Hungarian lessons for a world crisis

"Everything I say is a lie" has long been a favourite puzzle for philosophy students. But it took a Hungarian politician to turn a logical conundrum into a political strategy. Ferenc Gyurcsany's admission in 2006 to a closed session of the Hungarian Socialist party that he had "lied morning, noon and night" to win the election, was swiftly leaked. It provoked riots in Hungary.

Amazingly Mr Gyurcsany managed to soldier on as prime minister and only stepped down a couple of months ago. But Hungary, a country of just 10m people, now faces an economic and social crisis so deep that its fate is being watched with interest and alarm from Washington to Brussels.

At the Group of 20 leading nations' summit in London last month, the country's name was whispered in the corridors, as world leaders scanned the horizon for the next stage of the global economic crisis. The International Monetary Fund had put together a rescue package for Hungary last October – but many feared it would not be enough. Barack Obama, the US president, even spoke out, warning Americans in March to ensure that "problems that exist in emerging markets like Hungary or Ukraine don't have these enormous ripple effects that wash back on to our shores". (This statement was greeted with a certain irritation in Hungary, where many are under the impression that their economy is underwater because of a tidal wave that started from American shores.)

The horror scenario envisaged a Hungarian banking collapse that would ripple back into the rest of Europe and then around the world. Many EU banks have lent heavily in central Europe. Austrian banks are thought to have lent the equivalent of more than 70 per cent of their country's gross domestic product to the region. This idea – perhaps combined with a folk memory that the Great Depression had something to do with the collapse of an Austrian bank – helped heighten the panic about Hungary.

But, having just visited Budapest, I can return with good news. The immediate crisis is over. There was a moment when there was a real fear of a bank run. One Hungarian financier is quite precise about the date: Friday, March 13. However, confidence just about held up, the moment passed and so has the threat of imminent collapse.

The unfolding of the Hungarian crisis now looks like a microcosm of the world crisis. Fear of financial collapse is gradually giving way to worries about an unprecedented contraction in the economy – with all the social and political consequences that could imply.

The Hungarian government has predicted that the country's economy will shrink by 6 per cent this year. It has not performed that badly since 1945. Unemployment is rising and so is inflation, because of the fall in the Hungarian currency.

Hungary has no room for the kind of counter-cyclical Keynesianism that is being tried in the US and the UK. Nobody thinks the markets would tolerate huge fiscal deficits, so instead the government is cutting spending and raising taxes. State pensions were sliced by about 8 per cent last week. Sales tax has just been increased. And this is just the start of an austerity drive.

The political backlash is already beginning. Jobbik, a far-right party that plays on anti-gypsy sentiment, is likely to win a seat in the European parliament in elections next month. It has also formed a paramilitary wing, the Hungarian Guard, whose uniforms bear the insignia of pre-war Hungarian fascist parties – and which has staged marches in Budapest and has a presence in many small towns. Far-right arguments about crime and "welfare-scrounging" by the gypsy minority – who form between 5 and 10 per cent of the Hungarian population – are gaining ground. One mainstream politician worries that: "You now hear anti-gypsy sentiment at every level of society." There has been a spate of unsolved killings of gypsies, which has been widely blamed on rightwing vigilantes.

Jobbik is still miles from power and polling well below 10 per cent. So it will fall to Hungary's mainstream politicians to handle the shrinking economy and manage the austerity programme. For the moment a caretaker government is in power, but new elections must be held in the coming year. With the Socialists discredited by the economic crisis and Mr Gyurcsany damaged by his trouble with the truth, the centre-right Fidesz party is almost certain to win.

Victor Orban, the Fidesz leader, is scrupulously vague about his economic programme. But party officials fear they may end up presiding over a downward economic spiral, as a contracting economy shrinks government revenues, creating further pressure for cuts.

Hungary still has a lot of political, social and economic capital it can draw upon to see the country through hard times. For all the recent fear of upheaval, it remains a middle-income country firmly anchored in the European Union. The well-tended boulevards and comfortable cafes of Budapest do not look like obvious territory for revolution or social turmoil.

But, to an outsider, the country's politics also seem uncomfortably polarised. The mainstream left- and rightwing parties regularly trade accusations of "communist" or "fascist" sympathies – while anxiously watching the rise of the real extremists of Jobbik.

Hungary will soon surrender the dubious honour of being the fashionable subject for anxious chatter among the world's politicians and bankers. But the country's real crisis may only just be beginning.

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