Analysis of Hungarian Financial Crisis - Case Study Example

? Hungarian Financial Crisis In the year 2004, Hungary had become a constituent of the European Union, and was able to transform itself from a planned economy to a market economy. Even though this transition of Hungary was very encouraging and there was a continuous development in the performance of Hungary, but on the other hand due to adoption of incorrect domestic economic policies as well as international financial disorder has resulted in the Hungarian Financial Crisis in the year 2008. One way to get rid of this situation was to take help from the International Monetary Fund, but still there was doubt whether the Hungarian economy could get back to its previous situation (Horvath, 1). Hungarian Weaknesses The Hungarian Financial Crisis which occurred in the year 2008 was not due to frustration or fright. The occurrence of the international financial crisis has forced the financial markets to reexamine their patience to tolerate uncertainty. Day by day as the financial disaster increased, this in turn resulted in reduction of international liquidity and also an increase in uncertainty. On the other hand the shareholders had started to distinguish among the rising markets and judged that the Hungarian possessions have become more risky. However, it can be concluded that the vulnerability of the Hungarian economy was mostly due to these uncertainties. In this situation the Hungarian authorities were not very sure in what way they would handle these problems. They examined the market more minutely and had increased the deposit securities as per the European Union policy. But still this policy did not work and the Hungarian government was not able to save the public from this financial crisis and there was instability throughout the economy. So, in such a situation the Hungarian government had no other option than to take help from the International Monetary Fund and the European Union (Horvath, 1-2). Financial Crisis One of the major reasons of the Hungarian Financial Crisis was that the government debt of Hungary was to a great extent owned by foreign. When the financial crisis occurred the Hungarian bonds were sold by the foreigners but this was of no use as no one was willing to buy these bonds and this led to disorder in the market. Moreover auctions were held to sell the new government bonds, but this too did not work. Again the shares of the Hungarian bank had fallen to a great extent. The forint had started to fall; the rates of interest had started to increase. The security market of the Hungarian government had suffered huge loss and also there was scarcity of liquidity in different financial institutions. The Hungarian authority already had huge debt under the communist administration. The GDP-debt ratio had decreased from 90% to 50% in the year 2001. Again due to incorrect policies adopted in the year 2002 the ratio had increased to about 15% and this resulted in 65% rise in GDP. On the other hand the debts of Czech Republic and Slovakia were 30% and 50% respectively (Horvath, 1-3). Reasons of Hungarian Weakness In the year 2008, Hungary was the first member of the European Union who had wanted financial help from the International Monetary Fund. This was considered as a failure of the Hungarian government. At this moment it was very difficult to state that in the near future which are the other countries who will have to face such crisis and which country will be mostly affected. There are a number of causes why Hungary was the first target of this financial crisis. One of the reasons is that the Hungarian government did not take into account stability while implementing the monetary policies. Also there were not sufficient foreign exchange reserves with the central bank. The debt in Hungary was very high compared to other countries, (that is ratio of Public debt to GDP and ratio of external debt to GDP). Again the fiscal policy measures were not appropriate; there was doubt whether the government had the capacity to maintain deficit reduction even after two years of crisis. Also disorder in the financial market was another reason of economic crisis. Another reason was that the Hungarian government was not aware that external assistance could be taken from International monetary fund and the European Union who could provide credit immediately. This indicates that the nation is still in primitive stages of economic crisis without any knowledge about International financial institutions. On the basis of the crisis which occurred earlier, the presumption was that the foreigners would be able to buy, the shares of Hungarian companies (Andor, 285-287). Since, there is no doubt that the economic crisis in Hungary was due to both exogenous and endogenous factors, so though the crisis is global and its sources can be found easily but still it would be a prudent decision to examine the causes of weakness of such financial crisis. So, to maintain financial stability both fiscal and monetary policy should be changed in Central and South-East Europe mainly. Also for long term economic development there should be many-sided finance and policy coordination (Andor, 295). Hungarian Financial System The Hungarian banks had no direct contact with the subsequent markets of United States. The financial or banking system of Hungry was quite rewarding and had lot of assets. The restrictions on rate of interest was low and this reflects healthy competition and there was stability in