Sunday, February 13, 2011

ANALYSIS-Better on paper, but Romania shunned for Hungary

By Michael Winfrey

PRAGUE, Feb 11 (Reuters) - Emerging Europe's two main economies to receive IMF bailouts, Hungary and Romania, are taking starkly different approaches towards recovery, but the latter's pursuit of orthodox policy is failing to woo investors.

Even with most economists skeptical of Budapest's focus on stimulating demand rather than cutting budget flab, analysts say the draw of relatively high bond yields and its more liquid markets is keeping investors in play for now.

Romania's path to growth of 4.0-4.5 percent in 2012 -- a cost-cutting campaign sanctioned by the International Monetary Fund -- looks more convincing, they say. But its markets are still so small that investors in central and eastern Europe do not feel obliged to get involved.

"They are both trying to tackle fiscal problems by taking different approaches. But the market realities are also very different," said Barclay's Capital strategist Koon Chow.

"They've got different debt, liquidity benchmark inflows, and differ in how policymakers in Romania have been able to control nearly every element of the market by intervention and by not selling bonds above a certain yield."

The IMF forecasts Hungary's growth next year at just 3 percent, but right-wing Prime Minister Viktor Orban is aiming for 5 percent, having shunned IMF advice to cut public spending that makes up 50 percent of the economy.

Despite its debt carrying "junk" ratings status Romanian CDS prices to insure against default were $260,260 per $10 million in debt on Friday, while Hungary, which is rated one notch above that, was priced a more risky $275,730.

But the forint currency has outperformed Romania's leu, rising 2 percent this year versus a fall of 0.7 percent.


The IMF and the European Commission bailed out Hungary and Romania at the height of the crisis with two 20 billion euro emergency aid packages that called for painful austerity to cut debt and put the countries on a path towards sustainable growth.

While Romanian Prime Minister Emil Boc is struggling to stick to that advice by cutting pensions, state wages, and other costs, Orban chose not to extend his IMF deal and is funding spending and tax cuts with levies on big business and the "renationalisation" of some $14 billion in pension funds.

There is a chance he could meet his 5-percent growth target, helped by a boost for manufacturing when an 800 million euro Daimler AG comes on line in 2012 and an Audi plant finishes a smaller but similar expansion a year later.

But the IMF and Hungary's former budget council -- disbanded by Orban last year -- both forecast growth falling well short and the IMF sees the budget deficit ballooning to more than 7 percent of GDP as a result.

This month, the Fund recommended Budapest cut spending by about 4 percent of GDP because, at about half of the entire economy, Hungary's public spending is much larger than in its regional peers. It also said Orban's tax cuts may undercut domestic demand, leading to weaker than expected tax income.

"The government's strategy is risky as it needs the otherwise costly tax cuts to trigger a strong response in economic activity, which may not materialize," the IMF said earlier this month.


In the short term, however, investors say the extra taxes and pension grab mean Hungary can finance itself at least this year, alleviating at least some worry that Orban will take the country backwards with unsustainable budget policies.

The market is now watching for details of a three-year, 600-650 billion forint ($2.98-$3.23 billion) deficit reduction plan pledged by his government to address those fears.

After a series of communication missteps, investors are skittish, and this week bond yields rose and the forint stumbled when media reported the cabinet government was struggling to find areas for spending cuts -- worth some 2 to 3 percent of GDP -- meant to make up two thirds of the package. [ID:nLDE7190XY]

"If the government does not deliver, then the market might take another point of view from the one they've been taking so far," said BNP Paribas strategist Elisabeth Gruie.

But the strategists still saw most market players preferring Hungary over Romania, whose smaller markets have little participation from foreign investors and fewer assets to buy.

The Romanian central bank intervened to keep the currency in a tight band of around 4.1-4.3 per euro last year and the government frequently baulks at selling debt at high yields, reducing opportunities to dip in.

"People give Hungary the benefit of the doubt because it's quite an actively traded market. People expect a bit of a helter skelter ride there," said Nigel Rendell, a strategist at RBC.

"They are prepared to live with that because if you look at the yields, they are 6 percent, versus 3.5 for Poland, and you get a little more return... For Romania, it's going to take a couple more years to come good."

(Editing by Patrick Graham)

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