The European Commission, the EU’s executive, on Feb. 22 proposed to suspend 495 million euros ($665 million) in development subsidies to press Hungary to narrow its budget deficit. The commission has said the decision is linked to the nation’s fiscal policy and not to recent infringement proceedings against the government in three areas including central-bank independence which have blocked talks on a loan.
The proposal comes “as the country is in the midst of engaging with the EU and the IMF on an urgent external financial support package,” London-based Moody’s analyst Alpona Banerji said in a report today. “Although the EC stated that” this is “separate from the IMF/EU support discussions, it accentuates nervous investor perceptions and adds to domestic political debate, adding difficulty to those talks.”
Prime Minister Viktor Orban is trying to revive bailout talks with the EU and the IMF, which he requested in November after the forint fell to a record against the euro and as rating companies including Moody’s cut Hungary’s sovereign credit grade to junk. Talks broke down in December after the EU and the IMF said a new law may undermine central bank independence.
The forint weakened 0.4 percent against the euro today to 292.32 at 11:20 a.m. in Budapest. The currency rallied 7.8 percent this year against the euro, the most in the world after Orban on Jan. 5 pledged to come to a “quick” agreement with lenders. The forint fell 16 percent in the second half of last year, the biggest decline in that period.
The cut in Hungary’s cohesion funding, affecting 29 percent of the country’s EU development subsidies, followed a commission report last month that said Orban’s government failed to curb the budget deficit in a sustainable way.
Since coming to power in 2010, Orban has effectively nationalized $14 billion of private pension funds and levied extraordinary taxes on energy, financial, retail and telecommunication companies to plug budget holes from tax cuts.
The Cabinet has argued that its planned multiyear spending cuts will yield the necessary savings to end the reliance on one-time revenue measures to meet deficit goals. The government targets a shortfall of 2.5 percent of gross domestic product this year and 2.2 percent in 2013.
Meeting budget targets has “significant risks, given the combination of a poor growth outlook, higher inflation and the fragility of the funding markets affecting the exchange rate and cost of funds,” Banerji said. “The absence of one third of what Hungary expected in cohesion funds will exacerbate the country’s challenge in meeting deficit targets and delay investment needed for growth, which is credit negative.”
The suspension of Hungary’s cohesion funds is “unlikely” while putting pressure on Orban to reach an agreement with international lenders is “probably welcome at this point,” Pasquale Diana and Jaroslaw Strzalkowski, London-based economists at Morgan Stanley, said in an e-mailed report today.
“This is because any such program will likely include conditionality on Hungary’s fiscal policy, including sustainable deficit cuts,” Diana and Strzalkowski said. “We think that such pressure from the EC is welcome at a time when benign market trends could potentially lull the authorities into a false sense of security and conclude that a package may not be needed after all.”
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