Thomas Escritt in Budapest -

Hungary has been experiencing growing trouble finding buyers for its government debt over the past month, prompting analysts to warn of a new debt crisis to come.

The latest turn in the saga came on November 10, when the country's debt management agency only able to find buyers for only HUF23bn (€73m) in one-year treasury bills, compared with the HUF40bn it had been seeking to place. More worryingly still, the government was able to sell the bills at a price that implied an average yield of 6.79%, a full 24 basis points (bps) above the level at the bills were trading on the secondary market: institutional investors clearly felt they were taking on substantial risk in lending to the Hungarian state, and wanted substantial compensation.

Nor is this the first sign that Hungary could have difficulty raising funds. At an auction two weeks ago, even before concerns about the indebtedness of the Eurozone periphery set the forint on a renewed downward path through the psychological barrier of 300 to the euro, an auction had to be cancelled when no investors were interested in buying at the yield on offer. This time, the debt management agency thought better of calling investors' bluff.

Funding now looks almost as tight as it did in 2008, when investors were similarly spooked by the Lehman Brothers collapse, driving Hungary, along with much of the rest of Central and Eastern Europe, to the International Monetary Fund. But while Romania and Ukraine continue to stick to their IMF programmes, one of the first acts of Hungary's populist-conservative government when it took power some 18 months ago was to break with the IMF, which it said was demanding unacceptable levels of austerity. Now, analysts are starting to ponder whether the country will be driven back to the IMF.

Bleak times

Although Hungary had a good start to the year, with strong export demand from the Eurozone bringing about a return to growth in the country after a painful recession, recent news has been much bleaker. As early expectations of continued strong demand from Germany were dashed, growth forecasts have been revised sharply down: in the spring, the European Commission forecast growth well above 2% for 2011 and 2012. In its latest outlook, it expects growth of just 1.5% this year and only 0.5% in 2012.

While the decision to go ahead with the bond auction despite lenders' lack of interest in buying at the price the government was seeking might suggest immediate funding problems, Eszter Gargyan, a treasuries economist at Citigroup, suggests the move may have been merely precautionary. "It's a very good question, why the debt management agency was prepared to accept higher yields on this occasion. Caution is certainly part of it, since the situation surrounding the EU is deteriorating," she says. "But it could also have been a way of signalling that higher interest rates are on their way, or a tacit omission that the forint is going stay below 300 to the euro for more than just a few days."

The liquidity situation in Hungary is not yet dire. At the end of September, there was still liquidity of some HUF1000bn held in cash at the central bank. Furthermore, some HUF500bn remains of the privately-held pension fund assets that the government effectively nationalised last year to fill the funding gap left by the withdrawal of the IMF. "I think the IMF remains the last resort," says Gargyan. "The government would only turn to them if it ran out of liquidity or foreign currency liquidity - the Hungarian state debt market has to see much more difficult days before we get to that point."

Gabor Ambrus, an analyst at the London-based consultancy 4Cast, makes the same point. "There is no crunch on government finances, but these are signals of problems for the future... This becomes a problem if there are persistent failures," he says.

Around half of the €10bn in so of pension assets nationalised last year was itself in the form of government debt: these bond holdings were cancelled immediately when they returned to the state, immediately cutting public debt by some €5bn. The remainder is primarily in equities of various kinds, and is thus substantially less liquid. It could be that the government is reluctant to offload its shareholdings at today's depressed prices.

But what is clear is that the Hungarian government's 15-month experiment in what it calls "unorthodox economic policy" - in practice doing without the IMF - is running into difficulties. In a note following the disappointing bond auction, the Royal Bank of Canada wrote: "A rating downgrade, in our opinion, is becoming likely and tail-risk events - such as a sharp depreciation of the forint beyond the previous all-time high of 316 to the euro, large-scale rate hike of 300-400 bps, additional new unorthodox policies similar to forced bank FX mortgage adjustments or domestic private pension fund system transfer to the state, etc. - are becoming much more probable of materializing in coming days/weeks."