Paradoxes of downgrading and simple accounting

One of the worst, most feared moments of the crisis for many ECE countries is the event of downgrading by a credit rating agency. It is usually accompanied by a sudden fall of the respective currency on the market (sometimes as a lasting effect, sometimes followed by a recovery soon), by the growing spreads of government bonds and by a wavering credibility in the country's public finances etc. Although it is far from being a case of normality, such downgradings and its opposites, upgradings occur regularly. The reactions, usually in line with the agnecy's direction, express the faith of the market actors in those institutions, the fact that they accept: the agency is capable to analyze possible outcomes of the present situation with mathematical models and judge whether a country among fixed circumstances can repay its debt or not. (In case of some factors they should rely on hypothesis or forecasts.)

The crisis shattered the credibility of such agencies as their mathmatical models readily accepted the fact that subprime mortgages can be "repacked" into extraordinarily secure assets and from the perspective of the crisis it was clearly not the case. However, this fact seemingly didn't affect their credibility as evaluators of sovereign debts (Paradox 1). (Who knows why? Incompetence remains incompetence even if it is used to assess a different type of loans and bonds...) But one can assume that rating agencies drew the consequences and they logical reaction is to be more cautious, that means to make downgradings easier and earlier. Not that in case of a crisis, when forecasts have to be revised in every month or week caution wouldn't be advisable, but acting instinctively is not in line with the perceived scientifically based approach. (Paradox 2) Anyway, the agencies are desperate not to make the same mistake, and in the future assess risks more precisely, what also means to be able to forecast problems (in case of countries: sovereign default) earlier. Downgrading is a sign of taking into account risks and warning the markets and the respective states. And if the worst happens notwithstanding the early notice, the credit rating agency can only gain in credibility and standing.

It is cerainly a sound approach in normal times, especially as markets can calm down after a downgrading, government should have time to prepare the necessary action. But there is a not easily dismissable possibility that in times of crisis the more severe judgment can turn out to be a self fulfilling prophecy in a way not strengthening, but weakening the much desired trust. The external factors, quite independently from the government action, can deteriorate in a very short time span once again forcing the agencies to downgrade a country's debt and leaving no time even to prepare the necessary measures as a reaction to the earlier one and portraying even the most able government as inapt. The deathly circle of downgrading and raising bond sperads leading to downgrading again and raising the bond spreads again can emerge too easily. As there is no way to know how a very alarmed and uncertain market will react, it is not easy to know when will this prophecy fulfill itself at the very moment of the downgrading. But if it would happen it won't be a sign of the wisdom and professional capability, quite the contrary. In this case, as it would be very similar to those derivatives from sub-prime mortgages, it would be inevitable to think that they once again missed their point, and miscalculated themselves. (Paradox 3)

But beyond some intriguing, rather theoretical considerations, sometimes the practical capacities of such institutions seems to be problematic as well. Today Standards and Poor downgraded Hungary's long term sovereign debt and issued a statement in which they calculated that the present 72-73% debt in ratio of GDP will reach a 82% level next year, after an estimated 6% contraction followed by a 1% in 2010 and after the country will be compelled to ask more loans from IMF. This is more or less in line with the ideas of "experts", but nothing else than a simple miscalulation, presuming that the present-day gross debt will eventually turn out to be a net one. But it is far from being certain, moreover, up to this point it didn't happened. The problem with this calculation - as the deputy general director of Hungary's national agency for sovereign debt explained in an interview last week - that although Hungary has drawn a substantial part of its IMF loan last year, it is now either a deposit in the Hungarian National Bank, or was lent to commercial banks with market conditions. In case of the latter there is a fair chance that it will be returned in time with due interests. The former either will be used to buy back outstanding state bonds or pay for bonds in due time, therefore not piling up additional sovereign debt, or simply paid back to the IMF without being used. As long as this is a reserve and not paid for running state costs or used up as a resource for pensions or similar expenses there is no reason to assume that it will raise the level of sovereign debt. But even if it would be the case the 82% ratio is highly unrealistic. The present debt is calculated by S&P as 73% of the GDP, and they estimate a 6% decline for this year and a 1% for the next. Together we can assume that they calculate the GDP level in 2010 as the 93% of 2008. Accordingly today's debt ratio would be compared with this lower level, yielding a 77,4% result as the level of sovereign debt. Even if they were not presuming any governemnt measure to control this years deficit (although it is not the case) 82% seems to be a bit exagerrated. But the problem is not this calculation, but the fact that the "experts" at S&P, although certainly very smart at making mathematical models, are not capable to make a simple accounting work. Well, I know that it is tought at another department...

