Will new Hungary central bank head spook the markets?

Hungary's Prime Minister Viktor Orban nominated Economy Minister Gyorgy Matolcsy as central bank governor to replace the respected Andras Simor, whose fight for central bank independence earned him Emerging Markets' Emerging Europe Central Bank Governor of the Year award in 2010.

As Simor's 6-year mandate was approaching the end, markets were awash with speculation that Matolcsy, whom Orban called "his right hand" according to Reuters, would take his place.

"This is the least risky decision,” Orban told Hungarian radio on Friday morning, according to the news agency.

Back in January, in its Article IV consultation concluding statement on Hungary, the International Monetary Fund (IMF) called on the government to ensure central bank independence, but analysts say that Matolcsy appointment will mean the monetary authority will bend to the government's will.

"Whilst we shall wait to see how things unfold our view is that Matolcsy will be there to build a close partnership with the government, there to do a politically motivated policy mix, and there to probably still very much be a FIDESZ person," Peter Attard Montalto, Nomura emerging markets analyst, wrote in a market note after the appointment.

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"The MNB is now a non-independent central bank," Montalto added.

Orban said the central bank remained independent.

Neil Shearing and William Jackson, emerging markets economists at Capital Economics, warn in a market note that "by appointing a party loyalist as governor, the current administration has tightened its grip over monetary policy."

They remark that Matolcsy has been "a chief proponent" of the unorthodox fiscal policies of the ruling Fidesz party, including the controversial bank tax, and that the government has already appointed 4 of the 7 members of the Monetary Policy Committee.

"This is likely to erode the central bank's independence and the credibility of policymaking, and thus increase the risk premia on Hungarian assets," Shearing and Jackson said.

SENTIMENT REVERSAL

In mid-February, Hungary sold $3.25 billion worth of 5-year and 10-year bonds, an offer that was heavily oversubscribed amid hunger for higher yields from investors in the context of near-zero interest rates in developed markets.

But with a central bank that is less independent and if external financing deteriorates, Hungary might struggle to attract capital inflows, Shearing and Jackson warned.

"Any turn in sentiment would see bond yields rise and the forint fall, thus raising the local currency cost of servicing foreign currency debt," they said.

"This would remove the space for rate cuts, and even force rate hikes in order to shore up capital inflows and the currency."

Some market participants believe that because of the high proportion of foreign exchange loans – with around 55% of private sector debt in euros or Swiss francs – the government will not allow the forint to weaken significantly.

But Guillaume Salomon, a strategist with Societe Generale – who recommended to investors back in January to short the forint ahead of the announcement about the new central bank head - does not share this view.

"The Fidesz government has proved very creative in generating measures to ease the burden of households and corporate," Salomon said. "This usually involves transferring the risk onto the private sector or the public sector, or a mix of both."

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