Economy
Hungary will never be best buddies with EU/IMF, but will make concessions for bailout - Morgan Stanley
Pragmatism will prevail
Pasquale Diana, Executive Director, CEE Economist at Morgan Stanley in London, believes “there will probably never be a smooth relationship between the current Hungarian government and the EU (or the IMF), but even so, he thinks that “pragmatism will prevail and the Hungarian authorities will make the necessary concessions in order to seal the deal."
He expects a EUR 15-20 bn SBA, noting that Budapest will likely continue to treat this arrangement as precautionary.
“Policymaking is very centralised in Hungary around the figure of PM Orban. This is why his recent conciliatory tone towards the IMF and EU is the strongest indication that a deal is likely to eventually materialise," Diana said in a trip note dated 10 February.
75% chance
While acknowledging that it is difficult to make predictions when policy is so dependent on one person, Diana thinks that the PM will choose to be pragmatic.
“Making compromises in order to reach a safety net with the EU seems a small price to pay," he said.
“Conversely, making yet another U-turn and calling off the negotiations with international lenders would renew concerns about funding, possibly lower the forint and create deposit outflows," Diana added.
In his view, concessions to the EU/IMF are a “far more rational course of action" from Orbán’s point of view, especially in light of recent experience: HUF, bond yields and deposits all reacted negatively when the relationship with the international lenders deteriorated last December.
Citing opinion polls (showing Fidesz has lost a lot of ground and is polling around 20%), Diana said disillusioned Fidesz supporters are joining the ranks of the undecided, rather than turning to the opposition.
“This is very fertile ground for the emergence of a new party," he added.
Diana also interprets the recently seen stabilisation of support for Fidesz as “a sign that domestic voters do not see the recent more conciliatory stance towards international lenders as a sign of weakness."
“This is another reason why an agreement with international lenders is probably the most rational course of action for the government."
Diana noted that action should finally follow words. “We will need something concrete from the government over the next week or so, which looks likely to be the case according to recent commentary."
“Also, the authorities would like the government to take ownership of the programme, and not to simply view it as a safety net that it can just abandon or choose to overlook once funding markets improve. Following recent developments, our subjective probability of a deal by March-April is around 75%," he added.
Other investment banks in the City, however, take a different view and expect slower progress in the bailout talks. Barclays Capital Emerging Market analysts said in one of their latest research note that a “sensibly" assumable target month for a new IMF/EU deal to come into effect is June, considering the time needed to implement the required law changes and to assess these.
Preconditions, conditions, policy advice and deal-breakers
Prior to their trip, Morgan Stanley’s economists thought the main obstacle to the official start of the negotiations was the issue of the Central Bank Act. And in particular, the issues related to the governor’s salary, the number of MPC members, the MPC oath to the government and the merger between the financial markets watchdog (PSZÁF) and the central bank (NBH).
“While a compromise on the NBH Act seems fairly easy to reach, in our view, our trip has revealed that the judiciary issue is as important as the NBH Act," Diana said.
Diana noted that at this point it is not clear how the judiciary issue will be addressed, and the EU has not provided clear guidelines.
“Given the rising tension in Brussels regarding the Hungarian government, the European Commission is likely using this opportunity to exert as much pressure on Hungary as possible."
The ball is in Hungary’s court and the government has until 17 February to come up with some proposals to address the Commission’s concerns (i.e. a month after the infringement procedure was initiated.)
The next parliamentary session begins toady, so Diana presumes some measures will be presented soon.
Local newswires reported this week that the government is willing to let judges work beyond the age of 62, essentially reversing the recent changes.
“And while the issues of NBH salaries and MPC members having to take an oath to the constitution are likely to remain sticking points, we do not think that these are likely to be deal-breakers," the analyst noted.
The preconditions are really the conditions
Once the two key issues are resolved (NBH Act and the judiciary) Diana believes an agreement with the EU/IMF is well within reach. Based on previous experience, he estimates that two to three weeks would be sufficient to announce a package.
“In other words, the preconditions to start the talks officially are really also the conditions needed to complete the talks successfully."
