Fund to Hungary: drop dead (maybe)

By T.E. | BUDAPEST AND E.L. | WASHINGTON, DC

MONDAY may be a good time to pick up Hungarian assets on the cheap. The IMF and the EU walked away from negotiations with the Hungarian government on Saturday after the latter refused to give in to the international organisations' demands for more clarity on the country's plans for tax and spending. It seems safe to assume the Hungarian forint will start the week with a sharp lurch downwards.

And in a world where a misspoken word by a formerly obscure town mayor in a provincial city in eastern Hungary can wipe out trillions in global asset values, it is likely the impact of this weekend's events will make itself felt in emerging markets from Malaysia to Argentina.

All parties said talks would resume, but the uncertainty is the last thing Hungary, or any other emerging market needs to see right now.

The EU and the IMF wanted to see a commitment to spending cuts, reforms to ill-run state enterprises like the railways, and a clearer picture of how the government would be raising revenues.

One bone of contention was the government's planned windfall tax on banks and other financial institutions - from which it is hoping to raise some Ft200bn (€700m) a year over the next two years. Assuming it works—and Italy's Unicredit or Austria's Erste have plenty of other places to put their money—the international lenders wondered whether a windfall tax was a good basis for sound fiscal policy.

The IMF called for “durable, non-distortive measures,”

“Difficult decisions will be needed not only on the revenue side--where the high financial sector levy, which is likely to adversely affect lending and growth, is planned to be temporary—but also on the spending side.”

In an equally blunt statement, the European Commission wondered how Hungary was going to meet its 3 per cent budget deficit target for 2011, and urged the government to review “certain features” of the bank levy.

The talks breakdown will not cause immediate funding problems. After sharp spending cuts and tax hikes, Hungary finished 2009 with a 4 per cent budget deficit, one of Europe's lowest, and was not planning immediately to draw on its IMF/EU credit line. But the government was hoping to secure a “precautionary” extension of its standby agreement in to 2011.

As Nomura said in a note, the failure to issue a polite communique is:

“...a very rare event, countries usually go out of their way to satisfy these missions. The IMF has said indeed that they didn't even get to discuss the extension as they didn't reach agreement on the current SBA."

This was not a government dead set on pleasing its guests. Local media reported during the negotiations that the IMF was not pleased that Viktor Orban, the prime minister (pictured), chose to be in South Africa watching the World Cup final when the delegations arrived. Nor can it have helped that Sandor Csanyi, head of OTP, Hungary's largest bank, was there at the same time. It was also unfortunate that an amendment to the windfall tax law was introduced while the IMF was in town, one which would exclude seven insurance companies set up since 2007 from the tax, including one on whose board sits a key economics adviser to Mr Orban, along with several politicians from his Fidesz party.

One explanation for this intransigence is that Fidesz is under pressure. The party won a landslide election victory just three months ago with promises to “save the healthcare system”, spur economic growth and, above all, cut taxes. Last year's fiscal consolidation came at great social cost, and the outgoing government paid a heavy political price for it. The banking tax is an attempt to square the circle.

Local elections are due in October, and yapping at Fidesz's heels is Jobbik, a far-right nationalist party even less obeisant to the etiquette of international finance than Fidesz.

This was their response to the debacle:

“We can guess at the choreography that will follow from Monday: politicians, analysts and journalists serving the global financial powers will lay into the government for not giving into foreign pressure. Jobbik will not be part of this... The discussions with the IMF and the EU are a key front in the fight for economic independence,” they wrote, evoking the spirit of the “fight for independence” that followed the 1848 revolution against the Hapsburgs in Vienna.

From inside the country, the government feels pressure to take a bolder, even reckless, approach. Mr Orban himself talked about “debt rescheduling” in remarks to businessmen two years ago. Austerity has its limits. So does lenders' patience.