IMF presses Hungary on central bank law

Hungary must take action to guarantee the independence of its central bank before negotiations over a financial aid package can begin, a senior International Monetary Fund official told Emerging Markets on Thursday.

Budapest is seeking a precautionary credit line of E15 billion to stabilize its weakening economy and rein in its borrowing costs but the talks are on hold.

The IMF has insisted that Hungary amends laws that gave the government new power over the central bank and would dilute the governor’s power.

Mark Allen, the IMF’s senior official for the central and eastern Europe, told Emerging Markets in an interview: “The only precondition to the talks from our side is that adequate steps have to be taken to deal with central bank independence.”

Hungarian government passed legislation which changed the central bank act which caused problems for the European Union and they need to amend that legislation.

Other bones of contention include the recently-introduced flat income tax, which has seen the tax take drop, as well as a range of issues around state-owned enterprises. Neil Shearing, chief emerging markets economist at Capital Economics in London, said he had a “pretty bad prognosis for Hungary.”

He said he was more convinced than ever that his grim prediction of a 1.5% drop in Hungarian GDP this year – previously the bottom of his range – would be realised.

Agata Urbanska, central and eastern Europe economist at HSBC Bank in London said very weak growth numbers make it urgent for Hungary to secure a deal.

These negative growth predictions were echoed by Peter Attard Montalto, director at Nomura International in London, who has just slashed his growth predictions for the country. He now sees negative growth of 1.1% this year and a further 0.3% shrinkage next year.

That replaces predictions as recently as last week of a reduction in GDP 0.6% for this year and a healthy positive 1.7% for next year, he says. Lower GDP growth and the growing Eurozone crisis leaves even less wiggle room for the Hungarian government in dealing with the IMF and EU.

Until recently, Hungary got away with a tough negotiating position thanks to long-term refinancing operation (LTRO), which Shearing described as “a big sticking plaster over the European banking system”.

The European Commission had initially indicated it was prepared to accept “reassurances” from Hungary on key issues rather than concrete action but it has hardened its stance in line in line the IMF. “We aren’t prepared to move before the EU does,” Allen said.

Hungary appears to be one of the most vulnerable central European countries to eurozone instability. Shearing said the banking system was very fragile and there was a potential for “an explosive credit crunch before Christmas”.

Even if that does not transpire, he sees a gradual squeeze as parent banks deleverage, particularly as Hungary is dominated by western European financial institutions.

Once Hungary accepts IMF conditions, change could come fast. Montalto said Hungary’s objections to change will be dropped in June or July depending on the Greek crisis. That might enable a financial backstop to be in place by the end of the third quarter. “There will be muttering about cuts to the interest rates as soon as those talks start,” he said.