(Reuters) – The Hungarian town of Szigetvar has achieved fame just twice in its long history.

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The first time was in 1566 when the great Ottoman ruler Sultan Suleiman the Magnificent died beneath its walls during a siege. The second was earlier this year when it announced it had gone broke, crippled by huge Swiss franc debts.

Szigetvar ran up debts worth close to 4 billion forints ($20 million) to co-finance developments projects — a road many other Hungarian cities and villages took over recent years.

It chose to borrow in Swiss francs, far cheaper three years ago than forint financing; but it regretted this move last year when the forint fell, and debt costs soared.

Oversized, debt-ridden and inefficient, the local government sector — which operates most of Hungary’s schools and hospitals — consumes a quarter of state spending now and uses 11-13 percent of the country’s gross domestic product (GDP).

“Local governments are in survival mode. They don’t even have enough money to perform their mandatory tasks,” said Gabor Zongor, head of local municipality association TOOSZ.

“The bomb is ticking and everybody knows that, both government players and the opposition. But no one has ever tackled the problems of municipalities.”

Most analysts in a Reuters poll called the reform of the sector the key job of Hungary’s next government after parliamentary elections on April 11 and 25.

The local government sector is a drag on the budget because the state constantly needs to plug the holes in municipality finances. The opaque system is wasting money.

A failure to overhaul the operation of municipalities could hinder economic recovery, analysts say.

The sector’s problems date back to 1990 when after the collapse of communism the transition to democracy demanded the granting of more independence to local communities.

But the law was not accompanied by a proper distribution of roles and this created a mismatch between municipalities’ tasks and financing capabilities over the years.

A deep recession last year which eroded tax revenues exacerbated the financing problem, especially in areas where the jobless rate is above the national average of 11.4 percent, including the south of Hungary where Szigetvar is located.

“Many local governments have expired obligations to utilities and it hinges only on service providers’ benevolence and patience when they launch legal procedures,” Zongor said.

MAJOR OVERHAUL NEEDED

The Organization for Economic Cooperation and Development (OECD) said in report this year that Hungary’s public sector was one of the least efficient among its members.

“Increasing the efficiency of the public sector is therefore an obvious source of potential budgetary savings,” it said.

To tackle the problem, the law on local governments needs to be amended and this requires a two-thirds majority of votes.

The main opposition party Fidesz, which has a good chance of winning two thirds of the seats in Hungary’s next parliament, has revealed very little about its reform plans and has made only vague promises to cut public sector expenditure.

Szigetvar is one of Hungary’s 3,200 local governments. Belgium whose population is also 10 million, has less than 600.

The outdated local municipality law turned municipalities into small states within the state, with tasks ranging from running schools and hospitals to building sewage systems, aiding the poor and unemployed, or financing local sports and dance groups.

Local governments are obliged by law to fight through a jungle of over 2,000 public duties and to operate thousands of institutions which could be run by national government. Over the years the central government has shifted over more and more responsibilities to the local level without proper funding.

Most municipalities are small and do not have their own revenues.

Szigetvar, with a population of around 11,000, ran into trouble earlier than others mainly because of its Swiss franc debts, which it needed to finance its hospital and co-finance EU-sponsored development projects including a thermal bath, Vice Mayor Gyula Rodek said.

Its debt repayments this year will reach 450 million forints and the town faces a financing gap of about 1 billion.

“By February it turned out that we have a considerable unsettled invoice debt, around 230-250 million forints, and these included some which have been over 60 days or 90 days overdue,” Rodek said.

The town decided to ask for a “debt settlement procedure,” which the court launched in February, and it has approved an emergency budget which finances only basic tasks.

Residents of the picturesque small town close to the Croatian-Hungarian border are understandably concerned.

“Many people did not get salaries when they announced the bankruptcy, and entrepreneurs are also very worried because when people don’t have money then demand drops imminently,” said Diana Tihanyi, who owns a pizza restaurant.

“It’s just exasperating what happened here. There could have been a different solution than announcing bankruptcy as there are many similar municipalities in the country,” added another resident, Laszlo Ludas.

DEBTS MOUNTING

The municipal sector has debts of close to 1,000 billion forints, half of that in bonds issued for around 20 years.

Many cities have put aside the proceeds in bank deposits for worse times to come, while county municipalities which do not have their own revenues have borrowed to finance the operations of their hospitals and other institutions.

“Public sector deficit goals in the next years can be threatened if the money in bond-covered deposits is spent,” the State Audit Office said in a report.

Experts say the next government should reduce and centralize tasks in education, health care and social benefits, and overcome public fear that the measures could hit the quality of life.

To save money it should take over or privatize tasks which local governments are unable to fulfill and encourage them to team up to run administration, education and other services.

“I don’t think that more money to distribute could make this system able to operate,” Zongor from TOOSZ said.

“Instead we should determine what tasks can be classified as local municipality public services, state tasks or services which can be privatized.”