Mihaly Varga, Hungary’s finance minister (pictured) who recently promised “an end to unpredictability” for the banking sector, is a man with a conscience.

That’s probably the best explanation for why, when he revealed the latest of Hungary’s austerity packages on Monday, he avoided the biggest bombshell of the lot. That left assiduous journalists to find later, on the government website, that Hungarian banks that hold municipal debt being taken over by the state will pay a 7 per cent tax for the privilege.

How come? Why, the state is a more reliable debtor, of course, says the finance ministry, so banks can release provisions as a result of the transfers.

Thousands of local authorities took out foreign currency-denominated debts in the years before the 2008 crisis and have been struggling with payments following sharp changes in exchange rates. The government said it would take over the debts of smaller communities to ease their burden.

Since the total debt involved is Ft 612bn, (€2.1bn) the charge to the banks will amount to Ft43bn, a cool €148m, which the banks – which lost a combined €540m last year – will have to stump up by December.

Two Hungarian banks, including OTP, believed to be the hardest hit by the tax, declined to comment on the issue.

Not so Mujtaba Rahman, European director for the Eurasia Group, who told beyondbrics: “This tax is absolutely outrageous. It again shows the government is still willing to push policy boundaries to find quick, unconventional fixes to what are structural problems.”

It also raises the question of “selective default” – a charge the economy ministry swiftly countered, saying the transfer of the debt and the special taxes on the loans are legally separate issues.

Really? Peter Felcsuti, former chief executive of Raiffeisen Bank Hungary, questioned that logic on independent television station ATV (from 08:05).

“They can call this deduction a tax or what they like, the crux of the matter is that if you have state debt of say, Ft100 and the state decides to pay only Ft93, that for sure is selective default,” he said.

Peter Attard Montalto of Nomura was a tad more nuanced. He argued in a note that under the rules of the debt contracts and the interpretation of the rating agencies, technically speaking, the ministry was correct – though “it is pushing the latter right to the limit.” He added:

However, in spirit, this is most definitely a selective default to me, requiring under force of law for the net discounted present value of a credit instrument to be reduced by the legal entity which has repayment obligation on the debt.

Hungary may yet pay a price, Montalto warns.

We should watch however for the agencies reaction as this [move] is still pretty unprecedented, and whilst in the current benign local environment there is ratings stability – the ratings are of course still on negative watch from both Moody’s and S&P and they could well cite worries about precedent in terms of keeping a negative outlook – even if they don’t treat it as a selective default.

(Beyondbrics indeed asked for a comment from Moody’s received no response before press time.)

However, Montalto continued:

Overall this is kind of equivalent to the previously touted 15% hair cut that would be taken by banks over the life of debt on principle. The banks have just decided to make a one-off charge and get this issue out of the way with current provisioning, whilst the government has traded a long-run reduction in its debt sovereign level for a one-off boost to its budget this year.

Which might be fair enough with any normal European government. But just think “temporary, three-year bank tax” announced in 2010. Given the track record of the Orban administration, can anyone be sure this is a one-off move?

“True. I can imagine it being a yearly charge,” Montalto sighed to beyondbrics when the question was raised.

The problem for banks in Hungary, and business in general, is that this may not be the last time Varga feels embarrassed by the policies enacted by the economy ministry.

“The operating environment for markets and corporates is going to get riskier as Hungary enters its upcoming election cycle,” says Rahman at Eurasia.

Related reading:
Hungary: a little extra tax for the kitty, beyondbrics
Hungary: forint tumbles as Matolcsy and Orbán make their moves, beyondbrics

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