Hungary fiscal efforts in right direction, but IMF deal needed, says City

Hungary's fiscal and monetary policies are moving broadly in the right direction, but a precautionary stand-by arrangement with the IMF is needed to shield the economy against heightened global volatility and to reduce the risk of Hungary losing its investment grade status, London-based emerging markets economists said on Monday.

Analysts at BofA Merrill Lynch Global Research, the investment research unit of Bank of America-Merrill Lynch said in a report released to investors in London that they had recently visited Budapest and their talks confirmed "small but steady reform steps" continuing to be made by the government.

"The good news is that most of the structural measures announced last April have been implemented or are broadly on track to be completed by year-end as promised".

However, "while we believe that both fiscal and monetary policies are broadly attempting to steer the economy in the right direction, we remain of the view there isn't enough ammunition left to protect the economy" against an unfavorable global backdrop if the eurozone states, struggling with the fall-out of the sovereign debt crisis, do not take immediate action to stabilize the situation.

The report says that the domestic economy is "extremely weak and will remain so for years". Frequent changes in legislation, taxation and the spillover effects from the eurozone crisis continue to push the private sector into higher precautionary savings.

Furthermore, the rating agencies S&P and Moody's will visit Hungary this month, "raising new questions about Hungary's investment grade status" as both rank Hungary at the lowest investment grade level with a negative outlook. A downgrade would have "severe consequences" for Hungary, given the high reliance on foreign bond investors.

Given these conditions, a precautionary IMF program is "highly desirable at this stage, since it would support the execution of the fiscal tightening, reducing the risk of bond outflows and probably (that) of a rating downgrade".

In addition, the IMF could help in managing the restructuring of households' debt without causing unnecessary financial stability repercussions. "We believe that an IMF program is not currently the preferred option of (Prime Minister Viktor) Orbán, but we do not rule out that global conditions will lead to a reassessment", emerging markets economists at BofA Merrill Lynch Global Research said in the report.