Q+A: What next after IMF/EU suspend Hungary’s review?

By Gergely Szakacs

BUDAPEST (BestGrowthStock) – The International Monetary Fund and the European Union have suspended a review of Hungary’s 20 billion euro ($26 billion) financing agreement, but left the door open for more talks with the new center-right Fidesz government.

The decision means Hungary, which uses the package as a safety net, will not have immediate access to undrawn funds of 5.5 billion euros from the financing deal slated to expire in October.

Here are some questions and answers on what lies ahead:

WILL THERE BE A MARKET BACKLASH?

The forint, central Europe’s second-worst performing currency behind the Serbian dinar this year, is bound to weaken, probably in excess of 1 percent, and government bond yields will rise when local markets reopen on Monday.

That will increase Hungary’s borrowing costs and heightened market volatility may also force the central bank, which will discuss interest rates at a regular rate meeting on Monday, into adopting a more hawkish line.

The bank kept interest rates at a record low of 5.25 percent at the past two meetings after 10 months of easing worth 425 basis points. All 25 analysts in a Reuters poll on Thursday expected the bank to hold fire again.

But some analysts said that after Saturday’s unexpected suspension of talks with lenders, the bank may consider a rate hike if markets plunge on Monday.

Falls in the forint will also put pressure on Hungarian households holding trillions of forints worth of foreign currency (Read more about trading foreign currency. mortgages, primarily in the volatile Swiss franc, which hit record highs versus the forint in July.

With scarce details on the government’s plans for reforms and no clarity on its 2011 budget plans, a sustained period of uncertainty would have a negative impact on Hungarian markets.

WILL THERE BE AN AGREEMENT WITH LENDERS?

Analysts said despite the talks falling through this week, the government should eventually come to an agreement with the IMF and the European Union, but a deal may not materialize until local government elections due on October 3.

That will give more time for Fidesz to formulate plans on the 2011 budget and on how it wants to transform loss-making state transportation companies into viable businesses able to remain afloat without constant state support.

Analysts said the lack of agreement may also have been a tactical move by the government to postpone the announcement of painful budget cuts needed to cut the deficit below the EU’s 3 percent ceiling next year until after the October poll.

Hungary’s government must also seal a review of the current deal if, as announced earlier, it wants to secure a two-year precautionary agreement worth 10-20 billion euros to serve as a safety net in 2011-12.

DOES HUNGARY NEED IMF MONEY RIGHT NOW?

Hungary has been able to finance itself from the markets since last year and has all of its foreign issuance plans for this year already covered.

Earlier this week debt agency AKK sold all bonds on offer at an auction and raised its 10-year offer by 5 billion forints, with yields dropping about 25-30 basis points across the curve from the previous tenders two weeks earlier.

So far the state has drawn about 12.8 billion euros of the 20 billion available in the IMF/EU package and analysts have said it could safely finance this year’s budget deficit with the help of its available unspent IMF and EU funds worth about 3.5 billion euros. On top of this the central bank has called down 1.4 billion euros from the package and put it in its reserves.

CAN HUNGARY AFFORD TO ESCHEW AN IMF DEAL BEYOND 2010?

The government itself has said it would use a new agreement with the IMF and the EU as a safety net, and not rely on it to cover its funding needs for the next two years.

Analysts said not having a new agreement with international lenders after the current one expires in October would be risky as the deal would be an important credibility anchor but Hungary could still be able to finance itself from the markets.

In a worst case scenario, however, the lack of an agreement with lenders now may trigger a negative market reaction which would leave the government with no choice but to seek the IMF’s good graces again.

(Editing by David Holmes)

($1=.7706 Euro)

Q+A: What next after IMF/EU suspend Hungary’s review?