Hungary must cut spending because a plan to impose temporary taxes and retain pension-fund savings will fail to control the fiscal deficit from 2013 and risk long- term funding, Morgan Stanley and UniCredit SpA said.
The end of special corporate taxes, designed to bring down the deficit through 2012, and the introduction of a flat personal-income tax rate will create a shortfall in 2013 of about 700 billion forint ($3.6 billion), or 2.5 percent of gross domestic product, estimates from the two banks show.
“We found no clarity at all on measures to fill this structural hole, which will emerge fully in 2013, and we do not think it is likely that any will be announced any time soon,” Morgan Stanley analysts Pasquale Diana and Chuan Lim in London wrote in a report to clients yesterday.
Prime Minister Viktor Orban imposed a three-year tax on the financial, energy, telecommunications and retail industries to generate 343 billion forint of budget revenue this year. Hungary, which received a bailout in 2008 to avert default, is trying to convince investors it can finance itself without International Monetary Fund assistance.
The European Union country will cut as many as 30,000 public-sector jobs next year to help cut the fiscal gap to 2.94 percent of GDP from 3.8 percent this year and will use revenue from private pension savings to reduce the country’s debt, Economy Minister Gyorgy Matolcsy said on Oct. 30.
“Although the measures will undoubtedly improve the near- term deficit outlook, we believe the long-term financing risks are increasing,” Gyula Toth, an emerging-market strategist at UniCredit in Vienna, wrote in an Oct. 31 report.
The forint has been the world’s best-performing currency in the past eight weeks, with a 6.3 percent gain versus the euro. The government pledged on Sept. 8 to narrow the gap to 3.8 percent of GDP this year and below 3 percent in 2011, abandoning a fight with the IMF and EU over the same targets.
The government’s measures extend “uncertainty” about the country’s credit rating, Manik Narain and Gyorgy Kovacs, economists at UBS AG in London, said in an e-mailed note late yesterday. Moody’s Investors Service and Standard & Poor’s are reviewing Hungary’s grades for possible reduction.
“The government’s commitment to the 3 percent deficit and the likely acceleration of reduction in the public debt stock is positive,” Narain and Kovacs wrote. “On the other hand the reversal of pension fund reform and heavy reliance on temporary measures increase uncertainty.”
Hungary plans to partly use the proceeds from the new taxes to finance a reduction in the personal-income tax rate to 16 percent, a move designed to help boost growth. The economy is recovering from its worst recession in 18 years and the IMF last week said growth and tax revenue may miss government forecasts.
“Assuming no more expenditure cuts, the end of the crisis taxes and the introduction of a flat personal-income tax” would “increase the deficit by 2.5 percent to 3 percent of GDP in 2013,” UniCredit’s Toth wrote. “This comes on top of a hefty redemption schedule in 2013.”
The government will have to repay about 6 billion euros ($8.3 billion) of local-currency debt and 6.4 billion euros of external debt in 2013, compared with total redemptions of 8 billion euros next year, according to UniCredit’s estimates.
“In order to compensate for this, the government will need to adjust its expenditures and/or hope for a significant acceleration of GDP growth,” Toth wrote.
Hungary’s parliament on Oct. 26 approved the suspension of mandatory social-security payments to private pension funds until the end of next year. That will boost 2011 state revenue by 360 billion forint, and another 540 billion forint may come from savers who will choose to move their private pension-fund portfolios to the state, Matolcsy said.
“Another, very serious long-term issue is what will happen to the pension system after December 2011, when in principle the government should once again start making payments” into private pension funds, the Morgan Stanley analysts wrote.
The government may continue to divert all contributions to the state-run system beyond 2011, heading toward “full-scale nationalization of the pension funds,” Diana and Lim wrote. While that would bring “short-term improvements” in deficit and debt levels, relying solely on the public pay-as-you-go system “is probably not viable in the long run,” they wrote.
Longer-term Hungarian bonds have declined in the past three weeks on concern the new taxes will hurt the economic recovery, lifting the yield on the forint-denominated note due in 2015 to 6.726 percent at 5:53 p.m. in Budapest from 6.481 percent on Oct. 13. The 10-year yield has risen to 7.028 percent from 6.771 percent in the period, while two-year bonds are little changed.
The cost of protecting Hungarian bonds against non-payment with credit-default swaps advanced to 281 basis points yesterday from 258 on Oct. 13, CMA data show. The price of default swaps, or CDS, rises as risk perceptions deteriorate.
“We recommend taking profit on outright CDS seller positions,” UniCredit’s Toth said. “We also see logic in switching long-maturity Hungarian bonds to shorter maturities.”
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