January 6, 2012 / 4:00 PM / 8 years ago

Orban fails to address Hungary risks

LONDON, Jan 6 (IFR) - Hungarian Prime Minister Viktor Orban’s conciliatory tone towards a potential IMF agreement is likely to provide only temporary respite to the troubled country and fails to address the fundamental problems that are still plaguing it, warn analysts.

Hopes have risen the government will reach a deal with the multilateral over a new facility after Orban softened his stance towards such a measure, following a traumatic week for Hungary’s currency and bonds. But with little idea about what sort of loan agreement may follow, including doubts about the extent to which Hungary will implement conditional reforms, analysts say the country remains in the mire.

“The new approach by the authorities - for instance, talking even to their central bank - may be good news, but this does not change anything fundamentally,” says Benoit Anne, head of EM strategy at Societe Generale Corporate and Investment Banking.

Earlier in the week, Anne wrote in a research report that the situation in the central European nation was fast deteriorating, propelled by a stand-off between the government and the IMF over possible new funds and a series of controversial policies by Orban’s government, including a law that the EU warns infringes the independence of the central bank.

“We might in fact just be a few weeks away in a worst-case scenario from a full-blown currency crisis, at which point the central bank will have no other option than hiking its policy rate aggressively - that is if there is still a central bank properly operating in Budapest by then, of course,” he said on Tuesday.

Anne added Hungary’s local bond markets were experiencing a bloodbath. The forint fell to an all-time low against the euro, hitting 324.2 yesterday before firming up to 316.05 by this morning.

In the bond markets, the sovereign’s 10-year benchmark traded above 11%, while a one-year bond swap auction yesterday cost the government 9.96%. Its five-year CDS spread rose to a record high of 736bp on Thursday, before falling to 695bp earlier today, according to Markit. FIRST BASE

How long the respite lasts remains to be seen but Anne reckons Hungary, which Fitch downgraded to BB+ with a negative outlook today, is the most vulnerable country in the emerging markets. “The risk of severe capital outflows is high, which may trigger a proper balance of payments crisis,” he added in a note posted on Thursday.

Investors will hope that Orban’s conciliatory remarks will prove to be a turning point. In 2010 he insisted Hungary had no need go to the Fund, despite deteriorating economic fundamentals, and has stuck to his guns ever since. However, even if he is considering a rapprochement with the IMF a quick deal is very unlikely and Hungarian asset prices will remain volatile for some time, say analysts.

“We are still at first base,” says Peter Attard Montalto, an economist at Nomura. “We think investors are still underestimating the time it will take and the distance Mr. Orban will have to move on the policy front to get a [precautionary standby] with the IMF/EU. The list of policy changes required is long, complex and fundamentally ingrained in [the ruling party] FIDESZ’s strategy and Mr Orban’s ideology of economic nationalism.

“It is much more complex than the very short list of likely conditions needed for formal negotiations to actually start. As such, while HUF assets may well be bolstered by the start of talks we think such a move could well be misplaced and reversed once the government’s feet dragging then restarts.”

Attard Montalto believes that only a full-blown balance-of-payments crisis will force Orban’s hand to accept conditionality around a potential IMF deal.

Timothy Ash, head of emerging markets research at RBS, says that while the government recognizes that an IMF deal will lower its borrowing costs it is weighing this up against the likely political costs - that is, the extent to which it has to back down on its principles. “Squaring that circle could still be difficult,” he says.

DEBT DEFAULT?

The escalating political and financial risks have led some commentators to raise the spectre of a debt default. But although Hungary has a big external debt burden - about 140% of GDP, according to RBS including public and private debt - and external debt service amortizations of around EUR36bn for this year, Ash says these fears are overdone. The debt amortizations include a significant amount of inter-company loans, often from European lenders to their Hungarian subsidiaries, and trade finance repayments. These should be manageable.

Of the overall money due, bankers forecast the sovereign will need to raise about EUR4bn through the international capital markets, of which only EUR1.5bn is bond market financing that needs to be rolled over. Clearly tapping the markets is not an option open to the sovereign, except at prohibitive rates, but if an agreement with the IMF is reached it should find access easier.

One pressure point, however, could be a big unwinding of portfolio flows. Last September, the stock of foreign investors in Hungarian government bonds reached a record high of EUR12.5bn, up by around EUR5bn since the beginning of 2011, according to RBS, as investors were attracted by the potential for higher carry. “The continued unwinding of these positions could clearly create some considerable pressure on the external financing front, and the forint as a result,” says Ash.

“Add to this a weight of capital flight perhaps expressed in the EUR2bn or so “errors and omissions” net outflow in 2011 and it is possible to see that despite the presence of a current account surplus, the forint could yet see more significant downside pressure,” he adds.

With the central bank unlikely to come to the currency’s rescue - given the fact that it has only about US$47bn of FX reserves at its disposal - the main line of defence is likely to be rate hikes, which would be bad for the economy and ultimately for the government’s public finances.

“The message is thus while the government does appear to have options, some time on its hands to drive a hard bargain with the IMF, this time is not infinite, and the longer it leaves it, the weaker its negotiating position is likely to become,” says Ash. (Reporting by Sudip Roy; Editing by Julian Baker)

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