Hungarian Bond, Currency Purchases May Be Premature, Barclays Capital Says

Investors snapping up Hungarian assets after declines in the country’s currency and stock markets earlier this week may be moving too soon as further losses loom, Barclays Capital said.

“It may be premature to consider the current price adjustment as a natural buying opportunity,” Barclays analysts Koon Chow and Christian Keller wrote in a note to clients today.

The International Monetary Fund and European Union on July 17 suspended talks with Prime Minister Viktor Orban’s government after failing to agree on fiscal targets needed to comply with the terms of Hungary’s loan. An IMF statement that “a range of issues remains open,” suggests “the differences are substantial and far from being concluded,” Chow and Keller said.

“An agreement would likely require a significant shift in the government’s attitude. It may actually require further market weakness to achieve an agreement,” the analysts said.

The forint on July 19 tumbled to the weakest level against the euro in almost 15 months after the government failed to gain IMF and EU approval for its budget plan. The currency has recouped 1.8 percent since then as investors took advantage of low prices.

Since Orban’s Cabinet took office on May 29, the currency has slipped 5 percent versus the euro and 11 percent against the Swiss franc. Consumer loans in franc account for about 20 percent of Hungary’s gross domestic product.

The cost of credit-default swaps protecting against a default on Hungary’s debt has risen 108 basis points since May 29 to 350 basis points yesterday, according to CMA data. The yield on Hungary’s benchmark 5-year bond has risen 76 basis points during that period to 7.30 percent.

‘Serial Deficit Offender’

Hungary’s government won’t impose further austerity measures even after falling out with its creditors, Economy Minister Gyorgy Matolcsy said, adding he expects a new loan agreement will “eventually” be reached.

The IMF estimated during its last review that measures equivalent to 0.3 percent of GDP are needed to reach this year’s 3.8 percent budget deficit goal. The EU requires its members to cap deficits at 3 percent of GDP, failing which countries are placed under excessive deficit procedures.

‘Allowing a serial excessive deficit offender like Hungary to re-negotiate fiscal targets agreed to under the excessive deficit procedure would send the wrong signal at a critical juncture,” just as Brussels is trying to push austerity across the region, the Barclays analysts said. “The IMF cannot overrule the EU in this matter.”

Avoid CDS

The Washington-based fund in March estimated a further 1.3 percent of cuts will be required to bring the deficit to below 3 percent next year, Barclays said. The government’s plans to give tax breaks to small businesses and introduce a 16 percent flat tax for Hungarians will cost the budget 1 percent to 1.5 percent of GDP, Barclays estimated.

Barclays expects currency and bond prices, especially short-term debt, to decline further. Investors should avoid using credit default swaps to cash in on expected losses because the contracts have underperformed other emerging markets, according to Barclays. Short-dated bonds are set to decline as investors brace themselves for possible interest-rate increases by the central bank to defend the currency, they said.

The central bank said on July 19, after keeping borrowing costs unchanged for a third month, that it may need to raise rates and will move to stem forint volatility. The bank also said it may continue to convert EU funds into the forint on the market.

“Even those investors who may see the current weakness in Hungarian assets as a buying opportunity are doing so because they believe the government will ultimately agree with the IMF- EU and not because Hungary is in a position to actually ‘go it alone’ without the IMF-EU supervision,” the analysts said. “Hungary requires continued close supervision by the EU and IMF for investors to feel confident.”

To contact the reporters on this story: Agnes Lovasz in London at alovasz@bloomberg.net

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