EU mounts pressure on Hungary to 'change policies'

Investors fear the government's refusal to meet EU and IMF demands could derail a hoped-for financing deal, leading to a full-blown market crisis.

Yields on 5-year and 10-year bonds rose to around 10.40 percent, the highest since June 2009 in illiquid trade, up about 50 basis points on the day before retreating slightly in afternoon trade.

The ruling Fidesz party pushed through a controversial central bank law in parliament last week despite EU requests to withdraw it, and Prime Minister Viktor Orban looks to be sticking to his government's unorthodox economic policies.

The government denied a news report yesterday which said it was considering tapping part of the central bank's foreign currency reserves to fund economic stimulus. But the government did not address another point in the report suggesting reserves could be used to repay local government debt.

The new central bank law is part of a campaign by Orban's Fidesz government to strengthen its influence over media and public institutions that has prompted protests from business, investors and the EU.

"In our view, there is only one reason for the escalation in the sell-off in the Hungarian markets and that is the increasingly erratic communication from the Hungarian government," Danske Bank said.

"The Hungarian government's rhetoric has become increasingly hostile towards international investors, the EU, the IMF, rating agencies and the country's own central bank. Unsurprisingly, this is scaring international investors."

The IMF and EU cut short informal discussions with Hungary last month due to objections over the central bank legislation. Orban had refused an EU request to withdraw the bill, saying he would not take orders from Brussels.

Informal talks with the International Monetary Fund are expected to resume on January 11 in Washington but it is not clear when formal negotiations about a new credit line could start.

European Commission President Jose Manuel Barroso has stressed the importance of safeguarding the independence of the central bank, the EU's executive said yesterday.

"Prime Minister Orban and the president have exchanged many letters during the Christmas holidays and last week, and the Commission president stressed that this principle of independence for the central bank must be safeguarded," the spokesman told journalists at a regular press conference.

"Finally, we received a translation of the law this morning. We are now going to analyse it and check to see whether this new law is compatible with (European) community law," he said.

Fidesz amended the law before it was passed to comply with most of the European Central Bank's requests but left two contentious parts intact. These are the expansion of the Monetary Council and the nomination of a new deputy governor, likened by current Governor Andras Simor to the post of "political commissar."

Analysts said the moves could increase the government's influence over central bank policies.

But while Orban is seeking a funding deal, he does not want lenders interfering with his policies, which included special taxes on banks and a renationalization of pension assets.

He told HirTV last month that Hungary would "stay on its feet" even if there was no agreement reached with the IMF.

Financial markets have started to price in the risk there will not be a funding deal. The forint traded at 315.20 to the euro yesterday, just off its all-time low at 317.90, and the cost of insuring Hungary's debt against default rose to 630 bps, according to Markit.

The debt agency sold 3-month treasury bills on Tuesday at an auction but the yield rose 24 basis points to 7.67 percent from last week.

Hungary was forced to seek a bailout from the IMF and EU in October 2008 when local debt markets froze up. Traders said market had not yet reached the same state.

"The situation is not like it was in 2008, but the market is kind of struggling," a fixed income trader said. "And this all is purely due to our (worsened) assessment by investors."