* New govt sees higher deficit path in coming years
* Wants to reduce high debt with faster growth
* Strategy risky against backdrop of euro zone debt woes
By Krisztina Than
BUDAPEST, May 6 (Reuters) - Hungary's new government plans to run higher deficits to boost growth but its scope to do so is limited due to the country's high debt and the Greek crisis, and could only work if accompanied by credible reforms.
Centre-right Fidesz, which won elections last month, wants to cut taxes to kickstart the economy in the hope that faster growth will help Hungary grow out of its high debt which makes it the most vulnerable in central Europe.
By talking about a higher budget deficit trajectory than envisaged in Hungary's existing agreement with its lenders, Fidesz has embarked on a risky path at a time when markets are fretting over debt problems on the euro zone periphery.
Financial markets seem to have given Fidesz the benefit of the doubt and expect it to use its strong mandate to carry out structural reforms -- in the government sector, education, healthcare and taxation -- to make the economy more competitive.
But they also expect it to keep fiscal policy tight and offset any planned tax reductions with spending cuts.
"I hope the new government will have the courage and the vision to make significant structural reforms and that is the reason why it is now talking about higher deficits than agreed with the IMF," said Anders Svendsen at Nordea bank.
A higher gap could be acceptable if they were for reforms with upfront costs but which would result in lower deficits and higher structural growth in the long term, he said.
"But a higher deficit without any longer-term return would be bad for investor perception," Svendsen said.
A looser fiscal path would mean Hungary's public debt -- the highest in 2009 in central Europe at 78.3 percent of GDP -- would not peak and reverse this year as planned based on current targets, only later.
"There is a risk that Hungary could again attract attention mainly due to its high debt," said Zoltan Torok at Raiffeisen.
"The government has to weigh the potential benefit on growth from a larger deficit, against the potential negative drag on growth from a potential confidence loss as investors doubt its commitment to debt reduction," added Christian Keller at Barclays in London.
Contagion from the eurozone's worsening debt woes hit emerging Europe this week, pushing the forint to a six-month low versus the euro
BITTER PILL TO SWALLOW
Fidesz will also have to sell the idea of higher deficits to the International Monetary Fund and the EU which rescued Hungary from collapse in October 2008, as it wants a new deal with lenders to have it as a safety net.
Fidesz has said this year's budget deficit could sharply exceed the current target of 3.8 percent of GDP laid out in the financing deal, due to a lag in revenues and some items not consolidated into the budget and it wants to renegotiate the target with lenders.
Economy minister designate Gyorgy Matolcsy said on Thursday the 2010 deficit could come in at 7-8 percent of GDP based on current estimates but the new government would seek to get it down to 5-6 percent. He has said the new cabinet would cut the gap by 0.5-1.0 percentage points per year in coming years.
This means that next year Hungary would not bring its deficit below 3 percent of GDP -- which is not an IMF target but a key commitment to the EU as the country is still under the Excessive Deficit Procedure (EDP).
The Commission said on Wednesday Hungary will have to cut its deficit further from a projected 4.1 percent this year.
"Hungary has to put an end to its excessive deficit by 2011 at the latest which implies a need for further deficit-reducing measures at the latest next year of more than 1 percent of GDP," the European Commission said in a report.
Matolcsy said the main goal was to improve the economy's competitiveness by cutting taxes and bureaucracy which would amount to a "tax revolution" and would help create jobs.
"In terms of scope for tax cuts, the EU is only likely to facilitate this in a scenario whereby the authorities put forward expenditure reductions to compensate," said Gillian Edgeworth of Deutsche Bank.
Matolcsy said fiscal incentives were also needed to boost home construction, environmental investments and agriculture.
"Fiscal balance is very important and we must cut (the deficit) every year but the area where the main focus will be is how we can reduce debt and start growth," Matolcsy said.
"The situation today is that this is a trap, a debt trap, which we can escape only by growth," he said.
CONDITIONS NOT IDEAL
While reducing debt with the help of faster growth could work in theory, the present global environment with a still fragile recovery may not be the ideal setting for this.
With household consumption projected to fall further this year and banks still reluctant to lend, Hungary's recovery is slower than in nearby Poland or the Czech Republic which are seen growing by 2.9 and 1.5 percent respectively this year.
Hungary's economy is seen stagnating in 2010
"Let's assume the debt level rises somewhat nominally, while GDP grows really fast, in this case yes, we can outgrow debt," Torok said. "But this usually works when global sentiment (growth) is very positive and now this is not the case."
He said it seemed more likely that Hungary will "muddle through" with its economy growing again in the next years but not seeing annual growth rates of around 5-6 percent.
"The new government will have to implement structural reforms and reduce the deficit at the same time," Barclays' Keller said.
"Growth will have to come mainly from exports during this period -- this is not the time for trying to stimulate domestic demand through fiscal measures in Hungary."
(Reporting by Krisztina Than)