BUDAPEST—Moody's Investors Service's downgrade of Hungary's debt to "junk" status late Thursday is raising the pressure on Budapest to make concessions in its negotiations for help from the International Monetary Fund and the European Union, and sparked an angry reaction Friday from the government.
Hungary's Economy Ministry issued a statement Friday morning portraying the ratings downgrade—which triggered a sharp drop in the local currency—as part of a series of "financial attacks" on the country. It said Moody's unfavorable review had "no real basis," adding the government budget deficit is shrinking and the economy is expanding.
Unconventional policy choices by Prime Minister Viktor Orban's administration, heavy public debt and worsening economic conditions in the euro zone, Hungary's most important export market, however, have spooked investors, driving up government borrowing costs and hitting the currency.
That forced Mr. Orban to last week reverse himself and seek support from the IMF and EU, which he had spurned last year in an effort to gain more freedom in economic policy making. Gyorgy Matolcsy, Hungary' economy minister, said the country is now seeking a precautionary standby arrangement or precautionary credit line from the IMF as insurance against market turmoil.
A return by Hungary—a member of the EU but not of the euro zone—to an IMF-supervised program as part of a standby loan arrangement with the IMF, would be welcomed by capital markets as a sort of guarantee of good behavior by Budapest. It is unclear, however, how much control Mr. Orban would be willing to cede.
"It's really up to the Hungarian government right now—how much they are willing to cooperate, adjust and take the necessary steps," said a person familiar with the Hungarian request. Any form of support would come with significant conditions, the person said.
In 2008, Hungary became the first European country to be bailed out by the IMF and the EU when it was unable to finance itself through capital markets in the wake of the Lehman Brothers collapse in the U.S. and the onset of the global financial crisis.
The Moody's downgrade, issued late Thursday, has narrowed Hungary's room to maneuver, and the reaction to it is a sign of the direction markets likely would take if the country fails to reach some kind of agreement for precautionary financing.
Standard & Poor's said earlier Thursday that it would wait to see what happens in talks between Hungary and the IMF and EU before deciding whether to cut Hungary's rating. Both S&P and Fitch Ratings put Hungarian government debt one notch above junk status.
On Friday, the Hungarian forint weakened against the euro and the cost of insuring Hungarian bonds climbed abruptly. Hungary's troubles also weighed on currencies in neighboring Poland and the Czech Republic, which fell amid a general retreat from emerging markets.
Moody's said it was lowering Hungary's rating because of "uncertainty surrounding the Hungarian government's ability to meet its targets" on budget deficits and debt levels over the medium term, as economic growth slows and borrowing costs rise.
The agency said that Hungary's "reliance on one-off measures" such as channeling privately managed pension funds back into state coffers, will not "improve debt sustainably in the long term."
Since breaking with the IMF and EU, Hungary has enacted a series of temporary windfall taxes and taken other steps, such as the pension restructuring, as stop-gap measures in the expectation that economic growth would resume and limit the need for further action.
The steps are expected to result in a government budget surplus this year, one of the few in the EU. The government says it is on track to limit the deficit next year to below the EU limit of 3% of gross domestic product. The government said it will also cut public debt, which stood at 82% in September, the highest level in Central and Eastern Europe.
Hungary now also is staring at a likely slowdown next year, if not a return to recession, which will make it harder for the government to meet its goals. The Hungarian government is forecasting growth of 1.9% this year.
Hungary isn't in immediate danger of running out of funds. But next year, it will need to start rolling over €4.7 billion ($6.3 billion) in external debt as it begins repaying the loans it received under the 2008 bailout by the IMF and EU.
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