A rating downgrade on Friday left Hungary's debt rated junk across the board, underscoring investors' doubts about the government's willingness to change its controversial policies in return for aid to stave off a financial crisis.
Fitch Ratings said it was downgrading Hungarian sovereign debt by one notch to BB+ with a negative outlook, putting the country's bonds in the higher risk category and suggesting the investment climate was not going to get any better. Fellow credit rating agencies Moody's and Standard & Poor's already rate Hungary below investment grade.
(This) reflects further deterioration in the country's fiscal and external financing environment and growth outlook, caused in part by further unorthodox economic policies which are undermining investor confidence and complicating the agreement of a new IMF/EU deal, Fitch said in a statement.
Hungary's government said it found the move surprising.
Fitch's move comes as Prime Minister Viktor Orban's government has been seeking to ease tensions on financial markets by suggesting it is willing to work quickly toward a deal with the International Monetary Fund.
Orban's conservative government faces tough negotiations over a new funding deal with officials from the IMF and European Union later this month. The officials have made it clear the Hungarian government needs to change its stance on a law they have said curbs central bank independence.
Under mounting pressure from financial markets, the government has backtracked from its initial insistence on sticking to legislation disputed by the EU and IMF and has made some concessions to lenders in order to be able to start talks quickly and secure a new financing deal.
Orban met earlier on Friday's with central bank governor Andras Simor.
The government and the central bank agreed that an agreement (with the IMF) as soon as possible is in the interests of the economy. We also see it this way, Orban told reporters afterwards.
The forint currency has tumbled in recent months on clashes with the IMF and European Union.
Borrowing costs have also soared, and Thursday the government failed to sell the amount it had targeted in a treasury bill auction.
Separately, the chief economist of the European Bank for Reconstruction and Development said Hungary's government will have to accept a more traditional standby agreement in talks with the IMF and EU and the country has no alternative than to strike a deal with lenders.
Since sweeping to power in 2010, Orban's Fidesz party has tightened its grip on the media and the top constitutional court, taken over private pension funds and slapped Europe's biggest tax on banks, prompting international protests.
The European Commission has said Budapest must find a way to reassure foreign investors and governments about its intentions.
A new funding deal is crucial for Hungary, which has nearly five billion euros worth of external debt to roll over in 2012 on top of maturing forint paper as it begins repaying an earlier IMF/EU loan that saved it from financial collapse in 2008.
Foreign investors hold close to 3.8 trillion forints (9.9 billion pounds) worth of forint-denominated bonds. Austrian banks' exposure to Hungary, where they are major lenders, has hit their shares and Austrian government bond yields rose again Friday.
Relations between the government and the central bank have been strained ever since Orban's Fidesz party took power. The party has repeatedly criticised the bank for keeping interest rates too high and not backing the government's pro-growth policies with monetary tools.
Friday's meeting, called after Hungary's forint hit an all-time low versus the euro Thursday, marked a further attempt by Hungarian officials to shore up investor confidence, shattered by Orban's controversial policies and a breakdown of talks with lenders in December.
The government has made every step necessary for the talks to begin and to conclude as soon as possible, Orban said.
Concluding the IMF talks is important for Hungary because if we have a safety net then we can concentrate all of our efforts into rekindling growth. This is an urgent task.
In its statement, however, Fitch said the importance of securing a timely new IMF agreement had increased, while the prospects of reaching it have become more uncertain.
(Reporting by Krisztina Than/Gergely Szakacs; Editing by Jeremy Gaunt and Catherine Evans)