by Win Thin
Markets have given a big thumbs down to the austerity measures announced by Hungary this week, with the forint and foreign currency bonds giving up some of their recent gains. The government is still trying to go it alone without a new IMF program, which expires this month. Improving EM sentiment has lifted the entire asset class, even the EM countries with poor fundamentals like Hungary. Hungary’s so-called “crisis” taxes on energy, telecoms, and retail industries have not gone over well with the markets, which were hoping for more progress on spending cuts as Hungary already has one of the highest tax burdens in Eastern Europe. This comes after a bank tax was announced earlier this year that both the ECB and IMF have criticized. These taxes are supposed to be temporary, but we suspect that the government will find it hard to give up those revenues in the future. Also, the move to suspend Social Security payments to private pension funds for 14 months has raised eyebrows, as this is the sort of accounting gimmick that only serves as window dressing. Officials say that the government will eventually make up the withholdings and possibly the interest, but is clearly a sub-optimal policy.
The government has done little to improve its credibility with the markets, as the recent forint strength and sovereign bond spread tightening are really due to the overall rally in EM assets and not from anything Hungary has done. EUR/HUF has put in a near-term base around 270 and we think current levels offer value to go long EUR for a move back to the 279 and then 282 areas (50% and 62% retracement levels of the Sep-Oct drop). We also favor going short HUF vs. TRY and PLN. In the former, we think a near-term low was put in place around 136 and look for a move back to 145. In the latter, we look for a move back to 73 from current levels around 70.33.
Markets have simply gotten too bulled up on Hungary and are overlooking serious fiscal and downgrade risks ahead. S&P said earlier this year that it may cut Hungary’s current BBB- rating to junk after talks with the IMF collapsed, while Moody’s put Hungary’s Baa1 rating on review for possible downgrade in July. S&P is closest to our own sovereign model (junk) rating of BB+/Ba1/BB+, while Moody’s is most out of line. Fitch has Hungary at BBB. Unemployment remains high, and domestic activity remains quite weak. Central bank would probably like to cut rates during this period of forint strength, but may not do so given fiscal uncertainty.