Key findings:


Measures of the Hungarian government


  • Based on the measures unveiled in Parliament by Hungarian PM Ferenc Gyurcsány, it is apparent that the fierce struggle to recapture investors’ confidence forces Hungary to out for a more rational economic course; nevertheless, it may further undermine the government’s popularity. Three factors can explain why the unveiled measures are more drastic than expected:
    • Countries of the region and around the globe have to settle in for an economic slowdown that promises to be longer and deeper than expected.
    • The government failed to take certain necessary but unpopular measures both over the last six years and the last months.
    • The government is forced to introduce spectacular measures to meet IMF credit conditions, to restore waning confidence of the financial elite, and to avoid the threat of sovereign default.
  • Despite the measures, the vulnerability of HUF and rate risks are still extremely high.


Crisis management in emerging markets


  • Following the first phase of the economic crisis triggered by the September collapse of Lehman Brothers and the threat of sovereign defaults around the globe, each country had to settle in for an economic slowdown that promises to be longer and deeper than expected.
  • The first phase was characterised by “panic”. In many countries averting a catastrophe stabilised governments – even in countries most exposed to the crisis. However, the next phase will usher in a period of “protracted agony” signalled by a deepening recession, plummeting living standards and painful social and economic measures. This in turn will lead to a loss of confidence in governments and rising social tensions, i.e., not a recipe for consolidating the position of governments in office.
  • The political fallout may be the most severe in countries lacking the means of minimising the economic/social effects of the crisis through loosening the budget.
  • However, countries caught by the crisis in the weakest condition and with few economic policy tools in their arsenal (e.g., Hungary and Romania) may profit from the crisis in the long term for the following two reasons:
    • Fast deteriorating prospects and a fierce struggle to recapture credibility may convince these countries to abandon short-term political advantages for economically sound policies and force them to take dramatic and effective measures to cure the “disease” (overspending, dread of reforms and corruption).
    • Clearly, global financial organisations wish to prevent at all cost the collapse of emerging countries and the ensuing domino-effect, a policy that may again profit the most vulnerable countries (e.g., thanks to low-cost credit).
  • The region's stable economies (in Slovakia, Poland and the Czech Republic) follow the crisis management model seen in Western Europe and the United States; they try to compensate for a drop in demand by government investments. The policy offers these countries the opportunity to make a “soft landing”. However, this economic strategy carries a number of risks:
    • It increases the budget deficit that could undermine investor confidence in the long term and, in the case of Poland and the Czech Republic, it could push back the date of joining the euro zone.
    • The growth of these countries is based on artificial demand that in the long term may create a bubble similar to the one leading to the current crisis. Only time will tell whether the effects of the crisis can be remedied with the very tools (the artificial stimulation of consumption and the economy with credit) instrumental in leading to the current impasse. Conceivably, economic stimulation based on deficit growth would only prolong and not solve a country's economic woes.

Shared destiny


In the midst of worsening economic outlook all regional countries were forced to adjust their growth projections, especially the Baltic States hit hardest by the crisis. The depth of the plunge is illustrated by the fact that between November and January the European Commission's forecasts for 2009 gross GDPs (serving as a benchmark for governments as well) were reduced for all regional countries by an average of 2.7 percent. Compared to year-end projections, consumption and production is expected to decline in all countries, significantly reducing tax revenues. The situation is further aggravated by the fact that due to lower inflation government revenues from VAT will drop sharply. As a direct result, a number of regional countries (aside from Hungary, the Czech Republic, Slovakia, Romania, Poland and Russia) will have to amend their 2009 budget. In Slovakia, Hungary and the Czech Republic holes in budgets must be filled to the tune of EUR 200 million, 650 million and 1.3 billion (!), respectively. And due to increasingly gloomy prospects these holes may even deepen.


The situation is made worse by the fact that in the past few years a large number of people migrated to developed EU countries and sent a large part of their income back home. Today, thanks to the crisis, they lose their jobs in droves. As a result, remittance payments of those working in foreign countries will disappear from the national economy. Moreover, returning workers may apply for welfare benefits in their country of origin, putting additional pressure on the budget.


Effectively, the region faces the classic economic/political dilemma: either the deficit is allowed to grow or the balance is maintained through a combination of budget spending cuts and revenue increases. In the meantime, additional austerity measures exacerbate public frustration, undermine confidence in the government and may lead to violent demonstrations seen recently in Lithuania, Latvia and Bulgaria.


Countries that try to cut costs by reducing state administration) are especially vulnerable as high unemployment in countries hit hardest by the crisis is the major source of social discontent. Countries of the region follow a similar crisis management strategy: in response to deepening economic recession governments are forced to implement severe cost cutting and revenue increasing measures (see summary chart below). The two exceptions are represented by Slovakia and Bulgaria: in Slovakia the government tries to maintain growth through increasing the budget de_cit, while thanks to an expected budget sufficit, Bulgaria may be able to forego austerity measures.



