By Krisztina Than and Michael Winfrey
BUDAPEST/PRAGUE (Reuters) - The leaflets dropping into Hungarians' mailboxes this month told citizens the economy has turned a corner, whatever foreign critics might think.
Emblazoned with the red, white and green of the national flag, the government-funded brochure hailed the steps conservative Prime Minister Viktor Orban had taken. "Hungary is doing better," it read.
Orban can point to two significant developments to back up the leaflets' claims, and justify his rejection of orthodox austerity policies which have helped to push euro zone countries such as Greece into downward economic spirals.
First, the state statistics office announced that the economy grew 0.7 percent in the first three months of this year from the previous quarter, taking Hungary out of its second recession in the past few years.
Then, to complete what may be Orban's best month since he took power in 2010, the European Commission ruled this week that Hungary can leave the Excessive Deficit Procedure, a kind of sin bin for EU countries deemed to be spending beyond their means.
For Orban, these developments are a political triumph, and a vindication after Brussels, the International Monetary Fund (IMF) and legions of analysts had predicted for years that his idiosyncratic policies would ruin the country.
"I say this quietly," Orban said after the news of economic growth earlier this month. "I think what we are doing is successful."
Yet there is a cost. The data showed the economy had still shrunk 0.9 percent from the first three months of 2012, and many economists believe Orban's policies may consign Hungary to years of bumping along with very low growth. This, they say, is because he has scared off some of the foreign direct investors whose cash is needed to fund a stronger recovery.
"Orbanomics", broadly speaking, has involved transferring money from the private sector to consumers and to the public sector, in the hope that this will reduce the budget deficit and get the economy growing.
Measures have included forcing power companies to cut customers' energy bills, imposing Europe's highest tax on banks, effectively nationalizing private pension funds, and levying "crisis taxes" on telecom, energy and supermarket companies - all sectors where foreigners are major players.
Any short-term benefit from these steps "is at the expense of crushing potential growth from probably around 3.5-4.0 percent when he came into office to only around 1.0 percent now," said Peter Attard Montalto, an economist at Nomura.
MONEY IN POCKETS
Many economists say it is too early to declare a recovery in Hungary. Nevertheless, exports are up, led by high-end carmakers - one of the few sectors where foreigners escaped unscathed when Orban targeted investors with heavy taxes.
Daimler has ploughed 800 million euros ($1 billion) into its Hungarian Mercedes factory, opened last year. Fellow German carmaker Audi has created a new production line at its plant that is expected to run close to full capacity in the second half of this year.
Hungarian farmers expect a better harvest this year than the poor crop in 2012, which should also lift growth.
Another factor is that many of the policies for which Orban has been widely criticized, especially the lower power bills, have left money in ordinary Hungarians' pockets, and kept inflation low, helping consumer confidence.
Hungary's GKI-Erste index of consumer and business confidence, produced by an economic think-tank, jumped to a 22-month high in May.
"We can feel that our expenses have decreased somewhat," said Etelka Sas, a Budapest resident who has a clerical job. "I can't really save up yet, but there may be a chance to make some savings if the (further energy price) cuts the government promised happen."
Hungary's biggest vulnerability now is its government debt, which still stands at about 80 percent of gross domestic product, the highest level in central Europe.
Global financial markets are awash with cash pumped out by leading central banks trying to stimulate economic growth. Some of that is flowing into Hungarian financial assets, including government bonds, but they may crumble if the big economies stop printing money furiously.
Underscoring the risk, the forint currency fell 0.9 percent against the euro after Federal Reserve Chairman Ben Bernanke said last week that the U.S. central bank might curtail its stimulus program.
However, Hungary's debt is proportionately no higher than many western European countries' and a bond sell-off, which economists have warned of for months, has yet to happen.
Some people in Hungary say it is time to re-assess who has the best approach - Orban or the policymakers in Brussels and at the IMF who criticized him for so long.
"If you look at the southern European countries which carried out the textbook orthodoxy of austerity, they are in a recession spiral," said Takarekbank analyst Gergely Suppan. "So compared to that, we got away with it much better."
A recovering economy could help Orban to win next year's parliamentary election. An opinion poll last month showed his Fidesz party has 24 percent support, well ahead of the main opposition, though half of respondents were undecided.
INVESTORS TURNED OFF
Longer-term prospects for the economy look less rosy due to the effect of Orban's policies on the investment climate. He says they are about making foreign investors carry their fair share of the financial burden.
His officials are reassuring businesses that there will be no more drastic measures, but it will take time to restore investors' confidence.
The central Europe chief of one multinational said some business people he knew had been turned off by what they perceive as an anti-foreigner atmosphere. "The investors don't want to come," he said, speaking on condition of anonymity.
A real estate executive, who also did not want to be identified, said he had been working with a big European retailer which pulled out of Hungary two years ago, partly because of government policies.
An IMF report in March said investment in Hungary had dropped to a 10-year low, behind emerging market peers in Europe. "Unconventional policies, high and uneven tax rates, and heavy regulatory burden have eroded investors' confidence and contributed to a sharp decline in investment," the IMF said.
Hungary's potential annual economic growth in the medium-term was 1.5 percent, a rate "significantly below" its peers, it added.
Central bank data this week showed foreign direct investment (FDI) in 2012 was 10.46 billion euros, more than double the previous year. But the rise was largely due to financial flows and foreign banks re-capitalizing their Hungarian units, according to analysts and an economy ministry report.
The ministry said FDI, without financial flows and portfolio restructurings, was around 3.5 billion euros last year. It said FDI inflows were expected at around 3 billion euros this year without one-off transactions.
If low investment leads to sluggish growth, that is a problem for a country which is in a rush to catch up with western European living standards.
Hungarians' living standards are about 66 percent of the European Union average, unmoved since Orban came to power.
Edith Papp, 56, a dental assistant from eastern Hungary, said her two daughters - a doctor and a pediatric nurse - were working in Denmark and Britain because they could not get by on Hungarian wages. "They are not preparing to come home at all," she said. ($1 = 0.7712 euros)
(Additional reporting by Christian Lowe; editing by David Stamp)