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Hungary Struggles to Regain Trust of Global Markets

Monday, 07 June 2010 07:10 AM

Hungary is likely to take months to regain the trust of financial markets after politicians in its new government made controversial comments comparing its fiscal problems to the Greek debt crisis.

Reaching a detailed agreement with the International Monetary Fund and the European Union on a plan to restrain its budget deficit is a vital part of the recovery process.

But even if such an agreement is reached, markets may not stabilize before they see proof that the government is sufficiently unified and competent to implement it.

"We need full details of both their fiscal and economic plans but also wider plans for structural reform," said Peter Attard Montalto of Nomura in London.

"Very serious damage has been done to their image and it will take a very long time and a lot of 'hard data' to actually regain this credibility, not just with markets but more importantly FDI (foreign direct investment) investors."

Hungarian bond yields surged and the euro slid to a four-year low against the dollar on Friday after a ruling party official said the country had only a slim chance of avoiding Greece's fate, and the prime minister's spokesman said he supported this view.

At the weekend, top government officials launched a strong attempt at damage control, describing comparisons to Greece as "exaggerated" and insisting Hungary would continue trying to meet a deficit target of 3.8 percent of gross domestic product this year.

Many private economists agree that Hungary is not close to becoming another Greece. Its deficit and debt ratios to GDP are not nearly as high; public debt was about 80 percent last year, against 133 percent projected for Greece this year. Hungary's economy has emerged from recession, unlike Greece.

Nor does Hungary face the immediate pressure on state finances that Greece encountered. Its major bond expiries this year are a 30 billion yen ($324 million) bond on July 12, a 1 billion euro ($1.2 billion) bond in September, and two forint bond expiries each worth about 300 billion forints ($1.3 billion) in August and October.

Even if the markets become so jittery that Hungary loses the ability to fund itself in the international and domestic bond markets, unused loans and cash reserves appear sufficient to see the government through until at least the end of this year, assuming continued demand for its Treasury bills.

Of a near 20 billion euro credit line secured from the IMF, the EU and the World Bank in 2008, Hungary still has about 3.5 billion euros in hand and the opportunity to obtain a further 5 billion if it can agree with lenders at their next review.

In addition, central bank reserves total about 34 billion euros, while the central bank could in a pinch boost domestic demand for short-term Treasury bills by limiting access to its main short-term deposit facility. It did this successfully in 2003; currently, a huge 4.2 trillion forints are in two-week central bank bills, and some of this could be channeled into short-term government debt.

Many analysts think the politicians made the comparison to Greece not because they thought a Greek-style crisis was likely, but for domestic political effect.

The government may want to backtrack on earlier promises of deep tax cuts, or set the stage for potentially painful spending cuts or economic reforms, some analysts speculate.

At the very least, however, the remarks about Greece suggest Hungary's new center-right Fidesz government, which took office on May 29, is dangerously insensitive to the risks of destabilizing the markets. The incident may also indicate divisions on policy-making style or substance within Fidesz.

"Some permanent damage has been done in the sense that people now know that Fidesz is indeed quite radical and reckless in their approach, which means for investors that they have to be aware of further surprises and the related volatility," said Christian Keller, at Barclays.

Maintaining market confidence is important because Hungary runs a significant foreign exchange rate risk, partly due to large-scale Swiss franc and euro borrowing by households and firms. This could present a systemic risk to the banking system, should the forint weaken sharply for the long term.

"Hungary remains in a precarious position when accounting for the significant exchange rate risk in its debt stock" even before accounting for such risk in the private sector, which carries implicit liabilities for the government, Barclays said in a research note.

Hungary's credit line from the IMF, the EU and the World Bank will expire in October this year, and the exchange rate risk means markets will want to see some form of extension of the facility.

Officials said at the weekend that they would aim to draw up an economic "action plan" by the end of Monday to show how they would keep down the deficit while strengthening the economy.

The government has so far put forward only sketchy ideas for tax cuts to boost growth and create jobs, and because of last week's market turmoil, may now need to shelve tax cuts to demonstrate an intention to cut debt. If it goes ahead with tax cuts, they will probably need to be offset with spending cuts or some increases on the revenue side.

Economy Minister Gyorgy Matolcsy "can do the tax cuts but would have to make drastic spending cuts across the board," Nomura's Montalto said.

"While practically possible, I think it would be politically impossible without increasing the budget deficit. That however is impossible for markets and the IMF/EU to accept, so his tax plans may have to be phased in over a number of years."

Hungary's budget deficit was 4 percent of GDP last year and before last week's turmoil, analysts had predicted a deficit of about 5 percent for this year.

Gabor Orban, analyst at Aegon Securities, said that whatever action plan the government announced, the markets were unlikely to calm down much.

"What happened has damaged their credibility in a lasting way. What is needed now is solutions which are approved by the IMF and the EU."

The next IMF-EU review of Hungary's economic performance is due in June, but it is unclear when the review will start. IMF and EU officials are due to come to Hungary on Monday, but for talks rather than an official review.

The European Commission warned Hungary on Thursday against losing the confidence of markets after talks with Prime Minister Viktor Orban, and urged Hungary to accelerate fiscal consolidation. So far the IMF has not commented publicly about the new government's policies.

What Hungary needs now is an "external credibility anchor," and the best form of that would be a new program with international lenders, said Keller of Barclays Bank.

"I think they may have made themselves now more dependent on the IMF and the EU rather than becoming more independent as they had wished. They now need to agree to a new IMF-EU program more than ever in my view."

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Hungary is likely to take months to regain the trust of financial markets after politicians in its new government made controversial comments comparing its fiscal problems to the Greek debt crisis. Reaching a detailed agreement with the International Monetary Fund and the...
Monday, 07 June 2010 07:10 AM
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