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Hungary’s economic recovery is starting to look vulnerable as anxieties grow about the new European debt crisis. The central European country saw its economy rebound last year thanks to a booming export sector, a welcome change after years of pain. Hungary needed a bailout from the International Monetary Fund in 2008 as the global downturn exacerbated a domestic debt crisis, and the next year its economy shrank more than 6 percent. Now experts worry that the economy expected to continue last year’s rebound with growth this year of more than 2.5 percent – could be dealt a new blow if Germans and other Europeans get cold feet about consuming. Consumer demand is anemic because of austerity measures imposed in recent years to trim back the high deficit. That led to layoffs and wage cuts for people in the public sector as well as pension cuts for retirees. Unemployment is now about 11 percent. Current 5 Year credit-default swap (CDS) rates for Hungary read a high 420. Generally when 5 Year CDS rates hit 550, borrowing costs for a country become unstainable. Hungary, in my opinion is next in the bond vigilantes sights.

The vulnerability comes largely from the fact that economy is highly dependent on its exports to power growth and can’t count on Hungarians to consume much as their incomes get squeezed more and more. Domestic demand is extremely weak.

History Of  Hungary’s Economy 

Although Hungary enjoyed one of the most liberal and economically advanced economies of the former Eastern bloc, both agriculture and industry began to suffer from a lack of investment in the 1970s, and Hungary’s net foreign debt rose significantly—from $1 billion in 1973 to $15 billion in 1993—due largely to consumer subsidies and unprofitable state enterprises. In the face of economic stagnation, Hungary opted to try further liberalization by passing a joint venture law, instating an income tax, and joining the International Monetary Fund (IMF) and the World Bank. By 1988, Hungary had developed a two-tier banking system and had enacted significant corporate legislation which paved the way for the ambitious market-oriented reforms of the post-communist years.

After the fall of communism in Eastern Europe, the former Soviet satellites had to transition from a one-party, centrally planned economy to a market economy with a multi-party political system. With the collapse of the Soviet Union, the Eastern Bloc countries suffered a significant loss in both markets for goods, and subsidizing from the Soviet Union. Hungary, for example, “lost nearly 70% of its export markets in Eastern and Central Europe.” The loss of external markets in Hungary coupled with the loss of Soviet subsidies left “800,000 unemployed people because all the unprofitable and unsalvageable factories had been closed.Another form of Soviet subsidizing that greatly affected Hungary after the fall of communism was the loss of social welfare programs. Because of the lack of subsidies and a need to reduce expenditures, many social programs in Hungary had to be cut in an attempt to lower spending. As a result, many people in Hungary suffered incredible hardships during the transition to a market economy. Following privatization and tax reductions on Hungarian businesses, unemployment suddenly rose to 12% in 1991 (it was 1.7% in 1990 ), gradually decreasing until 2001. Economic growth, after a fall in 1991 to −11.9%, gradually grew until the end of the 1990s at an average annual rate of 4.2%. With the stabilization of the new market economy, Hungary has experienced growth in foreign investment with a “cumulative foreign direct investment totaling more than $60 billion since 1989.

The Antall government of 1990–94 began market reforms with price and trade liberation measures, a revamped tax system, and a nascent market-based banking system. By 1994, however, the costs of government overspending and hesitant privatization had become clearly visible. Cuts in consumer subsidies led to increases in the price of food, medicine, transportation services, and energy. Reduced exports to the former Soviet bloc and shrinking industrial output contributed to a sharp decline in GDP. Unemployment rose rapidly to about 12% in 1993. The external debt burden, one of the highest in Europe, reached 250% of annual export earnings, while the budget and current account deficits approached 10% of GDP. The devaluation of the currency (in order to support exports), without effective stabilization measures, such as indexation of wages, provoked an extremely high inflation rate, that in 1991 reached 35% and slightly decreased until 1994, growing again in 1995. In March 1995, the government of Prime Minister Gyula Horn implemented an austerity program, coupled with aggressive privatization of state-owned enterprises and an export-promoting exchange raw regime, to reduce indebtedness, cut the current account deficit, and shrink public spending. By the end of 1997 the consolidated public sector deficit decreased to 4.6% of GDP—with public sector spending falling from 62% of GDP to below 50%—the current account deficit was reduced to 2% of GDP, and government debt was paid down to 94% of annual export earnings.

The Government of Hungary no longer requires IMF financial assistance and has repaid all of its debt to the fund. Consequently, Hungary enjoys favorable borrowing terms. Hungary’s sovereign foreign currency debt issuance carries investment-grade ratings from all major credit-rating agencies, although recently the country was downgraded by Moody’s, S&P and remains on negative outlook at Fitch. In 1995 Hungary’s currency, the Forint (HUF), became convertible for all current account transactions, and subsequent to OECD membership in 1996, for almost all capital account transactions as well. Since 1995, Hungary has pegged the forint against a basket of currencies (in which the U.S. dollar is 30%), and the central rate against the basket is devalued at a preannounced rate, originally set at 0.8% per month, the Forint is now an entirely free-floating currency. The government privatization program ended on schedule in 1998: 80% of GDP is now produced by the private sector, and foreign owners control 70% of financial institutions, 66% of industry, 90% of telecommunications, and 50% of the trading sector.