An overview of adjustments implemented in countries of the region



Source: data compiled by Political Capital


Public opinion polls conducted in East- Central-Europe in the first months of the crisis clearly show that in its early phase the financial/economic crisis consolidated (or at least did not seriously undermine) the governments in office:


  • In Poland Prime Minister Donald Tusk and his party held on to wide support, Following a slight rise, in Hungary the popularity of the governing party, MSZP, effectively returned to the September level, while Prime Minister Ferenc Gyurcsány managed to gain some support,
  • In the Czech Republic, the popularity of Topolanek and his party also increased significantly following the eruption of the crisis,
  • In Slovakia the popularity of the government and the Prime Minister (already high) continued to rise, although the gas crisis hit the country particularly hard,
  • In Bulgaria support for the government and the Prime Minister (extremely low) remained practically unchanged.


The prolonged effects of the crisis are gradually eroding support even for the most popular governments. However, economic fundamentals before the crisis play a crucial role in governments’ ability to preserve their popularity and, in this context, their chances to mitigate the short-term effects to the crisis.














Diverging strategies


Threatened by economic decline and the flight of risk-shy investors, countries of the region have a ”shared destiny”, although countries’ scope for political/social action differs widely. Countries enjoying higher investor confidence are in a better position to loosen the budget in a new economic landscape. Hungary has a very low confidence index and the government has all but exhausted its options; i.e., under pressure form the IMF and nervous investors, it is in no position to increase the deficit. The Romanian government, possibly in need of an IMF loan as well, finds itself in a similarly tight situation and the new government will have to institute extremely unpopular measures (cut jobs, freeze wages and pension benefits and cut municipality budgets) if it is to reduce its close to 8 percent (expected by the European Commission) budget deficit to around 2 percent, as promised by the government and the Prime Minister. According to the European Commission's deficit forecast, Lithuania will also have to make additional deep cuts in government spending.


At the same time, as a member of the euro zone Slovakia is expected to run up its deficit by increasing public spending, intensifying government infrastructure projects, implementing tax cuts and employment creation programs. The country will be helped in its effort by the fact that in 2009 practically no country in the euro zone will meet the Maastricht criterion stipulating a maximum 3 percent budget deficit. By increasing public spending, in the short term the government may even mitigate the political fallout of the crisis. With all that, Slovakia faces the largest threat of mass unemployment (forecasts putting the jobless rate at over 10 percent) and the recession in the auto industry puts the country at severe risk.




Losers in the past – winners in the future?


Losers of the first phase of the crisis (the Baltic States, Hungary and, to a lesser extent, Romania and Bulgaria) continue to suffer from low competitiveness: fundamental problems persist and investor confidence has yet to recover, i.e., they have little room for manoeuvring. As a result, in the short term the negative effects of the crisis may cut deeper and a sudden “shock” may find them more vulnerable. The large current-account deficit (particularly in Romania and Bulgaria) may lead to serious consequences when foreign direct investment dries up by a significant degree.




At the same time, in the long term these countries could come out of the crisis with renewed vigour. For in the current climate economic rationale may overwrite short-term political thinking. In the coming period irresponsible governance will backfire much sooner and with greater force than ever before, as fearful investors will withhold their already shaken trust at the first signs of “loosening” and reckless spending. As the threat of collapse is all but palpable, governments’ scope for action has become extremely limited; international organisations and investor confidence exert such control that governments have no alternative but to implement necessary and politically sensitive measures.


The Baltic States will be forced to restructure their economies. Hungary and Romania may significantly reduce their budget deficits. Threatened by a freeze on (among others) EU grants, Bulgaria and Romania will have to take steps aimed at the elimination of political corruption. Under pressure to implement austerity measures and reforms, governments will topple taboos that may change ingrained public attitudes and expand the room for manoeuvring needed to make economically rational decisions. This may be particularly the case in Hungary: in the past few years all countries of the region implemented structural reforms, accounting for the dynamic growth of recent years. Hungary failed to take that path. However, if it is forced to introduce structural reforms in the near future, it may reap the same benefits as its neighbours did a few years ago.




Clearly, in the short term the country may pay the price in rising political tensions and a huge loss in popular support. The crisis will create hardship in all countries and reduce support for governments. However, these effects could be exponentially higher in countries hit hard by the crisis and forced to borrow from international organisations: the implementation of necessary but unpopular measure could be met by fierce opposition on the part of the population, potentially resulting in mass demonstrations, possibly riots and the rise of populist political forces, as well as the overall escalation of social conflicts. While typically governments in office do poorly in EP elections, in countries with worsening economic outlook they may face shattering losses.