Hungary - high time to act

In the past months, many voices have raised the fact of unsustainability of the twin deficits troubling Hungary. Among others, we expressed preoccupation about the build up of the fiscal and current account deficits (fiscal deficit for the year was recently predicted to exceed 10% of GDP, for an overview of the developments see: Hungary - heading for trouble? , Hungary - continuing to head for trouble? , Hungary's new tax increases - a comment). The need for an extensive fiscal reform, especially on the expenditure, but also on the revenue side was emphasized by international organizations (IMF, EU) and by economists and commentators (among others, Zsigmond Járai, the head of the Hungarian National Bank, MNB, FT, The Economist and this blog). We focused on the fact that tax reductions and increases in social spending promised during the recent elections were totally unrealistic. But it still seems some people believed the campaign slogans. Now the government admitted lying about the situation of the economy, and backed out on its promises, but as mentioned above the actual state of the economy was visible for quite some time - the development has hardly come as a surprise.

The need for reform is obvious and urgent. Yesterday (19/09/06) the forint dropped slightly against the euro (1% initially but only 0.7% on closure) and the stock market fell (by 1.2%). A relatively modest downturn, even if we take into account the developments since the beginning of the year (forint down against euro by almost 10% since January, BUX down by 10% since April/May levels), which signals there is hope in the turn around, and that despite the protesters on the street, honest, immediate and complex handling of the situation can steer the country into safe waters. Surely the situation is not simple - the current government openly caught on lying to the public has, many claim, lost legitimacy. On the other hand, it would take substantial time for another one to get elected. The decisions to cut spending and not to reduce (but even increase) taxes, will certainly be highly unpopular – especially after the high-blown promises of the recent election, but are absolutely necessary, though will not guarantee a safe exit. In the medium term, I don’t think a further fall in the forint and the BUX can be avoided, however, there seems to be room to escape a crash. The falls from the beginning of the year suggest investors may have been more reasonable with their expectations than the voters – expecting that the fiscal cuts must come, and therefore perhaps being also more ready to welcome them.

The developments in Hungary had limited effect on the markets in the region – the Czech Korona and the Polish Zloty barely moved (albeit downwards) closing respectively -0.2% and -0.4% against the euro. The PX and WIG also tipped downward, but again, not spectacularly.

Generally, I think the effect of contagion should be rather modest, albeit negative – Poland and the Czech Republic have budget deficits, which ought to be reduced, have pending campaign promised spending, but all of a more reasonable order.
The Baltics, despite their strong external exposure through current account deficits, contrary to Hungary have sound fiscal policy. They would be hurt by a flight of capital from the region, but this seems rather unlikely, as the situation in Hungary was bold and identified some time ago, and its troubles were more evident and in many cases different than in the other CEECs. However, the sooner the situation in Hungary is resolved, the better for the region.

The euro – no rush?

Recent declarations show that the enthusiasm among the NMS about early euro membership is fading. Before EU entry most countries declared they would like to join “asap”, and most seemed committed to doing so – but recent developments show that it will take much longer before they adopt the European common currency. We reviewed the exchange rate regimes in the NMS some time ago (to be found here), but it’s a good idea to summarize the current euro adoption targets:

• Czech Republic – targeted 2010, recently abandoned mainly because of fiscal criterion. Refused to give new target date (previous official strategies) aimed at 2009-2010);
• Estonia (in ERM II) – initially targeted 2007, however high inflation caused the revision to 2008, though relatively high inflation makes this date questionable;
• Hungary – targeted 2010, but fiscal deficit levels made this date unrealistic and it was abandoned in July. No new date was given;
• Latvia (in ERM II), – targeting 2008 though this date is questionable due to (relatively) high inflation;
• Lithuania (in ERM II)– aimed for entry in 2007 but marginally failed to fulfill the inflation criterion, thus the bid was rejected by the EU, now aiming at 2009/2010, though the exact date is to be given;
• Poland – no target date was given;
• Slovakia (in ERM II) – targeting date 2009;
• Slovenia (in ERM II)– on course to join the EMU in 2007;

Generally the NMS face two different sorts of obstacles. On one hand in the Baltics it is inflation that caused the postponement of euro adoption, and having already verified the entry dates for Lithuania and Estonia, seems to be set to jeopardize the target for Latvia, and perhaps even the new target dates for the other two.
With the combination of a basically fixed exchange rates and rapid growth, the prospect of a rapid decrease in inflation does not seem realistic. Moreover, the problem of not fulfilling the Maastricht inflation criterion is partly a result of a ‘lower than expected’ reference value of inflation in the EU. Fiscal deficit on the contrary is kept well within bounds.
On the other hand we have Hungary, Poland and Czech Republic - despite the declarations coming from each country it seems that it is the lack of political will which is decisive. Tax cuts and fiscal reform are the official priorities, backed with insufficient real convergence as an excuse, but somehow all this did not seem to matter when the strategies where initially set out. In fact all three countries have rather weak governments, and strong opposition to the euro adoption even within the ruling coalitions. This fuels the reluctance to cut spending and that seems to be the unofficial explanation.
The troubling question is that if these countries are unable to reduce deficits now – when growth is quite high when will be the right moment? It certainly will not be much easier when the boom is over.
Slovenia is joining soon, and Slovakia, at least up to now, seems to be following its set, albeit slower path, though it is still early enough for it to follow the path of its larger neighbors.

Fighting Corruption in Transition Economies – a WB report

Finally, back – but this time no numbers, just a loose comment. I recently came across a WB report on corruption (or rather anticorruption) in transition economies which certainly deserves some attention.

