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Orban’s Tax Binge Repels Investors

Hungarian snack maker Chio Magyarorszag Kft. was slated to receive funds last year from its Cologne-based parent, Intersnack Knabbergebaek GmbH, for two expansion projects. Then came the potato-chip tax.

The special duty imposed by Prime Minister Viktor Orban’s government meant Gyor, Hungary-based Chio Magyarorszag missed out on getting the cash as Intersnack diverted the money to another one of its non-German subsidiaries.

“We’ve been erased from the map,” said Gabor Agyai Szabo, the head of Chio Magyarorszag’s corporate relations and marketing, in a phone interview. “Hungary won’t be considered as long as regulations don’t change.”

While Orban’s policies are scaring off international investors, the European Union predicts the country may fall back into a recession in 2012. Orban is trying to shield Hungary from Europe’s worsening debt crisis with an economic program that’s focused on keeping the budget under control. Hungary had a capital investment deficit of 118 million euros ($144.8 million) in 2011, the first drop since at least 1995, according to data compiled by the central bank.

Investments, including those from the government as well as domestic and foreign companies, fell by about 1.2 trillion forint ($5.1 billion) from 2008 through the end of 2011 at constant prices, central bank data show. The drop in investment volumes equals about 4 percent of the nation’s gross domestic product at the end of last year. The economy may shrink 0.3 percent this year, making Hungary the sole non-euro EU member to suffer a contraction, according to a European Commission forecast published in May.

‘Spectacular Deterioration’

Two-thirds of executives surveyed in April by the German- Hungarian Chamber of Commerce said they were “very unsatisfied” with the predictability of the government’s policy decisions and this has led to a “spectacular deterioration” in confidence. Investments plunged to 12.6 percent of GDP in the first three months of 2012, the lowest for that period since at least 1995, according to the statistics office in Budapest

“The implications are rather damaging as a lack of investments impairs the country’s growth potential,” William Jackson, an emerging-markets economist at Capital Economics in London, said by phone. “If Hungary misses out on investments, it risks becoming a regional growth laggard.”

Since taking office in May 2010, Orban’s government has focused on bringing the budget deficit to within the EU limit of 3 percent of GDP for the first time since the country joined the bloc in 2004. He had campaigned with a promise to end fiscal austerity that started in 2006, leaving companies as his target for revenue.

Special Taxes

To help pay for a flat personal income tax, the government levied special retroactive corporate taxes, nationalized private pension-fund savings, dismantled the independent Fiscal Council and stripped the Constitutional Court of its right to rule on economic issues.

The measures have eroded investor confidence and contributed to a reduction in the country’s credit rating to so- called junk status, prompting Orban to turn to the International Monetary Fund for about $18 billion of financial aid.

Orban won a two-thirds parliamentary majority in 2010, making him Hungary’s most powerful premier since communism ended in 1989. His influence and reputation as a no-nonsense leader means many executives are wary of speaking publicly about his policies.

Officials from six foreign-owned companies interviewed by Bloomberg News about their investment plans declined to comment on the record, citing concern that criticizing the government may damage their business interests.

‘Literally Frightened’

Laszlo Kozma, a managing director who asked that the name of his factory’s German parent not be mentioned, said he has discarded three business plans this year because of changing regulations that prompted cuts in capital expenditures and led to a 10 percent reduction in the workforce.

“Our owners don’t feel the business environment is conducive to further investments in Hungary,” Kozma said.

Corporate executives “have literally become frightened as they witness developments here that are difficult for them even to translate,” Istvan Magas, a professor of economics and a department head at Corvinus University in Budapest, said in an interview.

The forint fell 15 percent against the euro, the most in the world, during the second half of 2011. The currency rebounded 9.1 percent this year as investors speculated Hungary will get funds from the IMF. The benchmark BUX (BUX) stock index has gained 0.7 percent since January, after plunging 25 percent in the second half of 2011.

