ECB slams Hungary's financial tax, IMF talks seen tricky

BUDAPEST Tue Jul 24, 2012 3:33pm EDT

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BUDAPEST (Reuters) - The European Central Bank slammed Hungary's new financial transactions tax on Tuesday saying it impaired the independence of the country's central bank, signalling a new hurdle in Budapest's vital loan talks with international lenders.

The ECB's criticism came only hours after Hungary's central bank kept interest rates steady, deciding against a rate cut as an escalating euro zone crisis poses risks to the forint, which has been undermined by shaky confidence in the country.

Investors have been spooked in the past two years by the government's unorthodox policies and tax changes, including the financial transactions tax, which the government pushed through parliament this month and which will finance social tax cuts next year, before elections which are due in 2014.

"The new FTT (financial transaction tax) law impairs the National Bank of Hungary's functional and institutional independence," the ECB said in a statement.

Budapest began talks with the International Monetary Fund and the EU last week after an eight-month delay, boosting investor hopes for a deal on a financing backstop which Hungary, with the highest debt in Central Europe, needs to cut its borrowing costs and avert a market blowout.

But the ECB statement signalled a fresh conflict with Viktor Orban's centre-right government, only weeks after Budapest ended a seventh-month dispute with lenders over another piece of legislation that jeopardised the central bank's independence.

The forint eased to 289.00 versus the euro from 288.30 after the ECB's comments.

Orban has said the financial transactions tax would remain in place even if lenders oppose it.

It will be levied on commercial banks as well as on the central bank's overnight facility and the two-week bills it sells to banks as part of its role in controlling money in circulation.

The ECB said the tax could disrupt monetary policy transmission and could be seen as a way to finance the public sector from central bank money, thus violating European Union rules.

"This confirms that this transaction tax issue could become a sticking point at the credit talks if the government is unable to backtrack on this. In its communication, the government has dug in its heels on this issue," said Eszter Gargyan, an economist at Citigroup.

"This will be a lengthy process and that will contribute to making the talks protracted."

An IMF/EU mission, which arrived for preliminary talks to Budapest last week, is due to end its visit on Wednesday. The negotiations, even before the ECB's statement on Tuesday, were expected to be difficult, spanning several months.

INFLATION ABOVE TARGET

Junk-rated Hungary's risk premiums have risen this week and the forint has fallen as global risk appetite was hit by worries that Spain may have to seek a full-blown bailout. Hungary's central bank acknowledged that the riskier environment was a reason it kept interest rates at 7 percent, the highest in the EU, on Tuesday for a seventh straight month.

"The volatile risk environment and above-target inflation for an extended period continue to warrant a cautious policy stance," the Council said in a statement after its rate meeting.

The Council reiterated that it would consider a rate cut if Hungary's risk premium falls "persistently and substantially" and the outlook for inflation, which hit 5.6 percent in June, improves.

With its export-driven economy on the brink of recession, some policymakers have called for a rate cut. Central bank Governor Andras Simor told a news conference that the bank considered a 25 basis point cut but a significant majority of the committee voted for no change.

Central Europe's exports are being hurt by a weak euro zone, the region's biggest trading partner, and the Czech Republic cut its key rate last month while in Poland some rate setters are now urging the central bank to start monetary easing.

Analysts polled by Reuters expect Hungary's interest rates to fall to 6.5 percent by the end of the year, assuming a deal with the IMF/EU is reached.

(This story corrects third paragraph to say elections are due in 2014, not next year)

(Editing by Susan Fenton)

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