As shockwaves from the eurozone crisis radiate outwards, Hungary has felt the full force of their impact.

Budapest has endured three difficult bond auctions in a week, yields have shot up, and the forint has tumbled to record lows. That, in turn, is fuelling inflation and increasing the pain for hundreds of thousands of Hungarians who took out mortgages in foreign currencies when the forint was much stronger.

Fitch and Standard & Poor’s on Friday shifted their credit outlook for Hungary, rated on the lowest investment grade, to negative – making a downgrade to junk status appear only a matter of time.

With the highest government debt among central and east European countries, Hungary has seen credit flows slow as investors have fled risk and the growth outlook for its biggest market – the eurozone – has darkened.

There are now fears that Hungary’s predicament could foreshadow a new wave of contagion to CEE countries, which were particularly badly hit by the 2008 financial crisis.

Hungary’s centre-right Fidesz government is nonplussed. It says it has worked hard to control the budget deficit, targeting 2.5 per cent of gross domestic product next year, and started reducing government debt from the 80 per cent of GDP inherited from the previous administration.

“We are not Greece,” says Zoltan Kovacs, a government communications minister. “We suspect some speculative steps behind this. It is not justified at all.”

Laszlo Akar, vice-president of GKI, a Budapest economic research institute, agrees that the current pressure is “not justified by the budget stance”.

Janos Samu, a macro-economist at Concorde Securities in Budapest, adds that Hungary’s strong exports and a current account surplus, together with EU funds flowing in, should put it in a strong position.

But many economists suggest Hungary may be being penalised for “unorthodox” policies.

After winning elections in April 2010, the Fidesz government turned its back on further funding from the International Monetary Fund, which provided a bail-out in 2008. It wanted, instead, to stimulate growth and temporarily run a higher deficit.

But the European Commission insisted Budapest must continue deficit-cutting, forcing a rethink. Economists say the government’s policies since then have often appeared improvised.

It went through with some planned tax cuts, but to fill the revenue gap it announced a big banking tax and “crisis” levies on the telecommunications, retailing and energy sectors, irking foreign investors.

The government sparked further controversy by shifting 3m Hungarians’ savings from a mandatory private pension system back into the state pension fund. Most recently, it riled Hungary’s mostly foreign-owned banks by offering foreign-currency mortgage holders the chance to pay off loans at artificially low exchange rates, with banks shouldering the losses.

“Probably the market has only now understood the economic effects of the negative institutional developments in Hungary since the last election,” says Mr Akar.

Analysts believe Hungary’s $52bn foreign exchange reserves mean it could survive the first half of next year without foreign financing, but then it would struggle.

To ease pressure on the forint, Timothy Ash, emerging markets analyst at Royal Bank of Scotland, suggests Hungary must raise interest rates, use reserves to defend the currency, or return to the IMF.

The central bank on Tuesday indicated it might “gradually” tighten monetary policy from the current 6 per cent, but Citigroup warned this would be a “shot in the head” for the economy.

Intriguingly, Janos Lazar, head of Fidesz’ parliamentary group, did not rule out returning to the IMF this week. But the government’s official line remains that it has “no intention” of doing so.

“I don’t sense yet from the government’s body language that they are ready to cave in on the IMF front,” said Mr Ash. “This leaves the forint centre-stage.”

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