BUDAPEST Standard & Poor's on Friday cut Hungary's long-term credit rating, already in junk territory, by one notch to BB, saying its government's unpredictable policies could hurt medium-term growth.
The move came almost a year after S&P slashed Hungary to below investment grade on similar grounds and could hit the forint currency and Hungarian bonds when markets reopen on Monday, analysts said.
Further downgrades by other agencies are also likely as Hungary's prospects of clinching a financing deal with the International Monetary Fund and the European Union have all but vanished after a year of stop-go talks.
Its growth outlook has also been dimmed by a wave of tax hikes and fiscal cuts.
"The downgrade reflects our opinion that the government's unorthodox policies, including exceptional measures applied to the financial sector, could erode the country's medium-term growth potential," S&P said in a statement.
"This could eventually undermine the government's efforts to sustainably reduce general government debt."
Hungary's Economy Ministry reacted to the move with fury, saying S&P should "downgrade itself", arguing that its decision did not properly reflect the economy's fundamentals.
The three leading rating agencies have classified Hungary as "junk" for almost a year and Fitch has already said it plans to review Hungary's rating in the coming weeks.
"We can face a rating downgrade wave. The chance has increased that the forint will weaken to 290-295 ... while the government will continue to float the IMF deal," said David Nemeth, an analyst at ING Bank in Budapest.
Prime Minister Viktor Orban's government has repeatedly clashed with Brussels over his go-it-alone approach to cutting the deficit, which has tried to avoid outright austerity that might hurt public support.
Last month, his government again opted for tax hikes - on banks, foreign energy firms and public utilities - in a move that ran counter to IMF and EU advice.
In the past few weeks, Budapest has also chosen to plug a hole in its budget by extending a windfall tax on banks beyond 2013 and by announcing more new taxes - again, precisely the kind of measures its prospective lenders have opposed.
Orban faces elections in 2014, but analysts say the prospect of an IMF deal, which could restore his tattered policy credibility, is slight. The economy is mired in recession and Orban seem only ready to agree to a deal on his own terms.
S&P said it expected the government's fiscal targets to be met in the short term but said keeping the budget deficit under control could become increasingly difficult if growth remained subdued. Hungary's economy is expected to contract by more than 1 percent this year, and some analysts are predicting a recession next year.
S&P said the extension of taxes on the financial sector - which has been paying Europe's highest bank tax since 2010 - may further reduce banks' willingness to lend.
With its rating at BB and a stable outlook, S&P now has Hungary in the same category as Turkey, even though the fundamentals of the two economies are different in many ways.
But there is one similarity: Just like Turkey a few years ago, Hungary has been trying to buy time from investors by holding out the promise of an IMF deal.
"It seems that S&P was just as bored as the market in waiting a year for an IMF deal and so have downgraded," said Peter Attard Montalto at Nomura.
RATE CUT MAY YET COME
Hungary has announced three fiscal adjustment packages in the past few weeks to keep the budget deficit under the EU's ceiling of 3 percent of economic output to try to avoid losing millions of euros in EU development funds.
Its current account has been in surplus, but the domestic economy is in bad shape, with investment falling.
The Economy Ministry said the S&P downgrade should not be taken seriously.
"S&P tries to put the Hungarian economy into a category where there is no (other) country that has a budget deficit below 3 percent (of GDP), state debt on a declining course and a current account posting a sustained surplus," it said.
The forint traded at 282.50 against the euro at 1800 GMT, 0.4 percent weaker than it was before the downgrade, but it could fall further on Monday, when yields on longer maturity bonds could also rise 20-30 basis points.
The forint and bonds have been firming in recent months, supported by hopes of an IMF deal and the lure of high yields on global markets. Hungary's benchmark rate is at 6.25 percent, still offering a lucrative premium to investors.
"The forint has traded at the strongest end of its recent ranges in the past days. It's possible that it weakens now close to the weak end, beyond 285 of the euro on Monday," Nemeth said.
He said the central bank, which has been cutting interest rates steadily in the past three months to aid the economy, could cut further on Tuesday when it meets to decide on rates, provided the forint's falls are limited.
"I think the central bank will cut rates (despite the downgrade) if the forint stays firmer than 290, but they may halt (rate easing) if it weakens beyond 290," he said.
(Reporting by Krisztina Than/Sandor Peto; Editing by Ron Askew and Andrew Osborn)