The story of Hungarian indebtedness

A few days ago GKI Gazdaságkutató Zrt. came out with a study of Hungarian sovereign debt from a historical perspective. The result of the study is that Hungarian national debt has been high ever since the 1970s with the exception of the period starting in 1995, lasting about five or six years. The drastic reduction in sovereign debt during this time was the result in large measure of the stringent austerity program of Lajos Bokros and Gyula Horn announced in March 1995. In 2001 the debt again began to grow until today it has reached 80% of the Hungarian GDP.

At the time of the change of regime in 1989 the national debt was already high, 73% of the GDP, and it kept growing until by the end of 1994 it was 90% of the GDP. There were several reasons for this incredible rise in the debt load, but the overarching reason was that the Hungarian economy practically collapsed as a result of the changeover from a socialist mode of production to capitalism. 

This was the situation when MSZP won a resounding electoral victory in 1994 and Gyula Horn formed a coalition government with the liberals. Horn, somewhat like Viktor Orbán in 2010, was most reluctant to use drastic measures to rescue the country from economic doom and waited nine months before he allowed Lajos Bokros, his new minister of finance, to introduce austerity measures. The shock was considerable. People's living standards, low in the first place, plummeted. But by the end of 1997, that is before the formation of the first Orbán government, the national debt had shrunk to 62%. Robust economic growth was primarily responsible for the reduction, although one mustn't forget that at that time there were still a number of valuable state assets that were sold off. The large amounts of money received from these sales were used to pay back some of the sovereign debt.

During 1998-2000 this trend continued. Although Viktor Orbán promised all sorts of things before the elections, he prudently didn't keep his word. For example, the Horn government in the last few months raised pensions, but Orbán refused to follow suit. Something that didn't go over too well with the pensioners. Even today one can hear older folks complaining about the money they lost in the last twelve years as a result. Although the Horn government promised to contribute to the building of a new section of the Budapest metro, Orbán simply refused to fulfill the obligation, finding some kind of legal loophole. Meanwhile the economy grew rapidly, reaching 5-6% a year, and thus by 2001 the national debt dropped as low as 52% of the GDP.

With elections looming, the Orbán government changed tactics. It was in 2000 that Zsigmond Járai, until then finance minister, was appointed chairman of the Hungarian National Bank and György Matolcsy took his place at the head of the ministry. Orbán wanted to spend more money on items that would raise the spirits of the electorate and Matolcsy promised an easy solution to cover the costs: raise internal consumption. Thus Orbán began to spend. He raised certain government salaries by 70% and cooked up a scheme by which the state subsidized purchases of houses or apartments up to a value of 30 milion forints, which cost the Hungarian state 300 billion forints a year. He lost the election nonetheless and the next government was stranded with promises made by Orbán as well as by his successor, Péter Medgyessy. The result was predictable. From 2001 on the sovereign debt grew year after year until 2007, when it reached 66% of the GDP.

Fidesz while in opposition opposed any kind of fiscal restraint, and during the election campaign of 2006 Orbán was still promising an extra month of pensions over and above the one granted by the Medgyessy government earlier. And he promised that certain drugs would be entirely free if he became the next prime minister of Hungary.

But the reality was that both parties excelled in making irresponsible promises. The final result was that government expenses during the 2001-2007 period grew by 3.2% while tax revenues shrank by 1%. 

Although Fidesz politicians love to intimate that MSZP politicians spent the money they received, mostly from abroad, on their own pleasures (they carried the money away in wheelbarrows is the favorite charge), the bulk of the money went to Hungarian households–into the pockets of pensioners and people who worked in the public sector–as well as for subsidies for natural gas consumption, subsidies on housing, and infrastructure. In addition, there was a decrease in taxes. 

But the situation was still manageable. After all, according to the Maastrich criteria, in order to join the eurozone the sovereign debt should be under 60%. With some effort that could have been achieved within a few years. But then came the international financial crisis. It was only in the 2008-2010 period that Hungary's indebtedness climbed to 80% of the GDP. The GDP dropped by close to 6%, the country had to borrow from the IMF and the EU, and the Hungarian forint weakened. The combination was lethal.

