Hungary Feels the Pain of Economic Tightening

Sources: Associated Press, Hungary's Central Bank Cuts Key Interest Rate; Bloomberg, Hungary's Forint Falls for Fifth Week on Recession, Rate Cuts; The Guardian, Hungary Wage Deal Poses Risk to 2009 Budget; Bloomberg, Hungary to Reduce Cost of Labor as Economy Heads to Recession; Bloomberg, Hungary Secures $518 Million EIB Loan for Development Projects

The Hungarian currency, the forint, fell to a record low last week in reaction to expectations that the central bank will continue its policy of lowering interest rates to control the current recession. Though this policy has helped to slow inflation and has been successful in bringing it down to a manageable level, the resulting currency depreciation is the greatest so far in European emerging markets. So far this year, the forint has already fallen 8.4%, reaching a rate of 289.87 forint per euro.

The Hungarian government has expressed an intention to work with the central bank to manage the currency, but low investor confidence in emerging markets overall is a major challenge. Hungary also suffers from the failing European economy, as it depends on the export of goods to eurozone countries.

The European Commission expects that the Hungarian economy will contract 1.6% in 2009, which puts it behind its Eastern and Central European neighbors. This forecast, which is worse than expected for the year, necessitates a budget re-write by the Hungarian government. One issue that particularly concerns the IMF is a wage deal that the government struck with unions for the 2009 budget that would in the IMF's view jeopardize Hungary's economic recovery. The IMF, World Bank, and European Union negotiated a $25.6 billion loan with Hungary in October 2008, and the IMF will conduct a review of Hungary's implementation of its plan in early February. Though Hungary is generally complying with agreed-upon adjustments, the wage deal is a sticking point, and the Hungarian Prime Minister noted today that the cost of labor will be one focus in redrawing the 2009 budget.

Hungary also announced today that it has reached an agreement with the European Investment Bank for an additional $518 million loan. This is a twenty-five year loan that is intended to help Hungary implement development projects co-financed by the European Union, in areas such as research and development and financing of small- to medium-sized businesses.

Questions:

1) Is it possible that external loans will put Hungary back on the path to economic recovery and eventually growth, or is the interconnectedness of markets and Hungary's dependence on Western Europe too great an obstacle?
2) Should those lending money to Hungary, such as the IMF, take a greater role in the budgetary process and in setting macroeconomic policy as a condition of the loans?