‘Dramatic Changes’

AstraZeneca Plc (AZN), the U.K.’s second-biggest drugmaker, set up its clinical research and development center in Warsaw instead of Budapest, and cut the number of clinical trials conducted in Hungary to 16 from 24 in 2010 because of “the unfavorable market environment,” country director Alexandra Heringh said.

Heringh said the “dramatic changes” in Hungary can be traced to the government’s decision to slash the state’s drug fund by more than half, implement “swift and frequent” regulatory changes, and introduce additional taxes and fees for the health-care industry.

“The results of the extremely unfavorable environment have become obvious by now,” Heringh said. “There have been very significant job cuts in the industry, while major developments are missing entirely and we see capacities being cut back or moved to other countries.”

Unprofitable Banks

Orban introduced levies on banks, energy, retail and telecommunications companies in 2010 without consultation, pledging to keep them in place through 2013. He then backtracked by making the bank, energy and telecommunications taxes permanent beginning in 2013.

Banks were unprofitable in 2011 for the first time in 13 years after the government allowed for the early repayment of foreign-currency household mortgages at below-market exchange rates.

About 75 percent of the 196 officials interviewed by the German-Hungarian Chamber of Commerce said they plan to invest less in Hungary than they did last year. The nation’s ranking among 20 central and eastern European countries slipped to 10th from fourth in 2011.

“Investments have been on the decline for years, net company setups are in negative territory, and the number of bankruptcies is outstandingly high,” central bank Deputy Governor Ferenc Karvalits said in a July 2 interview on commercial radio station InfoRadio. “We’re not seeing a temporary economic decline.”

‘Negative Spiral’

Foreign funding for Hungarian banks dropped by 6 billion euros since March 2011, according to a report published by Erste Group Bank AG (EBS) in June, squeezing liquidity and restraining corporate lending.

Hungary risks slipping into a “negative growth spiral,” said Attila Bartha, an economist and researcher at the Hungarian Academy of Sciences in Budapest. “What’s at stake here is that the country’s economic growth potential could decline to near- stagnation.”

The investment slump has affected all segments of the economy, according to statistics office data. The automotive industry fared the best as a result of a 800 million-euro investment by Daimler AG (DAI) in 2008, a 900 million-euro expansion project by Audi AG (NSU) in 2010 and a 500 million-euro factory enlargement at a local assembly plant of General Motors Co. (GM)

‘Turning Point’

Foreign direct investment accounted for as much as 25 percent of GDP in 2009, 39 percent of overall corporate tax payments and 70 percent of exports, according to a joint study by Budapest-based research institute Nezopont Intezet and the American Chamber of Commerce.

The government expects a “turning point” in investments in 2013, with volumes increasing 0.3 percent after an expected 2.3 percent decline this year, Economy Minister Gyorgy Matolcsy said on June 14.

The National Foreign Trade Office said in response to questions that it doesn’t see “any sign indicating that investors are taking flight or that interest” in Hungary is waning. “On the contrary, what we experience is a rise in interest, including from Chinese, Latin American and Arabic investors,” the trade office said, adding that it signed 24 investment deals in 2011 worth an estimated 924 million euros, which may create 5,736 jobs.

Winning the trust of companies such as Unilever Plc (ULVR), the maker of Dove soaps, Lipton tea and Hellmann’s mayonnaise, remains difficult.

Like Chio Magyarorszag, the snack-food levy prompted Unilever to suspend one project and delay another.

“The chip tax came along, which caused production volumes to nosedive,” said Andras Gyenes, managing director of the Hungarian unit of London- and Rotterdam-based Unilever.

Officials at corporate headquarters “decided to suspend the project even though we already had extensive negotiations with the government and the local council,” Gyenes said. “It’s extremely important that local market trends point toward growth, and not double-digit contraction.”

To contact the reporter on this story: Edith Balazs in Budapest at ebalazs1@bloomberg.net

To contact the editor responsible for this story: James M. Gomez at jagomez@bloomberg.net

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