beyondbrics

If Viktor Orban, Hungary’s recently-elected PM, was under any illusions that a two-thirds parliamentary majority would make life easy, Tuesday may have delivered something of a wake-up call.

In his inbox: protests over constitutional changes; international condemnation; and a small matter of bond yields at a two-and-a-half year high (not to mention recent downgrades by ratings agencies). On Tuesday Hungary sold three-month treasury bills at their highest yield since 2009, in the first debt auction since controversial new laws were passed that have put the possibility of assistance from the IMF and the EU in jeopardy.

The government raised 45bn forints ($190m), the full amount planned, according to government data published by Bloomberg. But the average yield increased to 7.67 percent, the highest for three-month debt since August 2009, climbing from 7.43 percent at the last – incomplete – bond sale a week ago. Yields on 5-year and 10-year bonds jumped about 50 basis points to around 10.40 per cent, the highest since June 2009. The forint was down around 0.2 per cent against the euro and 0.4 per cent against the dollar. The benchmark Bux equity index fell 1.22 per cent.

Standard & Poor’s cut Hungary to non-investment grade in December, following a similar downgrade by Moody’s, after the IMF and the EU suspended bailout talks citing proposed bills curbing the central bank’s independence. Those bills have now been passed and, as predicted, the markets are giving Orban’s policies short shrift.

So as Hungary’s borrowing costs rise, what are the government’s options? One suspicion is that new laws pushed through parliament allowing the National Bank of Hungary to merge with the country’s supervisory authority were created so the bank’s foreign exchange reserves can be used as a backstop if IMF talks fail. The government faces external borrowing requirements of €4.6bn in 2012.

This is Gyula Toth of UniCredit in a note to clients:

We currently estimate that the whole economy will have about €14bn external financing requirements. In [the case of] no IMF deal and no Eurobond issuance this borrowing need could be covered by FX reserves which would decline by about 13 per cent. This in turn could undermine local confidence in the currency and capital flight could intensify.

Peter Attard Montalto of Nomura put it even more bluntly:

Back in September I came in for a lot of stick from [the government] and [the national bank] for a chart alert I wrote about government policy likely being to use bank reserves to repay maturing FX debt through 2012 that could not be rolled over. The government said it wasn’t true (despite my understanding that it was on table) and the bank said it would never happen… either way regardless of the use, the reserve story is now mainstream and I think reserves (ex new IMF) can be on a downward path this year and loose an additional €5bn odd or more on top of other forms of intervention and bank support already occurring.

Not everyone has written off the deal. Zoltan Torok, head of research at Raiffeisen Bank in Budapest, told beyondbrics:

“For the time being, it seems that the Hungarian government is not being very constructive, not very cooperative, in the discussions with the IMF and EU. Obviously that causes further market turbulence, which makes refinancing even more difficult. So it is now a kind of vicious circle… [An] agreement is a 100 per cent certainty. It will come. But it is going to be a bumpy road.”

It will have to come sooner rather than later, though, if Hungary is to survive such very high borrowing costs without falling deeper into crisis.

So what next? Key date for the diary: talks with the IMF are due to resume on January 11. The outlook? As Simon Quijano of ING put it: “look for more noise ahead, with even the spectre of possible capital restrictions mounting by the day if no solution is found”.

And Benoit Anne of Société Générale sounded the alarm:

We might in fact just be a few weeks away in a worst-case scenario from a full-blown currency crisis. At which point, the central bank will have no other option than hiking its policy rate aggressively, that is if there is still a central bank properly operating in Budapest by then.

Sounds ominous. Welcome to 2012, Hungary style.

Additional reporting by Neil Buckley in Budapest

Related reading:
Hungary cannot continue to argue with the facts, FT
beyondbrics Hungary file
Hungary poised to widen rift with west, FT