The collapse of Hungary's talks with the International Monetary Fund and the EU is a chilly reminder that sovereign debt crises do not end with a rescue package and a click of the fingers. As austerity drags on for year after year, democracies react.
By Ambrose Evans-Pritchard, International Business Editor
Published: 8:32PM BST 19 Jul 2010
A slogan of Hungarian Natianal Bank (Magyar Nemzeti Bank) - the IMF has pulled out of talks on a bailout for Hungary. Photo: AFP
"We told the IMF/EU that further austerity was out of the question," said Hungary's economic minister Gyorgy Matolcsy, offering no hint that the Fidesz government is willing to back down despite yesterday's surge in Hungarian default costs by 51 basis points.
The Fidesz movement – an amalgam of libertarians and nationalists with a Left-populist tilt – won a crushing victory in April on a campaign of defiance against both Brussels and the IMF. It has been spoiling for a fight ever since.
Lars Christensen, of Danske Bank, said events in Budapest are a warning of what may happen in the Baltics later this year, and then in Greece and other parts of EMU-periphery forced to undergo wage cuts and harsh fiscal tightening.
"It is incredible how long Hungary has been struggling to get over its imbalances. It first began austerity measures in 2006, but four years later is still not out of the crisis and there is massive discontent. The Greek problem is even bigger by any measure, whether budget deficit, current account or public debt," he said.
"Austerity is extremely hard to sell to electorates. The risk is that this moves from a wider financial and economic crisis to a European political crisis as governments are punished by voters. The approval rating for Lithuanian's prime minister has fallen to 7pc."
Greece is at an early stage of this political sequel. It has won praise from the IMF so far but spending cuts have only just started over recent months, and will grind much deeper over the next three years. Two MPs from the ruling Pasok party have been expelled for refusing to toe the line, and some Greek analysts say the party may ultimately splinter.
"The issue is whether they can carry the Greek people when have to make the next round of cuts in 2011," said Chris Pryce, of Fitch Ratings.
Tim Ash, of RBS, said Hungary deserves some sympathy after sticking to agreed cuts last year as the economy contracted by 6pc. It has broadly complied with IMF terms. The budget deficit is just 3.8pc of GDP this year, far lower than Poland, Spain, France, Japan, the UK or the US.
Even so, he warned that Hungary is playing a "dangerous game" for a state with a public debt of 80pc of GDP and an external debt of 135pc. "If there is another bout of global risk aversion, Hungary is the first target. It has $40bn of reserves, or five months import cover, but in the end it probably can't survive without IMF money," Mr Ash said.
The country cannot easily devalue to claw its way out of its debt-trap because 63pc of loans from mortgages, households, and companies are in foreign currencies, much of it in the ever-soaring Swiss franc. "A weaker currency will crush households. Countries like Hungary with a debt-sustainability problem need to grow but there is no growth, and they can't reflate," he said.
Most investors thought Hungary's woes were over long ago with the approval of the €20bn rescue in 2008 – now mostly exhausted. It was assumed that the rest of Central and Eastern Europe were well on the way to recovery, underpinned by the G20 agreement in April 2009 to triple the IMF's fire-fighting fund to $750bn.
The picture is looking more fragile again. The IMF is nearing its own limits as a lender of last resort after its pledge to back the EU's Stability Facility for Club Med debtors with up $250bn if needed.
IMF chief Dominique Strauss-Kahn said yesterday that the Fund was in talks to raise its resources to a $1 trillion as a precaution. "Even when not in a time of crisis, a big fund, likely to intervene massively, is something that can help prevent crises. Just because the financing role decreases, it doesn't mean we don't need to have huge firepower," he said.