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Preview: RealClearPolitics - Articles - Ian Bremmer and Preston Keat

RealClearPolitics - Articles - Ian Bremmer and Preston Keat

Last Build Date: Sat, 09 Sep 2006 00:33:33 -0600

Copyright: Copyright 2007

Hungary's Economy Hinges on Key Reform Questions

Sat, 09 Sep 2006 00:33:33 -0600

Hungarian companies (such as MOL Hungarian Oil and Gas, OTP Bank and drugmaker Richter Gedeon) become regional leaders in emerging Europe. Fiscal reforms, well-targeted regulation and improvements in Hungary's infrastructure continue to improve the investment climate. Hungary establishes its bona fides as a highly competitive niche investment destination - as Ireland has done over the last 20 years. In a worst-case scenario (call it the Greek model), fiscal reform stalls and economic growth slows to one or two percent. As a consequence, the government fails to persuade participants in financial and capital markets over the next 12 to 18 months that it can improve Hungary's fiscal outlook. The twin deficits (fiscal and current account) remain alarmingly high. The resulting crisis in capital markets leads to a sharp slowdown in foreign investment, the cornerstone of Hungary's growth and development. Bond and currency investors take flight. The poor economic climate generates a brain drain as Hungary's homegrown talent migrates to more promising EU markets - Germany, the UK, Ireland and elsewhere. As a consequence, Hungary becomes dependent on EU development aid, and its economic dynamism fades. "Euro-slippage," the process by which some states fall further behind targets set for economic and monetary union, continues. Which of these scenarios is the more likely to develop? A few key near-term decisions by Hungarian policymakers are likely to answer this question. First, will they follow through on the vitally important fiscal reform agenda and demonstrate positive results? The answer is almost certainly yes. Second, to keep the deficit-reduction agenda on track, will the government take the politically unpalatable step of dramatically cutting spending in the coming year, rather than simply raising taxes and fees? Here the picture is much less clear. Third, will the government reduce and simplify the tax system over the next several years, once administrative reform measures have produced savings? Again, it's very difficult to say. Hungary is likely to move through 2006 in good shape. But tougher challenges lie ahead. As is usually the case when assessing the likelihood of an outcome between best- and worst-case scenarios, the answer probably lies somewhere between the two extremes. Likelier than the best- and worst-case scenarios is one in which Hungary enjoys strong growth and development in certain economic sectors and regions while others lag behind. Unemployment remains relatively high. The government dips its toes into the reform process to measure the political temperature without fully diving in. Hungary's governing Socialist-Liberal coalition won a clear re-election victory earlier this year. But it did so, in large part, thanks to promises of "reform without austerity." Given the state of Hungary's public finances, this formulation has only added to investor skepticism of official commitments to serious reform. Sharp spending cuts are often unpopular, particularly in emerging market countries. The risk is great that if losses in municipal elections in October diminish Prime Minister Ferenc Gyurcsany's standing within his Socialist party, he may step back from precisely the fiscal reforms needed to strengthen Hungary's appeal for foreign investors. The ruling Socialists are likely to suffer an electoral setback: They will likely lose most of the town and city councils that they control, and several of their incumbent mayors are expected to be defeated. But the impact on the party at the national level will be minimal. The leadership is anticipating these losses. But unless their defeat produces an "earthquake" in which the opposition Fidesz takes most of the local and regional councils and city halls of the largest cities, the government will move ahead with its fiscal reform agenda. Hungary's fiscal reform efforts matter enormously, because players in the capital markets are watching. They will have little mercy if the twin deficits cannot be tamed in a way that improves the country's investment climate. A[...]