Euro slides as Hungarian woes threaten a second credit crunch

By Sean O'Grady Economics Editor

Tuesday, 8 June 2010

The euro fell to a four-year low against the dollar yesterday and stock markets suffered further losses on persistent fears about the solvency of highly indebted EU member states. The immediate focus was on Hungary, following remarks by officials on Friday about them falling into a "Greek-style" crisis, and claims that the previous government had falsified statistics.

However, another senior figure in Budapest contradicted that yesterday. Mihaly Varga, in charge of the Hungarian budget, said that the nation was consolidating its finances and that its planned budget deficit of 3.8 per cent of GDP could be met, but in order to do so the government would have to act. Such a figure would be only just outside the old Maastricht criteria rule of 3 per cent, and is much lower than the double-digit deficits in the UK, Ireland and Greece, for example. The total stock of debt, at about 75 per cent of GDP, also compares relatively favourably with other EU states.

The weakness is that much of Hungary's public and private debt was funded by borrowing from abroad, which evaporated in the original credit crunch and has left substantial foreign currency liabilities. A current account deficit that peaked at 9 per cent of GDP recently turned to surplus.

Mr Varga said that comparing Hungary to Greece exaggerated the problems "and if a colleague said such things, then it is unfortunate". The new centre-right Fidesz government would deliver a "solid" economy, he added. The government is considering a special tax on banks and channelling private pension funds to the state system.

Eurozone finance ministers, meeting yesterday to pass plans for the bloc's €440bn (£363bn) financial safety net also sought to calm market nerves. Their chairman, Jean-Claude Junker, said: "I do not see any problem at all with Hungary. I only see the problem that politicians from Hungary talk too much."

The euro made up some of its losses after those remarks. And stronger industrial orders in Germany also bolstered sentiment. Meanwhile, Greece and Portugal reported on public finances for the first five months of the year: both claim spending and tax receipts are in line with expectations.

Behind all the plans for fiscal retrenchment from Dublin to Budapest lies the risk that political resistance could overcome the determination of governments to push cuts through. Some economists also fear that simultaneous deflation could trigger a "double dip" recession, which would exacerbate budgetary problems.

Hungary is not a member of the single currency, but investors fear an economic crisis there would rebound on other EU economies and banks exposed to Eastern Europe. That, in turn, could add to the strains in the wholesale money markets, where Libor-OIS spreads have widened. The ultimate calamity would be if the sovereign debt crisis in Europe spiralled into the sort of sub-prime crisis that virtually closed world money markets in 2007-08.

At the G20 summit at the weekend the EU economic and monetary affairs commissioner, Olli Rehn, said that talk of Hungary defaulting on its debt was mistaken. Julian Callow, at Barclays Capital, said: "Default risks should not be overplayed. The external funding needs and the government's funding needs are not onerous even though the headline number may seem large."