Online Extra: Q&A with Hungarian Banker Gyorgy Suranyi

Despite skeptics' fears, he says EU enlargement costs would not be excessive since the spending would generate new demand

Gyorgy Suranyi made his name as a bold dissenter in Communist-era Hungary. In 1986, as a member of the Hungarian Finance Ministry's Financial Research Institute, he co-authored a study on necessary political and economic reform. It proved so controversial that the Communist Party government dissolved the institute.

He served as governor of Hungary's central bank in 1991-92 and again in 1995-2001. During his second term, he was one of the chief architects of a tough reform package that rescued Hungary from economic crisis and laid the base for several years of impressive growth. Under his watch, Hungary's currency, the forint, became fully convertible for the first time.

Suranyi is now head of Central and East European operations for Italian bank IntesaBci and chairman of the board of directors at the Central European Investment Bank. He recently spoke with BusinessWeek special correspondent Christopher Condon about how European Union membership will play out for Eastern Europe's leading economies. Following are edited excerpts from the interview:

Q: For companies operating in the countries expected to join the European Union in 2004, will anything change the day these countries sign on?

A: I really don't think so. In Hungary, in fact, all the legislative conditions and necessary liberalization have been done over the previous decade. The [market] sector is entirely operating under the competitive pressure of the EU.

Q: What does a manager operating in the countries joining the EU need to know about enlargement?

A: I think the environment will continue to become more favorable: The final amendments to current rules, the fine-tuning of the legal and institutional frameworks, and the execution and enforcement of legislation [already enacted] will continue to improve.

Q: Will there be a psychological impact on investment?

A: I don't see a major impact. The attractiveness of the Central and East European countries is growing...but the major breakthrough was the invitation to join NATO [the Czech Republic, Hungary, and Poland joined NATO in 1999]. That created an entirely different environment, and sovereign risk was reduced dramatically. Official EU membership should give that trend further impetus.

Q: Is there any potential negative impact?

A: What makes me a little scared is the substantial appreciation of the currencies of candidate countries. It's not just that this is exceeding the productivity differential. The problem is that on top of the inevitable and positive appreciation of the currencies, reflecting faster productivity growth compared to core EU countries, there are two other factors. The first is bad policies, and the second is the overreaction of financial markets.

Naturally, investors want to benefit from the gain as currencies converge. [So, they] arbitrage the interest-rate differentials, and that drives up the currency regardless of whether it's in line with the underlying competitiveness of the currency. And then there's a bad policy mix: Loose fiscal policies, on one hand, and somewhat excessively restrictive monetary policies, on the other.

Q: What's behind these bad policies?

A: I'm of the same opinion as the European Central Bank and the European Commission that there's a serious misunderstanding in the region. [The joining countries] believe that faster accession to the monetary union is better. This is a deep misunderstanding. It means a substantial sacrifice in terms of growth over the next three to five years. [Slower growth] is linked directly to the appreciation of the currencies and the effect it has on unit costs.

Q: Is there further danger from rising wages, accelerated by EU membership?

A: Rising real wages in itself is not detrimental to competitiveness. But if, on top of that, you have the nominal appreciation of the currency, the two together are obviously excessive. This reduces the competitiveness of the [export] trade sector and the attractiveness of the trade sector to both foreign and domestic investors.

And it can have a serious effect on employment. After 1996 in Hungary, we had not only falling unemployment but a substantial increase in the absolute number of employed for five years. In recent years, though, we've lost 70,000 to 80,000 [jobs], and it shows the very negative side effect of the bad policy mix."

Q: It's not clear yet what benefits will be extended to the new members. Do you think, in the end, they'll win significant benefits in things like structural funds and subsidies?

A: Initially, in the first one to two years, I don't expect a substantial net inflow. But I hope afterward we may expect that. There's a fear across the EU that enlargement will cost an excessive amount of money. But even if the Central and Eastern countries were treated similarly to Ireland and Portugal when they joined, the net cost would not be excessive within the overall EU budget. In terms of the consolidated GDP of the EU 15 [the original 15 members], it would not be more than 0.1% by my calculations, including agricultural subsidies.

If the EU were to put in place a real vision for the future of Europe and see [higher spending] as an investment in the future of Europe -- especially if it were targeted on infrastructure, environmental protection, and education -- the spending would generate additional opportunities, not only for the accession countries but for the existing members. It would generate substantial new demand for products and services from Western Europe. And on the basis of that, the taxpayer's cost would be significantly less. It just requires a broader vision.

Q: Countries like Poland and Hungary have practiced much stronger free-market policies over the last decade in order to reform their economies. Will they bring that reforming energy into the EU, or will they fall into the bad habits of the current members?

A: This is one of the most exciting issues. One area where Central-Eastern Europe will not follow the West is in the labor market. In the case of Hungary, labor-market flexibility can't even be compared to any of the EU members. There are differences within the EU. Britain and the Netherlands, for instance, are less rigid than others, but I have first-hand experience in Italy, France, and Germany, and, frankly, it's frustrating.

If such rules were reintroduced in Central-Eastern Europe, it would kill growth potential in those countries. One of the reasons Hungary was able to catch up in the last 10 years is exactly because of the more competitive and flexible labor market. I hope none of the CEE countries intend to take up the paralyzing policies we see in Western Europe.

Q: Can the new members go beyond preserving their policies and actually help the reform movement in Brussels?

A: Well, I don't know about that. But there's always hope.

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