World Business

Hungary debt risks soar as halt to IMF talks sends forint down

By Balazs Penz (China Daily)
Updated: 2010-07-20 09:54

Trams pass over the Freedom Bridge in Budapest, Hungary. [Balint Porneczi / Bloomberg]

BUDAPEST - The cost to insure debt payments from Hungary jumped the most in six weeks and the forint tumbled after the International Monetary Fund (IMF) and European Union (EU) ended talks with the government without endorsing Prime Minister Viktor Orban's plans to control the budget deficit.

Credit-default swaps protecting the country's debt against nonpayment for five years climbed 47.5 basis points to 370 basis points, the most since June 7, according to CMA prices. The currency depreciated as much as 2.9 percent against the euro and was trading 2.3 percent lower at 288.74 at 9:50 am in Budapest, the biggest plunge since comments by local politicians comparing Hungary to Greece roiled world markets six weeks ago.

The IMF ended its review of Hungary's 20 billion-euro ($25.8 billion) emergency bailout because "a range of issues remain open," the Washington-based lender said in a July 17 statement. The government must make "tough decisions, notably on spending," to comply with deficit requirements, the EU said.

"This news is very negative," said Gabor Orban, who helps manage $4 billion in emerging market debt at Aegon Fund Management in Budapest. "This won't be the type of selloff where the smart investor is buying. The first reaction will be panic, then the market may calm down."

The IMF's statements are a blow to Prime Minister Orban's efforts to rebuild investor confidence after ruling party officials raised the specter of a Greek-like crisis last month, driving the forint down 4.6 percent against the euro in two days. Hungary, in its fifth year of austerity measures, sought to persuade creditors to widen the country's deficit target for next year.

" It seems the new government has not learnt its lessons from the previous gaffe, while the market is in no mood to overlook any fiscal laxity," Timothy Ash, head of emerging market research at Royal Bank of Scotland in London, said in a note to clients. "Unless something can be agreed to very quickly, the risk is that Hungary may be downgraded by ratings agencies as a result of the uncertainties that arise out of Sunday's developments."

The forint lost 6.5 percent against the euro in the past three months as of last week, the worst performance among 177 currencies tracked by Bloomberg. The yield on the benchmark three-year government bond rose 34 basis points today to 7.24 percent after increasing 153 basis points through the end of last week.

Orban won a landslide victory in April by pledging to end the budget cutting strategy of his predecessors, which helped reduce Hungary's deficit to 3.8 percent of gross domestic product in 2008 from 9.3 percent in 2006. The shortfall may widen to 4.1 percent this year, compared with the EU target of 3 percent, according to the European Commission.

After the election, the Fidesz party said the previous administration lied about the budget as they lobbied the IMF and EU to permit wider deficits this year and next. Fidesz officials roiled markets on June 3 and 4, saying the economy was "much worse" than the government had forecast and the country had a "slim chance to avoid a Greek situation".

Related readings:  Hungary's parliament approves new gov't  China's King Long bus company sets up plant in Hungary  Strike paralyzes Hungary's rail traffic  Vice president arrives in Budapest on visit to Hungary

While the government sought to ease concern by pledging to stick with this year's deficit target of 3.8 percent of GDP, it continued to seek relief from the 2011 goal.

"We believe the government will finally agree with the IMF/EU but it might not come before the autumn local elections," Gyula Toth, emerging-market strategist at UniCredit SpA wrote in a note to clients. "The government will simply have no other choice in our view." The bank retains "bearish positioning" in Hungary's assets and may recommend selling euro against the forint in case of "exaggerated moves" around 295 against the common currency.

RBS' Ash said Hungary's central bank may intervene to prop up the currency as the 300-forint-per-euro level draws near and raise interest rates if the currency breaches that.

"The Hungarian government does not have a short-term funding problem, but things are likely to get messy anyway as the breakdown has sparked a sharp sell-off in the Hungarian markets, which in itself is highly destabilizing," Copenhagen-based analysts at Danske Banka A/S wrote in a report. "We would not rule out an aggressive rate hike of 300-400 basis points to curb the sell-off in the forint if the situation gets worse."

The Polish zloty declined as much 1.2 percent before paring losses to 0.4 percent at 4.1221 per euro. The weakening has been "overdone" and investors should buy the zloty at current levels, according to Cheuvreux strategist Simon Quijano-Evans.

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