Suspension of cohesion funds unlikely
European Union finance ministers (Ecofin) endorsed on 24 January the European Commission's view that Hungary had failed to take sufficient action to bring its budget deficit below the EU ceiling in a sustainable way, opening the way to freezing EU funds for Hungary from 2013.
Diana thinks that suspension of cohesion funds would be a “harsh decision and would only be carried out under extreme circumstances."
“After all, the EU has a great deal of leverage over Hungary now, but we believe that it would not want to set any precedents on this issue."
Rate cuts may be ahead
Assuming that a deal is struck by April at the latest, Diana thinks that interest rates have peaked at 7.00%.
“The support coming from an important external cushion, the weak state of the domestic economy and the lower sensitivity to FX swings are all good reasons to expect the NBH to adopt a more dovish stance in the coming months," he said.
Diana therefore expects the central bank to gradually move to an easing bias.
“Assuming external risks are capped by a sizeable (EUR 15-20 billion) precautionary SBA, we think that the NBH will be able to take back at least the recent 100bp of rate increases by the end of this year." He thus sees rates at 6.00% by end-2012.
Other City banks are of the same view.
In a weekly emerging markets report, JPMorgan said about two weeks ago that the near-term rate outlook remains highly dependent on progress with IMF/EU talks and global risk appetite. If EUR/HUF remains below 300 on a sustained basis, the NBH "probably would not feel compelled to raise rates further from here".
"Renewed uncertainty" over PM Orbán’s willingness to agree to the full set of conditionality imposed by the IMF and the EU could still prompt the Monetary Council to hike another 50 bps in coming months.
Assuming a Stand-By Arrangement is concluded in the second quarter, however, "we remain of the view that the NBH could start to reverse its rate hikes in late 2Q or early 3Q, taking the policy rate back to 6.00% by end-2012", JP Morgan’s London-based analysts said.
Pasquale Diana, Executive Director, CEE Economist at Morgan Stanley in London, believes “there will probably never be a smooth relationship between the current Hungarian government and the EU (or the IMF), but even so, he thinks that “pragmatism will prevail and the Hungarian authorities will make the necessary concessions in order to seal the deal."
He expects a EUR 15-20 bn SBA, noting that Budapest will likely continue to treat this arrangement as precautionary.
“Policymaking is very centralised in Hungary around the figure of PM Orban. This is why his recent conciliatory tone towards the IMF and EU is the strongest indication that a deal is likely to eventually materialise," Diana said in a trip note dated 10 February.
75% chance
While acknowledging that it is difficult to make predictions when policy is so dependent on one person, Diana thinks that the PM will choose to be pragmatic.
“Making compromises in order to reach a safety net with the EU seems a small price to pay," he said.
“Conversely, making yet another U-turn and calling off the negotiations with international lenders would renew concerns about funding, possibly lower the forint and create deposit outflows," Diana added.
In his view, concessions to the EU/IMF are a “far more rational course of action" from Orbán’s point of view, especially in light of recent experience: HUF, bond yields and deposits all reacted negatively when the relationship with the international lenders deteriorated last December.
Citing opinion polls (showing Fidesz has lost a lot of ground and is polling around 20%), Diana said disillusioned Fidesz supporters are joining the ranks of the undecided, rather than turning to the opposition.
“This is very fertile ground for the emergence of a new party," he added.
Diana also interprets the recently seen stabilisation of support for Fidesz as “a sign that domestic voters do not see the recent more conciliatory stance towards international lenders as a sign of weakness."
“This is another reason why an agreement with international lenders is probably the most rational course of action for the government."
Diana noted that action should finally follow words. “We will need something concrete from the government over the next week or so, which looks likely to be the case according to recent commentary."
“Also, the authorities would like the government to take ownership of the programme, and not to simply view it as a safety net that it can just abandon or choose to overlook once funding markets improve. Following recent developments, our subjective probability of a deal by March-April is around 75%," he added.
Other investment banks in the City, however, take a different view and expect slower progress in the bailout talks. Barclays Capital Emerging Market analysts said in one of their latest research note that a “sensibly" assumable target month for a new IMF/EU deal to come into effect is June, considering the time needed to implement the required law changes and to assess these.
