The European Bank for Reconstruction and Development warned on Tuesday of contagion risk from a sell-off in Hungary as Budapest appeared unwilling to back down in a disagreement with lenders over fiscal reform and a bank tax.

The forint picked up after tumbling more than 3 percent on Monday after talks between Budapest and the International Monetary Fund and European Union were suspended as Hungary rebuffed calls for tougher spending cuts.

The local stock market was also calmer but analysts said gains in asset prices could be temporary given continued tensions.

The forint, after plunging to levels past 291 on Monday, was trading at 289.85 versus the euro at 0852 GMT.

Government bond yields were broadly unchanged from Monday ahead of a 3-month Treasury bill auction which HUISSUE is expected to be a key indicator of investor sentiment.

Markets remained shaky, however, although the European Bank for Reconstruction and Development (EBRD) said it expected Budapest to agree a solution with the IMF within weeks.

Hungary's case carries a contagion risk for other east European countries, but they can protect themselves from this to the extent that they continue their reforms and restructuring, EBRD President Thomas Mirow told Germany's Handelsblatt daily.

I think the Hungarian government will agree on a solution with the IMF in the coming weeks, he added in an interview.

But Hungary's new centre-right Fidesz government, which has spooked investors twice in the last two months since taking office in May, appeared determined to go ahead with a vote this week on a bank tax, which targets collecting 200 billion forints in both in 2010 and 2011.

Prime Minister Viktor Orban told his Fidesz party's MPs that the government would not back down in a disagreement with lenders over the bank tax, according to daily Nepszabadsag. Orban also said the government would not impose austerity measures, either before or after municipal elections due on October 3, the report said.

Analysts say the government, which swept into power after elections in April, could be playing for time by seeking to put off unpopular announcements about spending cuts until after municipal elections on Oct. 3.


Lenders said on Saturday, after talks were suspended, that the government needed to take sustainable structural measures, including on the spending side, to meet its budget deficit targets.

The big picture is 2011 ... there is a lot of economic adjustment necessary and that should not be achieved through a short-term distortive measure like the bank levy, the IMF's Mission chief Christoph Rosenberg told Reuters.

The IMF said on Monday it remained open for talks with the Hungarian government, while Economy Minister Gyorgy Matolcsy said he expected lenders to return in September.

But analysts said a surge in borrowing costs and weakness in the forint EURHUF=D2 may push the Fidesz government to reach a deal sooner.

Self-confident government statements would not be a surprise in the next few days, Commerzbank said.

However, we do not think that the government will ultimately risk a failure of the negotiations. The consequences for the forint and the Hungarian economy would be too severe.

Without a deal with lenders, Hungary, which runs central Europe's highest public debt at about 80 percent of gross domestic product, will not be able to use remaining funds in a 20 billion euro loan secured in 2008.

Even though Hungary is not under immediate financing pressure, such a delay would raise its financing costs and further erode investor confidence in Hungarian assets.

(Reporting by Krisztina Than; Editing by John Stonestreet and Susan Fenton)

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