By Sujata Rao and Sebastian Tong
LONDON, June 4 (Reuters) - Dire warnings by Hungary's new government have reignited market concern about the fiscal health of countries in eastern Europe, but many analysts believe the region's sound economic fundamentals will prevent a Greek-style debt crisis.
With investor nerves already frayed over the state of public finances in the euro zone, remarks by the Hungarian prime minister's spokesman supporting the view that the country had only a slim chance of avoiding a debt crisis similar to that of Greece triggered a regional sell-off on Friday. "The market fears another Greece situation ... Fear is taking its toll," said Marc Chandler, analyst at Brown Brothers Harriman.
As many economies in eastern Europe had secured billions of dollars in multilateral aid at the height of the global financial crisis nearly two years ago, investors had tended to be more sanguine about fiscal slippages in the region. But the latest comments from Hungary hasten a discernable erosion in belief that emerging Europe can withstand the crisis of investor confidence in the euro zone, sparked by concerns about debt-laden Greece, Portugal and Spain.
The Hungarian forint fell to a 12-month low to the euro on Friday, having lost 4.5 percent this week. Budapest stocks have fallen 5 percent this week.
Nor is the weakness confined to Hungary. Polish, Romanian and Czech stocks have all fallen between 2 and 3 percent this week while currencies have posted steep losses to the euro.
Debt insurance costs for Hungary and Romania are at one-year highs and bond yields across the region have spiked.
Eastern European stocks are down 8.5 percent this year, underperforming broader emerging equities which have fallen 7.7 percent over the same period.
"If you're a fund manager sitting in Greenwich, Connecticut, and you see eastern Europe going down the pan, you get rid of everything," Neal Shearing, economist at Capital Economics said.
"(This) will also put the spotlight on other weaker economies such as Bulgaria, Romania, Ukraine, and I'm also still not sure we've seen the end of the problem in the Baltics."
FEARS REKINDLED
For investors, the sell-off rekindles memories of 2008 when emerging Europe was at the epicentre of default fears, stepping back from the brink only with emergency aid from the International Monetary Fund (IMF) and its multilateral partners.
Now, investor concerns are resurfacing over rising deficits in the region. Romania, also on an IMF programme, this week suffered its third bond auction failure in a month with investors unconvinced about Bucharest's ability to implement austerity measures needed to access the crucial IMF funds.
Analysts say Poland, which faces an election next year, is also dragging its feet on trimming its fiscal deficit which is expected to come in at 7 percent of gross domestic product.
Hungary's new government has warned that its deficit could hit 7.5 percent compared with the 3.8 percent target set by the previous administration under its agreement with the IMF.
Meanwhile, this week's sharp currency falls could be perilous for the region's households, many of whom have debt in foreign currencies.
About 60 percent of all outstanding loans and mortgages in Hungary, for instance, are in euros or Swiss francs.
The country's total external debt is around 140 percent of gross domestic product.
Hungary also faces heavy foreign debt refinancing obligations with about 12 billion euros due in 2010 and 16 billion euros next year.
Western Europe's battered banking sector could also take a hit via its $1.3 trillion exposure to the former Communist bloc.
Banks such as Unicredit and Raiffeisen which are heavily exposed to emerging Europe, were among the biggest losers as stock markets fell on Friday.
KNEE-JERK REACTION?
Some of the fears may be overblown though. Analysts point out that the region still has the backing of the IMF and while Hungarian debt levels are high, public or government debt is 80 percent of GDP compared to 120 percent in Greece.
Short-term external government debt due within the next year is just 2.4 percent of GDP, Shearing of Capital Economics estimates. Budapest is yet to touch any of its IMF cash since the start of 2010 and its foreign currency reserves have doubled since October 2008 to 34.2 billion euros.
"There's been an overreaction caused by the political noise we're getting out of Hungary that is out of sync with the fundamentals of the economy. The spillover to the region is overdone," said Simon Quijano Evans, strategist at Chevreaux.
While economies in the region rely heavily on western Europe for exports, their economic fundamentals look much more solid than euro zone states. Poland was the only European Union country to avoid recession last year and growth is still relatively robust with the government forecasting at least 3 percent growth this year.
"Although the Hungarian comments dented sentiment for the region as a whole, we do see some signs of investors differentiating between countries," said Andreas Kolbe, EEMEA credit strategist at Barclays.
Hungarian CDS have now surged above Romania's, despite typically being lower, he said. "Going forward, I'd expect increased differentiation on fundamentals when the general market volatility settles," he said.
(Additional reporting by Boris Groendahl; Editing by Susan Fenton)