Update: Two feloows from the National Agency for State Debt published today an analysis refuting the prevailing perception of the inevitable sovereign default, pointing out the huge mistake regarding the IMF loan. Unfortunately it is in Hungarian.

The black hole called Hungary - Notes on exceptionalism VI.

After more than a week of frantic selectionary work (vetting a lá Hongrois) a new candidate for the position of the prime minister emerged. The twists and turns of last week were certainly fascinating for observers and outsiders and I wouldn't even astonished to attend once a theater play or a movie using the story as a basis. (Conmedy or tragedy, I don't really know.) But as the sun rose to it's dull and boring daily road to be accomplished, the scene was taken over by our "experts" and "analysts" conveying the judgement of the markets on the events. Many of them was eagerly and happily sharing with us their wisdom and it is conceivable that they hadn't omitted the effect of the recent political events on the exchange rate of the forint. And once again their majority saw clear and undoubtable signs of a strong causal realtionship. The fall of the forint againts euro at dawn was a message, expressing negative expectations and so on. And once again the story was completely dead half an hour later. The zloty, tha Czech koruna similarly fell even at dawn.

Not only the incompetence of these guys, perceivedly having the necessary qualifications for and being entitled to make more money with the use of that of others is a sad picture but their whole construction of the world so nicely expressed by these small episodes. Even though the resignation of a prime minister, the deterioration of the process of finding a new candidate to a farce and a stalemate at the weekend, when the early elections seemed inevitable was not able to influence the markets, they are sticking to the idea that Hungary has its own significance. As the once land of promise in ECE and now the sick man of the region, the adhorring example to where incompetence could lead. Either as the best or as the worst in the region, but Hungary stands out. They are clearly not disturbed by the fact that this is not the case. Their beloved and adored markets are making not much difference and as long as the most important concern on those markets is whether to buy US bonds or not, it will remain so.

Today's world seen from Bratislava

The liberal daily from Bratislava, SME, published today an article on the political situation in Hungary.(Unfortunately it is not a longer piece, as its author, Peter Morvay is a colorful personality, for example he was for a while probably the last Czechoslovak citizen, more than a decade after the dissolutuon of that country.) Otherwise the article is a short one, outlining the possibilities and arguing that the decision of one of the candidates for being designated prime minister to reject the offer was reasonable, given the limitations of his role. Later Morvay poses the question whether the leader of the Hungarian opposition, almost certainly prime minister after the next elections, will be able to implement reforms, even if these will be contrary to his campaign promises, replicating the situation that destroyed Gyurcsány's credibility.

What is interesting in this piece is the perspective and the implcit lecturing Hungary on the lack of reforms, similar to the achievements of the Dzurinda governments. Hungary is portrayed as very sick country with an almost dead economy, while its neighbors are realtively safe from the effects of the crisis. Even though both statements are exaggerated (Romania's budget are in a worse shape, and its economyc funamntals are maybe even worse - the driving force of growth was a housing bubble, instead ofr exports as in Hungary or Slovakia, Slovakia's budget, although clearly unnoticed for Morvay, is in the process of collapse because of the tax system's faults, the exchange rate for the koruna by the introduction of the euro disadvantaged the Slovak industry very much and paradoxically this is perhaps only veiled by the crisis (!)*, not to speak of Ukraine, and recession is hardly evitable in every country in the region) my aim is not to make an argument. On the one hand, because the criticisim is not completely unfounded, on the other hand because the stance of the SME is more important for this blog. It shows how easy it is in ECE to accept the role of leader of the pack, that of the model country's and how easy it is to present one country as superior to the others, using achievements and the sufferings leading to them as proofs of this. Today's world seen from Bratislava is a very assimetrical one, instead of the crisis, and Slovakia is its rigid schoolmaster.

