After shock therapy, Hungary's Orbanomics starts to produce rewards

September 22, 2016 1:17 PM EDT

Attila Behovits, owner and managing director of Hungarian firm Kobe Sausages, eats "kolbice", mini sausages and toppings stuffed in a cone-shaped bun, in a market hall in Budapest, Hungary, September 20, 2016. REUTERS/Laszlo Balogh


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By Krisztina Than

BUDAPEST (Reuters) - Attila Behovits launched his street food business during hard times for Hungary but four years on, the economy - like demand for his traditional spicy sausages - is growing well.

Entrepreneurs like Behovits still believe the country lacks innovative ideas and bemoan a labor shortage as young Hungarians keep heading abroad for a better life.

Nevertheless, "Orbanomics" - Prime Minister Viktor Orban's controversial form of shock therapy - is paying off. The sharp economic contraction of 2012 has turned into a solid expansion, the budget deficit is under control and Hungary is regaining its investment grade credit ratings.

Behovits's business of selling mini sausages and toppings stuffed into a cone-shaped bun, called "kolbice", has grown exponentially in parallel as Hungarians have started spending again after severe belt-tightening following the 2008 global financial crisis.

"Kolbice was my idea, as I go to festivals a lot, and we could see that the sausage and bread combo is always popular," Behovits said at his restaurant in one of Budapest's magnificent 19th century market halls.

Annual turnover at his company, Kobe Sausages, already exceeds 100 million forints ($365,000), and it is expanding a franchise network in Poland, the Czech Republic, Romania and Austria. A mechanical engineer by training, 45-year-old Behovits also manages several other firms.

Orban embarked on his independent policy course shortly after coming to power in 2010. He imposed big windfall taxes on banks, energy, telecoms and retail firms and nationalized private pension savings of 3 trillion forints ($11 billion).

Such unorthodox measures upset investors and brought him into conflict with the European Union, the International Monetary Fund and financial markets, but they also reined in the budget deficit.

After rating the country's debt as "junk" for five years, two of the three main credit agencies upgraded Hungary, once called the "sick man of Europe," to investment grade this year, recognizing for the first time that Orbanomics had worked.

Last week's upgrade by Standard and Poor's, which markets had not expected so soon, drove yields on Hungarian 10-year bonds below those of Poland this week. Analysts expect more investors to pile money into Hungarian assets in the short run.

STABILITY VS COMPETITIVENESS

The budget deficit is now below the EU ceiling of 3 percent of GDP, public debt is declining and the current account is running a huge surplus. The economy grew about 3 percent last year, helped by billions of euros of EU development funds.

By shifting financing to forint-denominated debt sales, Hungary's reliance on foreign currency debt and foreign investors has decreased. And after squeezing the banks for years, Orban started to cut the bank tax this year, improving investors' mood.

"If we look from the stability perspective ... the Hungarian economy is less vulnerable now than it was before the crisis, so from that perspective Hungarian economic policy was successful," David Nemeth, an analyst at K&H Bank said.

But the problems are not over. "On the competitiveness rankings, Hungary is well behind the regional competitors," said Nemeth.

In the World Economic Forum's 2015-2016 Global Competitiveness Report, Hungary ranked 63rd, behind Poland, the Czech Republic and Romania.

The volume of investments in Hungary fell by an annual 20.3 percent in the second quarter, the steepest decline since early 2012, due to EU-financed investments coming to a close.

This shows how much the economy still depends on funding from the EU - with which Orban has had a succession of disputes including over the refugee crisis and constitutional reform.

Small firms like Behovits's street food business are laboring under from Europe's highest value-added tax rate of 27 percent. Banks have tightened credit conditions, while venture capital financing is expensive, although a massive central bank loan program has helped.

VAT on restaurants, internet connections and basic foodstuffs will drop to 18 percent next year but companies still complain about excessive bureaucracy, a lack of transparency and corruption in the state sector.

The government is reluctant to cut the main VAT rate but has promised a reduction in social taxes on jobs. "In the coming years, the government will strive to further reduce the size of tax and social contributions burdening the economy," Economy Minister Mihaly Varga said on Thursday.

EXODUS

Hungary has attracted foreign investors partly because wages are low compared with in Western Europe but Behovits believes this model is at risk.

He says the main problems for the economy are a growing labor shortage, which is putting upwards pressure on pay, and a lack of innovative ideas in an emerging economy dominated by multinational firms, mainly big German car makers.

"It would be very important to have many more domestic innovations, home-grown firms which develop innovative products of their own," he said. "Our big competitive advantage is wages ... but now that we face a big shortage of labor, this is under pressure, wages will rise."

Families' tax burdens have decreased as Orban has introduced a flat personal income tax rate of 15 percent and allowances, but hundreds of thousands of Hungarians have still left the country to work in Western Europe, where they earn much more.

Jozsef Bonyar, 69, who was a miner for more than a decade, denies the economy is doing better. "It is not true," he said. "If that was the case, young people would not go abroad to work."

Bonyar lives on a monthly pension of 50,000 forints ($185) while his son works in Germany as a truck driver and his two step daughters are employed in Italy. He voted for Orban's Fidesz party in 2010 and 2014, but says he would not do so again.

Some take a more favorable view. "The government has made some good decisions," said Adam Paroczi, a 21 year-old who is studying to be a teacher.

But while Paroczi wants to stay in Hungary, he says tax cheating remains a big problem. "Many people are, on paper, employed at a certain wage, and then they get more money in their pockets. Let's be honest, this is the way it works."

(editing by David Stamp)



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