June 8, 2010 / 10:54 AM / 7 years ago

Hungarian PM vows tax cuts, targets banks, FX loans

<p>A clerk displays forint banknotes at Hungary's largest bank, OTP, in Budapest June 7, 2010.Laszlo Balogh</p>

BUDAPEST (Reuters) - Hungary's prime minister vowed on Tuesday to introduce a flat income tax and a tariff on banks, cut some public pay and ban foreign currency mortgages as he strove to reassure investors he can contain the budget deficit.

After sweeping an April election with a two-thirds majority, Viktor Orban unveiled a program departing from that of the previous caretaker Socialist cabinet that cut spending last year after narrowly avoiding economic meltdown in 2008.

Despite warnings his center-right Fidesz party's pro-growth strategy could undermine Hungary's pledges to cut its budget deficit under a 20 billion euro international aid package, Orban said boosting jobs and output were key to economic recovery.

Struggling to win back market confidence after Fidesz officials rattled investors by warning of a Greek-style debt crisis last week, Orban said he would enact a flat 16 percent income tax over two years, effectively cutting the rate.

He said his government would cut taxes to small and medium firms and ban foreign currency mortgage lending.

Those loans have been a crucial driver of Hungary's economy this decade, but have created a huge FX debt risk for Hungary.

Orban signaled his government would pay for the tax cuts by levying a new tariff on banks.

"We would like to start talks with the banks about what the base of this tax would be, how the burdens would be shared by banks, insurers and leasing companies, and we propose that we should introduce this for 3 years," he said in a speech.

Orban also vowed to freeze costs at state institutions, reduce some state wage costs by 15 percent.

The move would include a cut in salaries for board members of state-owned firms, and the central bank, whose governor, Andras Simor, Orban has clashed with and said should resign.

Mixed Reaction

Fidesz officials have shied from statements that hit global markets last week and helped push the euro to a four-year low, in which they said Budapest may face a similar crisis to Athens.

Hungary's deficit and debt ratios to GDP are not as high: public debt was about 80 percent last year, just over the EU average, against 133 percent projected for Greece this year.

But analysts said it still needed to pursue fiscal consolidation and questioned how such significant tax cuts plans would square with fiscal targets agreed under a European Union/International Monetary Fund bailout underpinning the export-heavy economy of 10 million people.

Officials said at the weekend they would stick to the deficit target agreed with the EU and IMF of 3.8 percent of gross domestic product, and Economy Minister Gyorgy Matolcsy said spending cuts of 1.0-1.5 percent of GDP were needed.

Some market watchers welcomed the flat income tax, noting similar schemes in Slovakia and Romania led to higher budget revenues because the lower rate cut down on tax evasion.

But they added that Orban had given few details on his plans and it was not clear whether the tax moves had been adequately offset by spending cuts, which had been the main pillar of the previous caretaker government's strategy.

"They are trying to pursue elements of their pro-growth strategy... There is real fiscal loosening going on in terms of the tax cuts," said Nomura economist Peter Attard Montalto.

Moody's investor service said on Monday that Fidesz's willingness to consider unorthodox pro-growth measures were credit negative.

News portal Index, citing unnamed sources, said the cabinet had bowed to EU and IMF pressure and would abandon channeling private pension funds to the state budget to raise income -- a proposal some analysts said was tantamount to nationalization.

Some analysts said reform plans were still lacking.

"We still hope (maybe naively) that the government will use its significant majority in Parliament to put through reforms in the welfare, education, health and local government sectors to continue with fiscal consolidation," Gyorgy Barta at CIB said.

Markets Rally

The forint pared short-lived gains in volatile trade. It was 0.8 percent up on the day at 282.8 to the euro, slightly down from levels before Orban's speech. The 5-year bond yield dropped around 15 basis points.

But after some early positive assessments of the proposed steps, analysts said the tax on banks and ban on foreign currency lending would hit banking profits and could smother growth, seen up 0.5 percent after a 6.3 percent fall in 2009.

The head of Hungary's banking association, Tamas Erdei, said a foreign currency mortgage ban would be acceptable, but the planned tax would be "drastic" and extremely harmful, damaging banks' capital position and reducing lending.

The country's largest bank OTP held onto gains, trading up 1.6 percent at 1400 GMT but still 12 percent down from last week. Analysts said the news of the tax was expected and had not changed the overall value assessment on the bank.

Economists said a bank tax would restrict a crucial driver of Hungary's feeble recovery and the entire plan left questions on budget sustainability unanswered.

Reporting by Krisztina Than; writing by Michael Winfrey; Editing by Ron Askew $1=239.80 Forint

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