Few institutions generate stronger hatred among emerging-market investors these days than Romania’s Constitutional Court. By striking down the Romanian government’s pension cuts June 25, the court sparked financial panic that led to a general loss of investor confidence in the entire Central and Eastern European region. As a result of the court’s ruling, the IMF decided to postpone its June 28 review of its €20 billion standby loan; fund managers are currently discussing the fate of the loan’s next €900 million tranche – money that the country desperately needs.
The ruling sent credit-default swap prices skywards while currencies across the region tumbled. The Romanian lei hit a record low of 4.37 to the euro on June 28. Not only investors who took the hit: Households and companies that have foreign currency-denominated loans are now at a higher risk of default than ever before, especially in Hungary, where more than 600,000 households have foreign-currency credits. Weaker currencies and higher debt-service expenses can hamper economic recovery; moreover, a rise in non-performing loans may destabilize the banking sector. It would be unjust to blame Romania’s Constitutional Court for all Central Europe’s economic hardships ¬ but its ruling is helping to destabilize the region’s still-unstable economies.
After the court handed down its decision, Romania’s government decided its only recourse was to raise the value-added tax to 24% from 19% as of July 1, or lose its IMF lifeline. Romania now has the second-highest VAT in the European Union behind Hungary, Sweden and Denmark at 25%. This kind of austerity measure will affect all Romanians, and not just pensioners. Is there anyone in Europe who is satisfied with the court’s action (besides maybe a few hundred thousand Romanian retirees)? The fact that the Constitutional Court is one of the most important democratic counterweights to the government is poor comfort to the millions who must bear the brunt of the ruling.
Across the border in Hungary, the problem is just the opposite. There, the governing Fidesz party is systematically eliminating institutional checks on its power, emboldened by a two-thirds parliamentary majority that allows the party to amend the Constitution singlehandedly. Last month, Fidesz MPs watered down the Constitutional Court’s independence by changing the rules for nominating the judges. Under the old system, each parliamentary caucus had the right to delegate one member to a committee that would nominate a judge by consensus. The full Parliament would then vote on the nominee, with a two-thirds majority required for confirmation to the court. Under Fidesz’s new rules, the governing majority will nominate Constitutional Court judges. Parliament still needs to confirm each candidate with a two-thirds majority, but Fidesz controls 68% of the seats. Fidesz can thus appoint and elect Constitutional Court judges on its own.
Fidesz’s efforts have met with harsh criticism at home and abroad. Outgoing President László Sólyom expressed his displeasure by vetoing the law on Constitutional Court nominations. However, Hungarian law makes it easy for MPs to override presidential vetoes, so Sólyom’s gesture was largely symbolic.
Romania and Hungary are grappling with problems that are mirror images of each other: In Hungary, Fidesz is meddling with nomination processes to switch off institutional controls on its powe; the Constitutional Court is just the tip of the iceberg. In Romania, an overly independent Constitutional Court is wreaking havoc across the region. The underlying tension is nothing new: Economic and governmental efficiency and the high principles of democracy are more often enemies than friends.
On the other hand, Fidesz doesn’t necessarily need the Constitutional Court to drive Hungary’s economy to near-bankruptcy; as the events of June 2010 proved, Hungary’s government is perfectly capable of doing that on its own.
Alex has just arrived back from Brussels, where he had the honour of posing a question to Gert-Jan Koopman, economic affairs adviser to European Commission President José Manuel Barrosso:
Alex: In Hungary, the people who are almost sure to win next April’s elections are talking about letting the budget deficit slide to 7.5% instead of the 3.9% agreed with the IMF. Since the country is small and is not a member of the Eurozone, would this pose a problem for the European Commission?
Koopman: “That would obviously be a problem… Hungary has a convergence plan and we would hope that Hungary sticks to it as much as possible.”
“It’s true that Hungary is a small country that doesn’t use the euro. But if every member starts relaxing its budget discipline… then we wouldn’t have much discipline anymore.”
This response strengthens our opinion that Fidesz, which is all but certain to win Hungary’s April elections with an unassailable majority, will face huge difficulties if they ignore the 2010 budget-deficit target of 3.9% of GDP and try to implement fiscal stimulus policies. The main barrier is not IMF, as several analysts have suggested, but rather the European Union as it trembles in the shadow of the financial markets.
