By Win Thin
The European Commission cleared the way today to start talks for an aid program for Hungary, citing “sufficient action and commitments” from officials. Talks had been held up since Hungary’s initial November 2011 request for aid due to objections to several questionable moves by the government. Hungary submitted an amended plan earlier this month, and today the EU gave the go ahead to talks. We must stress that opening talks does not mean that a deal is going to be easy. In our view, Hungary did the bare minimum to get the EU back to the negotiating table, and that difficult negotiations remain ahead. On a separate but related note, Hungary still faces a decision by the EU on an Excessive Deficit Procedure. The government has sent a convergence plan to Brussels this week, which Hungary hopes will be enough to close the procedure. If not, then Hungary would likely lose some EU funds.
Hungary has been saying the right things recently, but the EC news was a surprise in that was Commission was willing to accept “reassurances” from Hungary rather than a real resolution to outstanding issues. The EC surprise was enough to catch a heavily skewed market leaning the wrong way, with EUR/HUF falling to lows not seen since February. The 286 area is key, representing February lows as well as the last major retracement level of the big July 2011-January 2012 move up in EUR/HUF. Break would target that July low around 262. Talk is cheap in Hungary, and now comes the hard part. Let’s review what has actually happened and what still needs to be done.
Hungary said it “guaranteed” central bank independence and pledged not to expand the Monetary Policy Council under current Governor Simor’s tenure. His term ends March 2013, so that part of the pledge is hardly reassuring to us. Recall that the government of Viktor Orban proposed an expanded MPC as well as a huge salary cut for central bank officials as part of a perceived effort to erode the independence of monetary policy. With regards to the potential infringements on judicial and data reporting independence, the EC has referred it to the European Court of Justice and so this issue remains a potential sticking point.
Interestingly, the IMF has remained silent on these new developments. In effect, we think the IMF is wary of more promises and wants to see more concrete progress. We find it very telling that the senior Hungary official heading up talks with the IMF said today that the country is aiming for a precautionary package that will serve as a safety net, not for an actual loan to be tapped. That suggests continued pushback against conditionality, which is something the IMF will not and should not compromise on. If Hungary is hoping for an FCL, they can forget about it. Hungary simply does not have the fundamentals to qualify. If Hungary is saying they will try to get a standard program but not tap funds from it, the IMF will still insist on conditionality.
Looking ahead, the economic backdrop is not conducive to serious fiscal tightening. IMF sees zero growth in 2012 after growing 1.7%in 2011 and 1.3% 2010. We think the risks of a contraction this year are quite high given Hungary’s dependence on exports to Western Europe. As a result of the weak growth trajectory, the fundamentals continue to deteriorate. Our own sovereign ratings model shows Hungary falling into BB-/Ba3/BB- territory from BB/Ba1/BB last quarter. This suggests further downward ratings pressure on the current actual ratings of BB+/Ba1/BB+.
Monetary policy is a question mark despite today’s news. Several MPC members have ruled out any easing until an EU/IMF deal is at hand. Given the likelihood of a drawn out negotiating process, rates are likely to stay on hold at 7% for the time being. Next meeting is May 29, but minutes to the April 24 meeting are due out May 9 and could provide some insight into MPC thinking. Rates were kept at 7%, but apparently the MPC also discussed both a 25 bp cut and a 25 bp hike. Inflation appears to be easing somewhat, but at 5.5% remains far above the 2-4% target range. The poor growth outlook supports easing, but the timing remains open to question.
Bottom line: Hungary has done enough to get the talks going, but have yet to convince us that the pieces of the puzzle are in place to actually get a deal done. Negotiations are likely to drag on, and while Hungary may finally reach acceptable compromises on the outstanding issues, we then move on to the problem of implementation. Don’t forget that the last IMF program for Hungary collapsed when the country missed its performance targets (conditionality) and then dropped out rather than stick with the targets.