Europe's Next Debt Crisis: Hungary Talks Default, and Markets Tumble

Europe's precarious financial situation continues to weaken, casting doubt on the prospects for a global economic recovery. Hungary became the latest nation to join the club of decrepit countries on the economic brink Friday, helping to send the euro to below $1.20 for the first time in four years.

The latest crisis was touched off by a series of ill-timed remarks by the new government of Prime Minister Viktor Orban (pictured), whose Fidesz party won national elections in April.

Peter Szijjarto, Orban's spokesman, told journalists that "I don't think it an exaggeration at all" to talk about Hungary defaulting on its debts. "In Hungary, the previous government falsified data," he said. "In Greece, they also falsified data. In Greece, the moment of truth has arrived. Hungary is still before that."

Only the day before, a deputy chairman of Orban's party said there was only a "very slim" chance that Hungary would be able to avoid the fate of Greece, which was forced to take a $146 billion bailout from other European countries.

Hot Air From Hungary?

It should probably be a rule for new governments to never to invoke the "D" word: default. The European Union and the International Monetary Fund were forced to cobble together a $900 billion rescue package last month after Greece's debt woes raised fears that other European countries would be unable to pay their debts. If other European countries such as Portugal and Spain can't sell bonds to private investors, they'll need money from that package to pay off their existing loans.

Hungary, which is not part of the eurozone, paid an immediate price for its loose talk. The Hungarian currency, the forint, fell 2.8% against the euro, the Hungarian stock market plunged 4.4%, and credit default swaps sold as insurance on Hungarian debt shot up by 22%.

Europe as a whole also took a beating. Stock markets across the continent fell sharply , with the Stoxx Europe 600 index dropping 1.8%. The euro fell to 1.193 U.S. dollars, its lowest point since March 29, 2006.

Torok Zoltan, head of research at Raiffeisen Bank Hungary, said that in reality, there is little danger that Hungary will default on its debts. It still can raise money in the financial markets, he said, and even if that fails, the country has a standby agreement with the IMF. Hungary has nearly $2 billion in undrawn IMF credits which it could use to pay its debts in a crisis.

"I think these comments were made in order to let the people know the Orban government cannot make big changes," Zoltan said. "It cannot cut taxes drastically and it cannot spend a lot on social programs. But such statements can be a self-fulfilling prophecy."

New Government's Plans Don't Mesh With IMF, EU Wishes

The previous Hungarian government had worked out an agreement with the IMF under which it agreed to hold its budget deficit to 3.8% of GDP. In order to achieve these reductions, it had to slash government pensions and cut funding to schools, hospitals and local governments that depend on the state for their budgets.

Even under the old plan, Zoltan said, the projected budget deficit was unrealistic. The deficit this year would have been more like 5%, he said. But now, the Orban government may try to ease the pain by going back on some of the earlier cuts, which would put it in conflict with the IMF and the European Union.

Orban's party has pledged to cut taxes as a means of boosting the local economy. But that would threaten the austerity plan adopted by the previous government.

At 80% of GDP, Hungary has the highest ratio of government debt in Eastern Europe. In Poland it's 50%, and in the Czech Republic it's below 40%. Greece's debt level is 120%.

The sharp decline in the forint caused particular pain to Hungarian homeowners. Many had financed their mortgages in Swiss francs, which carried much cheaper interest rates than local loans. But the Swiss currency is now 36% more expensive in local terms, so many homeowners face huge increases in their mortgage payments. Royal Bank of Scotland (RBS) estimates that 61% of loans in Hungary are in Swiss francs.