In his political life Prime Minister Péter Medgyessy has embraced diffidence and predictability. These qualities helped propel him through the bureaucratic ranks of the Communist regime, then up to Finance minister in the post-1989 capitalist era, and finally, two years ago, to the pinnacle of the Hungarian Socialist Party-led government.
“This is a profession in which you cannot afford to be surprised,” Medgyessy told Institutional Investor in a recent interview in his Budapest office, replete with portraits and sculptures of eminent Hungarian statesmen. To underscore his point he leafs through a book by the early 20th-century Hungarian writer, Kálmán Mikszáth, until he finds some favorite words of political wisdom: “A good prime minister is never angry, hurried, embarrassed or surprised.”
By his own choice of definition, though, the 62-year-old prime minister seems to be falling well short of good. He barely bothers to contain his anger at the torrent of criticism from the right-wing Fidesz party, the political opposition led by former prime minister Viktor Orbán, a media-savvy 40-year-old. Medgyessy has been surprised and embarrassed by his government’s inability to bring the budget and current-account deficits under control. And now he seems in an awful hurry as well.
In January he suddenly fired his longtime friend, Finance minister Csaba László, directing his replacement, former cabinet chief Tibor Draskovics, to restore the economy’s health through painful cutbacks in public spending that could make the Medgyessy government an underdog in parliamentary elections scheduled for 2006. “The government is determined to carry out fiscal discipline regardless of coming elections,” Finance Minister Draskovics tells II. “I have authorization from the prime minister to do whatever is necessary.”
But well before those elections, Medgyessy must deal with increasing impatience within his own coalition. Rumors of rebellion against him were so rife in February that a leading newspaper, Magyar Hírlap, reported that Socialist Party dissidents were pushing three cabinet officials as candidates to replace him. “Those whose death is predicted live long and healthy lives,” the prime minister scoffed publicly.
Prime ministers of other prospective EU members face similar turmoil within their own coalition ranks as well as from opposition parties as they try to bring public finances under control and prepare their countries for eventual adoption of the euro. In Poland, Prime Minister Leszek Miller has announced that he will quit on May 2 -- the day after his country joins the EU -- in the hopes that a new government led by his ruling Democratic Left Alliance will be better able to forge ahead with deep spending cuts and other unpopular economic reforms. In the Czech Republic, Prime Minister Vladimir Spidla has threatened to resign and call early elections unless his Social Democrats back his economic austerity and reform program.
In Hungary, more than any other country in the region, politics is exacerbating economic problems. Bitterness between left and right continues to inflame political passions 50 years after local Communists supported the bloody Soviet military repression of the 1956 Hungarian uprising. “This is still a very divided society,” says Krisztián Szabados, director of Political Capital, a Budapest-based policy research and consulting institute, who assigns more blame to the right. “Fidesz’s message is that there are two Hungarys and that they represent the good one.”
Elections have become no-holds-barred contests, in which political smears blend with capricious economics. In 2002, for example, then prime minister Orbán was so intent on getting himself and his conservatives reelected that he recklessly pushed the budget deficit to 9.6 percent of gross domestic product -- much of it hidden in the ledgers of a state-run development bank. The Fidesz campaign also charged that Medgyessy had been a spy for the Communist-era secret police -- an accusation denied by the leftist candidate. “Because of elections every four years, the country is running pretty close to bankruptcy,” says György Barcza, an economist for ING Bank in Budapest.
Orbán still lost the election. But Medgyessy fumbled the opportunity to rein in government spending and blame a needed dose of austerity on his profligate predecessor. Instead, he carried out his own rash campaign vows, including 50 percent wage increases for most public sector employees. “This government did something very unusual -- it kept all its campaign promises,” says Péter Fáth, executive director of the American Chamber of Commerce in Hungary.
