(Edits, updates currency)
By Krisztina Than and Gergely Szakacs
BUDAPEST, Oct 16 (Reuters) - Hungary’s central bank took help from the European Central Bank and acted to bolster its banking sector on Thursday to stave off the effects of the financial crisis and avoid becoming the next Iceland.
The European Union newcomer’s prime minister also appeared to suggest that Hungary could join the ERM-2 euro zone waiting room before 2010 elections, a move that some analysts say could protect the country from market turbulence.
Investors have dumped Hungarian assets over fears its reliance on external financing and the high level of loans granted in foreign currency could spark a meltdown if foreign investors turn off the flow of euros, Swiss francs and dollars.
The government and central bank have scrambled to reassure investors and jump-start frozen markets in government bond and foreign currency swaps — somewhat obscure instruments that are crucial to Hungary’s financial health. After a government request this week for potential aid from the International Monetary Fund (IMF), Hungary’s central bank (MNB) on Thursday signed a 5 billion euro deal with the ECB allowing it to borrow if necessary to keep euros flowing.
The MNB also announced later on Thursday a key deal with primary bond dealers to kickstart bond markets.
Asked in an interview with the Financial Times whether Hungary could join the ERM-2 currency grid by 2010, Prime Minister Ferenc Gyurcsany said: “If all the relevant and not just the nominal conditions ... are favourable, yes we should.”
He gave no further details but has proposed that political and economic leaders hold a “national summit” on Oct. 18 with a view to adopting a plan to enter the euro zone and to discuss other strategic economic issues.
The central bank’s moves [ID:nLG296747] helped restore some confidence although by 1455 GMT the forint EURHUF=D2 had only recovered 1.8 percent of the previous day’s 7 percent dive.
“This is a first step in the right direction but it doesn’t mean the problem has been solved,” said Gyorgy Barcza, economist at KBC’s (KBC.BR) Hungarian unit. “The problem is not market liquidity but investor confidence.”
Standard & Poor’s on Wednesday said it put credit ratings for Hungary and Ukraine on review for a possible downgrade due to deteriorating financial sector conditions in both countries.
Finance Minister Janos Veres said the government will submit a new 2009 budget bill on Saturday which will include revised economic forecasts and a deficit cut to 2.9 percent of gross domestic product, from 3.2 percent earlier.
Veres said the IMF supported the measures, but he also repeated that Hungary would only use the Fund’s help in a worst-case scenario: “We maintain that this is a last resort”.
Hungarian officials have struggled to convince investors they are not in a similar situation to Iceland, on the verge of economic collapse following the collapse of its crown currency.
But it has had little success and investor flight has hammered its currency, stock and bond markets. The Budapest Stock Exchange lost almost 12 percent on Wednesday alone, though earlier gains mean it is only down half that since last week.
The foreign exchange swap market has all but seized up this week, creating a potential problem for the banking system.
Some banks have tightened or suspended foreign currency lending since Monday. On Thursday, a unit of Belgium’s KBC Group (KBC.BR), Hungary’s third biggest bank, stopped issuing two types of loans that required just 5 percent downpayments.
Most Hungarian borrowers — including 90 percent of mortgage borrowers this year — have taken loans in currencies with lower interest rates than Hungary’s 8.5 percent.
As western investors hold on to their own cash to protect themselves from the liquidity squeeze in more developed markets, that lowers the flow of hard currencies into Hungary and means banks have fewer funds to extend to borrowers or to refinance.
That could hit the economy, while a weaker forint also makes it harder for Hungarians to pay back loans in other currencies, even though analysts say real cracks would show only if the currency lost another 14 percent to around 300 forints per euro.
“The current dysfunction of the FX swaps market could cause a further FX devaluation, which would generate fundamental deterioration,” UBS analysts said. “It is imperative to stop this potential vicious circle at its first stage, in our view.”
To counter those effects, the MNB also launched a mechanism to offer FX swaps to boost euro liquidity, under which banks can deposit forints at the central bank and receive euros back at a predetermined price.
“We believe the measures ... are targeting the most problematic issues and may contribute to overcome the difficult period,” said Zoltan Torok at Raiffeisen. “Such a positive scenario requires global emerging markets panic to abate though — local measures cannot do miracles on their own.” (Additional reporting by Marc Jones in Frankfurt) (Reporting by Krisztina Than/Gergely Szakacs/Balazs Koranyi; Editing by Michael Winfrey and Patrick Graham)