Hungary: EU Presidency, but Full of Controversy

Hungary assumes the rotating EU presidency for the first half of 2011. Yet its is mired in controversy, but with the government enjoying a 2/3 majority in parliament, there more pressure is likely to have to be brought to bear on Prime Minister Orban if Hungary is going to adjust its positions.

The controversy is at least threefold. First, the media law, which allows large fines on media organizations for "unbalanced" reports or those that "offend human dignity" is being objected to throughout Europe. Second, the Orban is implementing increases retroactively, in violation of the constitution. The taxes levied on large companies in energy, financial, retail and telecom.

Third, the government has moved to curb the power of the Constitutional Court. This is part of the larger effort of the Orban government putting political appointees in charge of ostensibly independent institutions, including the audit office. It has undermined the independence of the central bank itself by cutting the salary of the president of the central bank and prohibiting him from naming outside members to the MPC. Fourth, the government has effectively nationalized private pension funds, according to press reports.

All three of the rating agencies have negative outlooks, with Fitch joining in with a cut to BBB and negative outlook in mid-December, following the 2011 budget which Fitch said represented a "material worsening" of the underlying medium term budget position. Fitch argued that the revenue from the pension fund and retroactive taxes provided only one-time boost.

Credit default swaps on Hungarian debt have risen the most in Europe since Orban was election except for Portugal and Spain.

In the H2 10, the forint rose about 2.4% against the euro. This was about half the gain of the Polish zloty (4.6%) and near the spot return of the Czech koruna (2.8%). However, Hungary's interest rates are much above Poland's and Czech's. So the total return (spot plus interest carry), for a forint position in H2 10 was about 4.75%, compared with 3.25% in krouna and 6.65% return for the zloty.

This illustrates that when all is said and done, the forint has held up better than one would have expected. The underlying political and economic fundamentals have deteriorating. The currency appears vulnerable.