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BUDAPEST (Reuters) - Hungary's government will take over 612 billion forints ($2.8 billion) of local government debt in a bid to give debt-laden municipalities a fresh start, Prime Minister Viktor Orban said on Saturday.
Local governments in Hungary, the most indebted among the European Union's eastern nations, have struggled with a debt stock of well over 1.2 trillion forints ($5.5 billion) and many have warned they could become insolvent by early next year.
The debt, taken on in the years of economic growth, often financed projects that added little to Hungary's productivity, Orban said. Once the crisis hit, many of the municipalities were unable to service those debts.
"Loans, indeed, are not diabolic as such, but debt that no longer has an economic reality behind it must be reorganized," Orban told a meeting of ruling-party municipal leaders.
Local government debt has been one subject of ongoing talks about a financial backstop between Hungary, the EU and the International Monetary Fund, which advised Hungary on municipal debt even before the aid talks began.
The government has planned some form of debt consolidation for local governments for more than a year. Its reforms included taking over certain tasks like running hospitals and schools, along with the corresponding financing.
The debt stock, however, has remained, with a large portion of it denominated in Swiss francs, which have soared against the forint amid the crisis and boosted debt service costs.
Orban said the government would take over the debts of the smallest municipalities of fewer than 5,000 inhabitants outright, while it would assume some debt from larger towns and cities as well, depending on how well they were doing.
It will take over 40 percent of the debt of the richest local governments, and gradually more for poorer ones, with 70 percent relief for the poorest towns - in all, relieving 1,956 of Hungary's 3,200 local governments.
It was not immediately clear how exactly the government would finance the takeover, and Orban said further talks would be necessary to hash out the details.
Because municipal debt is already part of state debt, the manoeuvre will only appear in Hungary's cash flow based fiscal accounts but most likely not in the EU-standard deficit or debt, said David Nemeth, ING's chief analyst in Hungary.
"The question is whether they can make the local governments sustainable after this," Nemeth told Reuters. "Obviously their interest expenses will be much lower and therefore their contribution to the overall fiscal deficit may drop."
In exchange for the debt relief, the prime minister said he expected local governments to balance their budgets and only take on tasks and development projects they could finance independently.
"We must avoid creating more debt," Orban said.
About half of municipal debt is in the form of bank loans and the other half in municipal bonds, a report released last year by PricewaterhouseCoopers showed. Most major banks in Hungary have a big exposure to the municipal sector. ($1 = 218.2462 Hungarian forints)
Reporting by Marton Dunai and Gergely Szakacs; Editing by Helen Massy-Beresford