Hungary's path to IMF deal diverted as it unveils more tax hikes

By bne IntelliNews October 18, 2012

bne -

It's off again then. No sooner had Hungarian markets settled into the optimism groove as investors started to believe Budapest's hype that a deal over an international bailout loan is close, than the government unveiled a raft of tax rises designed to protect the country's EU cohesion funding. However, the moves, which will annoy the International Monetary Fund (IMF) by hitting the banks once more, sent the forint sliding sharply.

Economy Minister Gyorgy Matolcsy signaled the latest step in the world's longest rendition of the hokey cokey as he announced revenue-raising measures to the tune of HUF367bn (€1.3bn) in a bid to avoid a threat from Brussels that it would cut close to €500m in cohesion funds unless Hungary finally pulls itself out of the EU's Excessive Deficit Procedure - for the first time since it joined in 2004 - by bringing the budget deficit to below 3% of GDP.

However, the measures are set to provoke the IMF, which is demanding Budapest rein in its "unorthodox" economic policies before it will agree a new loan programme. Top of the list of annoyances is Matolcsy's announcement that the banking sector tax will not, as originally agreed, be halved in 2013, a move designed to raise HUF72bn. In addition, the country's new financial transactions tax (FTT) - set to start in January - is also to be doubled to 0.2%, offering another HUF90bn or so. Other measures include a tax on utilities infrastructure, and higher taxes on employee benefits.

That has the banks - which have been fighting a bitter battle with the Fidesz government since it came to power in May 2010 - up in arms once more. After long negotiations, they had been promised that the windfall tax - the highest on the sector in Europe - would be reduced as the FTT came in, in exchange for promises that they would return to lending to help prop up economic growth. The European banking giants that dominate the local market have been busy lobbying both Brussels and international lenders to help them in that fight over the past couple of years.

The Hungarian Banking Association didn't drag its heels to express its displeasure, issuing a statement that stated: "The measures announced by the government today - if passed by parliament - endanger predictable financing to economic players and all their elements reduce the lending ability of banks."

Back to the drawing board

Hungary had finally managed to get the IMF to sit down to preliminary talks on a bailout in the summer, after months of seesawing. The Washington-based lender - which is yet to announce a return for a second round of negotiations - left Budapest in July insisting the government should abandon ad hoc tax measures, focus more on sustainable spending cuts, and seek to restore the soundness of the heavily-taxed financial sector.

"The fiscal measures outlined are... aimed in exactly the haphazard and growth-unfriendly manner that IMF is highly likely to deem as negative for the medium term outlook," says SEB in a note. That sent the gathering herd of bulls scattering, as the optimism which has grown on claims of an imminent deal from Prime Minister Viktor Orban and Budapest's lead negotiator Mihaly Vargas in the last week collapsed.

Despite Matolcsy's attempt to continue that optimistic tone, insisting that he is still hopeful of deal in the near future, the forint and bonds both took a tumble."EUR/HUF rose on the initial comments and [is] now back at where it closed the day before yesterday," SEB points out, "as Vargas' ambition outlined yesterday about reaching for an IMF deal today look less substantial." Hungarian debt yields rose 20-25 basis points, according to Reuters, after being at two-year lows recently.

Matolcsy has already set out Budapest's riposte to the forthcoming complaints from the IMF, with the government clearly ready to plead that it had no choice. Less than two weeks ago, another set of austerity measures - praised at the time for their "orthodox" nature - introduced promises of improving the state balance sheet by close to HUF400bn. That effort included some spending cuts, which Fidesz has been studiously avoiding despite the weak economy having now slipped back into recession.

Offering fresh impetus to speculation that the country is determined to drag out talks over a bailout for as long as possible in a bid to avoid the conditions for policymaking that it would entail, Hungary is now clearly set to attempt to play the European Commission off against the IMF. "However economically absurd we may find what the Commission has signaled, as well as being a political double standard, we undertake these measures to preserve Hungary's cohesion funds," Matolcsy told a news conference, according to Reuters. "This second round is not something we like, we did not want to introduce most of these... new steps."

The government disagrees with the EU's economic analysis, which is "baseless and mistaken from an economic and a professional point of view," Matolcsy said, according to Bloomberg, before adding: "Hungary can't take the risk that the EU will strip us of development funds that we're entitled to just because of mistaken calculations."

Budapest is under pressure from a November 7 deadline to get its finances in order or lose the EU development funds. The previous round of measures failed to convince Brussels, which forecasts Hungary's budget deficit at 3.7-3.9% of economic output next year - compared with the government's target of 2.7% - due to the economy's rapidly diminishing growth and what it says are unrealistic budget revenue targets. The government now expects growth of just 0.9% in 2013 after a recession this year.

At the same time, its tough to find an analyst that is now not convinced that Hungary is indeed "doing a Turkey": stringing the IMF along with little intent to actually sign a deal, in a bid to keep the markets off its back. The country's hefty trade surplus is keeping it supplied with hard currency reserves, while domestic bonds have sold well, offering Budapest ongoing hope of making it through to the other side of the Eurozone crisis without accepting a bailout and the conditions that entails. However, investors have repeatedly returned to buy Hungarian assets throughout the last year anytime the government has offered compromise, in a bid to cash in should a loan finally be agreed.

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