Hungary's central bank upped interest rates by 300 basis points today in an emergency bid to shore up its battered currency as officials signalled it was in talks with the IMF for help to ride out the crisis.
Just two days after a no-change vote at its regular meeting, the bank stepped in as the forint currency slumped to close to an all-time low against the euro, raising its benchmark interest rate to 11.5 per cent.
The forint bounced two percent on the move, but quickly slid back as investors continued to sell on concerns over the health of Hungary's banking system and its ability to finance a large external debt amid the global credit crunch.
Analysts also said the economy will pay heavily for the rate rise - aimed to draw investors back to the central European country with the European Union's highest returns on capital.
"It means the economy is toast," said Nigel Rendell, emerging market strategist with Royal Bank of Canada. "There is pretty much no chance of getting any reasonable economic growth out of Hungary in 2009."
Hungary's problem is that it relies heavily on foreign investors buying its bonds and its banks may face difficulty in securing foreign exchange financing as liquidity dries up in international and local money markets.
After the hike was announced, the state debt agency scrapped an auction of government bonds as bids failed to reach even half the 40 billion forint offer. It has scrapped or cut auctions due to poor demand in recent weeks.
Analysts said the central bank's move may give temporary support to the forint, but that the country will likely need to use the financial help offered by the International Monetary Fund (IMF) to stabilise its markets in a lasting way.
"Unfortunately, despite the good policy move, the external market sentiment remains very poor ... in addition there is a lot of volatility in many asset markets which ultimately means that higher carry does not bring investors back into Hungary," said Koon Chow, strategist at Barclays Capital.
"An IMF package with a sizeable commitment on loans would be key," he added.
Hungary's government and central bank have taken a series of steps in the past two weeks to boost markets after the bond market seized up. They have lined up potential help from the IMF and the European Central Bank (ECB) as a "last resort".