Hungary’s new Prime Minister Viktor Orbán, who took his oath in Parliament minutes ago, may ask the European Union and the International Monetary Fund (IMF), which provided a EUR 20 bn credit facility for Hungary, to let him loosen fiscal strings to foster growth after the worst recession since 1991, strategists at BNP Paribas SA and Budapest Investment Management told Bloomberg.

Orbán’s Fidesz party predicted during the election campaign that this year’s shortfall may be double the previous government’s target of 3.8% of GDP because it’s based on false figures.

Economy Minister-designate György Matolcsy is trying to persuade lenders to allow a gap of as much as 6% this year.

"Most of the investor community was just thinking this was pre-election rhetoric that would never be applied," Elisabeth Gruie, a London-based strategist at BNP Paribas, told Bloomberg in a phone interview yesterday.

"We’re having second-thoughts. This is a period of tentative risk appetite and the market will be quick to punish any expansionary budget policy."

The forint, which fell 4.1% against the euro in the past month, may decline a further 5% over the next month, Gruie said. The HUF was hovering between 275.50 and 276.00 shortly before 15:00 CET today. The yield on the benchmark three-year bond has fallen 73 basis points since mid-November.

"The impact on bond yields is much more muted as there are entrenched deflationary pressures on the economy which will compensate any budget-related sell-off," she said.

The IMF and EU have said the 3.8% target is attainable, and the EU, under procedures to curb excessive deficits, gave Hungary until 2011 to narrow its budget gap to 3% or face potential sanctions, including a suspension of grants.

Last time the European Central Bank (ECB) warned in its Convergence Report (earlier this week) that Hungary will need further consolidation measures in line with its commitments to the EU and the IMF.

"The government can say it’s gutsy and can widen the budget deficit but there’s no point taking the risk now," Daniel Bebesy, who helps manage USD 1.5 billion, mostly in Hungarian government bonds, at Budapest Investment Management, told Bloomberg by phone.

"We see how difficult it is to stop the slide once the market loses its confidence."

Bebesy has "continuously reduced" holdings of Hungarian government bonds, he said, adding that Matolcsy’s plan to reduce the budget gap by as much as 1 percentage point annually from next year "doesn’t appear too ambitious."

The government needs pro-growth policies to exit a "debt trap" that made Hungary "one of the world’s 10 most vulnerable" economies, Matolcsy said earlier this month.

Hungary’s general government debt is set to reach 79% of GDP this year, according to the European Commission, making it the bloc’s most indebted eastern member.

Two weeks ago, Matolcsy said the budget deficit that could be tolerated by the EU, the IMF and the market would be in a range between 4.5% and 6.5%. Later he revised this to between 5% and 6%.

Concerns build up

This is not the first time analysts have expressed their concerns about Hungarian assets. Credit Suisse said this week that the forint remains a vulnerable currency and that the haze about the new government’s fiscal plans weighs down on the HUF.

Analysts at Lombard Street Research said in mid-April that Hungary is vulnerable because of its reliance on foreign- currency loans, the level of government debt and an expected increase in the budget-deficit figure as the next government plans to consolidate losses at state-owned companies.

It is a bad omen too that Merrill Lynch that has been exceptionally upbeat about Hungary, have finally "got in touch with reality" last week and classified Hungary as one of the most vulnerable countries to contagion from Greece.

The forint will probably underperform other emerging- European currencies, because of fiscal risks and the new government’s intensifying conflict with the central bank, Gábor Ambrus, a Sofia-based analyst at 4Cast Ltd., said in a note.

"Markets have so far been overwhelmed by the external pressure back and forth but should these abate and local factors carry market weight again, we expect the forint's underperformance to be more pronounced," he added.

This, Ambrus noted, is only partly due to the row between Fidesz and the central bank, "other planned policy measures by Fidesz (such as converting household FX mortgage debt to HUF, tax cuts mid year and a massive slippage in the 2010 budget deficit) should equally keep the pressure on the local unit."

Central bank (NBH) Governor András Simor, his two deputies and the four outside members of the rate-setting Monetary Council should resign because of "policy mistakes" that included allowing increased use of foreign-currency loans in recent years, Matolcsy said this week.

Simor last week said the chances of the EU approving a wider deficit goal for next year were "doubtful" and urged the government to follow "very conservative" fiscal plans to convince markets the country can "outgrow" its debt."

Source: Portfolio Online Financial Journal