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Analysis: IMF, EU agree Hungary rescue

  The IMF, the EU and World Bank agreed to a $25.1 billion economic rescue package for Hungary which exceeded expectations and is seen boosting investor confidence in the country’s currency and markets.

 

Hungary turned to the IMF for help in order to shore up its forint currency and markets and shield the economy from the global financial crisis. The package, also taking into account Hungary’s FX reserves of about €17 billion ($21.6 billion), is more than sufficient to cover Hungary’s short-term financing need of around €32 billion in the next 12 months, including a current account deficit of about €5.6 billion expected for 2009.

The IMF help comes with conditions. It has forced the government to make additional painful spending cuts, including a reduction in social spending and public sector wages, which had been regarded as taboo so far. As a result, Hungary’s budget deficit is expected to fall to 2.6% of gross domestic product next year, much narrower than a projected 3.4% this year.

 

WHAT DO WE KNOW ABOUT THE DEAL?

* An IMF staff mission and Hungary have reached agreement on an economic program supported by an €12.5 billion loan under a 17-month Stand-By Arrangement.

* The package could go to the IMF Executive Board for approval in early November.

* The EU stands ready to provide a loan of €6.5 billion, and the World Bank has agreed to provide €1.0 billion.

* Core measures under the program are designed to improve fiscal sustainability and strengthen the Hungarian financial sector. The package includes measures to maintain adequate domestic and foreign currency liquidity, as well as strong levels of capital, for the banking system.

* Hungarian authorities have developed a policy package that will bolster the economy’s near-term stability and improve its long-term growth potential

* Measures in the fiscal area will reduce government- financing needs and ensure longer-term debt sustainability.

WILL INVESTORS APPROVE?

* Analysts said the deal would boost market sentiment, help stabilize Hungary’s currency and financial markets and prevent further capital outflows. The package is more than sufficient to help cover the country’s external financing need in the next 12 months.

Analysts had estimated the IMF package would come in at around $12 billion.

Orsolya Nyeste, analyst at Erste Bank on October 27: “Taking Hungary’s international reserves amounting to €17 billion, the €5 billion credit facility from the ECB and the estimated IMF support into consideration, these altogether should mean €32 billion, which fully covers the debt of the country, maturing in the coming 12 months. The announcement with the Fund should help to restore the confidence on domestic markets.”

Gergely Tardos, OTP Bank on October 28: “In order to minimize the risk of further (forint) depreciation, and to restore battered confidence, the ECB repo framework deal is good news, and so is the IMF deal which is about to be signed, as with these investors will believe that Hungary will not lose its solvency.”

 

WHY DOES HUNGARY NEED HELP?

* Hungary is seen as one of the most vulnerable countries in eastern Europe to the global credit crunch due to its large debt, reliance on external financing and large-scale foreign exchange borrowing in the past few years.

* Earlier this month ratings agency Fitch cut Hungary’s outlook to negative from stable, citing downside credit risks. Shortly afterwards, Standard & Poor’s put the country’s credit ratings on review for a possible downgrade.

* After a foreign currency lending boom, over half of bank lending to the private sector is in foreign currencies, and nearly 90% of all new household loans are in foreign currencies, mainly in Swiss francs and euros.

* Western European parent banks will likely reduce foreign currency lending to their subsidiaries and several banks have already restricted or suspended foreign exchange lending as banks have difficulty in hedging these exposures in international money markets.

* While the debt management agency has stressed the state’s financing is secure for the rest of the year, Hungary will need to keep financing its debt next year.

* Excessive forint weakening would increase the loan repayments of households and may increase the risk of more Hungarians having difficulty with repayments.

 

WHAT KEY MEASURES HAS HUNGARY TAKEN SO FAR?

* The central bank hiked the benchmark base rate by 300 bps to 11.50% as of October 22 and made it clear that it was prepared to defend the forint.

* The central bank has signed a €5 billion FX swap line with (ECB).

* It has also launched auctions where it buys government bonds in order to boost the bond market.

* The government has announced additional significant fiscal tightening for 2008 and 2009. (Reuters)