nonperforming loan ratio of Hungary as the banks had sold unpaid loans to various industries and small firms, those of them who will be willing to buy debts at reasonable prices, and after that to assist the borrowers to reorganize their debt commitments. The flexibility in the process of lending had allowed constant growth of credit for both customers and households (Horvath, 1-3). Steps Taken To Prevent Future Crisis One of the major steps to prevent future financial crisis would be reduction in labor costs and also there should be active contribution of labor which is the main objective of the government. Also the burden of tax should be shifted away from laborers and placed on consumption and property taxes. All these steps can help in improving the quality of work of the employees and would also increase employment opportunities, not only that it would also help in reducing tax evasion. And as a result the tax base would be broadened. Hungary also requires a wide-ranging structural transformation in public finances that has got enormous cuts in expenditure and tax rates. This is can be pointed out as one of the solutions to move the growth rate upwards and to reduce the risk of financial crisis in the future years, as the government constantly faces credibility crisis (Horvath, 1-3). Hungarian Fiscal Deficit The election campaign of Hungary in the year 2002 has increased competition within political parties and forced populism in such a manner that the theme of political proceedings had led to huge economic contributions from the state budget to different groups of people. For instance arrangements were made for pensioners to provide a thirteenth monthly payment and increase the income of the employees by 50%, in order to gain high amount of votes. At the same time many political clients pledged for financial assistance and favors. Again ineffective state administration and expensive municipal regulations had increased the cost of crisis. The graph below shows the total government expenditures of Hungary relating to compensation of employees, purchase of goods and services, social benefits, investment, interests and others in the years 2006, 2007 and 2008 respectively (Horvath, 1-3). GRAPH SHOWING GOVERNMENT EXPENDITURE IN HUNGARY DURING THE YEARS 2006-2008 (Horvath, 2) Hungarian Financial Markets In Hungary the Financial market was disturbed due to the crisis in Asia and Russia in the year 1997 and 1998. There were a number of banks which suffered huge losses, moreover the bond market and the equity market was badly affected. The equity index had suffered 50% loss in its value in the year 1998 and there was considerable panic among brokerages. There was no stability in financial market until the middle of 1999. Inspite of financial crisis in the year 1998 and significant rise in the rates of interest during the middle of 1999, still the bulk of real credit had shown significant increase by 5.9 percent approximately (Organization for Economic Co-operation & Development, 97). Short-Term Forecast of Growth of Hungary According To IMF According to the estimation made by International Monetary Fund, it has been presumed that the growth of Hungary will shrink by one percent in the year 2009. It has also been presumed that inflation will fall to 4% by end of the year 2009. In such a situation it is assumed that the economy will progress gradually, moreover this condition holds not only for Hungary, but also for its trading partners (Horvath, 1-3). Reaction in Hungary Due To Financial Crisis During the period 2001-2006 the Hungarian authority had adopted incorrect fiscal policies which have resulted in deficit of budget between 4% and 9% of the total GDP. One of the reasons for this deficit was that there was no balance in pension policies. Other reasons which are responsible for such fiscal deficit are too much expenditure on transportation system, health care and less reduction in personal income taxes. There were mainly two options in government’s hand, one was to increase taxes and other was to lessen expenditure. But the government had raised tax too much and did not pay any attention on expenditures. For instance, it had increased the value added tax from 15% to 20% and launched a rate for personal income tax which is of 40%. The GDP of Hungary had hardly increased in the year 2007. Due to political instability the privatization agenda on health care was cancelled by the government. The liberals had withdrawn the authority and the communists had to construct minority government. It was by chance in the year 2008, that the financial crisis had started and Hungary was the ultimate sufferer. One of the most important reasons of Hungarian crisis was that it was most indebted, and the debt /GDP ratio was about 66% in the year 2007. Also as a nation the reputation was not very good due to fiscal sloppiness. Another reason is that the inflation rate of Hungary was about 4-8% and it was accompanied with a constant nominal rate of exchange, this in turn was beneficial for the small firms in Hungaria and also for the people of Hungaria who could opt for business with low rate of interest. It is pointed out that though the budget deficit had fallen from 9% to 4% of the total GDP in the period 2006-2008 but the deficit in current account was quite high and it was about 8% of the total GDP. There was unexpected increase in the net external debt to GDP; it had increased from 75% in the year 2005 to 115% in the year 2008. In this situation there was