Bloomberg News

Hungary Runs Out of Options as Orban Bonds Routed in IMF Row

January 18, 2012

(Updates forint, CDS in seventh and eighth paragraphs, adds bond auction in ninth.)

Jan. 9 (Bloomberg) -- Hungary’s plunging bonds and falling currency pushed Prime Minister Viktor Orban into his first major U-turn in office in order to return to the negotiating table with the International Monetary Fund.

The risk of the country failing to reach an agreement with the lender sent the forint last week to a record low, pushed default risk to a record high and lifted government borrowing costs to the highest level since 2009. Talks for Hungary’s second bailout in four years broke down last month as the government refused to alter a central bank law that the EU said threatens the monetary authority’s independence.

Orban abandoned all previous objections to an IMF bailout yesterday, telling state news service MTI his government was open to “any kind” of credit line to prop up financing. Hungary needs to tap international markets in the first half and meet forint financing goals to about 15 billion euros ($19 billion) of payments due this year, according to data compiled by Bloomberg.

“They are clearly running out of time,” Lars Christensen, chief emerging-market analyst at Danske Bank A/S, said in a phone interview before Orban’s comments. “There are two options: the continuation of political and economic suicide or a return to normality, the acceptance of the rule of law, and normal conduct of affairs within a democratic market system.”

Debt Downgrades

European countries from Greece to Italy have adopted austerity plans in the past year as soaring bond yields led to financing troubles. Hungary may face more debt downgrades after its rating sank to junk at Moody’s Investors Service, Standard & Poor’s and Fitch Ratings in the past two months.

Bonds and the currency pared weekly losses after Orban eased his confrontation with central bank President Andras Simor on Jan. 6 and signaled a commitment to reviving bailout talks. It’s “only natural” the IMF will want to see an economic policy that “guarantees” the lender “will get its money back,” he said yesterday.

The forint is the world’s worst-performing currency in the last month, having lost 4.2 percent against the euro. It traded 0.2 percent stronger, at 313.87 per euro, at 10:34 a.m. in Budapest. The currency reached a record low of 324.24 on Jan. 5. Credit-default swaps climbed to 735 basis points on Jan. 5, the highest on record, according to data provider data provider CMA. They were at 681.07 basis points today, down for a second day.

Bond Yields Climb

The yield on the benchmark 10-year government bond was at 9.82 percent today in Budapest, compared with 10.83 percent on Jan. 4, the highest since April 2009. The debt-management agency failed to raise the planned amount of debt at four auctions in the past month and scrapped one bond-exchange auction.

Hungary sold a planned 40 billion forint ($163 million) in six-week Treasury bills at an auction today, with today the average yield rising to 7.77 percent from 7.24 percent on Nov. 28, the last sale of the same maturity. The BUX stock index was up 1.7 percent at 16,404 at 10:43 a.m. in Budapest, rebounding from a three-month low.

Even if the government engages in negotiations with the IMF, it must deal with objections from the EU, the IMF, the European Central Bank, the U.S. and the United Nations to its actions reducing the power of independent institutions.

Legislative Changes

Ruling-party lawmakers ousted the chief justice of the Supreme Court, narrowed the jurisdiction of the Constitutional Court, wrote a new constitution, replaced an independent Fiscal Council with one dominated by the premier’s allies, created a media regulator led by ruling-party appointees and chose a party member to lead the State Audit Office.

Hungary’s own resources to cover financing needs would run out by the end of the first half without IMF assistance or a successful foreign-currency debt offering, according to William Jackson, an emerging markets economist at London-based Capital Economics Ltd.

“Time is of the essence,” for Hungary to reach a financing agreement, IMF Managing Director Christine Lagarde said in a Jan. 6 interview with CNN. “We’re not complacent. We don’t compromise. But, equally, we never leave the table.”

The longer it takes to agree with international creditors, the higher the risk of further credit-rating downgrades, Michal Dybula, a Warsaw-based economist at BNP Paribas wrote in an e- mailed note on Jan. 4. He added that failing to agree with the IMF would result in an “ugly” scenario. A one-step cut in the country’s grade in Hungary has historically led to a 50 basis point increase in longer-dated government bond yields, he said.