(Ok, let me provide some proofs: the economic sentiment index hit in March an all time low in Slovakia, construction, services, retail sales confidence in almost free fall and industry and consumer confidence showing deep depression and no increase even though the Slovak car making plants were positively affected by the German "Umweltpraemie".)

Welcome to the machine?

As I was reading the "letters to the editor" pages of the weekly "Magyar Narancs" today, some intriguing thoughts occurred to me, as part of a debate on an op-ed piece some week ago the author of the original article criticized his opponents approach to public services. He denied that the state run and regulated, obligatory systems, like the pensions, health care, social benefits etc can be perceived as similar to markets, expressing the balance of supply and demand. (Well, it is a bit vague but it is not my intention to write about the debate. The point is that the, let's say traditional, sociological, approach to state run public services and the economical one, confronted.)

Chaos unleashed – Hungary in the Maelstrom

Four days after the announcement from premier Gyurcsány about his willingness to abdicate, the following events were very much in line with the predictable. The socialists are almost unanimously denounced as the roots of all evil; the first contemptous articles full of rage and triumphalism were published; the media is dominated by the expectations of the business elites regarding a prime minister convenient for their own interests, of course portrayed as the absolute public good; the president of the republic urged early elections; the socialists are in disarray, mainly only sticking to their positions and not to values or an ideology and we still don't know whether at least a new government will be installed or the dissolution of the parliament is inevitable. (Well, otherwise, everyday life seems not to be affected very much by the events. Hungary is a pessimistic country where passions are boiling under the surface but not outbursting at the moment.)

Conventional wisdom says that the fate of the Hungarian government was sealed by the crisis and the collapse was inevitable. Although there are many elements of the truth in this assumption I tend to disagree with its entirety. Not in the sense that the crisis wouldn't have had an impact on the events, quite the contrary. The decisive moment was the choice of the prime minister in the fall of last year to make an attempt to recover his credibility with effective handling of the crisis and at the same time snooker his opponent, Orbán, with the help of diverse social organization, from whom he hoped for support. He hoped for a reframing of the political discourse and legitimize not only his politics but the reform attempts as well. But the last decision, regarding Orbán, meant that instead of putting forward the structural problems of the world economy in the form of discussing the roots and possible outcomes of the crisis, the responsibility for the events etc. he returned to the earlier problems of Hungary and Hungary's economy, regardless any possible change in the external circumstances, because his would be allies were only interested in those problems. As a consequence, the discourse remained narrowly focused on Hungary as if it would be a sole entity, independent from the world economy, therefore capable to resolve its problems alone. Thus the presumption that the earlier economic policy was wrong and a decisive factor of the crisis, became an implicit axiom of every approach to the problem, that way not strengthening, but weakening the governments credibility, quite the contrary effect Gyurcsány wished for. Moreover the handling of the crisis became entangled with the problem of reforms. Those are not really popular and I suppose not only because of their effects on individual income and wealth. Similarly important is the fact that the vison and ideology behind them is very vague and clearly favoring only a minority of the society. Therefore without a profound debate, it is unrealistic to expect acceptance from those, who would be disadvantaged.

