Why Europe’s strongman may wobble

Viktor Orban’s policies have raised fears about the future of democracy in Hungary, but voters like his handling of the economy. Frédéric Guirinec reports.

Viktor Orban, Hungary’s prime minister, has long been universally expected to win the country’s next round of parliamentary elections in April. His policies – which include fervent opposition to immigration, strongly nationalistic tendencies and constitutional changes that have cemented his Fidesz party’s grip of power – worry many, including the European Commission.

Critics argue that Orban, once a liberal dissident who campaigned for the end of single-party rule under communism, has become an authoritarian strongman. Yet he remains popular domestically: opinion polls give Fidesz around 50% of the vote. The biggest opposition is Jobbik, a more right-wing party with policies that make Orban look cuddly, with 15%-20% support, while the Socialists are the leading force among a fragmented group of left-wing parties, polling around 10%-15%.

Why voters backed Orbanomics

Orban is popular in part because Hungary is a relatively conservative country in many respects and also because his stance on immigration is widely supported by many voters. However, economics has also played a major role. Hungary was one of the worst hit among emerging European economies by the global financial crisis of 2007-2009, due to a massive leverage problem in households, the financial sector and the government.

During a long housing boom from 1998 to 2007, house prices soared by 264% (a doubling in inflation-adjusted terms). As inflation and interests rates were relatively high, around 90% of mortgages were taken out in foreign currencies, including in Swiss francs.

If you visited Budapest towards the end of the boom, you would have seen advertisements around the city promoting these products – and might well have concluded that it would end in disaster, as mass borrowing in foreign currencies tends to do. Predictably enough, it did. In 2009, the Hungarian forint declined by nearly 30% versus the euro, sending the repayment costs of these mortgages soaring. Investors fled and interest rates on long-dated government bonds soared to 12%, putting public finances under pressure. GDP contracted by 17% in 2009 and even today still remains well below its 2008 level.

Hungary began by following the usual recommendations for dealing with a crisis and received €20bn through an international bailout. But in 2010, when Orban came to power, he embarked on some controversial and unorthodox economic policies, dubbed Orbanomics. These included resisting calls for further austerity and instead cutting taxes, paid for by a banking levy and crisis taxes on telecoms, retail and energy sectors, which are conveniently dominated by foreign investors.

The government also nationalised billions in private pension funds, which helped reduce government deficits at the expensive of increasing nominal long-term liabilities. It followed populist measures such as making utilities to cut costs for households. And it reduced foreign currency debt by pressuring banks – mostly Austrian – to convert up to €9bn of foreign currency loans into forint at the previous market rate, in effect compensating customers who had taken them out and subsequently suffered losses when the currency collapsed.

An unexpected turnaround

The long-term implications of some of these policies remains to be seem, but – to the chagrin of many critics – they seem to have worked for now. Unemployment – perhaps the most crucial factor for popularity – is just 3.9%. GDP has grown at 3%-4% per year since 2014, reaching 4.4% in the last quarter of 2017. The devaluation of the forint has helped to boost exports and Hungary ran a current-account surplus of 6.1%, up from a similar-sized deficit in 2008. Other policies such as slashing the corporate tax rate to 9% while raising VAT on products consumed domestically to 27% have also helped to promote exports.

Household debt has reduced from 40% to less than 20% while total private debt (including corporations) decreased from 185% GDP to 140%, now in line with the Czech Republic. Hungarians now have the lowest level of personal debt in the developed world, at 20% (compared with 88% for the UK). Even though government spending represents more than 50% of GDP, compared with less than 40% in most other central European countries, the government is running a fiscal surplus. Sovereign debt levels have declined and represents 74% of GDP; Hungary is now rated BBB, the bottom of the investment-grade scale by ratings agencies.

An export boom

The Hungarian economy is relatively small, with GDP of $134bn (two thirds of Czech Republic or less than 5% of the UK). The average salary in Hungary stands at €600 compared with €2,300 in Germany, the lowest in Europe after Romania and Bulgaria, with a minimum of €410 – in other words, this is not a wealthy consumer economy. However, it is an attractive destination for some foreign investors, notably manufacturers.

Exports play a major role, in particular for the car industry: last year it produced 472,000 cars including premium cars such as Audi A3 and Audi TT. Foreign firms continue to invest in manufacturing in the country: in 2016 Mercedes announced a €1bn investment in Hungary to extend its site at Kecskemét to double the car production to 330,000 by 2020. The combination of low corporate tax and low labour cost helps the company to offer its entry models (A class, CLA and B class) at a competitive price in Europe.

A good quality of life and an excellent education system also attract foreign companies. Hungary has some of the oldest universities in Europe with a focus on engineering, pharmaceuticals and economics and a 99% literacy rate. In 2016 it received €3.6bn of EU funding to help modernise infrastructure, from water pipes to a motorway to Romania and train lines. Foreign investors are not targeting low-value textile and food-processing sectors anymore, but premium cars (as with Mercedes), renewable energy, luxury tourism and technology.

For example, asset manager BlackRock opened an “innovation centre” in Budapest last year, while Samsung and Lego have also invested. Finally, in addition to being a major business and financial hub in Central Europe, Budapest is also a popular tourist destination, where areas such as the beautiful Lake Balaton and the largest natural lush grassland in Europe are also popular with foreign visitors.

A cheap, but narrow market

With a price/earnings (p/e) ratio of around 11, Hungary is one of the cheapest stockmarkets in Europe along with Poland, Iberia and the Czech Republic, although big gains have already been made since it began to recover from the crisis: the BUX index has already increased by over 130% since 2015. It is, however, a narrow market. Three large companies dominate the BUX index: OTP Bank, energy group MOL and pharmaceutical firm Richter Gedeon.

Richter Gedeon is growing: it generated €1.4bn sales in 2017, a 15% increase, driven by Western Europe and Russia. OTP is well capitalised, ready for a new credit cycle to start, after five years of restructuring. Lastly MOL is priced at a low p/e of seven and the company generates strong operating cash flow.

Drinks firm Zwack – founded in 1840 and partially owned by Diageo – produces the iconic Hungarian herbal liqueur Unicum, which is recording strong growth. However, that does not compensate for declines in vodka sales and the shares look expensive on a p/e of 16. Magyar Telekom is more attractive, with strong profit margins, strong cash flows, limited debt and a yield of 5.5%. Lastly, real estate is also getting strong traction with house prices increasing over 10% in 2017.

Budapest remains inexpensive for foreign investors with an average price of HUF 548,000 per square metre, although house prices in the fashionable districts have increased significantly in the last two years. Real-estate firms Graphisoft Park and Appeninn offer exposure to the sector.

The great unknown is politics. Until this week, Orban was considered a shoo-in to retain power. But at the weekend a Fidesz candidate suffered a shock loss in a mayoral by-election in a traditional stronghold for the party. Crucially, he lost after opposition parties banded together to support a single candidate against him – and after this success, there is talk of them following the same strategy in the general election next month.

Orban remains a clear favourite, but his victory no longer looks so assured. If he were to fall, that might be good in the eyes of those worried about the state of Hungary’s democracy – but it could also mean major changes to economic policies that have been successful, if unorthodox. So potential investors would be wise to wait until the result is clear.