International Business : Hungary, Former Eastern Bloc Star, Faces Painful Retrenchment : Europe: As austerity program draws criticism and praise, government refutes comparisons to Mexico.

Long the economic leader of the former Eastern Bloc, Hungary suddenly finds itself in the throes of a painful retrenchment while its government beats down suggestions that it is becoming the Mexico of Eastern Europe.

Although Hungary has drawn nearly half the foreign investment in the region since 1989, huge foreign debts and a massive budget deficit forced the government on March 12 to announce an immediate 9% currency devaluation and deep cuts in social welfare benefits.

Opposition parties, trade unions and student groups have strongly criticized the program and staged several demonstrations. Two Cabinet ministers resigned in protest. Students carried a coffin bearing the epitaph “Equal opportunity: born 1989, died 1995.”

But the austerity measures come just in time to rescue the economy, say leading Hungarian economists and international lending institutions. The tiny Budapest Stock Exchange has since climbed 20%. Foreign investors have reacted positively.

“We have had a couple of ‘go’ decisions in the last couple of weeks, and the announcement of the economic plan was definitely a part of their decision-making process,” said Michael Kevehazi, managing partner of Big Six accounting firm KPMG Peat Marwick’s Hungarian unit.

In announcing the austerity plan, Prime Minister Gyula Horn said the country “is drifting towards an unmanageable crisis” that would force the country to shut down many public institutions such as hospitals and schools if immediate measures were not taken.

Hungary ran a trade deficit of $3.9 billion in 1994, or 9% of its gross domestic product--a level economists have long warned cannot be maintained. The country’s foreign debt is also increasing quickly, rising by $4 billion last year to a current $28.5 billion.

The trade imbalance, an overvalued currency and Hungary’s reliance on foreign capital remind some observers of the conditions that led to Mexico’s economic crisis, though there are major differences. Less than 10% of Hungary’s debt is short-term and comes due this year, compared to more than 30% in Mexico. And the local currency, the forint, is not convertible, which rules out a run on the currency.

Akos Peter Bod, the former National Bank president who now works as regional director of the European Bank for Reconstruction and Development, said that despite the current problems, Hungary’s debt-servicing schedule is manageable and responsible, unlike Mexico’s.

The austerity measures, designed to chop $1.4 billion off the deficit, will be particularly tough on both the middle and working classes, say both supporters and critics. But the question was never really if, but when.

“The problem was that these measures were avoided by the first government and this government for the first seven months of their administration,” said Istvan Csillag, managing director of the Financial Research Institute, an independent economic research institute and privatization consultancy.

The austerity measures include an immediate 9% devaluation of the forint that will increase gradually to 27% by the end of year, and an 8% tariff on imports. These are, among other things, designed to reduce the country’s high trade deficit, which is a problem not so much of low exports but of high imports, Csillag said.

The most controversial parts of the plan are the cuts in Communist-era social welfare spending, which at 27% of GDP is the highest in Europe after Sweden. The plan would initiate needs testing for many of the country’s welfare programs, most of which are currently doled out regardless of a recipient’s income.

The cuts include reducing the two-year paid maternity leave to four months, the abolition of automatic family allowance payments, and the introduction of fees for higher education and medical exams.

“Now a woman who wants to give birth needs someone to support her,” said Dorottya Buky, a member of Parliament from the ruling coalition’s minority arm, the Alliance of Free Democrats.

Two-thirds of the population is “outraged” by the planned reforms, according to a recent poll. Only 4% think it will make a significant difference in the country’s economic situation.

The announcement of the austerity plan comes at time of doubt over whether the Socialist-led government coalition will have the political courage to implement the long-awaited reforms.

Investor confidence was shaken in December when Prime Minister Horn rejected the $57.5-million sale of the HungarHotels chain to American General Hospitality, a Dallas-based company, saying the price was too low. Standard & Poor’s promptly downgraded Hungary’s foreign currency debt outlook from “stable” to “negative.”

Privatization had already been lagging. While Hungary has taken in more than $7 billion in foreign investment--including $3 billion from the United States--the pace of privatization slowed in 1994 to half the previous pace, according to Hungarian National Bank.

But some critics argue that foreign money wields far too much power and that the government should not shape long-term social policy based on emergency measures.

“If you want to make Hungary part of Europe, you can’t introduce the social policy of Singapore,” said sociologist Janos Ladanyi of the Budapest University of Economics. “There is no vision about the future in Hungary or in any of the post-socialist countries.”

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