Sept 10 (Reuters) - Hungary's centre-right government hasbowed down to European Union demands to finally bring its budgetgap below the bloc's 3 percent of GDP ceiling next year,shelving plans to widen the deficit.

The pledge seems to have calmed currency and bond markets,helping the forint recover from record lows past 226 versus thevolatile Swiss franc -- the funding unit of trillions of forintsworth of foreign currency debt in the household sector.

The ruling Fidesz party faces local elections on Oct. 3where it will seek to consolidate its powers after April'stwo-thirds parliamentary triumph, ending eight years of ruleunder the left.

Investors hope the party, whose main priorities are jobcreation and boosting economic growth, will shed light on itsdetailed 2011 budget plans and present a medium-term policypackage after the municipal elections next month.


Most likely they will. By pushing the deadline of presentingthe draft budget to the government to Oct. 15, after the localelection, Fidesz has won more time to finalise its plans anddelay the announcement of budget cuts needed next year.

Fidesz has rejected the austerity measures of the previousSocialist government as a failed economic policy, but withefforts to widen the deficit slapped down by Brussels, it willhave to cut spending by 100-200 billion forints in 2011.

That could entail layoffs, public sector pay cuts or both --the annoucement of which Fidesz will want to avoid before thevote, focusing instead of popular issues, such as support forhousehold borrowers reeling under foreign currency debt.

The economy minister has pledged to launch public sectorreforms in 2011 without providing any details on what thosemight entail.

A new 200 billion forint financial sector tax will remain inplace in 2011 to plug holes in the budget and should economicgrowth miss the government's hopes of at least 2.5 percent nextyear, further belt-tightening may be necessary.

The government still plans to phase in a 16 percent flatpersonal income tax next year to stimulate demand.


It has for the time being. Credit rating agencies Moody'sand Standard & Poor's threatened Hungary with a downgrade inJuly after Budapest walked away from talks with the IMF, citingincreased fiscal risks and concerns over debt sustainability.

With Hungary now apparently committed to bringing the 2011defcit to levels agreed by the previous government under thecountry's 20 billion euro IMF/EU loan programme, the risk of animminent ratings downgrade has dissipated.

Credit rating agencies are likely to wait until the mainfigures of the 2011 budget and some policy details on achievingthe deficit target are known before they pull the trigger onHungary.

If rating agencies see the government's commitment backed upby credible and sustainable policies, they may remove thecountry from their watchlist and affirm its ratings -- clearingthe threat of a downgrade hanging over the Hungarian market.

Market participants say Hungarian assets could rally if thegovernment presents a credible 2011 budget -- with manyinvestors attracted by higher returns offered by Hungarianassets but staying put for a lack of clarity on the future.


The party has lowered corporate taxes and seeks to extendthe tax cuts to households next year by phasing in a flat, 16percent personal income tax rate in one, or two-three stages --hoping to boost ailing domestic demand.

The choice to put pro-growth minister Gyorgy Matolcsy incharge of the economy reflects the idea that deficits can bereduced not just by spending cuts but also by measuresincreasing the country's potential growth.

Fidesz, which wants to distance itself from leftistgovernments of the past eight years, loathes the idea ofausterity for fear of being branded the same as the Socialists.

Its efforts to meet this year's 3.8 percent of GDP budgetdeficit goal centre on a financial sector tax. Fidesz'sreluctance to introduce harsher spending cuts and its insistenceon the bank tax strengthened its populist image among investors.

Other measures, most notably a pay cut at the helm of thecentral bank as well as other public sector institutions,further enhance this image.


Prime Minister Viktor Orban, 47, is the ultimate decisionmaker in both the Fidesz party and the government.

Orban is the strategist when it comes to politics, while ineconomic matters he is said to be listening mostly to Matolcsy,who has a pro-growth vision of policy which differs from that offiscally-focused former Socialist prime minister Gordon Bajnai.

Orban is advised by experts including ex-central bankerGyorgy Szapary and former finance minister Mihaly Varga, but itis Orban who puts the final seal of approval on all majordecisions. He has a tight grip over his party and the cabinet.

Getting back into power with an unprecedented overtwo-thirds majority in parliament in April was his biggestvictory and gratification for elections lost in 2002 and 2006.Orban plans for the long term and has envisaged the next 15-20years of Hungarian politics would be defined by "one centralpolitical force" -- his Fidesz party.

(Reporting by Gergely Szakacs)