The problem of corruption is well present in policy debates by now. It is named as one of the most serious obstacles to the development in transition economies, and generally developing countries. In the long term high levels of corruption impede economic growth by leading to inefficient allocation of resources, disrespect for the rule of law and enforcing rent-seeking. Small and medium enterprises seem most adversely affected which in turn hurts job creation, the potential to adjust flexibly and innovation. On the other hand poverty tends to make corruption more tempting – government officials, tax authority workers, policemen etc. are poorly paid, and if the rule of law is weak the gain to risk ratio of accepting the bribe may prove more appealing. Thus we are dealing with some sort of vicious cycle, at least in some of the countries.

As the report justly emphasizes, the early 1990s were focused on macro stabilization, market reform and establishment of legal foundations of a market economy, liberalization of prices and trade and a shift towards private ownership in the transition economies. The institutional reforms that ensure transparency, public sector accountability and efficiency were in many cases given less attention. It mentions the role of many institutional and historical factors, but does not elaborate on this issue. What the report does not emphasize enough is that this ‘spur’ in corruption in the transition economies did not come from nowhere and perhaps was just the revealing and highlighting of a phenomena that has been around all the time. The former communist countries have a long, well established tradition of graft, reaching the start of the communism and far beyond. And while the many of the western economies were already noticing the problems in the post-war era, the communist regimes were a fertile ground for corruption. Obtaining favorable decisions from any, especially local level officials, involved gifts and other sorts of persuasion. Even simple, everyday issues such as shopping, when goods were scarce, often entailed convincing someone to sell the good from under-the-counter. The governments would put a blind eye on most of these rather preferring to swipe the issue under the carpet – as officially corruption was an evil that concerned only capitalism. Most of the ‘private initiative’ was at least partly in the grey zone, and as all sorts of officials could play a decisive role in its to be or not to be – and thus enjoyed skimming parts of their revenues.
Moreover in many of the countries corruption traditions date back further than communism. For instance in the nineteenth century Russian (which encompassed large parts of Poland, the Baltics, many of current CIS’) tsars officials were given low wages in the assumption that they can make a living out of local scale bribery. I do not know the area well enough to cite historical analyses, but it is sufficient to recall the novels by N. Gogol and other authors of the time.
Rooting out corruption requires a good understanding of the mentality and of its history. All the successes attained in combating it are not irreversible, especially as the change of mentality requires more time than the change of legislation.

Measuring corruption is obviously not based on hard data concerning the number of bribes. The numbers concern reported corruption or the perception of corruption. The report cites two sources - company level surveys or “experts’ surveys”. The first concern answers reported by companies on general questions (such as whether bribes are an obstacle to doing business, whether bribes can influence law setting) but also on more specific (like have you paid a bribe, how often do you pay, how much of the revenue goes to bribes). The second type named “experts’ opinions” concern rather foreign professionals perception of graft in a country.

The general picture presented by the report is that in many of the transition economies efforts to combat corruption are present and yield some success – the leaders being Georgia (thanks to strong commitment of the new regime) and Slovakia (partly thanks to commitment and the tax reform). Admittedly, starting from higher levels of corruption facilitates a more spectacular success, thus perhaps a slowdown in the
Moreover the report recognizes that Romania and Bulgaria made substantial progress in facing the problem, which can be certainly at least to a part admitted to the prospects of joining the EU, which as it seems both countries are set to do next year. On the other hand corruption in relatively rich countries which seemed to be dealing well with the problem, like the Czech Republic, especially in areas like government procurement seems to have recently increased.
The two countries that certainly stand out are Belarus and Uzbekistan, with, at first glance, surprisingly low reported levels of corruption. As in these cases the discrepancy between firm level reports and “experts’ opinions are the highest, the report mentions three possible explanations: 1) the measures do not capture the implicit corruption widely spread in such autocratic states, 2) fear of adverse consequences of reporting bribery even in an anonymous survey, 3) the failure to perceive everyday bribery as corruption in the same way that firms in more liberal systems do.

Moreover, probably the fact that companies do not believe that anything can be changed by reveling the truth in a survey plays a much more important role in these autocracies.
Generally I have some doubts about the reliability of these measures for the two countries and think they cannot be interpreted as in case of most other states. Also classifying the two states as “slow progress in transition” seems a bit misleading…

Next, I was a bit surprised to read that “manufacturing firms pay more bribes and pay them more frequently than firms in other sectors”[p.26] which seems to go against the common view of construction companies being among the top – but I did not find an elaborate explanation in the report.

Finally, the report compares levels of reported corruption in the transition economies with respect to benchmark countries: Greece, Portugal, Germany (Eastern Germany) Ireland, Spain and Turkey. The conclusion that overall the level of corruption is still significantly higher than in the EU counterparts, but on some dimensions a number of transition economies score better than for instance Greece and Portugal. What would be interesting to see, is how Italy (especially Southern Italy) would score in this type of comparison.

Summing up, the report is a third in a series of tri-annual investigations within the WB anticorruption in transition (ACT) scheme. It emphasizes continued improvements in a number of countries and progress in some areas but stalling in others. It attempts to identify the driving forces of anti-corruption originating both from within the countries and from outside. In combatting corruption the focus must be on the implementation of anticorruption legislation not just on producing it. Moreover, these steps have to be well though and careful in order not to impede important state decisions, solely because of fear of accusations of bribery. Transparency; accountability; efficient governance, audit and monitoring; free and independent media; reducing state involvement but also commitment and a tough stance are crucial keywords. Progress takes time, but the attention given to the problem is certainly the right way to go.