The result has been a bevy of negative statistics for a nation that was a post-Communist economic model throughout most of the 1990s. Hungary, which once led the region in foreign direct investment, a key component of export growth, last year experienced a net outflow of FDI as leading Hungarian companies expanded abroad. The National Bank of Hungary, the country’s central bank, predicts 6.9 percent inflation for 2004 -- the highest among new EU members. The budget deficit last year was equivalent to 5.6 percent of GDP, well over the government’s 4.5 percent target. It also far exceeds the 3 percent limit set by the Maastricht criteria for new EU members aiming to adopt the euro as their currency -- a goal that Medgyessy had hoped to achieve by 2008, but which now looks unlikely before 2010. Even success hurts. Average wages in Hungary, which were a third less than in Poland only three years ago, are now about the same in both countries. But this has reduced export competitiveness, leading to a 2003 trade deficit of almost E4.5 billion ($5.6 billion).
The most immediate impact of all this bad news has been felt on the currency market. Last year the Hungarian forint suffered three major speculative attacks. Because of high interest rates on forint-denominated debt and the prospect that Hungary would join the euro zone by 2008, “everybody wanted to own Hungarian bonds,” says Dwyfor Evans, London-based emerging-markets strategist for Bank of America. Foreign holdings of forint bonds reached $12.5 billion at the end of 2003, or 15 percent of GDP, making Hungary the most actively traded local debt market among prospective EU members.
But investors began to worry about the strength of the forint because of the mounting budget and current-account deficits and the likelihood that adoption of the euro would be postponed. Nor did it help that the government’s loose fiscal policies openly contradicted the central bank’s tight monetary policy. “We lost a substantial amount of credibility with the market,” says György Surányi, former governor of the central bank and now head of Central and East European operations for Italian bank IntesaBCI.
To defend the forint, the central bank raised interest rates several times last year, leaving the current prime rate at a whopping 12.5 percent. That will make it difficult for GDP to grow by the 3.5 percent predicted by the government for 2004, with businesses complaining that they are unable to borrow at reasonable interest rates. “The overall macroeconomic equilibrium of the Hungarian economy has deteriorated,” warned the European Commission in a November 2003 report on Hungary’s preparations for EU membership.
Although former Finance Minister László became the fall guy for all this bad news, he was in fact given little economic or political leeway to come up with remedies. Medgyessy didn’t allow him to put a lid on public sector wages or freeze expensive infrastructure projects. He was overly optimistic that the EU -- Hungary’s main trading partner -- would emerge from its economic doldrums of the past two years. And in his last few months in office, he suffered from such a lack of credibility that investment bankers and financial analysts openly speculated he would be fired.
The man appointed to reverse this tide of negativity is Finance Minister Draskovics, a 48-year-old lawyer and longtime Medgyessy political aide who has held numerous posts in the Finance Ministry. “He will have no easy job,” says Medgyessy. “This is like walking the tightrope, and you need nerves of steel.”
Draskovics has set as his ultimate priority a return to “sustainable growth by restoring the necessary economic equilibrium.” Although GDP growth in 2004 will probably not be much above last year’s 2.8 percent, the Finance minister is trying to engineer a shift from consumption-fueled growth to an economic expansion led more by investments and exports. Part of this shift will be achieved this year by budget cuts of 150 billion forint ($731 million), equivalent to about 0.8 percent of GDP, and tax increases of Ft35 billion. The rest will come by curtailing home mortgage subsidies, which amounted to Ft700 billion last year. This was one of the previous government’s most popular programs because it allowed hundreds of thousands of middle-class families to purchase residences. But it also reduced annual household savings to less than 1 percent of GDP from their historical 6 percent.
The Finance minister has pretty much rescinded the government’s commitment to adopt the euro by 2008, calling 2010 a more reasonable target date. “But fiscal discipline will be maintained regardless of what date we choose for entry into the euro zone,” he insists.
The government is also intent on ending its notorious squabbles with the central bank. Left-wing parliamentarians are no longer calling for the resignation of the bank’s governor, Zsigmond Járai, who was often accused by government partisans of being a Fidesz agent intent on sabotaging the economic program in order to help the conservatives win the next election. Nor is the government upbraiding the central bank for its tight monetary policy. “Interest rates are very high and are not favorable for economic growth,” says Draskovics. “But it’s my job to create the conditions to reduce these rates, and I’m sure the central bank will take the right steps if conditions allow them to do so.”
After informal talks with Finance Ministry officials, the central bank has responded in kind and is backing the government’s bid for greater credibility in the financial markets. “There is a real fiscal tightening, though the market doesn’t yet believe it,” says György Sándor, managing director at the central bank. “But as the economic numbers improve month by month and quarter by quarter, the market will come around.”