An 80% indebtedness is not extraordinarily high within the European Union, but the problem is that the borrowed money comes largely from foreign sources: almost 60% of the Hungarian sovereign debt is financed by foreigners. And these foreign investors demand sustainable economic growth that would lead to a decrease in the sovereign debt. According to GKI Zrt. that could be achieved by keeping the deficit under 3% and maintaining a 3% yearly economic growth. The economists of this research institute maintain that only ordinary prudent handling of the economy is required to meet this goal; extraordinary austerity measures are unnecessary.

I suspect that the somewhat hysterical reaction to the sovereign debt issue is only a ploy on the part of the Orbán government to prove to the people that these austerity measures are necessary because of the heavy indebtedness of the country. This way they can claim that they are compelled to introduce this new package in order to pay off the debt that was created by the irresponsible socialist-liberal governments. At the same time they are whipping up anti-foreign sentiment by pointing out that the fruits of Hungarian hard work are going to foreigners. And the population laps it up.

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Paul
Guest

“This way they can claim that they are compelled to introduce this new package in order to pay off the debt that was created by the irresponsible socialist-liberal governments.”
Sounds horribly familiar…

Paul
Guest

Can someone explain the difference between ‘sovereign debt’ and ‘deficit’?
This has long confused me.

Kirsten
Guest

Paul, a deficit is the outcome in a specific year, for instance if a government during (say) 2010 spent more than what it raised in taxes or through the sale of public property etc. If there is a gap between income and expenditure, this is called a deficit (if that gap is negative). Debt is then created through such deficits. Deficits have to be “financed” and this is being done through short-term or longer-term securities that result in “debt”. For the debt the government has to pay interest, the deficit is just the gap for which the government has to find “financing”.

Minusio
Guest

Paul: “sovereign debt” is what a country had borrowed by issuing bonds. So the total of the outstanding bonds is the debt.
A deficit is a budgetary matter. If in any year you spend more than you take in, you have a budgetary deficit. In order to pay your bills you have to borrow money (i.e. issue bonds you hope others will buy because they trust that you will pay them interest and pay back the capital). Thus a deficit – a current inconvenience – adds to the debt.

Minusio
Guest

Eva: I think this is a very fair and accurate appraisal of the Hungarian debt situation – including the political conclusions you reach.

Kirsten
Guest
Éva: “the problem is that … almost 60% of the Hungarian sovereign debt is financed by foreigners. And these foreign investors demand sustainable economic growth that would lead to a decrease in the sovereign debt.” The problem with foreign debt is also that any change in the exchange rate changes the debt burden of Hungary (in particular a depreciation raises the debt burden in forint). That can make it difficult to assess whether the debt level is too high or not. Foreign debt can be a problem also if the interest rates (and hence debt service) rise out of reasons that may be entirely unrelated to Hungary (political upheaval in the Arab world). Then Hungary with its relatively high foreign debt could be affected even if policies were exemplary. With lower debt such risks are lower. “The economists of this research institute maintain that only ordinary prudent handling of the economy is required to meet this goal; extraordinary austerity measures are unnecessary.” Such “ordinary prudent handling of the economy” somehow has not been often seen since 1990, it was a series of “extraordinary austerity measures” that followed “extraordinary spending measures” and emergency measures to stabilise the exchange rate (because of… Read more »
Member

Kirsten, I believe that the Hungarian economy would greatly benefit from establishing a tax system with proper control that is simple enough to follow and would stimulate the entrepreneurs to actually pay it. When I set up my tiny business in Budapest, I had to educate every single tax and Government employees on how can I pay the taxes, and how they have to set this up. I am not kidding, when I say that once they even called for advise. It was not a direct request but they were asking what and how did I do it, step by step. I pay the taxes, but I know plenty of people who does not. I would say at least 3 out 4 do not pay for the same business there. If someone would do some work about the black market in Hungary I believe the amount is lost because of the taxes would be staggering.

