The Hungary Games

The unorthodox policies of prime minister Viktor Orbán may be controversial, but they’ve helped kick-start the country’s economy. Most of the other CEE nations are also mounting turnarounds..

During the interminable eurozone meetings over the crisis in Greece (version 2015), Peter Kaimír cut an unhappy figure. As far back as March, Slovakia’s Finance minister said patience with Athens was running out, suggesting politics there had taken precedence over constructive policymaking.

Kaimír’s irritation is echoed across Central and Eastern Europe (CEE). Many government officials in the region are asking why countries poorer than Greece should have to support the financially strapped country. They also point out that Athens’ political leaders have yet to make the reforms that were essential preconditions to European Union (EU) membership for Slovakia—and, indeed, all former Soviet states.

Yet despite the continuing drama in Greece, sluggish eurozone growth and concerns about the aggressive actions of Russia, CEE nations seem to be having the last laugh.

“The region is better placed to weather any potential storm than in 2011, when Grexit [Greek exit] fears first surfaced,” says William Jackson, senior emerging markets economist at London-based research firm Capital Economics. “Financial linkages have fallen, there is scope for a fiscal policy response to counter any downturn, and the region is benefiting from strengthening labor market conditions and low inflation.”

In fact, CEE has been one of the year’s best emerging markets performers. The numbers across the region are almost uniformly good. Industrial production in Poland and the Czech Republic is up 5%, year-over-year. Poland’s central bank recently hiked its GDP growth forecast for 20152017, with 3.4% to 3.6% growth expected each year against a backdrop of mild deflation. Interest rates are low, with the key policy rate expected to remain unchanged at 1.50%.

Hungary, which has finally gotten its current-account and fiscal deficits under control, should see GDP growth this year of about 3%. The country’s stock market has been on a tear, with the benchmark BUX index rising by nearly 32% in the first half of 2015—the third-best showing in the world. One listed company, OTP Bank, saw its share price shoot up 50%.


The surge in valuations reflects a major turnaround in investor confidence in Hungary. The BUX index was down 21% in 2014. That was owing in large part to prime minister Viktor Orbán’s unorthodox and controversial policies, which imposed levies on foreign firms and local banks. Those local financial institutions were required to pay more than $3.3 billion to customers who had taken out loans in Swiss francs and were hit by the franc’s appreciation. In fact, Budapest has done just about everything the international financial community begged it not to. The list includes repaying foreign loans early, forcing utility firms to cut household bills and even closing the IMF’s local office.

Yet everything now seems to smell of roses. Public debt is now around 75% of GDP—well down—and the budget deficit is under 3%. Observers say a possible credit rating promotion to investment grade by the ratings agencies, along with the gradual scaling down of the bank tax, should help sustain the country’s economic momentum for the rest of the year and into 2016.

“Prime minister Viktor Orbán essentially used his electoral mandate to transfer wealth from the commercial to the household sector,” says Simon Quijano-Evans, CEE analyst at Commerzbank, in Frankfurt. “It’s hard to argue now that this wasn’t successful. Hungary has escaped from the liquidity trap that was holding it back.”

Some observers still advise caution, arguing that Budapest’s interventionist policies have helped stifle competition and depressed Hungary’s long-term investment potential. “Foreign capital stock is down, notably in sectors like finance and energy, suggesting investors have been alarmed by the government’s more active role,” says Alex Lehmann, the EBRD’s chief economist for Central Europe, in Warsaw. He does acknowledge, however, that confidence, along with domestic investment and consumption, is picking up.

The same can be said about Romania. The country has somehow overcome a poisonous political climate that has seen prime minister Victor Ponta indicted on corruption charges and president Klaus Iohannis’ relations with the government reach the breaking point. Some observers expect GDP this year to increase by almost 4% on the back of strong export growth. The fundamentals appear solid, with public-sector debt around 43% of GDP, high foreign-exchange reserves and healthy FDI inflows. Interest rates are at record lows, with the key policy rate at 1.75%. In addition, the country’s value-added tax is set to be cut next year to the pre-crisis level of 19%, a sizable drop from the current 24% rate. The reduction—which the European Commission warned against—will undoubtedly boost consumption.


