Editor's Note: This article is part of a series on the geopolitics of the global financial crisis. Here, we examine Hungary's economic troubles as an indicator of what Central Europe and the Balkans could experience as capital begins leaving the region. International Monetary Fund (IMF) officials indicated Oct. 14 that they are in close consultation with the Hungarian government about a potential package of technical and financial support. The Hungarian Finance Ministry maintains that going to the IMF is a "last resort" option. However, on Oct. 15 the BUX, Hungary's key stock benchmark index, fell 7.7 percent and the forint fell 5.4 percent against the euro.
Hungary's economy is one of the most fundamentally weak European economies; many years of fiscal irresponsibility left the country with one of the highest budget deficits in Europe — currently 5.5 percent of gross domestic product (GDP), which is actually a sharp improvement from previous years. The slumping forint and equity markets are therefore unsurprising in the current capital-starved environment, which is bound to exacerbate underlying deficiencies. However, the current crisis does not completely illuminate the daunting problem of foreign currency lending in Hungary — an issue that may loom for all of Central Europe and the Balkans. Likely, the IMF's involvement in Hungary's troubles only further illustrates
Europe's inability to weather the crisis as a bloc — a problem that could have far-reaching consequences for Europe's unity and ability to present itself as an economic powerhouse to new member states and prospective candidates.
Hungarian Origins of the Crisis
The problems for Hungary stem from a dysfunctional political system that has not been able to overcome intense party rivalry to resolve the budget deficit problems plaguing Budapest since Soviet times. The defeat of the conservative Fidesz party in 2002 left the already considerable budget deficit in the hands of the Socialist Party-led government that began a program of increased spending in order to fulfill the various campaign promises that got it into power. Hungarian Prime Minister Ferenc Gyurcsany finally admitted in September 2006 that the free spending days had to end and that the government had to stop "lying" to its constituents about the economy. His candor was rewarded with some of the
worst social unrest in the country since the 1956 Hungarian uprising.
The current economic situation in Hungary would therefore be dire even without the
global liquidity crisis. The government budget deficit stands at 5.5 percent of GDP, the trade deficit is at 5 percent of GDP and the total external national debt is at 122 percent of GDP. In the middle of a global credit shortage, the Hungarian government will be hard-pressed to raise the necessary capital to fund its deficit, particularly since it is already highly indebted abroad (the government's share of the external debt is at 66 percent of GDP). Government expenditure already equals nearly half of total GDP, which means that the ceiling of domestic credit has been pretty much reached unless the government raises taxes, which would almost certainly grind the economy into a deep recession.
The IMF has not had any major funds drawn from its coffers recently and has the capital to help. However, this situation may not last as countries begin seeking assistance from the IMF due to the growing credit crisis. Iceland, Hungary and Ukraine — and potentially Serbia — already are considering asking the IMF for money. However, to receive IMF funding, Hungary will have to cut its budget deficit first. This will amount to an 11 percent decrease in public spending across the board. It is unclear if the current government will be able to mount the support for such an effort, as it will have to collaborate with its conservative opposition to take the necessary steps. Any such broad austerity measures would also most likely reignite social unrest that rocked Budapest in 2006.
Regional Implications of the Crisis
Hungary's economic troubles go beyond its economy's flawed fundamentals, however. That is simply the part of the equation that the Hungarians have some (limited) degree of control over. Another part of the equation is related to announcements by three key foreign banks with large operations in Hungary — Austria's Raiffeisen Bank and Volksbank and Germany's Bayerische Landesbank — that they have stopped lending in Swiss francs and U.S. dollars. This seems to indicate that the underlying problem in Hungary may be one of the "carry trade." The carry trade is a form of financing in which loans are taken out by banks and financial institutions in low-interest currencies, such as the Japanese yen or the Swiss franc, and then offered to customers in high- (or relatively higher to the yen and Swiss franc) interest-rate countries (such as Hungary in this example). If an economic slowdown happens — like the current global economic crisis — and the currency in which the loan is being serviced depreciates against the yen or the Swiss franc, then the borrower is in trouble, to put it lightly.
Iceland's collapse on Oct. 6 was in large part caused by the collapse of the carry trade that the Icelandic banks were heavily involved with, as middlemen for the booming real estate market in Europe. Hungary is not facing anything similar to the Icelandic collapse because Hungarian banks were in no way the middlemen for the carry trade. Hungary was, however, a destination for the trade. Since 2003, Hungarian real estate has experienced a huge influx of Swiss franc-denominated mortgages, usually furnished by Austrian banks that have experience with Swiss franc loans. Since 2006, nearly 80 percent of all mortgages in Hungary have been made out in Swiss francs. In fact, around 40 percent of all mortgages and personal loans in Hungary by the end of 2007 were in non-euro and non-forint denominated currency (most likely Swiss francs). Hungarian mortgage holders who took out these Swiss franc-denominated loans in Austrian banks are therefore about to be squeezed between the depreciation of the forint against the Swiss franc (7.1 percent on Oct. 15 alone) and Hungary's endemic high inflation of 12.9 percent. Their loans are therefore appreciating in value and their ability to repay them is declining. Odds are that the possible IMF intervention will further depreciate the forint, thereby spiraling the country into an even greater crisis. Hungary is thus staring at a potential financial catastrophe waiting to happen. Austrian banks, particularly Raiffeisen, are heavily involved in Central Europe and the Balkans, as well as Russia. The expansion of credit into these emerging markets reached record peaks in 2002 when Central Europe replaced East Asia as the top destination for foreign credit. Austrian banks were well-positioned because of their proximity and centuries-long involvement in the region. Much as Icelandic banks acted as gatekeepers for Japanese yen carry trade to the United Kingdom and Scandinavia, so Austrian banks acted as middlemen for the Swiss franc to Eastern Europe. The list of countries that could be involved in the carry trade predicament is long. Particularly worrying is Croatia, which is involved in foreign currency mortgages and personal loans almost as much as Hungary is — but close behind are Romania, Bulgaria, the Baltics and the rest of the Balkans. As these countries' domestic currencies depreciate because of the global credit crunch and high inflation — already high before the credit crisis hit, due to astronomical growth figures fed by foreign credit — continues to be a problem, the loans consumers took out in foreign currencies such as the Swiss franc will appreciate. It is unlikely the consumers in Central Europe and the Balkans who took out these loans will be able to continue to finance them in these circumstances. Of course, this will all come back to haunt both the middlemen (Austrian banks) and the originators of these loans (Swiss banks) — but that is a story for another day.