Member

Do we have any idea who buys the government bonds? Or are they traded without restrictions after the initial auctions? I guess we should know who are we paying the interest to or who are we paying “back” to when the bonds “expire”.

Odin's lost eye
Guest
Mutt Government bonds are traded like any other stock. I buy some bonds they are mine and I can sell or do with them as I please. Their value on the market will fluctuate depending on the relative values of that currencies involved, the dividend payment schedule, the term to maturity and the risk. Trading in them can get quite complicated. Who buys them? Specialist traders who tend to resell them, people/companies who have surplus of cash in the short or long term –this includes foreign governments- banks, insurance companies especially those who sell ‘assurance policies’ whose maturity is known as opposed to ‘insurance’ which may have to be paid out at any time. Banks also trade in them as they at as they have a fixed rate of interest. They are useful as a hedge against falling general interest rates. Sometimes they are traded against the ‘Foreign exchange futures position’ (you know you can buy Fortints now for delivery in the future). Government Bond holding is usually quite a safe business, but the trading margins can be small and bond holders can get a nasty ‘haircut’ as happened with some South American bonds. The trade in Government bonds from… Read more »
Ron
Guest
Kirsten, I believe that the Hungarian economy would greatly benefit from establishing a tax system with proper control that is simple enough to follow and would stimulate the entrepreneurs to actually pay it. Posted by: someone | March 06, 2011 at 07:08 PM Someone you are absolutely right. It was calculated that 20% of the entrepreneur’s time went to filling out tax and other bureaucratic forms. I believe it is even higher if you take into consideration the regular audits companies received, especially if you have reclaimable VAT (mainly export companies). Furthermore, if an entrepreneur has a claim on the government, the government is not paying back quickly enough, resulting in extra interest costs. After more than 20 years there is still no cap on the premiums payable (by employer) to the Social Security. So somebody receiving HUF 10,000 or HUF 10,000,000 is paying percentage wise the same amount. I believe that all salary related taxes and premiums should be part of the gross salary. Then you will find out that in EUR amount the gross salaries are more or less equel to the the salaries of other EU countries, but netto it is a fraction compared to these other… Read more »
Odin's lost eye
Guest
Professor you write * “At the same time they are whipping up anti-foreign sentiment by pointing out that the fruits of Hungarian hard work are going to foreigners. And the population laps it up.” *. I will confirm the spread of this type of xenophobia Everyone knows that austerity is coming. For the past year I have seen little businesses just disappear. Much of this was not initially because of lack of trade, it seemed to have something to do with some sort of tax fiddles, but of late, this down turn has gotten worse. Businesses which were very viable are now on a care and maintenance. I suppose that the people must have to have someone to blame (other than themselves). People have short memories, and the ‘Government Propaganda Machine’ is feeding these memories but is not always succeeding because of blogs like this one, which remind people of the real past. What is Fidesz trying to do? Where is it going? I have a nasty feeling that they are going to steal some of Jobbik’s clothes. That is to borrow as much as possible and then by ‘popular demand’ (street demonstrations etc) renege on those loans/bonds. They have… Read more »
Minusio
Guest

Does anyone know at what rate money is fleeing the country these days? I know that it is…
The next step will have to be that Orbán puts a lid on the free movement of capital, one of the cornerstones of the European Single Market.

Ron
Guest

Does anyone know at what rate money is fleeing the country these days? I know that it is…
Posted by: Minusio | March 07, 2011 at 07:48 AM
Magyar Nemzeti Bank quarterly balance of payments.

Eva S. Balogh
Guest

Minusio: “Does anyone know at what rate money is fleeing the country these days?”
I’m afraid I don’t know the exact number but it is in the billions.

Minusio
Guest

Ron: Would the MNB know about forints changed at an exchange office in the street into Swiss francs and carried abroad in a handbag? At present anything below EUR 10,000 doesn’t have to be declared.

