INSIGHT-Hungary dug itself a debt hole, now it pays the piper=2


currency, and became so bad that the Socialist government needed a bailout.

Hungarians who had taken out loans when they could get exchange rates of 140 forints to the Swiss franc suddenly were having to pay 200 forints per franc or more.

The howls of outrage did not go unheeded by Viktor Orban, whose Fidesz party won a two thirds majority in parliament in 2010. His government came up with a plan for the banks to eat the losses, instead of the citizenry.

In one of those offers that sounds too good to be true, the government said it would let people pay off the mortgages, before the end of 2011, at a one-time-only exchange rate as much as 25 percent lower than the market level, in Swiss franc terms, with the banks absorbing the difference.

The local banks, many Austrian owned, cried foul. One analyst estimated that if every Swiss-franc-denominated mortgage in Hungary were converted, losses to the banking system would amount to 1.1 trillion forints.

Eight affected banks, some of which said they would report losses in part because of the scheme, sent a letter to the EU commissioner in charge of regulating finance in mid-November, calling the plan a "blatant violation" of their rights and asking the EU Commission to support them in fighting what they called "treaty violations by Hungary".

But the Hungarian public -- even people who had qualms about the ethics and legality of it all -- gobbled it up.


"It's the only decision in my favour in the last four and a half years," said Andras, a managing director of a company who is in his mid-30s and did not want his last name used due to the sensitivity surrounding the scheme.

He said that like many Hungarians, he had been lured by the siren call of luxury and used a foreign currency-denominated mortgage to buy a bigger flat when the rate of exchange was 143 forints to the Swiss franc, instead of today's rate of about 255.

Hungarian households hold about 4.8 trillion forints worth of foreign currency-denominated mortgage loans, equivalent to 17 percent of GDP, on which repayments have soared due to the Swiss franc's rise. Many companies and local governments also are indebted in francs.

"In this country everyone likes to buy a car one or two sizes bigger than they can afford, a big apartment, a plasma TV and a smart phone," Andras said over brunch at one of Budapest's swank cafes, where three different types of champagne in ice coolers tempt customers from atop a display case.

He was fully aware, however, that while he personally would benefit from the deal, it had its downside.

"In a country where former contracts can be redesigned on an ad hoc basis, who will come here to invest?"

This is precisely the position that the angry Austrian, as well as Italian and other foreign bank-holding companies, find themselves in as they survey the financial carnage wreaked upon them by Fidesz over the past year and a half, and with the uncertainty about what is to come.

Banking sources say that whatever may appear on the surface, foreign-based top management are viewing the futures of their Hungarian affiliates with concern. Decisions on whether to invest for the growth of these affiliates, or to leave them to wither on the vine, could well be determined by future Hungarian government policy, they say.

Zoltan Csefalvay, state secretary to Economy Minister Gyorgy Matolcsy, downplayed that likelihood.

"I said I think one month ago that no bank would leave Hungary, and this was a headline in Hungary, but I say the same, no bank will leave Hungary, because the banks look a little bit further and banks know one thing, the crisis will be over," he told Reuters in an interview.

He said the government had instituted structural reforms, cut the deficit and boosted economic growth, though the European Union and analysts think the growth forecast of 1.5 percent of GDP for next year is optimistic. The OECD said it actually expected the Hungarian economy to contract by 0.6 percent.

Csefalvay said steps were being taken to solve at least some of the problems of places like Inke by taking back financial control from local governments, which he said in future could only get loans with the permission of the central government. That would stop Inke from borrowing, though of course it might still not have money for heat.

He deflected a question about whether Orban, or his own boss, Economy Minister Gyorgy Matolcsy, should step down, even though prime ministers of Italy, Greece and some of the other European countries hit by economic turmoil either have resigned or been thrown out in the polls.

"That is not my responsibility to discuss this kind of personal question," he said. "There is a party, certainly, the ruling party, and I think the ruling party should decide it."

Fundamentally, Hungary was at the mercy of the economic turmoil sweeping Europe, he said, and that is why having broken with the IMF, Hungary was going back to try to forge a new deal, not because its policies had failed.

"If you look at what is happening in the whole of Europe, how the crisis is deepening can see that such a country as Hungary needs an additional safety net," he said. "And if you compare the whole situation between 2008 and today, 2011, you can see there are many changes also in the IMF, you can see the IMF can provide much more flexible solutions to these kinds of problems and on the other hand, if you look at the Hungarian economy, I think it is in much better condition."


Hungary, despite the grinding poverty of places like Inke, is on the whole better off in pure economic terms than it was in the 1990s, or even a few years ago.

The Orban government, in part because of its unorthodox measures, has brought down the budget deficit to just under 3 percent of GDP. Total GDP in 2010 was 27 trillion forints, or about $130 billion, double what it was about a decade ago.

"I can't imagine that Hungary can go bankrupt," analyst Gergely Suppan at Takarekbank in Budapest said.

In western Hungary, the massive investment by German automaker Audi on the outskirts of the city of Gyor, starting in the 1990s has grown into an enterprise whose turnover of 4.8 billion euros in 2010, as reported in the affiliate's annual report, is roughly equal to five percent of GDP. Those revenues grew by 23 percent from the previous year, and the company has announced plans for further expansion.

Audi is in the midst of building a new, 900-million-euro car factory that will create 2,100 jobs in the next two years, company spokesman Peter Lore said in an emailed response to questions submitted by Reuters.

Workers flowing out during a shift change recently said they liked working at Audi, compared to some Hungarian companies which, after communism, were privatised, restructured, downsized or even effectively closed down.

"Audi is a company that plans for the future," worker Istvan Toth said.

But to the extent the downgrade and negative sentiment about the country is tainted by Orban's unorthodoxy, Hungary will pay a heavy price for his populism. The day of the downgrade, Hungarian bond yields initially soared more than 100 basis points to between 9.5 and 9.8 percent, to 738 basis points above the benchmark 10-year German bund, boosting Hungary's costs for refinancing its massive debt that much higher.

"It is not because of this measure only that the currency depreciated, all the currencies in the region are under heavy pressure," Rafal Kierzenkowski, the OECD's senior economist for Hungary, said in a telephone interview, speaking about the mortgage-payoff scheme.

"It's true that this early repayment scheme at discounted exchange rates may have somehow amplified the effect and hence is increasing the burden on the economy. The public debt is growing and households who continue to be indebted in foreign currencies


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