Maybe it is worth to make a short excursus regarding this problems, as it could highlight a very peculiar specificity of the current proposals in Hungary: almost every one of them is aimed to solve a particular problem in the system with a general transformation. For example the most popular version of a pensions reform among „experts” is the cutting of the present pensions with 8-10% and their freezing in real terms. Thus today's standard of living would be offered for today's pensioners forever in order to save money, while at the same time almost every one emphasizes that those are the burden on the system who get early pensions as handicapped with fraud. (The estimated number is well over 400-500000!) Another example is the general property tax, 0,5-1% of the value of the real estate according to the proposals. As the value of real estate expressed as multiple of personal income is very high, it could lead to a new burden not counterbalanced with the proposed tax cuts and especially in the case of pensioners and those with a minimal wage, whose income is tax free at the moment. Therfore they won't receive any easing, only a new tax, that easily could compel them to sell their houses. The main argument supporting this proposal is once again the fact, that many entrepreneurs exist, who pay taxes and excises after a minimal wage, while having a large and luxurious house. But once again instead of making a correction in order to eliminate the specific problems, the proposals are designed to achieve a profound transformation.* Returning to the problem of the crisis and reforms the above examples show one more important characteristic of the respective plans: those usually tend to redistribute the burden favoring the upper income categories and hitting the lower ones significantly and it is comprehensibly not really popular.

Once again putting forward reforms as the way of handling the crisis was clearly a mistake, as it enraged significant groups of the society and the result was indecision and ineptitude. Moreover, as Gyurcsány was hoping for support from those who's plans he was not able to implement, he was at the same time not in a position to attack them and spark a debate in which the responsibility of the rich for the future of Hungary would have been the most important topic. As a consequence came a deadlock, and Gyurcsány lost the remnants of his credibility.

One can argue that it was the only way, not only because those reforms are necessary (something I would like to discuss, even though not in extenso, later), but because the country is depending on the benevolence of the markets and they expect such moves in order to lower the country's risk assessment. I won't be that convinced, especially as the two problems, crisis and reform can be detached from each other. The crisis is a matter of how to pay back your outrunning debt at the moment (the real economy deopends on the recovery of the export markets, first of all Germany) and nobody (especially not the markets) expects the crisis lasting forever or for too long. (The former assumption is almost certainly true, the latter one is more dubious, but we can see every day how markets believe in the easy remedy in the form of some very smart and sophisticated action plan restoring the assets to their true value and they are waiting its arrival in any moment.) Therefore the foremost problem is not how to pay back your outrunning debt ten years later, when according to the expectations everything will be in order again (especially as nobody knows how much it will be, and with what conditions) and not how to pay it back at the moment when Hungary has a short-term credit from IMF, EU, World Bank, but how to pay it back at the very moment without accumulating a huge burden of new debts. If one simplify this problem it is quite clear: the government has to control the budget deficit in accordance with its most important creditors conditions (what are softening from day to day) and with the need to make some kind of stimulus as well. This is a hard task but not necessarily means measures aimed at long term objectives, rather ones that are effective but clearly only temporary. Like cutting the working week with one day in the public service, suspending, but not erasing the so called 13th month pension etc. I would suppose that the temporariness of the measures would make it easier to accept them, the measures itself would portray the government as capable to act decisively, while not necessarily meaning the renunciation on structural changes after the crisis is over.

On the other hand I would suppose that such an approach to the problem would be even advantageous for the quality of the structural changes as well. The most important problem with the present proposals is that those were developed in a completely different environment, when it was easy to assume that the model implemented in many ECE countries as an effective means of attracting FDI brings a fast real convergence and is capable to restrain the accumulation of imbalances. But with the crisis (and with the developments in the Baltics, even before the crisis hit those states) it is hard not to place a question mark after this presumption. Thus it would be deadly important to put two questions not independent from each other: how far are the earlier models valid (especially in ECE) and how will be the world economy emerging from the purgatory of the global crisis? As far as these are not answered convincingly no reform proposal (except some vague and very universal assumptions,like the need of balanced budget etc.) can be treated as well founded because those clearly wouldn't be based on the realities. (It does not necessarily mean that no reform proposal would turn out to be effective and succesful, but it would be rather the result of luck and not of the quality of them.)

