ANALYST VIEW - Hungary vulnerability to worsening global risk sentiment may rise - Citi

Brace for bad news

In view of the latest developments related to the 2013 budget an increasing number of analysts believe that the signing of the credit deal with the IMF/EU will suffer a not insignificant delay.

In a research note published on Monday, Bank of America Merrill Lynch said the talks might even collapse. On Tuesday, Eszter Gárgyán, Citi’s Budapest-based economist, said the budget plans are working against a swift agreement.

“The supportive global risk environment has dominated local bond markets in previous weeks, disregarding the worrying fiscal and political news that points towards no progress in the IMF/EU loan talks in the absence of market pressure in the short term," she said.

The analyst noted that the recent rise in EUR/HUF has been in line with the correction in the Polish zloty and “does not suggest a deterioration in Hungary-specific risk assessment, while Hungarian CDS and bond yields continue to edge lower."

“This comes against negative recent headlines that potentially increase the probability of a stressful 4Q12 ahead in the absence of any real progress in the loan aid negotiations," Gárgyán added.

In her view, the finalization of the 2013 budget in an unchanged form from July by 28 September will likely complicate the loan talks.

Credit talks may not resume in Sept due to tax on central bank

The analyst reminded that state secretary Gyula Pleschinger’s interview in local print media (Magyar Nemzet) on the weekend has confirmed earlier news that the government will fight for the financial transaction tax levied on the central bank (NBH) and likely pass a budget bill that includes the revenue of 0.4% of GDP.

With regard to the FTT on the central bank Pleschinger noted that if the Bank incurs losses next year, the budget will need to compensate that in 2014. But he added that the FTT does not automatically mean that the NBH will make losses. The state secretary noted that the Commission expects Hungary’s budget deficit to remain below 3% of GDP also in 2013, which means there is some manoeuvring room (the target is 2.2% of GDP), only the cabinet “does not want to use that".

“Following the ECB’s negative opinion from July the EC is also assessing the impacts of the CB levy, which would only help the budget in 2013 as losses generated by the CB would have to be bailed out by the central budget in the following year," the analyst said.

According to local media sources Prime Minister Viktor Orbán is ready to fight for the levy and only surrender under the frames of a legal procedure with the EC, “which may remind investors of the long process over the Central Bank Bill that has been a precondition to start loan talks."

Given that from the IMF’s point it is for the Hungarian government to respond to issues raised by the Troika during the July visit, Gárgyán believes “it is uncertain if talks will resume in September."

No efforts seen to cut spending, funding needs

“Harmonizing growth forecasts and addressing taxation issues will also be more challenging once the budget bill is passed," she added.

“Fiscal plans to not demonstrate any effort to cut spending or funding needs," Gárgyán said, pointing out that Orbán has been advocating ambitious plans to cut personal income and corporate taxes further and is considering cutting VAT on special food items to offset draughts losses to producers.

The analyst also underlined that fiscal balance and funding reserves may also be impacted by plans to nationalize utility companies: The government is reportedly in talks to buy back the energy supply unit from German company E.ON.“The foreign affairs of the extradition of an Azeri convict to Azerbaijan which has led to the suspension of Armenian diplomatic relations with Hungary highlight efforts to utilize all potential tools to deepen economic ties with investors outside the Western world," Gárgyán said.

The conflict - which has also raised concern by the US and the European Commission - “may be in relation to either joint energy projects or FX bond purchase by Azerbaijan" (a week ago local media Figyelő has reported that Hungary may sell FX bonds to Azerbaijan of EUR 2-3bn) but both have been denied by the government.

Risks of forint weakening rise

The above arguments support the analyst’s view that “investors will likely be disappointed about local news in the coming months."

“Although market pressure may come delayed due to the expected FED and ECB policy actions, we believe with the start of the rate cutting cycle and negative fiscal headlines Hungary may become increasingly vulnerable to any deterioration in global risk sentiment," she said.

This, in her view, will likely limit the number of rate cuts the MPC can deliver this year therefore she maintains her year-end base rate forecast of 6.50% and sees risks skewed towards a weaker EUR/HUF rate.

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