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Hungary eyes budget cuts, market says signals mixed

By Krisztina Than and Marton Dunai

BUDAPEST (Reuters) - Hungary's government vowed to cut spending on Monday as it strove to repair damage from comments last week about a possible Greece-style debt crisis, but a renewed pledge of tax cuts kept markets on edge.

Economy Minister Gyorgy Matolcsy said the country's new center-right Fidesz government, which took office on May 29, would stick to the budget deficit target of 3.8 percent and would need to cut spending worth 1.0-1.5 percent of gross domestic product (GDP) to do so.

But he later said the government could introduce a flat personal income tax for families, lower than current rates, which would be hard to square with commitments agreed under a 2008 bailout from the European Union and International Monetary Fund.

Moody's credit rating agency said the government's willingness to consider unorthodox measures was cause for concern, while other analysts said Fidesz was still sending mixed messages to international and domestic audiences, a practice which prompted the selloff that sent the forint to a one-year low last week.

"We'll stick to our 3.8 percent budget deficit level for this year. It was agreed by the IMF and the EU and it was also agreed by the Hungarian government so there is no doubt about that, we'll stick to that figure," Matolcsy told CNBC.

He repeated that there were blunders in government communication last week, when officials suggested there was a slim chance Budapest would avoid a similar fate to Athens, but added "it is blatant that Hungary is not Greece."

Economists say last week's comments from officials appeared to be a case of the new government preparing to backtrack on promises made before it swept an April election.

But they said mixed messages, and previous statements that this year's budget deficit could be as high as 7 percent of GDP, continued to sow confusion.

"One cannot help being puzzled when Hungarian officials talk about a much larger than planned budget deficit and at the same time rule out austerity measures and instead promise tax cuts," said Danske Bank analyst Lars Christensen.

The government started a three-day meeting on Saturday and is expected to decide on an action plan on Monday.

UNORTHODOX METHODS

Most economists say Hungary is in a much stronger position than Greece. Its deficit and debt ratios to GDP are not nearly as high; public debt was about 80 percent last year, compared with 133 percent projected for Greece this year.

It also ran a current account surplus last year and had a budget gap of 4 percent after deep spending cuts.

But Moody's said the government's statements and its consideration of unorthodox measures to boost growth brought new attention to Hungary's still high public and external debt.

"In our view, these uncertainties threaten to further impair Hungary's creditworthiness," Moody's analyst Dietmar Hornung said, adding Hungary's Baa1-rated government bonds were on negative outlook.

Citing unnamed sources, online news portal Index reported the government was considering levying a special tax on banks and channeling private pension funds to the state system as a way to boost revenues and hit its budget deficit goal.

Neither the government nor banking officials were available to comment, but the report sent shares tumbling 5 percent on the Budapest bourse, which briefly suspended trading in leading lender OTP Bank <OTPB.BU> after its shares fell 10 percent.

At 0950 GMT, OTP was down 1.2 percent.

Markets steadied, with the forint hovering just off a one-year low, keeping pressure on regional peers like the Polish zloty. Concern over Hungary also helped drag the euro to a four-year low against the dollar on Friday.

The yield that investors demand to hold Hungary's 3-year government bonds rose by 15 basis points from Friday to 5-month highs at 7.25 percent, while 5- and 10-year yields stayed near 9-month highs.

"The market will return to normalcy once again," one fixed income trader said. "(But) it will take much longer than the weakening took."

Economy Minister Matolcsy said that by end-May the budget deficit had reached 87 percent of the full-year target but the government would keep it under control. While there was no need for an austerity package, having a fiscal stimulus package was not an option now.

He also told domestic viewers on TV2 television the government was examining a possible 15-20 percent flat tax for families.

"As we see now, and the government is preparing to make such a decision, that from January 1, 2011, a flat family tax could be introduced and finalized over a period of two years," he said.

(Reporting by Krisztina Than and Marton Dunai; writing by Michael Winfrey; Editing by Ruth Pitchford)

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