If the latter approach would have been prevailed it would have had political advantages as well. Gyurcsány would have had an opportunity to take stance against the unpopular reform proposals arguing that the country needs a solid plan and not one based on dubious premises, to make populist attacks on the „capitalists” or the „bankers” and „brokers” as responsible for the crisis, seeking their own personal advantage even in these dire hours and therefore lifting some of the burden on him and maybe generate a popular rage against them, giving him real political weight after months of minority government when he was treated as doomed to lose his position sooner or later. Maybe he even would have been capable to implement some measures for the handling of the crisis that would have distributed the sacrifices a bit more evenly (for example with a one time levy on large properties, a nice, one time income for a shattered budget), thus making it easier for the majority of the population to accept the inevitable. It would have meant the renunciation on the snookering of his opponent, but maybe it would have been a real chance to reframe the discourse and transform the political situation in order to emerge with more popular support even for well thought changes. It was not a very probable outcome, but the possibility certainly existed. With the abdication he not only accepted his failure, but once again returned to his earlier strategy, waging war as the champion of reforms and modernity and almost certainly lost the real opportunity forever.

*(I know that there are many other supportive arguments for pension and tax reform. But as these reasons surface the most often, I only would like to highlight the twist in this approach, because it is a general problem regarding the different plans.)

Who will be the next in the line?

Today the Lower House of the Czech Parliament expressed its no confidence regarding the government of Mirek Topolánek. It is far from being certain that we will see an early election in this country as well, but even though his fall is not so tightly connected to the crisis as in the case of Latvia or Hungary, Topolánek is the third head of government in ECE having his cabinet collapsed in the beginning of the crisis.

It would be misleading to interpret the event as a result of the crisis in its entirety. Topolánek's government was a minority one (and the country's president, Vaclav Klaus, the predecessor of Topolánek in the chairmanship of the party nurtured a very visible enmity towards the prime minister), it relied on to renegade social democratic representatives from the beginning and his coalitional partners slowly dissolved themselves. At the moment the governemtn has only 96 MPs, the opposition 97 and 7 "independents" are the tip of the balance. Topolánek survived 4 (!) no confidence votes, partly because such a move needs 101 votes from 200 in the lower house to succeed. It was from the beginning typical petty politics, with money paid for votes, blackmailing but on the other hand very typical in the Czech political culture even in the interwar period. The pretext for another proposal for the opposition was a leaked video depicting one of the premiers aides trying to obstruct the airing of a TV program dealing with one of the renegade social democrats, who allegedly took thick governemnt funding for non-existent activities in the recent years. But I suppose that the eventual collapse of the government is also a result of the crisis making the existing rifts in the coalition more emphasized, especially as the prime minister's party gained popular support in the last three months, but solely at the expense of its partners. (Therefore the coalition as a whole fared not better against the opposition.)

This last point makes the action from the social democrats to bring down the government at this moment a bit hastened. Maybe Paroubek was worried about the narrowing of the gap between his party and the ODS (Party of Civic Democracy), but it was only justified because of the narrowing of his options regarding a possible coalition after an eventual election victory. Two months ago it was highly feasible that he will be able to form a minority or a coalition government with the support of one of the junior partners in the present coalition (the christian democrats or the greens), as his party fared at 44-45% of the votes, easily bringing more than 90 seats in the lower house. (Although this assumption sounds certainly a bit inconceivable for strangers to Czech politics, the christian democrats participated in the governemnts led by the social democrats between 1998 and 2006*, and once again the forming of coalitions with parties from very different parts of the political spectrum belongs to the traditions of Czech political culture as well.) Now he would be reliant on the communists, the outcasts of Czech politics, because they are not only legal but ideological sucessors of the Czech Communist Party. (But once again an illustrative event of the Czech politics, they played an important part in the re-election of their arch-enemy, Klaus as president). And maybe Topolánek will be secretly greatful for his opponents to take the burden of the handling of the crisis that is affecting the country more and more. It is certainly not a pure coincidence that Paroubek proposes to set up a government of experts until this fall instead of taking the responsibility.

