The Hungarian markets tumbled Monday morning as talks between a delegation from the EU and International Monetary Fund (IMF) and the new Hungarian government surprisingly collapsed on Saturday afternoon due to disagreements over parts of the country's fiscal consolidation plan. But is this just a delaying tactic by the new government?
The forint has weakened significantly over the past few days and earlier Monday was at one point trading at above HUF290 to the euro, taking it back to levels of over a year ago. The forint's plummet dragged other currencies in the region down with it. Hungary's benchmark stock index, the BUX, opened with a drop of 3% and was trading below 22,000 points in the early morning session. OTP, Hungary's biggest bank, fell 6.5% to HUF4,830, while Mol Oil & Gas was down by 4% at HUF19,750. Credit default swaps on 5-year Hungarian government bonds widened to 316.35 basis points.
The falls come after representatives of both the IMF and the EU were unable to reach agreement with the Hungarian government on certain parts of the country's fiscal consolidation process, which led to the delegates leaving Hungary on Saturday even though the talks were scheduled to last until Monday. The reason given for the breaking up of the talks was that, "even though there is a common basis in the talks, a range of issues remains open," according to a statement from the departing IMF mission.
The IMF stressed the fiscal deficit targets previously announced - 3.8% of GDP in 2010 and below 3.0% of GDP in 2011 - "remain an appropriate anchor for the necessary consolidation process and debt sustainability, and should be adhered to." The IMF also warned about the HUF200bn windfall bank tax's adverse impacts on lending and growth, given the government plans to maintain the tax in 2011 and 2012 at levels that would yield similar amounts. Meanwhile, EU officials stated that Hungary needed to take tough decisions on the spending front, which Tim Ash of Royal Bank of Scotland says is most likely a reference to the government's intentions of creating a national asset company that would purchase foreign currency-denominated mortgages from banks and allow home owners to stay in their houses as tenants.
The EU also postponed the conclusion of the review of Hungary's €20bn credit facility, meaning the government can't draw on the remainder of the IMF/EU loan package, which is set to expire in October - though there were signs the government wasn't intending to access this money in any event.
Analysts at Equilor in Budapest note that there are already some voices out there saying an agreement between the sides should occur in October at the latest and this breakdown in talks was a move planned in advance by the Hungarian government, which hopes to win some time until the local government elections on October 3. "Analysts expect that the cabinet would announce another set of austerity measures after the elections, which would result in the government coming to an agreement with the IMF and the EU," Equilor says in a note.
The following is a research note by Timothy Ash of RBS:
As we expected (please see our latest EM weekly on Hungary), the Fidesz administration has run into trouble with visiting IMF/EU teams. Both have postponed conclusions of their visits and returned home, reportedly due to differences with the government over fiscal issues. IMF and EU teams had been visiting Budapest to complete the sixth and seventh program reviews of the lending program approved in October/November 2008, and were scheduled to hold a joint press conference today. While the Hungarian government was likely to have agreed to the fiscal deficit target set for this year (-3.8% of GDP), the target for 2011 was likely one topic of disagreement. As we reported in our last weekly, Fund officials were unhappy over the inflexibility of the Fidesz administration on the proposed bank levy expected to yield between HUF180-200 billion this year, the 'bad bank' idea to help FX borrowers and a fiscal deficit wider than 3% in 2011; the March 26th fifth program review report projects the fiscal deficit at 2.8% of GDP in 2011.
Indeed, in the press statement released yesterday, the departing IMF mission stated that while progress had been made on the macroeconomic front under the IMF program, "...the fiscal deficit targets previously announced-3.8 percent of GDP in 2010 and below 3 percent of GDP in 2011-remain an appropriate anchor for the necessary consolidation process and debt sustainability, and should be adhered to...". The Fund also took a swipe at the HUF200 billion bank levy saying that it would adversely impact lending and growth; reportedly the IMF had issues with the government maintaining the tax in 2011 and 2012 at levels that would yield similar amounts. Meanwhile, EU officials stated that Hungary needed to take tough decisions on the spending front, most likely a reference to the government's intentions of creating a national asset company that would purchase FX denominated mortgages from banks and allow home owners to stay in their houses as tenants.