Ron
Guest

Minusio, even the exchange office need to report to the MNB, however, it is not reported as money going abroad. But even without these transfers, there are other ways of transferring money abroad as well. For example, reduction of the equity or closing down companies and repackaging. Please find the latest balance of payments (up to 3rd qtr 2010) http://english.mnb.hu/ under latest releases.

Kirsten
Guest

@Minusio: At present anything below EUR 10,000 doesn’t have to be declared.
That sum alone even 100 times I would not call “money is fleeing the country”. (GDP of Hungary in 2010 will have been about 98 billion EUR; gross reserves of the MNB according to the IMF 33 billion EUR). As far as I see the exchange rate did not move much, and the exchange rate should reflect major movement and “fleeing money”. Might be that the MNB intervened but such information is rather unlikely to be known by people other than those actually working there or receiving the order. I think the MNB does not publish when it intervenes in the market. The balance of payments or the MNB’s balance sheet can indicate such intervention, as Ron also suggested.

Minusio
Guest

Bloomberg has reported large-scale money transfers abroad. But I couldn’t find it again. It is certainly not only 100 times EUR 10,000, Kirsten. Eva seems to agree.
Hungary is still a country with big FDI. This and the FDI-generated exports beautify Hungary’s balance sheets (and are bound to prolong the Orbán agony). I am interested in private savings crossing the border, however.

Kirsten
Guest

“This and the FDI-generated exports beautify Hungary’s balance sheets”.
I see your point, for me this is rightfully earned income of Hungary and Hungarians (as long as the firms do not leave Hungary and the goods are sold, euros or dollars are flowing into the country). The profits could be repatriated and reduce this income but the rest I would not consider to be “beautification”. The point that I wanted to make was that there are always persons that change forint into euro, but as long as these are individuals who try to protect their savings or as long as there is enough money flowing into the country (through exports or tourists or investments), it is not money flight. For that (I think) you need massive sales that would either weaken the forint or make the MNB intervene. You seem to have heard some information directly from some market participant but you can check it (and get an impression of how massive or not this flight was) with some delay in the balance sheets.

Paul
Guest

Thanks to Kirsten and Minusio for the answer to my question. Understanding dawns!
Presumably then, to reduce the national debt you have to run the economy with a ‘negative deficit’ (surplus?) for a number of years? Is this likely for Hungary?
Are there many countries that manage a budget surplus each year? If not, how does the world economy sustain so many countries getting into greater and greater debt?

Minusio
Guest

Paul: Not the economy (that, too), but government should not run at a deficit. Think of the government as a household that either spends more or less than the family income would allow for. 🙂
And: It is not the government that creates “a million jobs in 10 years” (hopefully!), but the idea is that the government creates conditions that may induce employers to hire more people. What the government can do is provide infrastructure, good education, good governance, a good tax structure.
We’ll see.

Minusio
Guest

Kirsten: “The profits could be repatriated and reduce this income but the rest I would not consider to be “beautification”.”
I was talking about the “dual economy” which means that if you take away this one (FDI-based) half you end up with a third world economy. For example, the Mercedes car that will be produced in Kecskemét will have no more than 7% of parts provided by Hungarian suppliers – although Daimler searched intensively to increase this input. Hungary just doesn’t have enough companies that are up to high-tech requirements. As a consequence, the “industrial clusters” are built around foreign companies by foreign companies.
Just try to imagine the Hungarian economy without foreign direct investment. So MTI news about a positive balance of trade have to be seen in this context. Authoritarian governments do not necessarily provide unfavourable conditions for foreign investments. But the Hungarian individual may still think that his/her savings are safer abroad. And that seems to be the case.