no stability in the nominal exchange rate, similar unbalance in the exchange rates was also seen in countries like Poland and Czech Republic, but their situation was different because like Hungary they did not collect huge amount of private debts. Inspite of all these, the Hungarian government was still not willing to make the necessary changes. Though it was quite clear that it was not possible for the government to increase the tax and contribution rates, but still the authority was not determined to make adjustments in expenditures. It was observed that in every month during the period September 2008 to January 2009 the forecast of GDP by the government of Hungary had fallen by 2% points (Simonovits, 8-11). Table showing Government debt and External debt in the year 2005-2010 YEAR GOVERNMENT DEBT/GDP, % GROSS EXTERNAL DEBT/GDP, % 2005 62.0 75.1 2006 65.6 91.1 2007 65.8 98.4 2008 72.9 115.3 2009 77.7 137.3 2010 78.9 132.3 (Simonovits, 16) Impact of Financial Crisis on Hungary The economic crisis which occurred in Hungary during 2008 had a major impact on Hungary’s industrial sector. It was observed that the automobile industrial sector and electronics sector was badly affected. Since these industries are located in northern area of the country, and the crisis also had taken place in this particular region. The Hungarian government had to apply rigorous fiscal policy measures in order to overcome the financial crisis; however this was not sufficient as the financial crisis had started to deepen throughout the nation. So, it was quite obvious that many more measures are required to keep in track with the international monetary fund macroeconomic plan. Due to the economic crisis Prime Minister Ferenc Gyurcsany had withdrawn from his post and a new government was created by Gordon Bajnai (Andor, 286). Steps Taken by Hungarian Supervisory Authority The supervisory authority of Hungary is continuously examining the impacts of the financial crisis in the financial sector of Hungary. Assuming that the crisis will continue the authority had started to take care of the insurance sector of Hungary based on the stress test circumstances. The Hungarian financial authority had introduced a method on stress test. This test mainly concentrated on the strong and important effects on the financial system of Hungary. The main motive to perform this stress test was to check whether the domestic undertakings are valid or not. The stress scenario basically looked into the progress in the asset side and liquidity during the period of financial crisis. Moreover the supervisory authority also needed unit-linked measures to test the impact of a constant increase in liquidation of assets, the probable management instruments, etc (Organization for Economic Co-operation & Development, 70). Growth Performance of Hungary During the period 1995 to 2004, Hungary had shown rapid growth in gross domestic product, just like countries like Poland, Czech Republic and Slovakia. But from the year 2005 the growth of Hungary slowed down and it failed to converge with the European unions. The reason for this slow growth was due to fall in the total factor productivity from the year 1995. This problem can be solved only by rapid capital assimilation and by increasing the working hours could help in developing Hungary. However until and unless the total factor productivity improves Hungary will not be able to catch up with the rest of the countries like Poland, Czech Republic and Slovakia. One of the major problems the policy makers are facing is that how to increase the rate of labor participation, in a country like Hungary where the ratio of employment to population is relatively low. If the level of employment increases, then the level of income would also increase given a fixed level of labor efficiency (Valentinvi). Conclusion There is no doubt that during the year 2001-2006 the Hungarian Government had adopted incorrect fiscal policies because it raised the tax too high and there was very little reduction in expenditure and as a result the economy was growing at a very slow pace. But fortunately in this situation two communist authorities had been successful in obtaining large amount of credits from the international institutions and required adjustments was made. One such adjustment was reduction in pensions. This solved the problem to a great extent and credit was recovered in the economy. However still a question arises, that whether the future authorities will be able to maintain these reforms or again it will start adopting incorrect financial policies. REFERENCES 1. Andor, Laszlo. Hungary in the Financial crisis: A (Basket) case study, Journal of Contemporary Central and Eastern Europe (2009)17.3, pp.285-296. 2. Horvath, Julius. Hungarian Financial Crisis, European Union, 2008, April 15, 2012 from: http://www.case-research.eu/upload/publikacja_plik/23686666_E-brief_012009%20FINAL.pdf 3. Organisation for Economic Co-operation and Development, Policy Issues in Insurance The Impact of the Financial Crisis on the Insurance Sector and Policy Responses. OECD, 2011 4. Organisation for Economic Co-operation and Development (2000). OECD Economic Surveys 1999-2000: Hungary. OECD, 2011 5. Simonovits, Andras. International Economic Crisis and the Hungarian Pension Reform, 2011, pp. 8-16. April 15, 2012 from: http://econ.core.hu/file/download/mtdp/MTDP1111.pdf 6. Valentinyi, Akos. The Hungarian crisis. 2012, April 15, 2012 from http://www.voxeu.org/index.php?q=node/7740 Read More