* S&P sets outlook negative
* Forint falls sharply, bond yields rise
* Downgrade, forint fall pose policy dilemma for central bank
(Changes to Budapest, updates with detail, analysts, market)
BUDAPEST March 30 (Reuters) - Standard & Poor's cut
Hungary's long-term foreign and local currency credit ratings to
BBB-, from BBB, with a negative outlook due to deterioration in
economic and fiscal indicators there, S&P said on Monday.
The move brought Hungary, which averted financial meltdown
late last year with a $25.1 billion International Monetary
Fund-led bailout package, one level above "junk" status and sent
the forint sharply lower.
The downgrade highlights the problems facing the incoming
government of Gordon Bajnai, who already said painful but
immediate steps have to be taken to handle Hungary's worst
economic crisis in almost two decades.
"Pressure on public finances continues to mount as revenues
fall short, the government debt ratio mounts, and the risk of
financial sector contingent liabilities materialising
increases," S&P said in a statement.
S&P said it expected the European Union member's economy to
shrink by 6 percent this year and 1 percent in 2010, faster than
the government's forecast for a 3.5 percent decline, which would
hurt the government's ability to meet its total fiscal deficit
target of 2.9 percent of gross domestic product.
"Further deterioration in Hungary's economic and fiscal
outlook, signs of liquidity or solvency problems in the
financial sector, or a period of prolonged political paralysis
could lead to a further downgrade of the ratings," S&P added.
Hungary's politics have been in turmoil since Ferenc
Gyurcsany, the deeply unpopular Socialist prime minister
announced on March 21 he would step down. Gyurcsany's party and
the liberal Free Democrats wrangled over a week and rejected
over a half dozen candidates before they agreed on Bajnai's
selection.
Although the parties pledged support for Bajnai, analysts
said support could waver when Bajnai will try to push though
spending cuts of up to 600 billion forints, mostly from welfare
spending.
"When there is an economic crisis and a government crisis at
the same time, that never just passes without heightened credit
risk. The trouble is, we are at the edge of junk status,"
Commerzbank analyst Barbara Nestor said.
"For the National Bank of Hungary, this presents a dilemma.
They can't easily raise rates in an economy this deep in
recession," Nestor said.
At 1431 GMT, the forint traded at 311.10 versus the euro,
weaker from an opening level of 307.50 but stronger from 315 hit
shortly after the downgrade.
(Reporting by Balazs Koranyi and Michael Winfrey; Editing by
Victoria Main)
