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The Hungarian government shocked investors yet again on June 17, as it announced increases for extraordinary taxes on the country's banks, telecom operators and miners. Budapest claims that the raised levies are needed to ensure the country's budget remains in the EU's good books, but most observers expect the revenue will be used to boost spending in the run-up to next year's elections.

Economy Minister Mihaly Varga opened the week with a surprise announcement that the government would introduce a bill to parliament the same day proposing a hike in the financial transaction tax and the telecoms tax. The Economy Ministry told MTI that extra revenue from the tax hikes could total as much as HUF100bn (€343m)

The tax on cash withdrawals will be raised to 0.6% and the HUF6,000 (€21) cap removed. Electronic money transfers will be taxed at 0.3% (rather than the current 0.2%), with the cap retained. When it turned up on the parliament website, the draft bill also included a stipulation that the banks will face a 7% tax on the HUF691bn in municipality debt that was recently transferred to the central budget. Banks must pay the charge in forints by December 20 this year, according to Reuters.

At the same time, the levy on telephone calls and text messages will be raised from HUF2 to HUF3, while mining royalties will rise from 12% to 16%, Varga said. A healthcare contribution of 6% on interest and capital gains will be introduced as of August. The official added that the changes have been approved by the Banking Association - which this year is remarkably compliant compared with its previous noisy opposition to the government's rough handling of the sector.

Necessary evils

The government argues the tax increases are necessary to keep the country from sliding back into the EU's Excessive Deficit Procedure (EDP). At a meeting on June 22, Hungary is expected to seal final approval to exit the monitoring programme for budget offenders for the first time since it joined the bloc in 2004. However, Varga said that recent drops in inflation to below expectations have thrown the government's revenue calculations out of whack. By the end of May, the state had received only 17% of the planned HUF300bn it hopes to raise from the financial transaction tax in 2013, he pointed out according to the Wall Street Journal, instead of the anticipated 42%.

The minister noted that the European Commission made its recommendation that Hungary should now be allowed to exit the EDP at the end of May, and that at the same time it announced that Malta - which had only escaped six months earlier - would re-enter. The successful bid to exit came under duress from the European Commission, which had threatened to block around half a billion euros in cohesion funding for Hungary. To cross the line, Varga in May announced a HUF93bn spending freeze for 2013-2014, and promising a further HUF80bn in cuts next year if necessary.

However, implementing such large-scale spending cuts would be electorally harmful to the government ahead of the parliamentary elections that are due next year. The ruling Fidesz party is desperate to maintain the constitutional majority it has enjoyed since 2010, which has allowed it to follow its unorthodox policies and flex its nationalist muscles in its almost constant bickering with Brussels. The country's energy utilities - foreign-owned for the most part - have been put in harness to shoulder the cost of populist tariff cuts; analysts suspect the new extraordinary tax rises will be used to fund programmes such as a promised pay rise for teachers.

"The steps come basically out of the blue," Erste Bank analysts write in a note. "Hungary could quit EDP without this package, and thus, it is likely that these steps generate room for extra spending." However, while agreeing that the tax hikes cannot be justified by any EDP-related issue, analysts at portfolio.hu posit that the government is perhaps worried that the upcoming half-yearly review of the budget will show that public debt has failed to start falling. In that case the cabinet would be obliged by law to take action, they note.

Meanwhile, the news will put further pressure on Hungarian equities, already struggling in the sluggish economy. VTB Capital reiterated in a note its grim outlook for the country's largest telecom operator. "One of the key reasons for our Sell recommendation on Magyar Telekom is that the government is trying to find additional budget revenue streams at the expense of telecom companies."

Erste suggests the news "should be roughly neutral for [forex] and [fixed income] markets," but adds that the "steps are slightly negative for GDP". It is only "due to positive risks in the outlook, we will likely not adjust our 0.2% call for real GDP growth for 2013," it adds.

Longer term is a bigger worry however, with the government yet again undermining lending by the battered banks and offering investors another stark warning that there are no guarantees in Hungary. "Today's unexpected steps again highlight the uncertainty of government policy," Erste adds. "[I]ncreasing the burden on corporates can have negative implications on private investment, while it may increase state investment and state redistribution, if the government really uses the proceeds for higher spending. The steps may have negative implications on long-term growth prospects."