But even if the collapse of this government is easy to be attributed to internal factors it highlits a very dangerous possibility: there is a not altogether slight chance for more and more political convulsion if the EU won't be able to stabilize the situation both in its core and at its periphery. Governemnts can fall one by one, social unrest can conquer the mind of the parliamentaries or the streets and spread towards the West. Even if the succesors of Topolánek or Gyurcsány will try to counter the crisis, the recipes offered at the moment won't be capable to calm down a gathering storm. What if the Polish government, having a populist opposition and president, will be compelled to admit that its budget is flawed and it will need harsh cuts? Unions in Romania are preparing demonstrations because of freezing the wages in the public sector. Ukraine is divided, its government is fighting with the president again and again while the economy's prospects are very dire. Bulgaria's unpopular government is facing a populist opposition as well. The EU elections will give an opportunity the unpoularity of the governments to be expressed, only to raise the pressure on the politicians. All those threats won't be relized necessarily but a domino effect is not the least probable scenario and a series of collapsing governments will once again, certainly in a strange way, call attention for the existence of ECE. Even if it is probable that almost every government in Europe will have to face very serious defeat in June.

(Actually the Czech Republic holds the rotating presidency of the EU for the first half of 2009 and the collapse of the government can be a serious blow to the community itself. But as the most important decisions regarding the crisis can be made by the large countries and the European Central Bank - that means the eurozone member states - it is not a real obstacle in the way of more determined action.)
*I should ask for my readers' forgiveness, as actually the first social democratic cabinet led by Milos Zeman was a minority government tolerated by Vaclav Klaus' ODS, the christian democrats were among the parties forcing Klaus to resign in 1997 and they only joined a coalition with the social democrats after the 2002 elections.

Doomsday reports? - notes on exceptionalism V.

Although I have my doubts regarding economic forecasts - especially in case of longer periods - and in these times it is hardly possible to make a prognosis valid even for a few weeks, today's newsreel contained two interesting pieces. The estimated growth of Germany was cut by many economic institues, while a London based research center published a series of prognosis regarding ECE, painting a dire picture of the regions outlooks. I won't discuss these analysis in detail, neither at this occasion nor later, but in this case it is not unnecessary to point out the most important elements, at least from an East-Central European perspective: Germany's recesion is forecasted in the 4-5% range, and as this country is the foremost export market of ECE countries (for example the correlation etween Hungary's and Germany's growth is extremly tight)and the strengthening of internal demand is not really possible due to the importance of the credit bubble in it's earlier drive, it is very likely that the region as a whole will be affected. Similarly important is the revision of growth estimates for the Czech Republic and Poland for this year. Up to this point these countries - with Slovakia - were considered as positive examples of prudent economic policies making them capable to weather the storm. (The specialist press here, in Hungary even now treats these countries as examples of very tiny positive growth in this year.) The forecasts for Slovakia were modified a couple of weeks ago (it has passed the Hungarian public's attention unobserved) and now the Czech central bank, having even in January a forecast of 2,9% growth changed it's view and now they are counting a -2%. The Londoners published a -3% forecast for Poland as well, a sharp reduction from earlier positive estimates and accompanied in this model with a 5% budget deficit as a ratio of GDP. Even though the perspective outlined for Hungary is worse (-7,5%) the whole picture depicts a catastrophic situation. (-15% and -10% in the Baltics, -5% in Bulgaria, -7,5% in Romania etc.and the revision for Hungary are now very modest compared to the estimates for other countries, not that it is very important.) The processes seem to be very similar and even if some differences will remain the direction is the same: no country will remain unaffected, and every one of them is heading towards a very dire ecnomic situation, regardless of earlier "good" or "bad" behaviour. It is highly feasible that at the end there won't be a defence line left on country level, no means to counterbalance the effects of the crisis.