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Analysis - Risk seen rising in Poland, Hungary over budgets

PRAGUE (Reuters) - Investor concerns about soaring budget deficits in Europe may shift eastwards to Hungary and possibly Poland unless both countries back up one-off fiscal measures that have already unnerved economists with more durable reforms.

Hungarian Prime Minister Viktor Orban addresses journalists during a press briefing at the European Parliament in Strasbourg January 19, 2011. REUTERS/Vincent Kessler

From the Baltics to the Black Sea, the European Union’s eastern members are struggling to close fiscal gaps to avoid the type of market backlash that has driven bond yields to record highs on the euro zone’s periphery.

So far they have largely sidestepped the turmoil, drawing strong portfolio flows from investors fleeing very low interest rates in the developed world in favour of higher yields.

But with the government in the region’s biggest economy, Poland, eschewing fiscal cuts ahead of an autumn election, and Hungary’s centre-right cabinet pursing a pro-growth strategy that rejects austerity, economists say risks are rising.

“For the time being markets are focussed on the troubles in the euro zone’s periphery, and fiscal concerns in Eastern Europe - particularly in Poland - have slipped under the radar,” said Neil Shearing, an economist at London-based Capital Economics.

“The risk is that if and when the market’s attention shifts from Portugal, investors could start focus on those countries in the region that have so far talked a good game on fiscal austerity but yet to push through meaningful reforms.”

While euro zone policymakers step up efforts to contain the region’s debt crisis, analysts are looking forward to two events further east.

Hungarian Prime Minister Viktor Orban is expected to announce the details of a deficit reduction package next month.

And in Poland, all eyes are on whether Prime Minister Donald Tusk will tackle structural reforms following an autumn election he is expected to win.

A European Commission spokesman said on Thursday the EU executive had asked Poland for details of how it plans to cut the deficit amid doubts over whether it can meet an agreed deadline to trim the gap to below the bloc’s 3 percent of gross domestic product limit by the end of 2012.


Economists say that, on paper, Hungary is at the vanguard of deficit reduction efforts. It will become one of the EU’s only countries to hit the 3 percent target this year.

But it will do that with a series of one-off revenue boosting plans that include appropriating up to $14 billion in private pension assets and big taxes on banks and other mostly foreign-owned industries to cover its public spending shortfall.

Another is the government’s outlook. It expects growth of 3 percent in 2011 and 3.5 percent in 2012, accelerating to 5-5.5 percent in 2013-2015. That compares with European Commission forecasts of 2.8 percent this year and 3.2 percent in 2012.

This week, a Hungarian government official said Budapest would reveal a plan next month to trim 600 to 660 billion forints ($3.24 billion) from fiscal gaps in 2011-2013.

Investors said the structure of the plan was vital and if not deemed adequate, the market would punish Budapest, which has seen its 10-year bond yields rise 1 percentage point to 7.75 percent since Orban won last year’s election and is now rated a notch above “junk” by all three major ratings agencies.

“If they don’t deliver it could be very negative for Hungarian assets,” said RBC strategist Nigel Rendell.


Markets have been relatively bullish on the two countries this year. The Polish zloty is up 1.75 percent, and the Hungarian forint 1.9 percent.

Poland, the only country to avoid recession during the crisis, aims to cut its deficit under its EU convergence plan by a third this year and to 3 percent of GDP by 2012, from last year’s forecast 7.9 percent.

But analysts say those measures are based less on tackling big structural imbalances and more on boosting revenues and relying on an outlook for strong growth.

It will plug its 2011 budget hole with a $5 billion zloty privatisation campaign and will roll back one of its most successful post-communist economic reforms by shifting some of the $8 billion a year in private pension contributions back to state coffers to cover public spending.

This week, Anne-Marie Gulde, a senior adviser at the International Monetary Fund’s European department, said there was “an undefined structural adjustment needed to meet the deficit reduction programme target” for Poland -- meaning it would miss its 2012 goal without more action.

“We are certainly concerned in all countries there is a tendency to do one-off measures,” she said.

According to the European Commission, Poland’s 2011 cyclically adjusted net borrowing -- its fiscal deficit minus temporary measures like crisis-related unemployment costs -- will be 6.1 percent of GDP, versus 3.9 percent for the Czechs, 3.7 percent for Hungary and a euro zone average of 3.5.

That could cause a sharp market reaction if Tusk’s government does not address the budget’s structural imbalances.

“Once the Polish election has been and gone, the market will demand some fairly big fiscal measures,” Rendell said. “You can brush these things under the carpet for so long, but... if they don’t Poland could find itself out of favour pretty quickly.

Reporting by Michael Winfrey; Editing by John Stonestreet