Ron
Guest

Minusio: “But the Hungarian individual may still think that his/her savings are safer abroad”.
You may be right. However, if funds are going abroad than the Hungarians require to open bank accounts (as private individual) or set up a company. I did not receive indications that this is an increased activity, although it has been going on for a number of years.
Partly, due to the powers that APEH have re. collecting from bank accounts in Hungary and the continue distrust of the Hungarian government, and lately the obviously reverse privatization of the pension funds. The question is if Fidesz is going to nationalize the savings of the people as well.
Although people may change their HUF for EURO or other currency it does not necessary mean that the money is brought abroad, it may well be that it is buried in the garden.
What I do see is that people (having a business) re-direct the turnover from Hungary to somewhere abroad, so the impact will be seen towards the end of this year.

Guest

When we travel from Hungary to Germany or back (which we do every 6 to 8 weeks), we always laugh at the many signs by the road in Austria which say “Bank xyz – we speak Hungarian” …
The nearer we come to the (non-existent) border, the more signs we see …

Kirsten
Guest

Ron: “What I do see is that people (having a business) re-direct the turnover from Hungary to somewhere abroad, so the impact will be seen towards the end of this year.”
I hope the average voter also notices that, could be a useful information if some “surprising” additional austerity measures might be needed as tax revenue does not rise in the envisaged manner.

Kirsten
Guest

Paul: “Presumably then, to reduce the national debt you have to run the economy with a ‘negative deficit’ (surplus?) for a number of years?”
In principle yes, but there are some subtleties and accounting issues (complex matter). But perhaps a relatively general rule is that the surplus is needed in something called primary balance, where the interest payments for the accumulated debt are excluded. In Hungary this is 4 % of GDP every year that are paid on interest. So any deficit below 4 % should mean that debt is not rising (all that I wrote now are very rough approximations and furthermore there are these complicated accounting issues). You can get rid of some debt also through privatisation of state property (e.g. MALEV or state-owned real estate, the more usual approach) or through the nationalisation of private pension savings (the less usual approach).
“Is that likely in Hungary?”
At least it was already possible during the 1990s as Éva wrote in the post. And because 4 % of GDP are transferred every year on interest, Hungary is less unthrifty than what appears from the deficits alone.

Paul
Guest

Thanks again, Kirsten.
Without knowing anything about it, 4% of GDP doesn’t sound a great deal. Is this actually a high figure, or in the normal range for smaler Europen countries? How does it compare to the UK – or, come to that, Germany and France?

Kirsten
Guest

I looked it up for the UK, before the current debt surge it was 2 % of GDP every year. These 4 % of Hungary are relatively high and because this debt is partly owned by foreigners, interest is really transferred abroad and not to Hungarian households or banks (or private pension funds). I am not sure that I identified these IMF data correctly but it appears that these interest payments are higher than investment into public infrastructure (roads, railways, schools etc.).

Paul
Guest

I know it isn’t too sensible to compare a country’s economy with a household one (although the evil Thatcher came to power doing just that!), but I’m trying to get some perpective on this, so let’s compare this with household debt repayments as a percentage of household income.
I my particular case, the only household debt we have is a small mortgage we took out to buy our flat in Debrecen, but the annual interest on this alone exceeds 5% of our annual income (before tax).
And we have a very low mortgage by UK standards (less than £30,000), most households, even those on a relatively low income like ours would have a much larger mortgage (well over £100,000 in many cases) and other debts such as credit cards and car loans. Their debt repayment as a percentage of income would be many times ours – probably exceeding 20%.
And yet, in most cases, their ‘economy’ functions perfectly well. So, if households can survive a 20% or more annual interest on ‘GDP’, why can’t countries?

Kirsten
Guest

Paul: So, if households can survive a 20% or more annual interest on ‘GDP’, why can’t countries?
Because in democratic countries expenditure (and taxes) are decided by a parliament and are (typically) governed by law. A household will be able to decide ad hoc not to go on vacations but a government cannot decide ad hoc to close schools, universities or the army or to cancel pensions, family support etc. It can reduce public investment, so no repairs of roads etc. But that chapter in the budget is often not too big, money is spent mainly on the functioning of the state including schools, hospitals, army and social payments (often “mandatory” i.e. due to a law and therefore enforceable). Higher taxes or reductions in social benefits are not always accepted easily.

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