Wednesday, 19 May 2004

Buda and Pest

Observations of Eastern Europe and the European Bank for Reconstruction and Development from 2003 to 2009


Hungary’s Budapest is a cultured sophisticated and very European city. The magnificent architecture is a tribute to the glory days of the Austro-Hungarian Empire. Some of the buildings are incredible, the restaurants are good and ‘to take the waters’ in the numerous and extravagant baths is a ‘must do and enjoy’ experience.


Most Aussies, except the 60,000 Australians of Hungarian, descent know little of Hungary and most Hungarians have no idea about us.

But Australians are welcome in Hungary mainly because we have had so little to do with Hungary we have never caused much offence. Some Australians will remember the courage of the Hungarian people in standing up to their Russian oppressors in 1956. If Hungarians remember anything about Australia then it may be the 1956 Melbourne Olympics when they famously beat the Russians for the gold medal in the men’s water polo. The swimming pool was red with blood.

Today Hungary is a member of the European Union and NATO. It has a free enterprise economy and a democracy.

In the Austro-Hungarian Empire, Hungary was at the centre of the world and a pre-eminent society within Europe. Since those good old days, the Hungarians have lost 60% of their territory, went with the wrong side in WW2 and then had the Russians walk all over them.

Now they are back where they belong in the centre of Europe.

Even the 2 million Hungarians who are stuck within neighbouring Romania’s borders must be feeling a bit happier knowing that the boundaries between Romania and Hungary are slowly dissolving as the EU becomes a reality. Romania joined the EU in 2007.  Those Hungarians living in Slovakia and Serbia will eventually enjoy the same benefits of EU club membership. And when all these neighbouring countries get their fiscal act together they will probably even have the same euro currency. But life in Hungary is not all good local wine and goulash.

Hungary acceded to the EU on 1st May 2004. There were some negative impacts that would make anyone wonder about being in the EU. The price of electricity jumped by 22% due to a change to the value added tax system required for the EU entry. The EU has high tariffs on bananas so the price jumped 15-20%. For similar reasons and to the annoyance of sugar growers in Queensland, who are denied access to their market, Hungarians now have to pay 30% more for sugar. And meat prices jumped as well. EU laws that protect geese from inhumane treatment will now threaten the foie gras industry because the Hungarians still use the traditional methods of force feeding the geese. I know animal welfare is important but try and explain that to a Hungarian peasant who thought his country had just escaped the clutches of bureaucrats in Moscow only to find that there are thousands of new politically correct ones in Brussels. Bureaucrats are a problem everywhere. As Australia’s great Prime Minister Bob Menzies once said, the trouble with bureaucrats is that they don’t eat their young.

But Hungary’s problems do not start in the EU. Like everyone else, most of their problems are of their own making. The chance to join the EU was a great spur to reform. Basically the EU sets out a list of requirements before you can get in so, if you want to join, you do not have any choice but to comply. But once you are in then the motive is no longer as strong. That seems to be what has happened in Hungary. For a while they were reform leaders but since entering the EU, things have been pedestrian.

The government had been spending too much. The budget deficit is above 5% of GDP. The current account deficit was over 8% of GDP and inflation is a problem.  Competitiveness has slipped, particularly with wage levels. And the economic zeal for reform has waned. The political party that once were the loudest and most active supporters of privatisation are now publicly thinking of proposing a ban on any further privatisation. That makes them sound like our very own former Prime Minister Paul Keating but it is the ‘right wing’ party.

The central bank is independent but it has 2 goals; to keep inflation down and maintain a reasonable level for the exchange rate. To keep inflation down, interest rates have been kept fairly high. But as interest rates are low in Europe a lot of money has poured in to Hungary to take advantage of the higher rates. This has pushed up the currency. This makes it more difficult to export and too easy to import. A while ago the bank had to lower rates just to get the currency down a bit. The 2 goals for the central bank are, in my opinion, contradictory. Something has to give. I reckon it will be the currency. It will have to be floated and the bank will have to give up its twin goals and solely focus on inflation. So, I would not buy property in Hungary just yet. But it will be a good deal after my speculation turns out to be correct, if it does! And there are some superb properties if you want to get in to that market.

I was told that local people reckon it is better to buy a new house out of town than to live in the central district. This has, for the moment, kept demand for inner city properties down a little.  No-one else in Europe thinks like that and over time the suburbanites are going to work out that it is much more convenient to live in the city. This will push prices up. Today, if you buy a flat, most of your neighbours will be poor and no-one can afford to renovate the common property let alone the dirty drab exterior of the building. The buildings in Budapest are as good as anything you will see in Paris or London and they sell for a song. All they need is some plaster and some paint and someone with some capital to restore them to their former glory. But wait for the currency to crash a bit first and then go for it!

The bottom line on Hungary is that it is a pretty good place with a good record. Not only did Hungary challenge the Russians in 1956, it was the first to introduce some limited free markets back in 1968 and then in 1989 it opened its borders to escaping East Germans and so accelerated the collapse of communism. Of course, it has lots of problems, some of which I have not covered.  But it is a genuine democracy and market economy with 80% of economic activity in private hands and so the country has a good future.


PS I went to Budapest in October 2004 and wrote the above piece shortly after. By the time I had reread my first draft in 2006 my 2004 prediction on the forint had started to come true. It had just fallen to a new low. The Economist (8 April 2006) reported in the run-up to the first round of Hungary’s elections on 9th April 2006 that the incumbent government ‘has presided over the worst mismanagement of public finances anywhere in post-communist Europe. Officially, the budget deficit is 8% of GDP. Including off-balance-sheet financing, it is more like 10%. That has helped stoke a huge current-account deficit, and has now sent the forint to a 28 month low’. On the elections, the Economist was not optimistic about the outcomes – regardless of who would win. It said, ‘In private, both parties say much the same things: in the short term, there must be fiscal tightening and, thereafter, radical public-sector reform. The first, particularly, will be an unpleasant shock for Hungarians, who have got used to living well but dangerously on borrowed money.’

Hungary is a free market, as much as any other economy in Europe and it is certainly a democracy. But it is in for a rough ride, largely as a result of its own mistakes and poor government. It will have to live with the consequences of its own actions. There should be no recourse to the EBRD just because the Hungarians have made a mess of their economy. They have made the transition and in their new world of freedom the Hungarians must now accept that they have to take responsibility for their own future. This is the freedom to make mistakes and the freedom and opportunity to learn from those mistakes and be independent in the future as the result of fixing your own mistakes.


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