Hungary Warned Against New Laws that Violate European Pacts

Late on Wednesday, Standard & Poor’s issued Hungary’s second credit rating downgrade to ‘junk’ in the last month, citing center-right government’s unpredictable policies and renewed meddling with the independence of the central bank. Moody’s also cut Hungary’s debt to junk grade last month.

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Hungary’s downgrades heightened the risk of a full-blown market crisis, and investors are waiting anxiously to see whether they will push the country to seek an international aid deal, or whether they will conversely see Hungary move further away from such a deal.

The European Commission said on Thursday that Hungary has yet to respond formally to a letter from European Commission President Jose Manuel Barroso seeking the withdrawal of legislation Brussels believes to be in violation of European Union law.

The dispute is over a new central bank law, which the EU says threatens the bank’s autonomy. The EU claims that the law led to a collapse of informal talks with the International Monetary Fund and the European Union last week over a proposed financial safety net that would protect the indebted country during the Continent’s financial crisis.

“President Barroso asked for the bills to be withdrawn, because he’s concerned that they might contravene the treaty,” said Commission spokesman Olivier Bailly. However, at this point, “it is still up to the Hungarian authorities to respond to the president’s request.”

Bailly says Budapest has requested talks on possible financial support from the EU and IMF, which would likely start in January with formal discussions. The Hungarian government has said it expects official aid talks to start on January 10.

But Brussels and the IMF have warned Hungary than any financial assistance would come with conditions attached, something Prime Minister Viktor Orban and his aides have said is unnecessary and unwelcome.

Preliminary talks between Hungary and EU and IMF officials broke off last week as Hungarian lawmakers sped up consideration of the central bank law, which the European Central Bank and the National Bank of Hungary have both said poses a serious threat to the independence of the country’s central bank.

Last night, Standard & Poor’s lowered Hungary’s long-term credit rating by one notch to BB+, one step below investment grade, because of its central bank’s policies. The downgrade sent the forint currency lower and lifted bond yields, adding to the pressure on Orban to begin negotiations with leaders on a funding backstop.

Orban’s Fidesz party is expected to push through legislation this year that would establish “insurance” type funding that would help Hungary retain access to the markets next year. It would change the management structure of the central bank and the makeup of its interest-rate-setting committee, and the EU and IMF say the financial-stability law, which would also set tax and debt policies, could limit the government’s flexibility to negotiate budgetary requirements in any loan package.

However, Orban says he does not want lenders interfering with his unconventional economic policies. Hungarian officials say the proposed legislation won’t impinge upon the central bank’s freedom. A senior Hungarian lawmaker said Tuesday the act had been amended to address many of the issues raised by the EU.

Since Orban’s Fidesz party was swept into power with a two-thirds majority in April 2010, his government has stabilized its budget with a series of ad hoc taxes and nationalized pension assets. Several of its measures have shocked investors and earned the ire of the European Union. Barroso asked in his letter for the central bank bill to be withdrawn.

Orban has proposed several amendments, but has left some contentious parts about the expansion of the Monetary Council intact. Orban says the Hungarian government and the country’s central bank should cooperate to provide funding for the economy.

If Orban does not withdraw or at least delay the bill, it is likely no deal would be struck with the EU and IMF. Without such a deal, the forint currency would be further weakened, in turn causing the government’s borrowing costs to soar and making it harder for the country to raise the necessary funds to sustain deficit-reduction targets.

Hungary is aiming for one of the EU’s lowest budget deficits next year at 2.5 percent of gross domestic product. Hungary needs to roll over 4.8 billion euros in external debt next year. The debt agency said on Thursday that its net financing needs for 2012 totalled 674 billion forints and that it would borrow 4 billion euros in hard currency from the market or other sources.

Hungary sold 30 billion forints worth of 12-month Treasury bills at an auction on Thursday, the first test of market sentiment following the S&P’s downgrade. The sale was reduced in size by 10 billion forints, and the yield climbed 62 basis points to 7.91 percent compared to a previous auction two weeks ago. The yield on Hungary’s five-year bonds climbed to 9.10 percent.

“Hungary’s economic fundamentals do not justify a junk rating, but the damaging policies of the Hungarian government have undermined investor confidence and this is the key reason why both Moody’s and S&P have decided to cut Hungary’s rating,”
Danske Bank said.

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