Prior to the current review, the IMF had shown considerable flexibility with Hungary, largely due to worse than expected macroeconomic outcomes. The original fiscal deficit target for 2009 was 2.5% of GDP agreed to in November 2008; this was allowed to rise to 2.9% in March 2009, and further to 3.9% of GDP by June 2009. The Hungarian government also convinced Fund officials to relax the 2010 fiscal deficit target from the 2% agreed to in November 2008 to 2.5% by March 2009 and further to 3.8% in June 2009. Similarly, the 2011 target/projection for the fiscal deficit rose from 1.5% in November 2008 to 2.2% in March 2009 and further to 2.9% in June 2009. It seems the Fund has now had enough and will now not tinker with fiscal targets anymore - contrary to the time of the previous revisions, there is too much attention on sovereign balance sheets/fiscal weakness at the moment.
Looking ahead, given that the Fidesz administration did not reportedly intend to draw the money that would have become available at the end of the sixth/seventh IMF review had been successful (roughly about US$2.2 billion from the IMF), deficit financing will not be directly impacted. However, there will be a severe indirect impact. Yields on Hungarian government debt will rise, making it more expensive for the authorities to borrow which will not only result in expenditure-side pressures (interest expenses are expected to amount to 4.2% of GDP in 2010), but in the event of a total sell-off, deficit financing may become very difficult with Hungary unable to meet roll-over requirements. According to the IMF, while the Q3-2010 net borrowing requirement for the central government is HUF119.2 billion, gross redemptions total HUF1.73 trillion, of which the government was hoping to roll-over HUF1.57 trillion through new issuance.
Given the market's reaction the last time Fidedz officials talked of fiscal laxity, we expect Hungarian asset prices to tumble this morning. The impact will only be magnified by the sell-off on Friday that is likely to batter markets this morning. More broadly, 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. 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, given the country's high debt dynamics: gross public debt is about 80% of GDP, external debt is over 130% of GDP, FX reserve coverage of ST debt is about 88%, and import cover is roughly 5 months. Arguably continued adherance to the current IMF programme had anchored both markets, and Hungary's ratings: the fact that Hungary is now going off-piste suggests both may be under threat. Indeed, without IMF financing over the longer term we doubt that Hungary can fund itself. In addition, the banking system is an additional source of vulnerability: according to IMF data, in end 2009, 63% of total loans were denominated in foreign currency; NPLs were low though at around 7% of gross loans; 72% of all loans are to households and corporates in roughly equal proportions (75% of the loans to corporates are in Euros); the loan-to-deposit ratio of banks in Hungary stood at 115%; FX liabilities to total liabilities is about 47%; and, liquid assets to ST liabilities is 45.2%.
Note here that it was these vulnerabilities that led Hungary to one of first post-global financial crisis programs. In October/November 2008, a front-loaded US$15.7 billion (EUR 12.5 billion) Stand-By arrangement from the IMF, supplemented by US$8.1 billion (EUR 6.5 billion) in balance of payments support loans from the EU, and another US$1.3 billion (EUR 1.0 billion) from the World Bank was approved; US$6.3 billion was disbursed immediately, while the program was later extended by three months to October 2010. The Hungarian authorities did not draw the fourth and the fifth tranche under the IMF program (cumulatively worth about US$2.2 billion), and also has EUR 300 million (~US$450 million) in undrawn funds with the EU. Hence, in sum, EUR 8.7 billion has been disbursed so far under the IMF program and another EUR 5.5 billion from the EU in three instalments. While the program was scheduled to be completed in October this year, but press reports had suggested that the Fidesz administration would request an extension till December after which they would enter another two year precautionary program (worth EUR 10-20 billion, according to some reports).
In summary, news over the weekend was unexpected - the market consensus was that the government would ultimately (kicking and screaming) sign up to the demands of the IMF; simply because Hungary has no alternative but to fall-back on IMF/EC cash. News that the government is willing to go "off-piste" and that the IMF is willing to play hard ball is a significant new negative both for Hungary and the wider region. A new crisis in Hungary will also have regional implications this morning, with the region's assets likely all following Hungary lower; unfortunately despite its better stand-alone fundamentals Poland (and the zloty) will likely be front like - the zloty remains the surrogate short for the region's woes. In Hungary specifically we expect the forint to weaken towards the HUF290:EUR 1 level and beyond. As the HUF300:EUR 1 level is approached the assumption will be that the NBH will be forced to intervene in defense of the currency, given the large net open positions of households and corporates. Beyond the HUF300:EUR 1 level the NBH may be forced to hike rates; note that the NBH board meets this week - likely to be an intense meeting. Any hopes of near term rate cuts have clearly now gone out of the window.
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