348. Telegram From the Embassy in Hungary to the Department of State1
SUBJECT
- Deputy Secretary Whitehead’s Meeting With Deputy Prime Minister Medgyessy.
1. Summary:
In Deputy Secretary Whitehead’s meeting with Deputy Prime Minister Medgyessy, Medgyessy outlined Hungary’s current balance of payments picture. While Hungary could possibly achieve a positive trade balance in convertible currencies by the end of the year high debt levels and high interest rates would continue to put pressure on the current account. The country’s future program to deal with its economic situation would be three pronged: restrictions, liberalization and deregulation. A tight monetary policy and a reduction of government subsidies were planned. Among the liberalizing policies being pursued are wage and price reforms, as well as the development of a capital market, to be aided by a new law of corporate association. Finally, while increased autonomy would be given enterprises, stricter enforcement of the bankruptcy law could be expected. These policies, however, require the development of a new social consensus—economic and political freedoms would be increased, but at the expense of the security which the government had previously provided. Medgyessy noted that U.S. help would be important in two areas—political support for the reform process, particularly with the international financial institutions, and in the development of business contacts.
End summary.
2. The Macro Picture
Deputy Secretary Whitehead opened the meeting by noting his interest in discussing Hungarian economic reforms with Deputy Prime Minister Medgyessy. Medgyessy then outlined the status of the government stabilization program. According to Medgyessy, the first five months of 1988 showed some positive results, some negative. The government’s basic approach was to improve the convertible currency balance of payments by increasing exports. To do so, it was attempting to restrict other possible channels of commercial activity by cutting exports to CMEA countries, reducing domestic demand, and by pursuing a strict monetary policy. In addition, the new tax system had [Page 1111] produced a practical devaluation of the forint. As a result of these policies, Hungary’s hard currency exports had increased 27 percent in the first five months of 1988, while exports to other socialist countries had increased by only three percent.
Thus, the country had achieved an even balance in its trade with the West, but a positive trade balance by year end was sought, which Medgyessy believed was achievable. The picture concerning the current account balance, however, is not so bright because of high debt levels and high interest rates. Thus, the current account deficit requires a substantial surplus on the trade account. Medgyessy also noted that the status of the government’s budget deficit was not satisfactory. The government was taking steps to reduce subsidies. That morning, a decision had been reached to reduce subsidies to the coal mining industry, and even more significant reductions would take place next year. He believed that it was inevitable that one or two coal mines would be closed down this year. Other subsidies were also being reduced. Steps were being taken to encourage household savings.
3. The Future Approach
The Deputy Secretary asked about the Hungarian experience in implementing its new income and value added tax systems. Medgyessy responded that the tax system was operational, but that some minor corrections would be made. The government’s proposals would be presented to the parliament at its fall session. Medgyessy argued, however, that a healthy market was a prerequisite for the tax system to operate well. The Hungarian market was highly protectionist and its operation was hampered by government subsidies and the lack of competition from imported goods.
Medgyessy then launched into a description of what the government hopes to achieve in 1989. According to him, the government’s future program can be divided into three areas: restrictions, liberalization, and deregulation. The restrictions include a tight monetary policy and a reduction of government subsidies in 1989 of 15–20 percent (30–40 billion HFTs). Liberalizing actions include wage and price reforms and the development of a capital market. The introduction of a new law of corporate association in 1989 would further the latter. In addition, the country’s import policy should be liberalized although further devaluations could be expected. Asked by the Deputy Secretary about the proposed wage reform, Medgyessy answered that workers already have the opportunity to change jobs and that some firms had fired workers. By 1989 the government hoped to achieve more freedom of movement in wages. A tripartite coordinating mechanism including the trade unions, the government and enterprise leaders would be established, to coordinate minimum and maximum wages during 1989. Over time the goal would be to do away with limits on wage movements.
[Page 1112]The final part of the government’s program, deregulation, would include the grant of increased authority to enterprises. The flip side of this, however, would be the stricter enforcement of bankruptcy laws. Medgyessy noted that he expected one coal mine would go bankrupt this year and expressed his doubts about the future viability of Ganz-Mavag’s successor enterprises.
4. A New Social Consensus?
Medgyessy then stressed that the government was following a high risk policy—there was a great demand for imports and the country’s monetary institutions, which should regulate demand, were not yet fully established. Nonetheless, the government had to proceed. Its difficult task was to establish a social consensus around its policies. One advantage of the current system was its ability to provide Hungarians with a sense of security. This would, however, decline in the future. In return, enterprises would obtain a wider sphere of activity and individual liberty would be increased. He noted that while it was possible to strike such a deal intellectually, it was much harder to do so on a practical level. Two preconditions for achieving this social consensus, according to Medgyessy, are enabling individuals to move up in enterprises and maintaining the social security net.
Here, the government had concluded that it was cheaper to have early retirements than to maintain loss-making industries. The public’s concern about inflation was another factor affecting the government program. Medgyessy said that he was optimistic that it would not exceed 15 to 17 percent in 1988, but was uncertain whether it would be possible to reduce inflation next year because combatting inflation could not be at the top of the government’s list of priorities.
5. The U.S. Role
The Deputy Secretary responded that Hungary was moving in the right direction. While it was true that people would be giving up security, they would obtain greater freedom in exchange. People would prefer the freedom to start their own businesses and move on to better paying jobs. As a result, the security net would rarely be necessary. He then noted that Hungary could count on U.S. help in the areas of trade and investment. Medgyessy agreed that the use of the official safety net would be a last resort, but stated that there would still be problems. He added that they had discovered that too much emphasis had, in the past, been placed on gradualism. Changes had been introduced so slowly that they had lost their vigor. Thus, in 1989, the government wanted changes that would achieve a critical mass. He then noted that U.S. help would be important in two areas: political support for the reform process, particularly with the international financial organizations, and in the development of business contacts.
[Page 1113]In regard to the latter point, Medgyessy stated that a favorable judgement by the USG of the Hungarian situation could have a positive effect on the attitude of American businessmen towards Hungary. More progress, however, could have been achieved to date. Here he noted Hungary’s interest in the removal of some discrimination in tariffs (FYI—He was presumably referring to Hungary’s interest in obtaining GSP) and the recent defeat by the Congress of an amendment which would have enabled OPIC to operate in Hungary. He added that he hoped that Prime Minister Grosz’s visit to the U.S. would help contribute to an increased interest by U.S. firms in investing in Hungary. The Deputy Secretary responded that he was working to help make Grosz’s visit a success, but that the most important precondition for increased interest by American firms in Hungary was the Hungarian legal structure. Firms needed to know that they would be able to produce and sell without government interference. Medgyessy here noted that efforts were being made to establish the right background. Citibank had established a Budapest office; if other banks or insurance companies were interested in opening offices in Hungary, they would be welcomed.
- Source: Reagan Library, Rudolf Perina Files, Hungary—Bilateral 1988 (1). Confidential; Immediate. Sent for information to Eastern European posts, Vienna, Geneva, the mission to NATO, and the Department of Commerce.↩