Bloomberg News

IMF Warns Hungary of Debt-Repayment Risk If Euro Crisis Worsens

January 26, 2012

Jan. 25 (Bloomberg) -- Hungary may be pressed to meet its debt payments this year if the euro crisis worsens and the economy slips into a recession, the International Monetary Fund said, underscoring the need for a financial safety net.

Economic growth may miss the government’s 2012 estimate of 0.5 percent and the budget gap may be 3.5 percent of gross domestic product, compared with a target of 2.5 percent, the Washington-based lender said in a report today. The IMF estimates 0.3 percent growth or a recession in a crisis scenario.

Hungary is trying to revive bailout talks with the IMF and the European Union to quell investor concern about the country’s ability to service the highest debt level among the trading bloc’s eastern members. Talks broke down last month over disagreements over a new central bank law. Premier Viktor Orban sought aid in November as the forint plunged to a record and Hungary’s credit grade was cut to junk at Standard & Poor’s, Fitch Ratings and Moody’s Investors Service.

Hungary’s growth outlook is “subject to significant downside risks, including possibly the emergence of an external funding gap,” the IMF said in its annual country review. “A Fund-supported program in concert with other international lenders, which would require a strengthened policy framework and strong ownership by the authorities, could relieve some of the constraints facing the Hungarian economy.”

Forint Rally

The forint appreciated to a three-month high of 296.76 per euro today before dropping to 299.35 at 1:35 p.m. in Budapest. The forint rallied after falling to a record low of 324.24 on Jan. 4 as the government said it is willing to compromise on the central bank law and other legislation the EU contests to start bailout talks.

Hungary may start negotiations with the EU and the IMF “any time,” Orban told HirTV yesterday after meeting European Commission President Jose Barroso in Brussels. While the gap between positions on disputed issues has narrowed, the government won’t compromise on some issues, including central bank salary cuts, Orban said.

The commission on Jan. 17 threatened to file a lawsuit against Hungary because of the central bank law, moves to force hundreds of judges into retirement by cutting their pension age and the dismissal of the data protection ombudsman.

The central bank maintaining a “tightening bias” is “appropriate,” while the Magyar Nemzeti Bank doesn’t have room to cut rates, the IMF said.

Unexpected Rate Decision

The Magyar Nemzeti Bank unexpectedly held the benchmark two-week deposit rate at 7 percent yesterday after a “close vote,” during which policy makers also considered a third consecutive half-point increase, central bank Governor Andras Simor said after the decision. Policy makers raised rates by one percentage point in the previous two months to bolster the currency.

Hungary may need to raise the main rate further if the country’s risk assessment and inflation outlook “deteriorate significantly,” Simor said, adding that only a “substantial and sustained improvement” in risk premiums would warrant a rate cut.

“The MNB’s tightening bias is justified,” the IMF said. “While the output gap remains relatively large, the scope for rate cuts is constrained by the worsened inflation outlook and the need to avoid a destabilizing weakening of the exchange rate and capital outflows. Official reserve levels are too modest to provide additional room for maneuver.”

‘Contingency’ Measures

The government should identify “contingency” budget measures even with an “ambitious” fiscal consolidation that includes welfare spending cuts and value-added tax increases, the IMF said. The fund said its 3.5 percent budget-gap estimate reflects a “more conservative” forecast for growth, interest rates and the exchange rate.

The government may need to “revisit” elements of a flat personal income tax that forced an 18 percent increase in the minimum wage to shield lower income workers, the IMF said.

Hungary, which is the subject of an excessive-deficit procedure from the European Commission, faces a “real risk” that its so-called cohesion funding, which finances investment and development projects, may be suspended from next year if the government fails to proves it can keep the shortfall below 3 percent, the IMF said.

The government should also strengthen the Fiscal Council after abolishing its independent predecessor and replacing it with a three-person council dominated by Orban allies, it said.

‘Lasting Damage’

Hungary’s government needs to also work to restore investor confidence, after possibly inflicting a “large and lasting damage” on the country’s reputation with the unilateral revision of bank contracts to allow for the early repayment of foreign currency mortgages at exchange rates below the market rate, the IMF said.

The move forced banks to swallow exchange-rate losses as the government worked to reduce foreign-currency loans. About 20 percent of foreign-currency borrowers were able to repay their loans early in a lump sum, according to the financial regulator.

The foreign-owned banks that dominate the country’s financial industry may as a result become less willing to fund their Hungarian units to the same extent as after the 2008 credit crisis, raising debt servicing risks, the IMF said.

“Unlike in the previous crisis, parent banks may be less likely to significantly increase their funding to subsidiaries given the policy environment in Hungary and pressures in the Eurozone,” the IMF said. “Given low fiscal and external buffers, such a scenario could well weaken Hungary’s capacity to meet its external obligations in 2012-13.”

--Editors: Balazs Penz, Alan Crosby

To contact the reporter on this story: Zoltan Simon in Budapest at zsimon@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net


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