Hungary: Final U-turn towards International Financial Institutions

A new black Friday (6th of January) hit Hungary, when Fitch rating agency - following similar moves made by Moody’s and S&P’s over the previous two months - decided to downgrade the Country’s sovereign debt to junk status due to “uncertainties over Hungary’s eventual credit agreement with IMF-EU, threatened by further unorthodox economic policies undermining investors’ confidence”. The move brought the Country’s crisis to the world’s attention and induced Orbán’s Government to a policy shift over the weekend in favour of International Financial Institutions’ requests. Indeed, the Government announced its readiness to discuss “any kind” of credit line with IMF and EU, accepting implicitly the possibility of new conditions being imposed in return for the money, and that the central bank law would be open to discussion.

Background and Analysis:


Orbán’s cabinet turned back to the IMF and the EU already in Nov. 2011, announcing that it was willing to seek a new financing agreement in the form of a flexible or a precautionary credit line – following a weakening of the forint, an increase in bond auction yields, a rise in Hungary’s credit default swap rating to its highest in two and a half years, as well as growing market concerns over the Country’s debt financing capabilities and S&P’s warning it may cut the country’s credit rating to junk over the month. This decision marked already a U-turn in Fidesz Government’s policy compared to its previous last 18 months standing on the matter, when it insisted that Hungary could survive without multilateral help and rely only on market funding and “unorthodox” economic policies.

Negotiations are meant to start at the beginning of 2012. Nevertheless, a first disagreement already occurred in the middle of December when EU and IMF officials broke off preliminary talks because of fears the government was trying to limit central bank independence and lock in fiscal policies with two bills relating to financial stability and the reform of the Central Bank under parliamentary debate. Moreover, the IMF indicated that only a traditional Stand-by agreement with normal conditionalities would represent an appropriate programme for the Country. Nevertheless, despite EU, European Central Bank and IMF’s concerns, the Parliament approved this controversial legislation by the year end, thus causing in the following days strong negative markets’ reaction and finally forcing the Government to back down again.

The Government’s Chief IMF negotiator Tamás Fellegi has thus already started preparatory talks with IMF representatives in Washington on 9 January and met IMF Managing Director Lagarde on 12 January. The EU Economic and Monetary Affairs Commissioner Olli Rehn has reiterated that “securing Hungarian Central Bank’s independence remains one of the key issues for any help from the EU and IMF”. Meanwhile, the European Commission is close to concluding its assessment on the recently approved Central Bank Act. According to Fitch’s Head of emerging Europe sovereign ratings group “Hungary is left with no choice but to agree with the IMF/EU and it should do so by the end of June 2012”. The IMF support is seen as critical for stabilizing the markets and as a backup for Hungary’s debt financing at least in the short term.

Scenario:


The question is now how many real concessions the IMF and EU will be able to achieve from Orbàn’s cabinet in return for access to credit. Almost certainly, IMF-EU demands will insist on orthodoxy – meaning another round of cuts – and on a set of measures they will want to be chanced – other than securing National Bank’s independence, possible scrapping of Hungary’s banking tax and of other controversial policies.

Subsequently, the Government will necessarily come under further strain, not only internationally, but also domestically. First, in terms of further deceiving its electorate – this Government has been elected on a pro-growth and anti- austerity platform – and, secondly, in terms of increasing tension within the cabinet itself. The latter may further split between those who support the Orbán and Matolcsy’s “third way” attitude (main responsible of Hungary’s “unorthodox” economic policies and international contradictory communication) and those, such as Fellegi and Foreign Minister Martonyi, who represent a clearer Euro-Atlantic orientation within it. Therefore, a possible reshuffle of Government leading to some major figure changes within it (possibly including that of the Prime Minister) - coming along with securing the IMF-EU deal - may not be excluded by 2012 second quarter.