Other analysts insist that Hungary will continue to have currency problems as long as it operates with a relatively fixed exchange rate that follows the euro within a plus-or-minus 15 percent band. Hungary decided against the free float chosen by neighbors like the Czech Republic, Poland and Slovakia in the hopes of burnishing its image among investors as the most economically advanced of the prospective EU members -- and the one likeliest to adopt the euro first. Even though the strategy has failed, government officials fear that abandoning the fixed exchange rate at this late date might provoke another market sell-off of the forint.
But according to Charles Wyplosz, an economics professor and currency expert at the Graduate Institute of International Studies in Geneva, Hungary might not have a choice. “Everywhere in the world, we have seen that when you have free capital movement, it is almost impossible to operate a fixed exchange rate,” says Wyplosz. “The rational thing for the Hungarians to do would be to let their currency float until their economy is good enough to join the euro zone.”
Hungary’s central bankers insist that the threat of currency crises -- past and future -- has been exaggerated. “The fluctuations over the course of 2003 were plus or minus 8 percent,” says Sándor, the central bank managing director. “Some countries might even call that exchange-rate stability. It is peanuts compared with the euro-dollar exchange rate movement.”
Beyond the currency issue, some analysts have long-term anxieties about the Hungarian economy. “It’s true that growth this year will come more from capital expansion than consumption,” says Ryzard Petru, a Warsaw-based economist covering the region for the World Bank. “But further down the road, I’m concerned about Hungary’s ability to grow, by say 5 percent annually, because labor isn’t as competitive as it used to be.” Moreover, says economist Wyplosz, it will take Hungary some time to overcome an image of ineptitude. “The Hungarians have made a succession of mistakes and then reacted clumsily when things went wrong,” he says. “So the markets have come to see Hungary -- both its government and its central bank -- as error-prone.”
This opinion is shared by some in the local business community. “The government has made quite some effort to improve the situation,” says Tamás Simonyi, a partner with KPMG Hungária in Budapest. “However, to restore confidence in economic policies takes much longer than to lose it.”
Indeed, even the best-managed Hungarian companies have been buffeted by government miscues. A case in point is Magyar Olaj-és Gázipari (MOL), the oil and gas producer that is the country’s biggest corporation. In 2003, MOL far exceeded analysts’ predictions with a net income of $447 million, up from $292 million the year before. Late in 2003 the government announced its intention to sell about half its remaining 22.7 percent stake in MOL. But in December, the sale was abruptly called off because investors were driving MOL share prices below government expectations.
“MOL was a victim of the country’s macroeconomic environment,” says György Mosonyi, MOL’s chief executive officer.
Market analysts tend to agree. “The placement took place in the midst of a currency crisis,” says Toomas Reisenbuk, head of investment at Trigon Central and Eastern European Fund, in Tallinn, Estonia. Just before MOL shares were offered, there was another, smaller placement -- for government shares in a mortgage bank, Földhitel és Jelzálogbank (FHB) -- and with the forint slipping, that issue traded well below the offering price. Investors figured MOL shares would also plunge.
Another negative factor was an untimely comment by thenFinance minister László that the government might sell the remainder of its MOL shares in mid-2004 -- or about a year earlier than previously indicated. “That just created more share overhang, in effect warning investors that more supply was coming to the market,” says Róbert Réthy, an equity analyst who follows MOL for CA IB Securities in Budapest. According to Mosonyi, the government’s growing fiscal problems also affected market perceptions. “A lot of investors thought the government would be forced to sell its shares at any price because of budgetary issues, and that also created a lower-than-expected price for our shares,” says the oil company CEO.
In the aftermath of the debacle, the government decided to forgo another public offering of its MOL shares that might provoke a fall in their price. In a surprise move, it announced in February a private placement of half its MOL shares through Citigroup in a deal valued at some $345 million -- or about 10 percent more than what the government was offered in the abortive December sale. With the MOL placement, the privatization of former state companies is nearing an end, and with it, a major source of the financing that helped smooth the transition toward a market economy.
Increasingly, Hungarians in both the private and public sectors are arguing that further economic progress will require a more civilized political discourse between left and right.
