Tim Gosling in Prague
April 25, 2012
Confirming intense market speculation following meetings a day previously, the European Commission gave the green light for Hungary to open talks on a loan programme with the International Monetary Fund and the EU on April 25.
Commission spokesman Olivier Bailly told reporters in Brussels that it is "ready today to enter into the negotiations on financial aid that Hungary asked for." The next step is to examine the “modalities of these discussions,” he added, according to Bloomberg.
Facing mounting storm clouds across Europe, Brussels had blinked first in its stand off with Budapest a day previously on April 24. Following a meeting between European Commission President Jose Barroso and Hungarian Prime Minister Viktor Orban, dwindling hopes that Budapest is really pushing for a loan programme from the IMF and EU were revived.
The Hungarian PM emerged from the meeting in bullish mood, suggesting that it may have finally opened the way for talks to start, after a five month delay during which relations between the pair have grown steadily more antagonistic.
Given that Orban has made numerous similar claims during that time, the response was wary. Until, that is, economy commissioner Olli Rehn indicated that the commission is now unlikely to follow through on its threats to refer its dispute with Hungary over its recent central bank law to the European courts, having noted concessions from Hungary.
The case will be dropped “provided Hungary follows through on the measures it has communicated,” reads a note by the EU executive, reports Euractiv. “The commission is prepared to close this case once the legislation is adopted.”
The central bank issue has been the major stumbling block to Brussels' approval for talks with the IMF to start, and although the commission said it still plans to take Hungary to the European Court of Justice over data protection and judiciary issues, analysts and the market leapt on the news.
"We assess yesterday’s signals … significantly positive," write Erste analysts, saying that "[the] developments confirm our earlier expectations that the agreement with the IMF/EU on a financial aid will be reached, probably in [the third quarter of 2012]." Meanwhile, the forint strengthened strongly against the euro and Hungarian CDS spreads fell following the meeting, and the confirmation that the talks can go forward sparked more buying.
The news clearly "suggests a softening in the [commission's] line," points out Tim Ash at Royal Bank of Scotland, who joins other analysts in pointing to the deteriorating climate across Europe as the probable key.
With the EU's Merkozy-led austerity demands now provoking political instability in the core EU, and news flow hinting that the debt crisis is about to reassert itself, Brussels looks to be pulling back from a stance that has become more and more hard-nosed as economic sentiment improved through the first quarter of the year. As Ash puts it, the commission has "blinked first."
The political messes in France, the Netherlands and the Czech Republic - all powered by opposition to austerity - clearly offer some support for Hungary's position, including its "unorthodox" economic policies, despite having bludgeoned Western European banks, telecoms and retailers in a bid to avoid stringent austerity measures. At the same time, it's unlikely that Brussels wants to add another crisis country to a growing list by pushing Hungary to the brink.
However, whether that means a deal on new financing from the IMF and EU is likely to now be sealed quickly is a large conclusion to which to leap. "[W]e still have our doubts," says Ash. "Indeed, given the past track record of relations between the various sides, negotiations are still likely to be tough (taking perhaps a month plus, rather than a few weeks), with the IMF still likely to drive for tough conditionality which could still be resisted by the Hungarian side."
To illustrate that point, Orban has twice insisted within the last seven days that his country does not need a loan but a "safety net". That appears a clear reference to his intention to pursue the sort of "precautionary arrangement" enjoyed by robust economies such as Central European peer Poland, which comes with few strings attached. That's unlikely to be accepted by the IMF and EU however, as for them – along with investors sniffing at cheap Hungarian assets – the whole point of a potential deal is for its attached conditions to reign in Budapest's policy making.
"[Another] risk," to a deal, points out Ash, "is the danger that the government seeks to take advantage of short term positive market momentum by seeking to tap the Eurobond market, before any … deal is concluded. We still think this is possible, but would expect the government will want to let the market benefit from any "feel good factor" for some time yet, to reduce its borrowing costs, before coming to market."
However, just as Orban has gained from the reinvigoration of the debt crisis, so it appears to limit his options. The swell of conflict is fueling risk aversion in Europe, which will, as ever, hit CEE assets across the board hard. That will test the Hungarian government's clear hope (despite denials of a "plan B") that it can use the prospect of an IMF/EU deal to stave off market pressure and wait out the crisis until it can finance itself through the markets instead.
Whilst the market response to the improved relations between Brussels and Budapest will obviously be enthusiastic in the short term, investors are likely to be more wary should agreement during the negotiations drag on in similar fashion to the route to opening them has, especially should the situation across the wider Eurozone continue to deteriorate.
Still, Erste is convinced the bailout is on. The bank's analysts say that with an autumn deal now looking even more likely in their opinion, "we maintain our assumptions that Hungarian markets may appreciate from the current levels until this year-end. We confirm our earlier year-end target of 282.5 for the €/HUF and 7.9% for 10-year yields."
In contrast, Ash remains on the fence despite the market's enthusiasm. "Ultimately this could all end in disappointment, i.e. no near term deal with the IMF/EC over financing," he worries, "but short term technicals/momentum seems supportive of this trade."