The economic downturn in Hungary has forced Viktor Orbán to make compromises with Brussels and the financial markets that were considered unthinkable before Russia’s war in Ukraine.
Soaring inflation, a gaping budget deficit, a plummeting forint and a huge sell-off in Hungarian assets have conspired to force the prime minister, once seen as Brussels’ enfant terrible, to bow to the EU as he seeks to unblock €15 billion Funds worth of pandemic recovery funds pledged to Budapest but withheld for rule of law reasons.
To free up the funds, Orbán also had to make concessions on fighting corruption and decoupling Hungary’s energy system from Russian imports. Meanwhile, investor concerns about the large budget deficit has prompted Orbán to scrap parts of his populist agenda, including caps on household expenses and low taxes on small businesses to keep the budget under control.
“The market pressure on Hungary is extreme,” said Raiffeisenbank economist Zoltan Török. “The government really has no choice but to make a deal with the EU. The lack of funds has undermined growth prospects and greatly damaged the perception of the Hungarian economy.”
Though his Fidesz party still eclipses the opposition after four straight landslide victories, some Orbán supporters — drawn by his low-tax, low-spending doctrine — are angered by the about-face.
Demonstrations erupted in Budapest earlier this month as several thousand people blocked bridges and disrupted traffic in the city center after the government cut its price cap on household energy, a €5 billion subsidy it can no longer afford. The government has also all but scrapped a favorable small business tax, hoping to save another €750 million.
“I thought he only had our best interests in mind,” said Balázs, a car mechanic from Budapest. “The fact that he would turn around and just hit us with higher taxes and energy bills and act like everything is business as usual told me that he is not the defender of the people.”
He added that the Prime Minister is “just another politician who does business and forgets about his constituents when the pressure is high enough”.
Orbán, buoyed by his spring election victory, has appeared unperturbed by the protests. “Some will understand, some will not,” he said on July 15. “Some things are affordable, some aren’t . . . It’s good if we can see it, but unfortunately if we don’t see it, it doesn’t change the facts.”
The prime minister’s advisers insist they will make the necessary changes to quell the economic turmoil. “Winter is coming, all over Europe. . . It will be a reality check,” Orbán’s political director, Balázs Orbán, who is not related to the prime minister, told the Financial Times. “We want to remain a stable point in Eastern Europe.”
The invasion of Ukraine has increased the risk of recession across the EU, which is heavily dependent on Russia for its energy supply. Hungary, along with the rest of Central and Eastern Europe, is acutely affected by the effects of the war. Supply chain disruptions, rising financing costs and a flood of refugees mean the risk of a recession is significantly higher in countries closer to Ukraine. The IMF warned in mid-July that Hungary’s gross domestic product could shrink by up to 6 percent if Russia cuts off natural gas supplies.
As everywhere in Europe, the price pressure is strong. Inflation in Hungary rose 11.5 percent in the year to June. The Hungarian National Bank hiked interest rates to 10.75 percent on Tuesday from just 2 percent in the autumn and will hike further until it sees a turnaround in inflation expectations. Analysts at Goldman Sachs warned last week that inflation was several months away from peaking.
The forint has fallen 7 percent this year despite sharp interest rate hikes by the central bank, while the price of assets including shares in OTP Bank, the country’s largest bank and most liquid stock, has halved.
The budget deficit in the first half of 2022 is over 7.2 billion euros or 4.5 percent of GDP. The planned deficit for the full year is about 7.9 billion euros, which the government insists on.
However, if the conflict in Ukraine drags on, it will place an “unbearable strain” on the government’s finances, as the prime minister’s political director describes it.
“We will [need to] the workings of the economy completely overhaul and at times like this [as these]that means additional effort,” said Balázs Orbán.
As late as last fall, the prime minister said that if the EU insisted on improvements in the rule of law and Budapest froze billions in restructuring funds, he would put up resistance and raise the money on the market. Since then, however, government borrowing costs have skyrocketed. Yields on its 10-year bonds have risen to about 9 percent this month from 3 percent in September.
Borrowing costs have skyrocketed in emerging markets. Sri Lanka’s default on its external debt in May has left many investors wondering who the next sovereign borrower to restructure will be. The dollar-denominated bonds of 23 developing countries, mostly low-income but also some middle-income countries, are trading at levels that suggest a default is imminent.
Concerns about the government’s cash flow have at times extended to Budapest’s ability to renew its debt. The bond market remains liquid, with several recent foreign currency bond auctions being deemed successful. But the lack of an EU deal could negate that.
Investors expect Brussels to release the Covid recovery funds later this year and they have already started pricing in a deal, with the forint gaining several percent in recent days. Such gains are limited, however, as Orbán is unlikely to be able to rely on the favorable economic environment that prevailed in Ukraine before the war began. Török warned: “High borrowing costs, a weak currency and rising interest rates will remain a reality in the medium term.”
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