“The root of our problems is that government and opposition are in a fierce, permanent fight,” says Fáth, the executive director of the American Chamber of Commerce. “If there were a nationwide consensus on economic policies, we would be much better off.” Politicians on both sides, in calmer moments, allow that some consensus-building ought to be possible. According to János Martonyi, who was minister of Foreign Affairs under Orbán, enough time has passed since the fall of Communism “to permit a dialogue between the opposing political forces on the major national issues, like a European policy, the adoption of the euro and health system reform.”
But Medgyessy and Orbán have managed to take only the most tentative steps toward such a dialogue. Even two years out of power, Orbán insists on projecting himself on an equal footing with Medgyessy and continues to deliver an annual state-of-the-nation address a week or so before Medgyessy gives his own official speech. In his address this year, delivered in February, Orbán made biting remarks about the government’s “not delivering on almost any of its promises” and included a few trademark incendiary phrases, such as proposing that “Hungarians should take action themselves” to press for a change in government policies. But he also sounded somewhat conciliatory toward the left, suggesting that well-intentioned Hungarians of different political persuasions were forced to survive as best they could under decades of Communist rule.
In the real state-of-the-union address delivered a week later, Medgyessy stopped blaming economic setbacks on his predecessor and conceded his own government had “overestimated the strength of our economy.” But in an interview with Institutional Investor only a day later, the prime minister complained that Orbán and his party were “not interested in political calm . . . Confrontation is in their very nature.”
Then zigzagging once again, Med-gyessy met with Orbán for the first time on March 1 in a stilted affair open to the press, with each man offering a list of proposals rejected by the other. Nothing of substance was achieved, except for a photo opportunity of the leaders in a semblance of national unity.
Both sides have something to gain by displaying less belligerence. Public opinion polls in January showed close to half the electorate favoring Fidesz, which had almost a 10 percent lead over the Socialist Party. “But Orbán has to tone down his divisive, angry rhetoric and project a more statesmanlike image if he wants to keep that lead,” says one European diplomat. “He scares too many people.”
Meanwhile, in order to increase its reelection chances, the government would like to claim some sort of political consensus behind its austerity plans that call for thousands of cutbacks in public sector jobs, a hold on wage increases for state employees and other budget reductions. “The Socialists lost to the right in 1998 because they introduced some very tough economic reforms,” says Tamás Dávid, head of research at the Budapest Economics Institute, which studies economic development in Central and Eastern Europe. “And they are worried the situation is very similar as they approach the 2006 elections.”
According to Finance Minister Draskovics, with luck the economy will rebound in time for elections and voter anger over belt-
tightening will subside. “The toughest steps will have been taken last year and this year, so it may be possible to reduce the pace of budget cuts afterward,” he says. But former central bank governor Surányi, who carried out some of the most painful and successful economic reforms for the Socialist Partyled government that fell in 1998, warns that the government is running out of options and faces prohibitively higher interest rates if it fails to bring spending under control.
“Politicians may argue that elections in 2006 make it impossible to carry out painful reforms,” says Surányi. “But it’s no longer a national decision. The market will force the government to act -- and the cost will be much higher if that happens.”
MEDGYESSY: ‘A NATIONAL CONSENSUS IS NEEDED’ Hungary’s prime minister, Péter Medgyessy, cultivates an ascetic, low profile. The 62-year-old former Communist-era bureaucrat and capitalist-era banker and finance minister has been in power since 2002. He makes few public speeches and rarely grants interviews. A workaholic, he insists that aides come quickly to the point. They are only too glad to oblige, since the temperature in his Budapest headquarters -- which he insists be neither heated nor air conditioned -- is often uncomfortably cold or hot. Institutional Investor Contributing Editor Jonathan Kandell recently met the prime minister for an hourlong interview at his office in the Parliament building where the wide-open windows invited breathtaking views of the Danube and the Royal Palace, as well as bracing winter gusts.
Institutional Investor: What do you consider your most important accomplishment and your biggest disappointment in office?
Medgyessy: The biggest achievement is taking the first steps towards a modern European Hungary by becoming an EU member. My greatest disappointment is the political style that still reigns in Hungary and continues to slow the pace of economic reforms.
Friction between the government and the opposition seems to be more acute in Hungary than in neighboring countries. Why is this so and what can be done about it?
