IMF deal for Hungary eases nerves in Central Europe

BUDAPEST (Reuters) - A larger-than-expected bailout of Hungary by the IMF and European Union settled nerves in the bloc's ex-communist countries on Wednesday, though the regional fallout of the financial crisis looked to have some way to run.

The $25.1 billion rescue deal, the biggest for an emerging market economy since the global crisis began, was the first for an EU member and dwarfed the $2 billion and $16.5 billion sums offered earlier to fellow strugglers Iceland and Ukraine.

The agreement will force Hungary to make painful budget cuts that could worsen the already grim economic outlook of an impending recession and analysts still wonder whether others in the region may yet need propping up.

But its immediate impact on Wednesday was to boost the forint currency and stock exchange -- welcome relief after weeks of panic selling that had hammered the forint lower by almost 20 percent and caused the bond market to freeze up.

IMF Managing Director Dominique Strauss-Kahn said in a statement the deal would "bolster the economy's near-term stability and improve its long-term growth potential."

"At the same time, it is designed to restore investor confidence and alleviate the stress experienced in recent weeks in the Hungarian financial markets," he said.

The IMF said it had agreed to offer Hungary a $15.7 billion (12.5 billion euros) loan program, while the EU stood ready with an additional $8.1 billion in financing and the World Bank another $1.3 billion.

The full amount was about twice what analysts said Hungary had needed and comes on top of a 5 billion euro facility agreed with the European Central Bank earlier this month.

"In short, this is close to the overkill scenario," UniCredit economist Martin Blum said.

"More broadly, we consider today's news positive for all EU new member states to the extent the EU is providing meaningful support too."

Hungary's forint jumped more than 2.5 percent versus the euro in early trade and the Polish zloty and Czech crown also gained. Shares on the Budapest boursejumped 9.8 percent, led by OTP Bank and oil group MOL.

RECESSION LOOMS

The financial crisis has come as a shock to most countries in central and eastern Europe, a region of states ranging from those still struggling with fundamental economic problems to those fully integrated in the European Union and euro zone.

The IMF said on Tuesday it was not in talks with Romania -- whose debt Standard & Poor's cut to "junk" status a day earlier -- but said its external environment, or its ability to borrow cash to fuel the economy, was "very difficult."

Countries across the region have slashed growth forecasts and analysts have expressed worries over economies in the Baltics and Balkans, which were headed for at best bumpy landings even before the latest round of financial turmoil.

Investors had feared Hungary's heavy dependence on borrowing from abroad -- 90 percent of mortgages this year were in Swiss franc loans -- meant the country could struggle to continue to find financing from foreign sources to fuel its economy.

To encourage investors to keep cash in the country, the central bank raised interest rates last week by 3 percentage points to 11.5 percent, but even that measure failed to kick-start the bond market and support the currency.

Market watchers said the new funding deal had removed much of the doubt over Hungary's ability to find funds.

"This package should be sufficient to restore confidence in Hungary's ability to finance its 2009 budget," KBC economist Zsolt Papp said in note.

It was also a boost after the government said on Tuesday the economy could contract by up to 1 percent next year -- the first recession since the fall of communism -- although the effects of budget cuts to accompany the deal were still not clear.

As part of the deal with he IMF, Hungary agreed to lower its 2009 spending through cutting once taboo welfare benefits and will reduce the deficit to 2.6 percent of GDP from an earlier plan for 2.9 percent.

Bond dealers said the IMF package could allow the central bank to cautiously claw back some of last week's emergency rate hike but the first move should only come once markets calm.

(Reporting by Balazs Koranyi)