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Stock rally may end on elections, deficit concerns

Hungarian stocks may lose this year's gains as voters in municipal elections this weekend are set to reject the party of Prime Minister Ferenc Gyurcsány, who admitted lying to the public about the state of the economy. The BUX Index has climbed 5.7% this year, helped by a rebound from this year's low on June 16. OTP Bank Nyrt, the nation's largest bank, and Richter Gedeon Nyrt, the biggest drugmaker, have led the advance after the companies reported earnings that topped analysts' estimates. Gyurcsány, who has cut subsidies and increased taxes since his re-election in April, said in a tape leaked to the media last week that his party misled the public to win. His budget measures have been aimed at reducing the deficit, the biggest in Europe as a percentage of GDP. „Gyurcsány is key to the reforms,” said Jenő Nagy, who oversees about $2.9 billion at ING Investment Management in Budapest. „It would be very negative for the economy and markets” if his measures were stopped. Hungarians go to the polls on October 1 to elect mayors, city councils and county assemblies. While the outcome won't affect the standing of Gyurcsány’s ruling Socialist Party in parliament, the ballot is the first nationwide referendum after the release of the tape, which triggered the worst violence in Budapest since 1956 and calls for the prime minister's resignation. Support for the Socialists fell to 23% in August, according to a survey by Gallup, a US-based polling company. That's less than the 43% showing in the April election, when Gyurcsány took office for a second term. He later began austerity measures to tackle a spiraling budget deficit.
After the leaked tape on September 17 the BUX Index sank the most in three months in the week after the release, while bonds and the currency also tumbled. The stock benchmark recovered some of its losses this week. A ballooning deficit may trigger credit downgrades and further undermine investor confidence in Hungarian assets. Last week, Moody's Investors Service and Fitch Ratings put the country's credit rating on review for possible downgrade, citing concern that the protests may weaken the government's ability to push through reforms. Gyurcsány has refused to step down and said September 27 that he would continue his government's policies to cut the shortfall and to overhaul public spending. The Socialists hold 190 seats in the 386-member parliament and run the government through a coalition with the Free Democrats' Alliance (SzDSz). „If Gyurcsány’s party is defeated in regional elections, then the protests may renew,” Nagy said. „There is no one else we can imagine who would bring the reforms through.”
Shares of OTP lost 7.4% in the five days. Hungary's largest lender has still climbed 32% from this year's low in June on prospects for earnings growth as it spends more than $2 billion to expand in eastern Europe. The company reported a better-than-expected 23% gain in Q2 profit last month. OTP is a „proxy” for the economy, said Andrea Nannini, who oversees about $300 million at Bankinvest Asset Management in Copenhagen. The bank can suffer from an economic downturn as consumers take out fewer loans, he said. The bank accounts for 29% of the BUX, making it the biggest member of the benchmark index. Richter dropped 7% last week. The drugmaker, which reported record Q2 profit in July on a surge in exports, is still up 29% since June 16. OTP and Richter rebounded 7% and 1.4% this week, respectively.
Nerea Heras-Mendaza, who manages $193 million in east European stocks at Axa Investment Managers in Paris, cut her holdings this week in Hungarian equities on concern the deficit will increase. „I still want to see that government is really willing to cut spending,” Heras-Mendaza said. „The situation is not very good.” Not all investors agree. Stocks will probably recover as investors focus on the region's potential for economic and profit growth, said Thomas Farthofer, who manages $300 million at Bank Fuer Arbeit und Wirtschaft AG in Vienna. The turbulence „will last for a few weeks and then all the problems are gone with the wind,” Farthofer said. Companies such as OTP „have regional exposure and are not solely dependent on local markets.” Economic growth for countries in central and eastern Europe will average 5.3% this year, more than double the 2.4% forecast for the 12 countries that share the euro, the International Monetary Fund said on September 14. Hungary's economy will grow 4.5%, the IMF report said.
Still, European regulators this week reiterated that risks remain if the country's deficit isn't controlled. „Hungary appears to be at high risk with regard to the sustainability of public finances,” the European Commission said a report published September 26. The shortfall may reach 10.2% of GDP this year, instead of the government's goal of 10.1%, and be as much as 7.8% next year, above the 6.8% target, according to a report by Ecostat, the research arm of the country's statistics office, released September 26. The deficit was 7.5% last year, according to the government. „The situation doesn't look rosy,” said Viktor Baroti, who helps manage $2 billion at Erste Bank AG in Budapest. „We are uncertain until we see what will happen after the regional election.” (Bloomberg)