When I first got into office, I wanted nothing more than national unity. And I won’t stop working towards this goal even if we haven’t yet succeeded. But the opposition is not interested in political calm. Confrontation is in their very nature. The battle lines weren’t drawn in 1956 [when the Soviet military backed by local Communists crushed a popular uprising]. I can’t even say that this is an ideological conflict between social democrats and conservatives. The reason is much simpler: a struggle for power. And this is best illustrated by the opposition’s populism versus our liberal social democratic values.
Is a consensus with the opposition necessary on major economic issues?
That’s a very good question. Like every European country, Hungary is facing the need for economic reforms. Without them, Europe won’t be able to meet the challenge from America. Many economic reforms take longer to pass than one term in office. And even if a government carries out reforms, they still risk being rejected by the next government. So a national consensus is needed. That is why I have initiated a series of meetings with former prime ministers.
What major economic issues require this sort of consensus?
One of the fundamental issues is health care reform. Another is the overhaul of public administration. And joining the euro zone will require a broad consensus on the need for more balanced economic growth, lower inflation and higher competitiveness.
Is 2008 still Hungary’s target date for entry into the euro zone?
We want to join the euro zone because it will bring more stability and predictability to our economy. For investors it will mean a more stable exchange rate. It will also promote development by keeping interest rates lower. So it’s in our interest to adopt the euro as soon as possible. However, we also want to set a realistic target date. Previously, we aimed for 2008. But now I’ve requested the Finance minister to look into all possibilities. His review will be completed by spring.
How will economic policy change under Finance Minister Tibor Draskovics?
I expect from the new minister a tougher enforcement of financial austerity measures, but coupled with economic growth. And I have also requested him to speed up economic reforms. We have put together a plan for 185 billion forint [$901 million] in budget cuts this year. I want to link these savings to reform efforts [aimed at reducing the state’s burden on the economy]. We should ask whether some government agencies that were created many years ago still make sense in the current market economy. We also want to regain the trust of the markets and adopt predictable policies that will encourage foreign investment.
What economic difficulties do you foresee in the first few years after EU accession?
I expect EU membership to guarantee much faster economic development for Hungary. Infrastructure development will definitely speed up. But there are certain risks and problems that require major changes. Take agriculture, for example. Investments to increase its competitiveness are necessary. And we will have to convince small farmers that they must adapt or perish.
Besides the economic impact, what does Hungary’s integration into the EU mean to you personally?
The 20th century was not a good one for this country. We lost so much [national territory] in World War I. After that we had a terrible right-wing regime. Then came World War II with its massive loss of life, and Communism after that. So I truly believe that for Hungary a more hopeful 21st century begins with accession to the EU on May 1.
What has been your biggest surprise since taking office?
This is a profession in which you cannot afford to be surprised.
THE BUDAPEST PHILHARMONIC: HUNGARIANS IN HARMONY A smoothly functioning economy is often compared to a finely tuned orchestra. Hungarians can only wish that their sputtering economy resembled their beloved Budapest Philharmonic Orchestra, which last year celebrated its 150th anniversary. Although orchestras throughout the former Soviet bloc have suffered mass defections to the West by their most talented musicians, the BPO remains an all-Hungarian ensemble that has lost only a handful of performers. The orchestra’s almost seamless transition from communism to capitalism has no doubt been helped by the continuous presence of its conductor, Rico Saccani, now in his 21st season, the last seven as musical director. “The beauty of this orchestra is that those musicians in my generation or older are the same ones who were here when I started conducting,” says Saccani, a boyish, 51-year-old native of Tucson, Arizona.
To use the parlance of economists, the BPO presses its comparative advantages. Start with what might be described only half-jokingly as the Hungarian DNA strain for music. This nation of 10 million people has assembled an awesome roll call of musical talent -- composers Franz Liszt and Béla Bártok, conductors Eugene Ormandy and Georg Solti, pianists Zoltán Kocsis and Andras Schiff, to name just a few standouts. Then there is the famously velvet tone of Hungarian string players. “It is genetically impossible for a Hungarian musician to make an ugly violin sound,” asserts Saccani.