In our previous analysis we described the situation following the Greek crisis as possibly advantageous for Hungary:
Predictably, the Greek crisis caused a domino effect in emerging markets as investors became skittish. The prestige of the euro has also been seriously damaged. Even so, Hungary should be grateful to Greece. After 2006, Hungary gained a reputation as the “liar of Europe” – not just because of former Prime Minister Ferenc Gyurcsány’s infamous “Oszöd speech,” but because of Hungary’s much higher-than-expected budget deficit in 2006. Hungary can now pass on this title to Greece… By tightening their belts and pursuing strict fiscal policy during the recession, Hungarians have become models of prudence, to such an extent that Greek Prime Minister Geórgios Papandréou attempted to calm the markets by saying he would follow the Hungarian path.
At the same time, we added:
The bad news is that Fidesz, the party that is all but sure to win this April’s election, cannot let the deficit climb back upwards.
Fidesz’s chances of renegotiating Hungary’s $15.7 billion (€11.5 billion) loan from the IMF may be better. We should recall the rumours that the IMF had agreed to allow Fidesz to run a deficit of 5.5% of GDP for 2010. While this hearsay has proven false (Fidesz, still an opposition party, is not a typical negotiation partner for IMF), it is based on the fact that the IMF has been open to modifying the terms of its loans in the past.
Fidesz will have a much tougher time convincing the EU that it needs to loosen its deficit target. Koopman’s comment reflects fears of a domino effect – if Hungary wants to loosen the conditions, everyone else will, too. Given the shock over the Greek crisis, the Hungarian economy’s less-than-stellar reputation, and past experience, fears of Hungary falling back into a state of “fiscal alcoholism” would be justified.
Fidesz seems to be getting the message: The party’s policy wonks are talking less and less about fiscal stimulus and Fidesz’s election manifesto is cautious on this question. On the other hand, Fidesz still hopes it will have some room for bargaining – and they probably do. Former National Bank of Hungary Governor Zsigmond Járai, an economist close to Fidesz, recently declared that a 5% GDP deficit would be acceptable for both the IMF and the EU. Given that Fidesz’s “offer” was 7-8% several months ago, we can see a clear tendency toward improvement. And, since serious doubts have arisen about Hungary’s ability to fulfil its 2010 deficit target, 5% may prove quite realistic.
Even if the IMF and the EU are willing to let Hungary’s deficit rise slightly (8% of GDP is out of the question), the price of their indulgence may be deep and extensive economic reforms – an extremely unappetizing prospect for the next government.
Peter Kreko-Alex Kuli
Over the past few weeks I have been meeting with leading analysts from banks, funds and other financial institutions from all over the world. Everybody is interested in what’s going to happen to Hungary after the elections and what risks the future may hold. I have come to realize that there are two common misunderstandings about Hungary.
The first is about the euro. Accession to the euro zone is not the focus of the election campaign at all. Except for the far-right Jobbik party, all mainstream political parties agree that Hungary needs to adopt the euro as soon as possible. This is actually the only political issue that enjoys widespread political consensus. Parties don’t campaign for or against the euro and don’t expect any political benefits from doing so. Financial analysts tend to see the euro as essential for political success, but that’s not the case. The issue is simply not on the table. Of course, should Jobbik perform surprisingly well in the elections (which is exactly what I anticipate), the euro may get into the spotlight. This scenario is unlikely, since Jobbik will not have any real power unless it becomes Fidesz’s coalition partner or wins the elections. Neither scenario can be excluded, but at this stage neither has much chance.
Certainly Fidesz has not helped foreign analysts better understand its stance on euro. Fidesz’s economic- and fiscal-policy talking heads have declared several times that boosting the economy (even at the price of boosting the deficit) is a priority, while introduction of the euro is not. There is a persistent conflict within Fidesz between the desire for short-term economic growth and quick Eurozone accession.
The second misunderstanding stems from Western political experience. In old democracies, voters usually reward or punish the incumbent government based on the country’s economic situation. If the economy is doing fine, voters tend to support the incumbent party; if not, they vote for the opposition. This is not valid for Hungary. The country’s economic performance has never had any effect on the outcome of the elections. There is no correlation between support for the government and GDP growth.