Preconditions, conditions, policy advice and deal-breakers
Prior to their trip, Morgan Stanley’s economists thought the main obstacle to the official start of the negotiations was the issue of the Central Bank Act. And in particular, the issues related to the governor’s salary, the number of MPC members, the MPC oath to the government and the merger between the financial markets watchdog (PSZÁF) and the central bank (NBH).
“While a compromise on the NBH Act seems fairly easy to reach, in our view, our trip has revealed that the judiciary issue is as important as the NBH Act," Diana said.
The judiciary issue in a nutshell
Starting on January 1, 2012, the government lowered the retirement age of judges from 70 to 62 years. This would force 274 judges to retire early, in a move which the EU judged discriminatory on age grounds: the EC does not see any objective justification for treating judges and prosecutors differently than other groups, especially at a time when retirement ages across Europe are being progressively increased, not lowered.
Also, the Hungarian government has already communicated to the Commission that it intends to raise the general retirement age to 65, which raises even more questions about the judges’ issue.
Also, the Hungarian government has already communicated to the Commission that it intends to raise the general retirement age to 65, which raises even more questions about the judges’ issue.
Diana noted that at this point it is not clear how the judiciary issue will be addressed, and the EU has not provided clear guidelines.
“Given the rising tension in Brussels regarding the Hungarian government, the European Commission is likely using this opportunity to exert as much pressure on Hungary as possible."
The ball is in Hungary’s court and the government has until 17 February to come up with some proposals to address the Commission’s concerns (i.e. a month after the infringement procedure was initiated.)
The next parliamentary session begins toady, so Diana presumes some measures will be presented soon.
Local newswires reported this week that the government is willing to let judges work beyond the age of 62, essentially reversing the recent changes.
“And while the issues of NBH salaries and MPC members having to take an oath to the constitution are likely to remain sticking points, we do not think that these are likely to be deal-breakers," the analyst noted.
The preconditions are really the conditions
Once the two key issues are resolved (NBH Act and the judiciary) Diana believes an agreement with the EU/IMF is well within reach. Based on previous experience, he estimates that two to three weeks would be sufficient to announce a package.
“In other words, the preconditions to start the talks officially are really also the conditions needed to complete the talks successfully."
Suspension of cohesion funds unlikely
European Union finance ministers (Ecofin) endorsed on 24 January the European Commission's view that Hungary had failed to take sufficient action to bring its budget deficit below the EU ceiling in a sustainable way, opening the way to freezing EU funds for Hungary from 2013.
Diana thinks that suspension of cohesion funds would be a “harsh decision and would only be carried out under extreme circumstances."
“After all, the EU has a great deal of leverage over Hungary now, but we believe that it would not want to set any precedents on this issue."
Rate cuts may be ahead
Assuming that a deal is struck by April at the latest, Diana thinks that interest rates have peaked at 7.00%.
“The support coming from an important external cushion, the weak state of the domestic economy and the lower sensitivity to FX swings are all good reasons to expect the NBH to adopt a more dovish stance in the coming months," he said.
Diana therefore expects the central bank to gradually move to an easing bias.
“Assuming external risks are capped by a sizeable (EUR 15-20 billion) precautionary SBA, we think that the NBH will be able to take back at least the recent 100bp of rate increases by the end of this year." He thus sees rates at 6.00% by end-2012.
Other City banks are of the same view.
In a weekly emerging markets report, JPMorgan said about two weeks ago that the near-term rate outlook remains highly dependent on progress with IMF/EU talks and global risk appetite. If EUR/HUF remains below 300 on a sustained basis, the NBH "probably would not feel compelled to raise rates further from here".
"Renewed uncertainty" over PM Orbán’s willingness to agree to the full set of conditionality imposed by the IMF and the EU could still prompt the Monetary Council to hike another 50 bps in coming months.
Assuming a Stand-By Arrangement is concluded in the second quarter, however, "we remain of the view that the NBH could start to reverse its rate hikes in late 2Q or early 3Q, taking the policy rate back to 6.00% by end-2012", JP Morgan’s London-based analysts said.