Highest Debt Level

Hungary will have the highest debt level, at 76.5 percent of gross domestic product, and the slowest economic growth, at 0.5 percent, among the EU’s eastern members in 2012, the European Commission forecast on Nov. 10.

Hungary needs a “strong policy framework” for an international loan, Hungarian business weekly Figyelo reported on Jan. 6, citing an IMF report it obtained that it said would form the basis of the IMF board’s discussion on Hungary on Jan. 18. The IMF’s recommendations include strengthening central bank independence and fiscal policy oversight, changing the tax regime and reorganizing public transport companies, Figyelo said.

Bankruptcy Possibility

Orban’s Jan. 6 comments suggest the prime minister may have realized the gravity of the situation, according to Christian Schulz, an economist at Berenberg Bank in London. He wrote on Jan. 5 that bankruptcy was “a real possibility” and an IMF pact may be Hungary’s last chance to stave off a default.

“He may be waking up to the fact that he himself might not survive a Hungarian bankruptcy,” Schulz said in a phone interview. “Hungary doesn’t need to go bankrupt if it gets help from the IMF and the EU. But going through all the things he has done in the past months he has a long, long way to go to do everything to comply with the demands of the creditors.”

Orban has shunned the IMF since taking office in 2010 to prevent interference in what he called his “unorthodox” measures. They included the effective nationalization of $13 billion of private pension-fund assets, extraordinary industry taxes to raise revenue for the budget, Europe’s highest bank levy and forcing lenders to swallow exchange-rate losses on foreign-currency mortgages.

“It’s completely self-induced stress,” said Danske’s Christensen. “This government could end this stress tomorrow. Bond yields would be back at 6 percent in 24 hours if the Hungarian government enacted the right policies. They wouldn’t need the IMF.”

Bailout Payments

The country will have to make payments on its 20 billion- euro 2008 bailout this year totaling more than 4 billion euros. An installment of about 700 million euros is due in February and then the same amount at quarterly intervals, plus 300 million euros in June and 500 million euros in each of September and December, according to the IMF’s website.

The government also needs to refinance a 1 billion-euro bond maturing in November and a smaller yen note due in July, according to data on the website of the debt-management agency, known as AKK.

Against that, the agency has deposits of 2.5 billion euros at the central bank and would be able to raise money by selling nationalized private pension-fund assets. The state had 1 trillion forint remaining from the pension assets at the end of October, according to data on AKK’s website, including 192 billion forint in foreign-currency denominated securities.

‘Zero’ Chance

Prospects of Hungary financing itself from the market have faded following the rating downgrades and the dispute with the EU and the IMF.

Hungary would have “zero” chance of tapping international markets, said Kieran Curtis, who helps manage $3.5 billion in emerging-market assets at Aviva Investors Ltd. in London. Its international plan for the year calls for raising 4 billion euros.

“The market and the IMF want the same thing,” Curtis said. “If you’ve got to do it for one, you’ve got to do it for the other, and the IMF financing would be much cheaper.”

Hungary may struggle to grow its way out of the crisis. A 100-basis point increase in state borrowing costs reduces GDP growth by half a percentage point within a year, Dybula said.

The 2 percentage-point increase in borrowing costs since the end of the third quarter has probably cut growth by 1 percentage point, he said.

A recession would put strain on the budget by sapping tax receipts, with a 1 percentage-point reduction in GDP growth cutting revenues by 0.4 percentage point of GDP, Dybula wrote.

“We don’t think there’s any sensible alternative to an IMF/EU package and we believe an agreement can be reached,” Dybula said. Signing a deal in February would avert interest- rate increases by the central bank, strengthen the forint toward 300 per euro and bring 10-year bond yields to about 8.50 percent, he said.

While Orban’s Jan. 6 comments were “a near-term positive,” Hungary’s government can still brace itself for tough negotiations with the IMF, said Raffaella Tenconi, a London-based economist at Bank of America Corp.

--With assistance from Zoltan Simon and Edith Balazs in Budapest. Editors: Balazs Penz, Anne Swardson, Andrew Langley

To contact the reporters on this story: Agnes Lovasz in London at alovasz@bloomberg.net; Andras Gergely in Budapest at agergely@bloomberg.net

To contact the editors responsible for this story: Balazs Penz at bpenz@bloomberg.net; Gavin Serkin at gserkin@bloomberg.net


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