As talks between Hungary and its international creditors heat up, sharp European Union criticism of the country's lack of progress in tackling its high budget deficit added to pressure on Hungarian negotiators, who already seemed to be softening their tough stance.
Hungary appears to have cracked under the pressure of financial markets and seems willing to reverse controversial new laws — in particular a new law which the IMF and the European Union say curtails the independence of its central bank. Those policies havecaused tension and complicated negotiations for a new credit lifeline, analysts told CNBC Wednesday
The International Monetary Fund and Hungarian negotiators meet in Washington later on Wednesday to outline the conditions for formal funding.
“Since the middle of last week we have seen change in the tone of government communication,” Zoltan Arokszallasi, economist at Erste Bank told CNBC.
“Now we are seeing that the government is aiming for a quicker agreement with the IMF, and I think eventually there is no real alternative to an IMF agreement because of the funding situation,” he said.
The European Commission said the country had not made sufficient progress in cutting its public deficit and recommended moving to the next stage in the procedure, a move which could lead to financial sanctions.
In a separate statement, the European Commission said on Wednesday that it remained preoccupied that a number of the new provisions may violate EU law.
The Commission is now in the final stage of this analysis, it said.
"Without prejudging the final outcome of this analysis, the Commission is committed to fully use all its powers to analyse the compatibility of national law with EU law and reserves the right to take any steps that it deems appropriate," the statement said.
Its concerns related to the independence of the central bank, the mandatory early retirement of judges and prosecutors at the age of 62 instead of 70, and the independence of the national data protection authority, according to the statement.
Hungarian bond yields have been driven up to unsustainable levels and the Hungarian forint was pushed down to record lows in recent weeks. All the major rating agencies downgraded the country’s debt to junk status.
Tamas Boros, Co-Director, Policy Solutions noted the change in tone of Hungarian government officials but warned that many issues remained unresolved.
“What we see is really the weakening of the democratic checks and balance in Hungary. And we see an unpredictable economic policy,” he said.
“This is a big u-turn in communication but we don’t see any concrete measures for this u-turn.” Arokszallasi also warned of higher volatility as negotiations with the IMF continue.
Hungary’s tough stance has also weighed on Austrian bond yields in recent weeks as investors grew concerned over the country’s exposure to Hungary.
But a relatively smooth Austrian bond auction on Tuesday offered proof investors had grown less concerned about the risk of a Hungarian default.
“With these steps contagion has been contained,” Arokszallasi said. “If these agreements can go smoothly in the upcoming weeks and months, the government bonds can appreciate and the forint can also appreciate. This should be positive for the banks and for the exposure.”
Hungary’s positive current account balance and positive trade balance, along with a fairly high interest rate compared to the euro zone which warrants further forint appreciation, should help Hungarian markets and see them end the year at stronger levels than we are seeing now, he said.