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Hungary Struggles to Cope With Mass Capital Flight

Posted February. 23, 2009 08:11,   


With the forint-euro exchange rate well above 300 Saturday, people in Hungary’s capital of Budapest doing their weekend shopping fixated on an electronic board displaying the exchange rate on Karoly Street.

With the skyrocketing exchange rate, many Hungarians have bargained with dollars at the exchange booths. One 37-year-old man who lives near Budapest said, “The booth offered me more forints for my dollars than what the exchange rate would give. I turned it down because the exchange rate will certainly go up further.”

A sharp rise in the exchange rate has led to massive hoarding. In southern Budapest Saturday, the large electronics store Saturn was crowded with shoppers who heard that the store did not raise the prices of their forint-denominated merchandise.

One employee said, “Customers came rushing into the store after hearing that they can save money if they buy the products before the forint drops further this week. So we canceled discount offers on certain products and plan to put the prices in euro soon.”

A World War II survivor who lives on pension said with a sigh, “Things would not have been this bad even if the city were bombed in a war.”

Hungarians have greatly benefited from their nation’s transition from a socialist to a capitalist system and support from Western Europe following its entry into the European Union.

For starters, it has received financial support from Western European countries for road and city maintenance. With rising product exports and remittance from Hungarians working in Western Europe, Hungary became the richest nation in Eastern Europe in 2005.

With the outbreak of the global financial crisis, however, Hungary has suffered a sudden exodus of capital from Western European financial institutions. National wealth and household wealth have shrunk as a result.

One Hungarian said, “It feels like our foreign reserves have disappeared into thin air without even getting our hands on it.”

Out of frustration, some citizens asked what has become of their once-abundant foreign reserve.

Certain people who opened accounts in banks located in Budapest’s financial district seemed to know the answer: failure of financial policies.

Commercial banks maintained their loan interest rate for foreign currency at around six percent Saturday while drastically raising that of forints to more than 12 percent following their commitment to tighten financial policy after receiving a bailout worth 25 billion dollars from the International Monetary Fund and the EU in October last year.

Though Hungary has lifted interest rates on forint loans to prevent a further flight of foreign capital, the difference in rates has reportedly raised the number of businesses and households who took out loans in Swiss francs. The shrinkage in the amount of foreign currency has led to further drop in the forint’s value, causing foreign investors to leave the Hungarian market or engage in speculative activities such as hoarding Hungarian government bonds.

Consequently, the forint-euro exchange rate went from 230-240 until early October last year to more than 300 Feb. 16.

Hungarian Prime Minister Ferenc Gyurcsany’s inconsistent policies have made the problem worse.

Regardless of the IMF’s warning made late last year, the Hungarian government used the financial bailout it received from abroad to make up for losses in its railroad operations and to raise pension and salaries for public servants.

“The government’s fiscal deficit and populist policies have eroded Hungary’s ability to defend against exchange rate hikes,” the IMF warned Dec. 22.

Until the beginning of December last year, Gyurcsany seemed committed to reforming the national pension program and reducing the pay of public servants. With 30 percent of Hungarians living on pension, the government’s deficit amounts to five percent of the nation’s foreign reserves.

This is known to be the main cause of Hungary’s fiscal deficit. Unfortunately, Gyurcsany scrapped the pension plan only days after it was announced.

Hungary could also declare national bankruptcy given the government’s weak commitment and lack of tools to overcome the crisis.

Kim Jong-chun, trade commissioner in Budapest for the Korea Trade-Investment Promotion Agency, said, “Many predict that Hungary will need an additional 12.5 billion euros to help its households and provide bank guarantees even after receiving an external financial bailout. As a result, there is high possibility it will go into default.”

Other experts said that given Hungary’s chronic fiscal deficit and shortage of foreign reserves, its only hope is receiving external help.

Many European countries are keeping a close watch on Hungary - long cited as a successful example of capitalist transition - since its declaration of national bankruptcy could trigger the same in its neighboring countries.

Kim said, “The recent exchange rate hike has forced foreign companies such as Audi and GE to either suspend their operations or shut down their factories in Hungary.”

“If the real economy (in Hungary) shows no signs of recovery despite Europe’s help, it will be a long time before Hungary rises again.”