After Hungary’s GDP declined about 18% from 1990 to 1993 and grew only 1%–1.5% up to 1996, strong export performance has propelled GDP growth to 4.4% in 1997, with other macroeconomic indicators similarly improving. These successes allowed the government to concentrate in 1996 and 1997 on major structural reforms such as the implementation of a fully funded pension system (partly modelled after Chile’s pension system with major modifications), reform of higher education, and the creation of a national treasury. Remaining economic challenges include reducing fiscal deficits and inflation, maintaining stable external balances, and completing structural reforms of the tax system, health care, and local government financing. Recently, the overriding goal of Hungarian economic policy has been to prepare the country for entry into the European Union, which it joined in late 2004.

By 2006 Hungary’s economic outlook had deteriorated. Wage growth had kept up with other nations in the region; however, this growth has largely been driven by increased government spending. This has resulted in the budget deficit ballooning to over 10% of GDP and inflation rates predicted to exceed 6%. This prompted Nouriel Roubini, a White House economist in the Clinton administration, to state that “Hungary is an accident waiting to happen.

Hungary, as a member state of the European Union may seek to adopt the common European currency, the Euro. To achieve this, Hungary would need to fulfill the Maastricht criteria. In foreign investments, Hungary has seen a shift from lower-value textile and food industry to investment in luxury vehicle production, renewable energy systems, high-end tourism, and information technology. The austerity measures introduced by the government are in part an attempt to fulfill the Maastricht criteria. The austerity measures include a 2% rise in social security contributions, half of which is paid by employees, and a large increase in the minimum rate of sales tax (levied on food and basic services) from 15 to 20%.

The Hungarian Central Statistical Office reported a decrease in real wages in the first five months of 2007. Gross average income rose by 7%, while net average income increased by 1%. When adjusted for inflation, this corresponded to a 7% decline compared with real wages a year before. The drop was due mainly to the 2006 austerity package; however, state measures to combat the black economy may also have had an impact on pay developments. Hungary’s low employment rate remains a key structural handicap to achieving higher living standards. The government introduced useful measures in the key areas, namely early retirement, disability and old pensions.

On 10 October 2008, the Forint dropped by 10%.Many loans are made in Euro or Swiss Francs in Hungary. On 27 October 2008, Hungary reached an agreement with the IMF and EU for a rescue package worth about US$20 billion. Total government spending is high. Many state-owned enterprises have not been privatized. Business licensing is a problem, as regulations are not applied consistently. According to the conservative think tank Heritage Foundation, Hungary’s economy was 67.2% “free” in 2008, which makes it the world’s 43rd-freest economy. Its overall score is 1% lower than last year, partially reflecting new methodological detail. Hungary is ranked 25th out of 41 countries in the European region, and its overall score is slightly lower than the regional average.

The Hungarian sovereign debt’s credit rating is BBB+ as of October 2008. However Standard & Poor’s may downgrade Hungary’s BBB+ sovereign credit rating because of mounting financial-sector funding pressures and their potential to raise general government debt materially from its current level of 67% of GDP (October 2008). Economic reform measures such as health care reform, tax reform, and local government financing are being addressed by the present government. 

Because of the large austerity program, the real growth of the incomes was negative in 2007 at −5.5%, and the estimates say 1% increase in 2008. The GDP growth was only 1.4% in 2007, much lower than in 2006 because of the decreased government spending; in first quarter of 2008 the GDP growth was 1.7%, slightly stronger than last quarter of 2007 (0.9%). During the second quarter in 2008, the GDP growth was 2.0% annual, and because of the effects of the 2008 financial crisis on the Hungarian forint and on the bank system, the 3rd quarter growth was slowed to 0.8% annual. The estimates for 2009 are 1–1.5% decline.

The 2008 financial crisis hit Hungary mainly in October 2008. When the Forint declined quickly against the euro, the Hungarian National Bank raised interest rates from 3.0% to 11.5% on 22 October. As the Hungarian Government asked financial rescue package worth $25.1 billion from the International Monetary Fund, the European Union, and the World Bank, promising to IMF that recalculate the 2009 budget, as Hungary’s GDP declines 1.0%, and slow down government spending, for example, stop the wage increase for state workers. This way, the budget gap decline to 2.6% down from 5.5% of GDP in 2007 and will meet Maastricht criteria. In this circumstances, more and more economists estimate, that Hungary can join the ERM II, which gives the possibility that Hungary can adopt the euro 2 years after joining the ERM-II monetary system.

Hungary’s Current Woes- Real Estate, Unemployment, & Debt

The Hungarian government Friday launched a three-year scheme to help households that find it tough to service their Swiss franc mortgages. The government offers households close to defaulting on their mortgages the choice of paying monthly installments to service the loans at a fixed exchange rate; an important step in Budapest’s campaign to help troubled Hungarian homeowners. Many Hungarians took out foreign currency mortgage loans years ago when this type of lending was introduced. Swiss-franc loans were the most popular, because they came with low interest rates and the Hungarian forint was stable against the franc before the financial markets crisis hit in 2008.

Since then, the franc has risen relentlessly against most currencies, as investors were looking for safe-haven for their assets at a time of economic turmoil. In many cases, this has doubled monthly payments for Hungarian homeowners. Most of these loans were taken when a Swiss franc bought you 160 forints. Since then, the franc has risen 53% to HUF250 today. It briefly traded as high as HUF270. The program is only open to debtors who have arrears less than 90 days overdue. About 140,000 Hungarian households with debts more than 90 days overdue,  may get aid from a soon-to-be-established asset management company