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Political leaders in recession-wracked Eastern Europe are being forced to swallow the bitter medicine of fiscal austerity. It may prove to be economic elixir for their nations — and political poison for them.

From the Baltic to the Balkans, governments are reluctantly implementing unpopular budget cuts they put off during boom years. Hungarian Prime Minister Gordon Bajnai will pare pensions, wages and family benefits to meet conditions of a $27 billion package led by the International Monetary Fund. Latvian Premier Valdis Dombrovskis will reduce most costs by 40 percent after his predecessor lowered state salaries by one-fifth.

“Politicians will be pushed to restructure the economy and do the homework they didn’t do before,” says Monica Mastroberardino, who manages the equivalent of $2.6 billion in global debt at Credit Suisse Group AG in Zurich.

It comes at a political cost. The deepening recession, spending cutbacks and rising unemployment have already sparked protests across the region and toppled governments in Latvia, Hungary and the Czech Republic, with more to follow. Some leaders “will have to sacrifice themselves” politically, Mastroberardino says.

Bulgarians, voting in a general election on July 5, will probably replace the ruling Socialist-led coalition, according to opinion polls. A vote must be held by Oct. 15 in the Czech Republic, where former Prime Minister Mirek Topolanek, 52, was toppled in a no-confidence vote.

Fueling Discontent

“As countries go through tough economic times, and if governments have to implement fiscal-austerity measures on top of that, then that is adding to political discontent,” says Edward Parker, London-based head of emerging Europe ratings at Fitch Ratings.

For two decades, Eastern Europe’s politicians preserved welfare systems inherited from communism to please voters seeking western living standards.

“When the going was very good, the political system didn’t seem to be effective enough to push through these very complicated reforms that you need, like putting the pension and health-care systems on a more sustainable footing,” says Katinka Barysch, the deputy director of the London-based Centre for European Reform.

Now politicians have little choice. The 10 eastern countries that joined the European Union between 2004 and 2007 are on the hook for rescue loans totaling $84 billion, three- quarters of which is tied to austerity conditions.

Forecasting Contraction

The IMF forecasts a contraction in 2009 of 3.7 percent across the 26 countries of Eastern Europe and former Soviet states, compared with growth of 2.9 percent last year. Gross domestic product will fall by as much as 12 percent in Latvia and 6 percent in Hungary, according to their governments.

Even Slovakia and Slovenia, the only easterners to adopt the euro, face a recession this year. Of the eight 2004 entrants, only Poland forecasts growth, of 1.7 percent — while the IMF predicts a 0.7 percent drop.

Western European politicians are pumping unprecedented amounts into the economy, racking up public debt and deficits. The Group of 20 industrial and developing countries will spend $820 billion on stimulus measures in 2009, the IMF says.

The East’s leaders don’t have the luxury of going down the same path. Even though the IMF, the Washington-based lender with 185 member-nations, is demanding less aggressive overhauls now than it did from Asia’s economies during the late 1990s, the spending curtailments in Eastern Europe are still enough to make the recession more painful.

Thrown Out

Governments in Romania, Lithuania and Slovenia were thrown out in votes in the last five months of 2008, while Latvia’s was forced out Feb. 20 by public protests against austerity measures.

“We would be concerned if that spread into either violent protests, increased populism or a change to less appropriate economic policies,” threatening IMF financing, Fitch’s Parker says payday cash loan.

Hungary’s Socialist prime minister, Ferenc Gyurcsany, 47, quit in March to make way for a new cabinet headed by Bajnai, 41, a non-affiliated technocrat who plans to lead until the next elections, due this time next year.

Hungary was the first nation in the region to secure an IMF bailout in October after its currency plunged to a record low and government-bond auctions failed to attract bids. In exchange, Gyurcsany froze public salaries and eliminated bonuses to push the budget gap below euro limits of 3 percent of GDP.

‘A Cleansing Process’

Hungarian Finance Minister Peter Oszko said in an interview on April 25 that business and political leaders are facing “a cleansing process” that is forcing them “to carry out tasks that they earlier didn’t deem to be so urgent.”

Romanian Prime Minister Emil Boc, 42, is freezing state workers’ wages for this year, reversing an earlier decision to raise them 5 percent in the second half. He is also increasing some taxes to narrow the budget deficit to 4.6 percent of GDP to meet the terms of a $27 billion IMF-led loan package.

IMF pledges of more lending have helped lower the cost in the past month of insuring eastern European government bonds, even though they remain among the world’s most expensive to protect against default. Latvia’s credit-default swaps have dropped by a third from a record high on March 10.

Recessions are sapping demand for exports, forcing plant closures and driving up unemployment across the region. The local units of Fairfield, Connecticut-based General Electric Co. and Brussels-based KBC Groep NV, along with domestic companies such as Warsaw-based Telekomunikacja Polska SA, are curtailing production or cutting jobs.

Euro Adoption

Countries that aren’t under IMF programs also must watch spending: All the EU’s eastern members are obliged to switch to the euro when they are ready. Lower tax revenue as a result of the crisis inflates their budget deficits, making it harder to achieve the goal.

Estonia’s government ordered public institutions last week to limit payments from their budgets for the second time in four months as revenue trails targets. Prime Minister Andrus Ansip, 52, is finding it increasingly difficult to keep the deficit below 3 percent of GDP to join the single currency from 2011 as planned.

Poland, the biggest of the nations that joined the EU five years ago, wants to start using the euro in 2012, an objective already jeopardized by the economic slump.

Even as the country stands by its nominal budget deficit target of 18 billion zloty ($5.5 billion), lower-than-forecast economic output this year means the shortfall will increase in proportion to GDP, Deputy Finance Minister Dominik Radziwill said in an interview on April 26. The ministry’s latest estimate is for a deficit of 4.6 percent of GDP.

No Conditions for Poland

Poland took a $20.5 billion IMF credit line, which has no conditions because of its track record of fiscal prudence.

The squeeze on tax receipts is already undermining IMF accords. The fund withheld a 200 million-euro ($265 million) transfer to Latvia in March because of failure to curb expenditure. To secure resumption of payments, the government will cut most expenses by at least 40 percent to get the deficit to 7 percent of GDP, Latvian Finance Minister Einars Repse said in an interview on April 24.

“During boom years, when we were expanding our budgets every year, we had no incentives except theoretical ones to bring down the deficits, to introduce discipline and make so- called structural reforms,” Repse said. “Today’s crisis will force governments to review almost all sectors and policies. Better we do it now than not do it again for 10 years.”

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