The BPO is also renowned for its productivity. In one recent week the orchestra’s performances included five operas -- Wagner’s Ring Cycle and Mozart’s Così fan tutte -- and two concert evenings of Schubert’s rarely performed Symphony no. 7 and Tschedrin’s rambunctious version of Bizet’s Carmen Suite. BPO musicians are gluttons for punishing practice schedules. “I have the incredible luxury of seven rehearsals before each performance,” says Saccani. “That’s unheard of elsewhere.”
Yet the average monthly salary at the BPO is $600 to $700, before taxes. This probably explains why half the orchestra members are women under 30 years old. Men are still expected to be the bigger breadwinners in households and thus are choosing more lucrative careers.
Another comparative advantage enjoyed by the BPO is location. With the same logic that has spurred foreign investment in auto plants in adjoining Central European countries, Budapest forms part of a classical music triangle with Vienna and Prague that attracts tourist dollars and euros. Of the three capitals, Budapest has arguably the most beautiful opera house. The Magyar Allami Operaház is an acoustic jewel box of gold plaster, red velvet and lush frescoes. With only 1,800 seats -- compared with 4,000 at New York’s cavernous Metropolitan Opera House -- nobody complains about being too far from the stage to see or hear the singers and musicians.
To be sure, the BPO has obstacles to overcome if it is to continue to thrive. It markets itself poorly. The tiny gift shop at the Budapest opera house doesn’t have a single BPO recording for sale. The concept of private sponsorship as practiced in the U.S. and increasingly in Western Europe is nonexistent in Hungary, where there are no tax benefits for philanthropic donations. State funding continues to cover more than 90 percent of the orchestra’s expenses, with box office receipts accounting for the remainder.
Still, the BPO sounds a lot more optimistic about its future than other Hungarian enterprises facing increased competition with the country’s accession to the European Union in May. “I see absolutely no drawbacks for the orchestra in joining the EU,” says Saccani. -- J.K.
WHAT TO DO IN BUDAPEST Budapest has reemerged as a cosmopolitan capital by recapturing its art nouveau splendor of a century ago. To savor the nostalgia of that golden age, begin by taking the waters at the famed thermal baths of the Danubius Hotel Gellért. The cavernous baths (though not the swimming pool) are segregated by sex. In the men’s spa the walls are stunningly tiled in turquoise and salmon, with scimitar flourishes and other Moorish motifs. Bathers are given a half loincloth, aptly called a decency panel, for wading into two ample mineral pools, one slightly more heated than the other. (Women bring their own bathing suits.) The Gellért spa, located on the Buda bank of the Danube River, has an entrance separate from the hotel’s. Use of the mineral pools costs 2,700 forint (about $13); tip the locker attendant Ft100. Baths are open 6:00 a.m. to 9:00 p.m. on weekdays and 6:00 a.m. to 5:00 p.m. on weekends. Telephone: 466-6166. No reservations necessary.
After soaking for an hour, you’re ready for dinner at Gundel, the city’s most celebrated and historic restaurant. Opened in 1894 and renovated a century later by George Lang, the Hungarian-American restaurateur, with backing from U.S. financier and cosmetics heir Ronald Lauder, Gundel boasts a palatial setting with marble columns, thick carpets, richly upholstered banquettes and a six-piece orchestra that includes a hammered dulcimer. As an appetizer, try the roasted goose liver, served cold, with a glass of sweet Tokaji Muscat. For fish, there is fogas -- the pike-perch specialty from Lake Balaton -- sautéed and ladled with a white wine sauce. Paprika chicken with egg spaetzle is an admirable main course. And for dessert, choose the pancake stuffed with walnuts and slathered with chocolate sauce. Gundel, 2 Allatkerti út; telephone: 321-3550; open daily; about $90 per person, including wine and the standard 10 percent tip.
Heading most lists of business-oriented luxury hotels is the Hilton Budapest, rated tops in the city in the Institutional Investor December 2003 rankings of lodgings around the world. Built on a hill around the ruins of a medieval monastery and next to the Royal Palace, it offers the spectacular views of the Danube and downtown Pest that Habsburg monarchs enjoyed. Hilton Budapest, Hess András tér 1-3; telephone: 889-6600; 322 rooms and suites, starting at $185 including tax and service charge. -- J.K.
