Hungary sends the IMF packing

By bne IntelliNews July 16, 2013

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Looking to rub the noses of Brussels and the International Monetary Fund in its recent economic "success" - as well as set up a campaign platform for next year's elections - Hungary's ruling Fidesz party announced on July 15 that it plans to pay the international lender off early and kick it out of the country. The IMF promptly replied it's already packing its bags.

In a letter to IMF Director Christine Lagarde on July 16, Governor Gyorgy Matolcsy of the Magyar Nemzeti Bank (MNB) said Hungary was considering an early repayment of the outstanding sums owed on the loan the country took to avoid bankruptcy in 2008. Prime Minister Viktor Orban's right-hand man also wrote that he intends to close the IMF's resident representative office in Budapest, saying it is "not necessary to maintain" any longer, according to Reuters.

"Let me use this opportunity to personally congratulate you for your efforts in making the most of the Fund's mandate... to promote economic growth," Matolcsy wrote to Lagarde with the kind of flair he used throughout his time as the leading architect of the government's "unorthodox" policy at the head of the economy ministry. "Let me assure you that at the Magyar Nemzeti Bank, the central bank of Hungary, we put equal emphasis on this goal, in line with our legal mandate," he continued.

According to analysts at Citigroup, Hungary has €2.9bn of obligations outstanding to the IMF, which consist of obligations of the government and MNB.

The state debt agency says Hungary is due to repay €913m in each of the third and fourth quarters, with a further €299m in the first quarter of next year. On top of that, the MNB has €700m in outstanding obligations to the IMF, with €180m redemption payments due at the end of each quarter to the middle of next year. In addition, Budapest has a €2bn obligation to the EU due in December 2014. However, analysts suggest early repayment to the IMF is unlikely to stretch reserves dramatically.

Apparently weary of the battles with Orban, the IMF indicated in a curt missive that it will vacate the country almost immediately. The international lender said in its statement: "As Ms. Iryna Ivaschenko's posting as Resident Representative in Hungary was due to end in late August and the IMF's presence in member countries is at the invitation of country authorities, the IMF will not seek to replace her. The IMF looks forward to continued cooperation with Hungary in the context of regular bilateral consultations as with other member countries."

Double-edged sword

Hungary was pulled back from the brink of bankruptcy with a €20bn rescue package from the IMF and EU during the first wave of the global crisis. However, practically the first move of Orban's conservative and mildly nationalist Fidesz government on coming to office in 2010 was to end the programme in favour of its own "unorthodox" policy, much of it reportedly designed by Matolcsy.

By late 2011, Hungary was already back in deep trouble, with the forint sliding to fresh new lows. That kicked off a long and ill-tempered domestic media campaign against the IMF and EU from Orban's government through most of 2012, even as it told the markets it was hoping to secure a new €20bn bailout, in a bid to keep bond investors off its back.

The main point for investors baulking at Budapest's erratic policymaking was that a deal with the lenders in Brussels and Washington would rein it in. However, as the emerging market bond rally took hold in the second half of the year, Orban and Matolcsy grew ever more bullish. The prospect of a deal finally crashed some time around October.

By then, driven by quantitative easing from the likes of the US Federal Reserve and European Central Bank, demand for emerging market assets was able to help support the forint and bond yields, and by February it had built to the point at which Hungary was able to issue its first external debt since 2011, raising $3.25bn from a dollar-denominated, 10-year bond. The hunger for high-yielding assets has backed off in recent months, but Hungary's currency and yields have held up thanks to improved economic and fiscal data in the first quarter of 2013.

Investors have also become calmer as Matolcsy appears to have settled into his seat at the central bank with a minimum of fuss and relatively conservative monetary policy. Ahead of his appointment in March, the likelihood of his stewardship at the MNB had investors on tenterhooks. However, analysts have even recently praised his scheme to try to get lending to small businesses going again.

However, moving his spotlight back onto the IMF risks bringing those fears back to the fore. On top of that, the government's fiscal improvement in particular looks a double-edged sword. The likely reduction of the deficit to below 3% this year has seen the country exit the EU's Excessive Deficit Procedure for the first time since it joined the bloc in 2004, but that performance is almost entirely thanks to the "unorthodox" policies that are extracting cash from foreign investors in the banking, energy and telecoms sectors, amongst others.

That is likely to put the economic recovery that has started this year at risk. The banks are still fuming over taxes and forex loan schemes that have driven their Hungarian units into the red over the past two years or so, and have practically halted lending. At the same time, European energy giants such as E.ON have been forced to swallow lowered tariffs and forced sales to the government.

Put together, the lack of finance and clarity over governance is likely to keep a lid on investment, regardless of Orban and Matolcsy's triumphalism. Indeed, the same day, Austria's Raiffeisen Bank International announced "massive" cutbacks in its CEE network, with Hungary - alongside troubled Slovenia - earmarked as the main targets for savings. "In Hungary, the continued political pressure on the banking sector is probably the main driver of RBI's decision to take a step back," suggests Tomas Oliveira da Silva of IHS Banking Risk.

Short-term priorities

However, Fidesz's primary focus - as illustrated by the promised 30% cut to energy tariffs before 2014 - is next year's parliamentary elections, rather than the longer-term health of the economy. While polls suggest Fidesz should be able to form another government, it is the constitutional majority it currently holds in parliament that has allowed it to implement so many controversial policies.

Orban has pressed hard to tap into the populism seen across Europe during the crisis, accusing international institutions of plundering the country hand-in-hand with market speculators. He has compared the EU to the Soviet Union and German Chancellor Angela Merkel's policymaking to Nazi tanks which invaded in 1944. The chance to boast of wresting national sovereignty from such clutches would clearly offer a potential boost for a campaign playing to an audience for that sort of rhetoric.

As Citi analysts point out, "an IMF-loan prepayment would not change the financing outlook significantly and its primary message is addressed to domestic voters to demonstrate Hungary's economic and financial independence by closing the EDP and relations with the IMF."

However, they also note that it only adds pressure on Budapest to continue juggling its funding options ahead of a deeper potential pullback in appetite for higher yielding assets. "We believe another Eurobond issuance may still follow later this year or before February 2014 - when the government faces €2bn in bond redemptions - in order to keep fiscal cash reserves high in case global flows to [emerging markets] would dry out."

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