VZCZCXRO8744
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHUP #0593/01 1651325
ZNR UUUUU ZZH
R 131325Z JUN 08
FM AMEMBASSY BUDAPEST
TO RUEHC/SECSTATE WASHDC 3056
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE

UNCLAS SECTION 01 OF 02 BUDAPEST 000593 
 
SENSITIVE 
SIPDIS 
 
DEPARTMENT FOR EUR/NCE AND EB/IFD,OMA, AND INR/EC 
TREASURY FOR JEFF BAKER AND LARRY NORTON 
 
E.O. 12958: N/A 
TAGS: PREL ECON EFIN HU
SUBJECT: IMF ON HUNGARY'S ECONOMY: STABLE NOW BUT WARY 
ABOUT GROWTH AND SUSTAINABILITY 
 
Summary 
------- 
¶1. (U) Growing concerns regarding Hungary's current growth 
indicators and long-term sustainability have tempered an IMF 
assessment team's "favorable" assessment of Hungary's 
short-term, macro-economic indicators.  The country has made 
a good start in its deficit reduction plans but must continue 
with stalled structural reforms.  Its deficit remains the 
highest in the region, and while it has been able to rein 
this in since 2006 through revenue enhancements rather then 
spending cuts, its ability to continue this as elections 
approach is questionable.  Hungary's bond market needs reform 
as well to increase access for foreign banks to decrease 
volatility.  IMF analysts believe monetary policy decisions 
have been grounded in sound judgment, noting the recent 
removal of the exchange rate band and the recent increases in 
the benchmark interest rate.  But caution regarding fiscal 
practices is still the order of the day, with a continued 
focus on wages and inflation in the years ahead.  End Summary. 
 
A "Start"...But "A Long Way to Go" 
---------------------------------- 
¶2. (U) Assessing Hungary's macro-economic situation during 
its regular Article IV consultations, IMF European Department 
Assistant Director James Morsink privately briefed Ambassador 
Foley on June 9.  Morsink recently met with senior officials 
in key government agencies and the Central Bank, as well as 
with Prime Minister Gyurcsany and FIDESZ opposition leader 
Viktor Orban.  Morsink concludes that while current 
short-term, macro-economic indicators are trending positively 
and are "favorable" given the cyclical upturn, he is also 
concerned about weak growth prospects for the long-term, 
especially when compared to the regional average. 
 
¶3. (U) Morsink believes indicators including positive GDP 
growth, declining inflation, a narrowing current account 
deficit, an improved trade balance due to weak domestic 
demand, an upturn in private and public investment, and 
higher labor productivity (output per worker) will be stable 
in the short-term.  He acknowledged, however, that these 
figures are still weak when compared to other countries in 
the region and recognized that labor participation is also 
important.  (Note: At 56 percent, Hungary's labor 
participation rate is among the lowest in the EU countries. 
End Note.)  Morsink said that Hungary has made a "start" in 
fiscal consolidation, but has "a long way to go" and faces 
risks ahead. 
 
¶4. (SBU) Morsink believes there is agreement among senior 
government "technocrats" on what needs to be done - 
significant structural reforms to cut government expenditures 
and then lower taxes - but the lack of political will to do 
so.  On macro-economic vulnerability, he said that compared 
to 2006, when the IMF was very concerned about this, Hungary 
moved in the right direction last year.  But he said there is 
concern this year that the fiscal adjustments needed to make 
further progress have "stalled." 
 
Debt, Debt, and More Debt 
------------------------- 
¶5. (SBU) Concerning talk of tax cuts, Morsink said the IMF 
view is that there is no "room for maneuver."  He underscored 
that tax cuts would be possible only if combined with cuts in 
government expenditures.  In a press conference on June 10, 
Morsink elaborated further that tax cuts must be 
deficit-neutral and cuts in labor taxes should be balanced 
with increases in other taxes such as for consumption or 
property.  He also suggested potential expenditure reductions 
through a combination of reforming welfare programs, health 
care, education, and the pension system.  Commenting that 
Hungary has the largest debt in the region with high public 
debt, high net external debt, and high gross external debt; 
Morsink cautioned that Hungary must continue with macro 
fiscal consolidation by reducing its fiscal deficit.  While 
the IMF believes Hungary may do even better than its 4 
percent of GDP deficit target this year, it is concerned 
about whether it can achieve its goal of 3.2 percent in 2009 
with elections on the horizon. 
 
¶6. (U) Hungary's government bond spreads are wider than 
others in the region due to its high deficit, according to 
Morsink.  He gave the example of Hungary's recent floating of 
a Euro bond issue worth 1.5 million Euros at 98 basis points. 
 The day before, the Czech Republic did something similar on 
the same order of magnitude for 25 basis points.  Morsink 
predicted a major negative impact for Hungary if risk 
appetite declines. 
 
BUDAPEST 00000593  002 OF 002 
 
 
 
Liquidity in the Bond Market: Increase Access 
--------------------------------------------- 
¶7. (SBU) Morsink explained that the factors contributing to a 
freeze in the bond market earlier this year arose from global 
financial markets being unsettled and the pension fund shift 
towards equities.  He believes these factors were largely 
beyond the GoH's control, but implied that the pension fund 
shift could have been better managed as they had been given 
three years to do this.  Morsink believes increasing access 
for foreign banks to serve as bond dealers is the most 
important change needed to increase liquidity in the domestic 
bond market.  The Central Bank has told Morsink that it will 
take action on this proposal in January 2009.  He explained 
that foreign investors interested in the primary market would 
play a stabilizing role since they would be more willing to 
take the risk of investing in a small country like Hungary. 
Morsink also said deepening the repurchase "repo" operations 
market with the Debt Management Agency and commercial private 
banks would help liquidity since people would be more willing 
to take possession of bonds if they know they can get 
liquidity given a deeper repo market. 
 
Monetary Policy On The Right Track 
---------------------------------- 
¶8. (SBU) Commenting that the Monetary Council's decision to 
remove the exchange rate band was a good thing, Morsink said 
its subsequent decision to increase the benchmark interest 
rate to 8.5 percent was also appropriate.  He believes there 
may be a need for further interest rate increases.  But 
Morsink also expressed concerns about the growing number of 
foreign currency loans being taken by households (estimated 
at up to 30 percent of outstanding loans) and cautioned that 
inflation should be down to 3 percent on a 2-year horizon. 
Emphasizing that nominal wage growth needs to come down, 
Morsink said reduction in this will bring down core 
inflation.  He explained that with inflation turning out to 
be higher than expected, the GoH could and may decide to 
raise wages by 1 percent.  The IMF was "surprised" by the 
small uptick in GDP growth for the first quarter and believes 
this is what may have contributed to the turnaround this year 
in private sector wages, which he said was due mainly to the 
increase in the minimum wage by sector. 
 
Comment: Economists vs. Investors 
--------------------------------- 
¶9. (SBU) Economists and investors continue to look for ) and 
to see ) different things as they examine the Hungarian 
economy.  Although the IMF team noted reduced concerns 
regarding a prospective economic meltdown here, investors 
continue to focus on growth, transparency, and 
competitiveness indicators.  In tempering its recognition of 
progress on deficit reduction with a strong public message on 
the importance of continued fiscal discipline, the IMF team 
helped ensure that their assessment of macroeconomic 
stability is not used to further stave off the structural 
reforms that economists and investors agree are needed. 
Foley