At the same time, Political Capital’s research has found a strong correlation between support for governing parties and the perceived state of the economy and the perceived outlook for living standards. Hungarian voters are strongly influenced by perception — and there is frequently a disconnect between the popular perception of economic growth and reality. This is why many of the analysts I met were surprised that Hungarians don’t appreciate the caretaker government’s performance.
Nationalism loves nothing like uncertainty. People who feel insecure about their place in the global pecking order compensate with patriotic zealotry. Politicians love to manipulate this anxiety with vague, hard-to-pin-down policies on national greatness. Ambiguity is key: It makes it easier to deflect criticism from uppity liberals at home and gives them broad wiggle-room in the face of international condemnation.
Slovak Prime Minister Robert Fico has demonstrated a genius for nebulous nationalism in his handling of Slovakia’s amendments to its language law. The new rules, which took effect in January, are designed to force Slovakia’s ethnic Hungarian population to speak more Slovak. Yet they are shrouded in such obscurity that people have broad freedom to read them as they please. This is a gift for nationalists not just in Slovakia, but in Hungary, with even Prime Minister Gordon Bajnai – not known for chauvinistic posturing – getting in on the game. The opposition Fidesz party, which is all but certain to replace Bajnai’s Socialists in Hungary’s April elections, is likely to escalate the tension. The ultra right-wing Jobbik party, which could conceivably beat the Socialists into second place next April, will certainly hold Slovakia’s feet to the fire.
The gist of the law is that Slovakia’s 520,000-strong ethnic Hungarian minority can get fined up to €5,000 if they use any language other than Slovak in government settings, unless the local population is more than 20% Hungarian. This raises Fico’s standing among nationalist voters and scares the stuffing out of ethnic Hungarians, which increases the likelihood that Fico will keep his job in Slovakia’s elections in June. The fact that not a single individual has been prosecuted under the law – and Fico has pledged that none will – is immaterial.
Bajnai, who knows a vote-magnet when he sees it, established a HUF 50 million (€183,848) fund on February 1 to pay the fines of ethnic Hungarians who breach the language law. Anyone can contribute to the fund, raising the possibility that wealthy Hungarian emigrés will rally to the cause. The fund is fodder for nationalists. Slovakia’s Culture Ministry complained that Bajnai is interfering in Slovakia’s domestic affairs. The Slovak National Party, a member of the governing coalition, accused Hungary of encouraging Slovak citizens to break the law.
In Hungary, Fidesz leader Viktor Orbán pledged his wholehearted support for the fund. Fidesz takes a much more strident tone on Slovakia’s Language Act than Bajnai’s Socialists: “They need to get over the fact that we exist,” said Zsolt Németh, Fidesz’s point man on foreign affairs, in a July 2009 interview with FigyelőNet. “When [Hungarian diplomats] are on the offensive, their words must not be subject to interpretation.”
What is subject to interpretation is the Slovak Language Act itself. Under pressure from the Organization for Security and Cooperation in Europe, Fico’s government adopted a set of 21 non-binding criteria under which the law is to be enforced. The guidelines say that any fine must be justified by at least six of these criteria; however, the law contains no such provision, according to Lukáš Fila, who writes on the language law at Slovak newspaper Sme. It is thus unclear what constitutes a punishable violation.
Fico’s criteria contain other absurdities. “You are not allowed to use a minority language when talking to the postman if you are in a place where fewer than 20 percent of the population belongs to that minority,” Fila said. “The guidelines say you can, providing you both agree to do so – and everyone else who is present also gives their consent.”
This is what happens when national insecurities clash: Fico, whose country has only existed in its current form for 17 years, sallies forth like Don Quixote to slay the dragon of Hungarian hegemony – a threat that does not exist. The Hungarians, still miffed about losing most of their land after World War I, rush to help their kinfolk fight a ridiculous law that has little chance of being enforced. All the more absurd, given that Hungary is Slovakia’s fifth-biggest foreign investor, having sunk nearly €2.1 billion into the country.
It is no accident that all this is happening against the backdrop of elections in both countries. The likely winners – Orbán and Fico – share the same admiration for big-government policies tinged with nationalist rhetoric. It is precisely this similarity that will make it impossible for them to cooperate.