Banks or Pensions?

That’s the difficult choice which faced Hungary as its international support package was put together in the last couple of weeks.  One thing that happens between the initial announcement that a package has been agreed and its final endorsement by the International Monetary Fund’s board is that we get to find out a lot more about the specifics of what has been agreed.

And whereas a major focus of the Ukraine announcement yesterday was the death knell for the exchange rate peg, the news from the Hungary agreement with the Fund is a severe fiscal retrenchment and a bleak growth outlook for the next three years —

Growth is not expected to reach its estimated potential of 3 percent until after 2011 …The program envisages a large structural fiscal adjustment of 2½ percent of GDP with emphasis on expenditure measures, consistent with the need to reduce the country’s large public sector. To put fiscal sustainability on a permanent footing, a rules-based fiscal framework will also be introduced. To mitigate social impacts, low-income pensioners will be exempt from the elimination of pension bonuses.

So where are the billions going?  Two areas.  First, there will be a bank recapitalization and funding of a guarantee scheme for Hungarian banks to help restore confidence in the system and get the domestic banks back on a level playing field given the proliferation of guarantee schemes throughout the EU once Ireland got it started a couple of months ago.  Second, there will be a big infusion to the reserves of the central bank so that the punishing schedule of external debt repayments can be met and still leave the central bank with enough reserves to give confidence to creditors that debt repayments will continue.

But all this can only be made to work with a sizable fiscal contraction: 1.3% of GDP of spending cuts (mostly) will need to be found in 2009 — in the context of a weak government which according to the program it has just agreed to, can’t promise a decent rate of growth till 2011.  3 years is an eternity in politics.   During which time the government will have to explain why the pension bonus cuts and all the other measures were worth it to restore international confidence in Hungary’s banks and its solvency.  An unenviable task.