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Hungary has found itself at the sharp end of the global financial crisis, calling in the International Monetary Fund to support its struggling currency and economy after a 3% rise in interest rates last week failed to reassure the markets.

Gucci's new store in Budapest may find the months ahead tough

Hungary's problems are twofold.

The government had recently been trying to cut back borrowing and spending, but after years of high spending it has failed to make deep enough cuts to reassure the international markets.

The other problem is that many Hungarians have been borrowing money in foreign currencies to buy their homes, cars or even to support their businesses.

Those borrowings in euros, Swiss francs and even Japanese yen had the advantage that they were at much lower interest rates than those in Hungarian forints, and when the forint was a stable currency they looked very attractive.

But now that the forint is falling sharply the cost of repaying those loans is rising massively.

Speculators have found Hungary to be very weak and vulnerable Dr Zoltan Pogatsa

The high level of private and state borrowing combined has left Hungary vulnerable to the credit crunch. Now the IMF, the European Central Bank and other EU institutions are going to have to step in and support the Hungarian economy with multi-billion dollar loans, and the price they will demand is likely to mean harsh economic reforms and cuts in government spending.

Dr Zoltan Pogatsa, an economist at the Hungarian Academy of Sciences, says that "this is a double-edged sword - it shows that the IMF and the ECB are behind Hungary and the forint, but also that Hungary needs their help".

Grim picture

For the average Hungarian this also means that tougher times are ahead.

Unemployment here is already high, civil service jobs have been cut and there has been a wage freeze for those that have kept their jobs.

Krisztina Sarkadi was advised a Swiss franc mortgage would be more secure

But many ordinary people with mortgages or other loans now face the prospect of much higher payments as the forint falls, or converting their foreign loans into local ones and therefore paying sky-high Hungarian interest rates.

Krisztina Sarkadi was advised to take out a mortgage in Swiss francs to help buy a new flat in Budapest.

The teacher and translator, who is a young mother, borrowed 5m forints (about £15,000), in Swiss francs.

"That's what they recommended because they said that's probably the most secure one," she says.

But last month alone the repayments jumped by more than 10%.

"I think it will get a bit worse, even. It's not killing us, but I know some of my friends are being pretty much killed by it," she says.

"I know a friend who took out a loan for all of her flat - so that's a 60m loan - and imagine if that goes up 10%? She's raising a child by herself, so it's really tough - I'm sure she's struggling."

Economic reforms will also mean painful restructuring and possibly higher taxes, and falling demand from abroad means that local factories in Hungary have already shut down for lack of orders.

As for Hungarian aspirations to join the euro - that is looking further away than ever.

Its borrowing is too high, it has failed to introduce the free market reforms that other Central and East European countries have forced through in recent years, and its spending on social security payments is looking increasingly unaffordable.

Dr Zoltan Pogatsa Hungary's hopes of joining the euro are thin

It all adds up, says Dr Pogatsa, to a grim picture.

"Hungary is the weakest link in the new member states of the EU," he says.

"It doesn't meet any of the stability pact criteria, it has very high foreign debt, and the economic reforms that are necessary to bring Hungary into the eurozone have not gone through, which means that speculators have found Hungary to be very weak and vulnerable. "

However, Hungarians are keen to point out that they are not a second Iceland - most of their banks are foreign owned and well supported, and Hungary has not been speculating on foreign markets with borrowed money.

// posted by Alice @ Monday, October 27, 2008