Hungary moves to escape EU fines, aid deal hopes dim

BUDAPEST Wed Oct 17, 2012 9:32am EDT

BUDAPEST (Reuters) - Hungary opted on Wednesday to use tax hikes to avert European Union sanctions over its budget deficit, reopening policy differences with its international lenders and dimming prospects for a long-delayed financing deal.

The government said one of its flagship measures, Europe's highest bank tax, would not be halved next year, drawing a protest from bankers and sending shares in central Europe's biggest independent lender OTP OTPB.BU down 8 percent.

Less than a week after Prime Minister Viktor Orban said Budapest was "not far" from a deal with the International Monetary Fund, boosting the forint to a seven-week high against the euro, policy differences now look wide again.

Pressured by a November 7 deadline to get Hungary's finances in order or lose vital EU development funds, Economy Minister Gyorgy Matolcsy unveiled a package of new taxes worth 367 billion forints ($1.7 billion) -- less than two weeks after announcing a similarly-sized package that also included some spending cuts.

"However economically absurd we may find what the Commission had signaled, as well as being a political double standard, we undertake these measures to preserve Hungary's cohesion funds," Matolcsy told a news conference.

Hungary has been unable to bring its budget deficit below 3 percent of economic output in a lasting way since joining the EU eight years ago.

The latest budget measures underscore the persistent rift between Orban's government and lenders over its taxation choices and its reluctance to implement the sort of spending cuts that have toppled governments across Europe.

The previous round of measures failed to convince Brussels which forecast Hungary's budget deficit at 3.7-3.9 percent of economic output next year, above the government's target of 2.7 percent, due to lower growth and unfounded budget revenues.

The government now expects growth of just 0.9 percent in 2013 after a recession this year, one of the weakest in central Europe due to weak lending, high unemployment and unorthodox policies that have deterred investments.

Hungarian debt yields rose 20-25 basis points on Wednesday, erasing part of a week-long rally, based on hopes of a quick international loan deal that had taken prices of the country's junk-rated sovereign debt to more than two-year highs.

Matolcsy struck an optimistic tone on Wednesday, saying he was still hopeful of a positive outcome with lenders.

But Orban, who abruptly ended another IMF programme shortly after taking power in 2010, faces an election in the first half of 2014 and is running a local media campaign to reject any IMF-imposed austerity. The latest steps also reveal a deep-seated reluctance to abandon his flagship flat tax policy.

GROWTH-UNFRIENDLY

When the IMF ended a preliminary leg of talks in Budapest in July, it said Budapest should abandon ad hoc tax measures, focus more on sustainable spending cuts and seek to restore the soundness of the heavily-taxed financial sector.

But "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," SEB said in a note, casting doubt over progress towards an agreement.

Matolcsy also said the government would levy a new tax on public utilities which will mainly apply to foreign firms, another rebuke to international advice to create a business-friendly environment and a level playing field for all firms.

With budget cuts announced earlier this month, the latest decisions bring deficit-shrinking to 764 billion forints next year in a country that has been reeling under such programmes since 2006.

"This second round is not something we like, we did not want to introduce most of these ... new steps," Matolcsy said, repeatedly criticizing the EU Commission's assessment of Hungary's previous set of measures.

Following a tumble in Hungarian assets late last year, Orban stabilized markets by pledging to seek aid from the EU and IMF.

Supported by cheap money from U.S. pump-priming measures and efforts by the European Central Bank to reduce the borrowing costs of struggling countries in the euro zone, investors have given Orban the benefit of the doubt.

While it has not tapped international debt markets this year, the government is under no financing pressures because it has buffers lasting well into 2013. There is no date yet for fresh talks with the IMF.

"The government returned to unorthodox measures," said Janos Samu an analyst at brokerage Concorde.

"This confirms my earlier view that there will be no credit deal unless markets force it on the government. If there is no market pressure, they see no need for a deal." ($1 = 213.29 Hungarian forints) (Reporting by Gergely Szakacs/Krisztina Than; Editing by Ruth Pitchford)