Fri Oct 17, 2008 6:14am EDT

By Sandor Peto and Krisztina Than

BUDAPEST, Oct 17 (Reuters) - Hungary slashed its forecast for growth next year by almost two percentage points on Friday, showing its economy set to suffer even if it can quell this week’s market upheaval around its banks and finances.

Officials have been struggling for a week to shore up the falling forint currency and boost liquidity in markets after investors dumped Hungarian assets over fears the European Union newcomer might turn into the next Iceland.

Finance Minister Janos Veres told employers and unions on Friday the economy would grow just 1.2 percent in 2009, compared to an earlier forecast 3 percent, due to the wider global slowdown and impact of banking turmoil on domestic credit.

“We can expect significantly lower growth in our partner countries which take up most of our exports,” he told the meeting.

“Due to the situation in financial markets, credit to both households and companies will narrow substantially and that will generate substantially lower demand next year.”

The central bank has turned to the European Central Bank (ECB) for funds and the government has lined up potential help from the International Monetary Fund (IMF) as a “last resort”, helping to prop up the forint.

But analysts said the steps, which include the central bank buying government bonds to restart a frozen debt market, will ease but not resolve the main problem — how Hungary can prevent foreigners closing off flows of euros, Swiss francs and dollars.

Hungary relies on foreign investors buying its government papers to finance its large external debt and, with interest rates high, the vast majority of lending has been in foreign currencies. Banks are now moving to curb such loans.

“The steps go in the right direction as they can help alleviate immediate liquidity pressures, but they can’t resolve the fundamental issue of capital flows needed to finance Hungary’s external financing needs,” said Christian Keller, economist at Barclays Capital in London.

“Hungarian banks will face a challenge of rolling over their external liabilities but the challenges of Hungary are far away from what is going on in Iceland.”

SLOWDOWN

In a Reuters poll published on Friday analysts slashed their forecast for Hungary’s growth to 1.2 percent from 2.6 percent for next year and to 1.8 percent from 2.15 for this year.

“Given its high degree of openness … and vulnerability to a downturn in global trade flows, our projection for Hungarian GDP growth is already the weakest in CEEMEA at just 1.0 percent for next year,” JP Morgan analyst Nora Szentivanyi said.

The economy will also be hampered by an expected slowdown in foreign currency lending to households and corporates as many banks have already said they would restrict or suspend these loans in the face of the global credit crunch.

Private sector credit growth has been very dynamic in Hungary in the past few years and nearly 90 percent of new household loans in Hungary this year were made in foreign currencies, mainly in euros and Swiss francs.

Prime Minister Ferenc Gyurcsany said the government was planning to make proposals by next week to ease the exchange rate risks linked to households’ foreign currency borrowing as a weaker forint may increase the loan repayments of households.

“I also think this is one of the… risks that if the forint weakens significantly, then monthly repayments can rise,” Gyurcsany told public television on Friday.

“We will make proposals, I think by next week, which will ease risks in this (area),” he added.

(Reporting by Krisztina Than and Sandor Peto; editing by Patrick Graham)

This article was derived from reuters.com/article/marketsNews/idUSLH35291320081017?sp=true