pressure, the parliament eliminated a clause that gave the country's media regulatory body the power to order journalists to reveal their sources. However, opposition parties warned that the regulatory body is still allowed to shut down radio and television media companies — a power it could use to target opposition media outlets.
The Hungarian government was forced to reverse these measures because they have prevented the country from receiving international financial assistance. After taking power in May 2010, Orban declared that Hungary did not need the assistance of the International Monetary Fund (IMF), which had provided a loan to the country in 2008. However, after two years of unorthodox economic measures, Budapest was punished by ratings agencies, which downgraded Hungary's debt to junk status in late 2011 and early 2012. The forint, Hungary's currency, plunged to its weakest level against the euro in more than four months on June 1 after sliding 4.7 percent in May. The currency fell about 20 percent in the second half of 2011 alone.
Moreover, official statistics show that Hungary is projected to enter its second recession in the past three years. Gross domestic product dropped 1.3 percent from the fourth quarter of 2011, and the commission estimates the Hungarian economy will shrink 0.3 percent this year. Hungary also risks a credit crunch as commercial banks curb lending after paying the government's crisis taxes and being forced to take losses on foreign-currency mortgages in 2011. As a result, Hungary was forced to ask the IMF for aid. Formal negotiations for a three-year credit line of 15 billion euros are expected to begin later in 2012.
Budapest's policy shifts have brought the government's position more in line with the IMF and European Union than it was earlier this year, but some issues remain. According to the commission, Hungary's efforts to lower the retirement age of judges (and thus appoint new judges more to Fidesz's liking in their place) and weaken the independence of Hungary's data protection authority violate EU laws. The commission has already declared its willingness to bring the issues to the European Court of Justice, a threat the commission had alread issued in regards to the proposed reforms to the MNB. Even the MNB issue has not been completely resolved, with the IMF stating that Hungary must make changes to the central bank reform law beyond those requested by the European Union, particularly regarding the government's authority over the MNB's reserves.
The dispute between Budapest and Brussels shows how the commission applies a different type of pressure to countries at the heart of the financial crisis than it does to countries that do not directly threaten the existence of the eurozone. Hungary is not a member of the eurozone, which gives the commission greater latitude to show its power to punish countries that do not meet EU budgetary targets. While countries such as Spain and Italy are under great pressure to reduce their deficits, the commission is obliged to apply a delicate balance of threats and concessions, since too much pressure could exacerbate the eurozone's problems or even bring about its collapse. Hungary is a source of concern for the European Union, as Western European banks — particularly Austrian banks — are exposed to the country, but it does not represent an immediate threat to the stability of the European Union in the same way that troubled eurozone countries do.
Hungary has already signaled its willingness to compromise with its international lenders, and Orban may very well have proposed the new laws with the expectation they would be challenged by the IMF and European Union in order to strengthen his government's negotiating position. Since Orban's party holds a two-thirds majority in the parliament, its promises to moderate or drop the controversial policy moves are not a significant threat to his power. While the commission and the IMF will likely set other conditions for Budapest to meet in the next months, an agreement to normalize Hungary's economic relations with the two institutions will likely be reached before the end of the year.