The EU And IMF Watch In Horror As Everything Goes To Hell In Hungary

Simone Foxman 

 Dec. 30, 2011

Hungary just approved a new central bank law, to the dismay of the International Monetary Fund and European Union.
It's the same law that caused the two international organizations to withdraw their support for Hungary's bailout earlier this month.
The law changes the way Hungary's central bank is managed, in a way the EU and IMF have argued will to compromise its independence from politics.

Hungary has been at the center of quiet economic angst in Eastern Europe, largely overshadowed by the sovereign debt crisis in southern Europe. Standard & Poor's downgraded Hungarian government debt to junk last week and the government staged the latest in a series of failed bond auctions yesterday.

However, Austrian banks' ties to the struggling country are the primary cause for concern in European economy. They have an estimated $226 billion in exposure to Eastern Europe, with €1.14 trillion ($1.6 trillion) of assets held in the region. Though the silent beneficiary of liquidity measures by the European Central Bank, yields on Austrian 10-year government bonds have risen to more than 2.93% this morning.

Image: Bloomberg Yields on Hungarian 10-year government bonds have spiked this year.

The fact that an estimated 50% of government debt is denominated in foreign debt seriously calls into question Hungary's ability to pay back lenders. The forint is hitting its lowest value against the dollar since early 2009 and bailout aid in jeopardy, the prognosis is grim for investors.

S&P synopsized Hungary's problems neatly in a note out earlier this month:

In our opinion, changes to the constitution and the functioning of some independent institutions, including the central bank and the constitutional court, have undermined Hungary's institutional effectiveness.

Following changes to the process of appointing members of the central bank's monetary policy committee in 2010, the authorities most recently have proposed legislation that we believe could further compromise the central bank's independence.

The EU and IMF had asked Hungary to consider other proposals for maintaining the bank's independence. In particular, the European Union disagreed with two major points of the new law—an increase in the number of representatives in the monetary council and the number of deputy governors and a stability law that would force banks to stomach losses on foreign loans.
Again, from S&P:

Moreover, we believe that measures taken over the past year, which affect several services sectors, could hinder economic growth by reducing banks' willingness to lend and companies' appetite to invest. In particular, the imposition of temporary tax hikes on various services--including telecoms,
energy, and the financial and retail sectors--is likely to depress investment and job creation in the short term, in our view. This could constrain growth prospects at a time when we see risks to the open Hungarian economy are rising due to the uncertain outlook for the global economy."

While Bloomberg reports that the EU government will examine the new law "in depth" and has sworn it will be "constructive" in its dealings with the country, continued government unwillingness to bend to the whims of international organizations bodes ill for the sustainability of government debt.