Granted, part of the rebound of CEE nations has been fueled by EU funds. With the small size of the markets in the region, the capital has had a dramatic impact. Most CEE countries are still absorbing funds from the EU’s 20072013 budget, which must be utilized by the end of 2015. The flows from the 20142020 EU budget, set to commence next year, will also be considerable. Quijano-Evans reckons the money is equivalent to some 10% of Hungary’s nominal GDP. “Most of the countries have proven themselves good at absorbing and utilizing these funds,” he says.

In addition, analysts say the ongoing recovery in CEE reflects the reforms that were pursued years ago—ahead of EU accession— coupled with fiscal consolidation and judicious management in the years following the 20082009 economic crisis. “The Central European countries in particular have the tools to withstand fallout from the eurozone or Greek crises,” notes Quijano-Evans. “They have positioned themselves well and benefit from generally prudent economic policies.”

In fact, observers say the only real question mark in the region is Poland. Parliamentary elections will take place in late October 25, The vote follows the May presidential elections, won unexpectedly by Andrzej Duda, of the right-wing Law and Justice Party (PiS). Opinion polls suggest Law and Justice and its candidate for prime minister, Beata Szydlo, will beat the incumbent Civic Platform party. Almost all observers expect a change in economic policy toward a more populist and interventionist approach, with party chairman Jarosaw Kaczyski strongly influencing policy.

The shift will likely mean, among other things, a bolder approach to Russia’s aggression and a more skeptical approach to the EU. As is true of almost all CEE countries, joining the eurozone anytime soon will be off the agenda in Poland, despite the legal obligation to eventually do so, with Warsaw wanting to retain control of its own monetary policy.

Lehmann says Poland’s benign economic picture—which persists despite the absence of a feel-good factor—and low level of foreign loans should free authorities to tackle long-term challenges. The hurdles include pension reform and low labor participation rates for men (around 65%). Authorities also have to figure out a way to boost investment in the eastern part of the country.


Another worry: Hungary’s success in defying economic convention may prompt imitation. “Though it made investors jittery, Orbán’s approach is vindicated by Hungary’s rebound,” warns Katya Kocourek, Central Europe analyst at risk management firm Stroz Friedberg. “The PiS may find some elements—the foreign-exchange loan conversion scheme, for instance— irresistible as a quick way to raise cash, and popular because it targets banks.”

That scenario, however, pales in comparison to the problems in southeastern Europe. Worries persist about the fallout from the possible collapse of Greek banks on countries in this region, which are generally economically weaker than the Central European countries. The ECB and EBRD have tried to prop up the financial institutions in Bulgaria, Albania, Macedonia and Serbia. But many of them are owned by Greek banks and thus remain vulnerable to a collapse in Greece. Quijano-Evans estimates that exports from these countries to Greece account for up to 7% of total trade, while Greek bank assets are equal to some 20% of GDP of the countries in the region.

Though it made investors jittery, Orban’s approach is vindicated by Hungary’s rebound.

~ Katya Kocourek, Stroz Friedberg

Even without the Greek overhang, growth in southeastern Europe will be sluggish, according to a report released in May by the IMF. The Fund suggests GDP will rise 1.9% at best, with the economies dogged by a welter of problems. Failure to complete structural reforms tops the list, but the countries are also beset by high indebtedness, dependence on trade with weaker eurozone economies (including Greece) and labor market problems. Overall, growth is expected to rise by 2.4% next year, buoyed by a resurgent Romania and hopes surrounding the start of Serbia’s EU accession talks.


Given the options, investors in emerging Europe will remain zeroed in on the Central European countries, encouraged by the region’s growth and stability. Along with Hungary, capital markets in Poland and the Czech and Slovak Republics have been on a good run, and in spring hit levels not seen since 2000. The CETOP20 Index of leading Central European blue-chip companies continues to shine. Among the best performers are banks, including Erste Group and Komerní banka.

Property is also expected to build on its strong 2014 performance, boosted partly by the ECB’s bond purchase program. The plan has encouraged financial institutions to look for new destinations for their—and investors’—cash. Capital funneled into Central European property last year shot up by 25%, with Warsaw, Prague, Budapest and Bratislava leading the way. The trend is likely to continue, with commercial and residential real estate both benefiting. As with capital markets, the underperformance of the once-important Russian market will benefit Central Europe.

“Providing these countries maintain their export competitiveness and retain investor confidence,” Kocourek of Stroz Friedberg says, “there is a good chance they can return to pre-2008-crisis growth levels of 4% to 5% a year.”