Hungary still riskier than its CDS trend suggests

Hungary’s score trend remains one of the more potent stories emanating from Euromoney Country Risk's Q2 risk results (Euromoney Country Risk Q2 2012 Results: Global risk ratchets up in 1H 2012) where readers can be left in no doubt about the country’s fall from grace: “Hungary, the region’s worst performer, has fallen 5.2 points to 49.1, plunging 10 places in the global rankings to 67. Economists have responded to the government’s stalling programme of fiscal consolidation – complicated by a weak economy, currency depreciation and a delayed agreement with multilateral lenders – by downgrading the country across 10 of the survey’s 15 indicators since January. The borrower has slipped below 12 other sovereigns, including not only Croatia, Bulgaria and Portugal, but also India, Russia and Indonesia.”

Hungary’s CDS spreads may be improving – down to 468 basis points yesterday, from over 700 in early January – suggesting less risk of a default, but the situation remains precarious - in line with its ECR score trend.

Even the Organization for Economic Cooperation and Development cannot believe the government’s forecast of 0.1% real GDP growth this year. The OECD’s latest prognosis (Hungary: economic forecast summary, May 2012) suggests a 1.5% decline, which is bad news for the government as it deals with its deficit, and a public debt burden approximating 80% of GDP.

According to research trip notes passed on to ECR by Pasquale Diana, CEE economist at Morgan Stanley, and one of ECR’s contributors: “The IMF mission left Budapest, and it seems to us that while official commentary is overall broadly encouraging, there is still plenty of work to do."

“As far as we can see, these are the main points of disagreement between the Fund and Hungary at this stage:

The flat tax and its structure, which the IMF asked to be modified;

The macro assumptions behind the 2013 budget draft, which the Fund thinks are too optimistic (as the official IMF press release also suggests);

The Financial Transactions Tax, criticized also by the ECB this week. Chief negotiator Varga said he awaits suggestions from the EC on how to change the current tax, PM Orban sounded a bit more cautious on his intentions to amend the bill;

The role of the Fiscal Council (probably, we think, though not mentioned explicitly)."

“It seems to us that the negotiations will be bumpy and uncertain at times. We still expect a deal to be made (in late September, with risks of a later agreement), after which Hungary’s risk profile is likely to improve, which would allow the NBH to start cutting rates aggressively (by at least 150bp cumulatively in our forecast).”