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Wednesday, October 29, 2008

After Wearing The Hair Shirt For Over Two Years Hungary Is Now Helped Into The Straight Jacket

Well we now have some of the details of the IMF package for Hungary, and interesting reading it makes. Hungary has in effect secured a 20 billion-euro ($25.5 billion) loan which is going to be sourced by three institutions: the IMF, the EU and the World Bank. The International Monetary Fund is going lend Hungary 12.5 billion euros, the European Union will provide another 6.5 billion euros, and the World Bank is chipping in with a symbolic 1 billion euros. (Really the reasoning behind the tripartite division of the loan may relate more to the pressure which it is thought might fall on IMF funding provision - which stands at about $250 billion at the present time - if more emerging market economies follow the lead of Ukraine, Hungary and Iceland. See this post here for more details and argumentation on this whole problem).

The forint naturally rose - to 257.05 per euro at 9:10 a.m. in Budapest - on the news, in the process getting below the psychologically important 260 mark and very near to a two-week high.

The Analyst View

``The agreement is designed to restore investor confidence and alleviate the stress experienced in recent weeks in the Hungarian financial markets,'' IMF Managing Director Dominique Strauss-Kahn said in a statement in Washington yesterday.

“One way to look at the EU assistance to New Member States is that this is also part of the operation aimed at making sure Euroland banks don't get into trouble. The banking systems in New Member States are practically owned by foreign (mainly Euroland) banks, and if their NMS subsidiaries get into trouble, that would not be good news for the holding companies either. In the current environment that is a strong additional argument for major Euroland countries to make sure that New Member States (and their banking systems) do not get into trouble because of the liquidity crunch."
István Zsoldos, Goldman Sachs, London

``The aid package won't make Hungary immune to the real economy effects of the financial crisis..........Where the IMF appears with its strict conditions, the requirement of consolidation inevitably leads to real economy and social consequences.''
Laszlo Andor, European Bank For Reconstruction and Development Board Member

``A sharp economic slowdown, driven by declining foreign- currency credit flows to the private sector, tight fiscal conditions and weak external demand is unlikely to be avoided''
Eszter Gargyan, Citigroup Inc, Budapest

“We expect the EU and the IMF to announce additional rescue packages for other Central and Eastern European economies in the coming days and weeks. Top of the list are the most imbalanced countries in the region - the Baltic States, Romania and Bulgaria."
Lars Christensen, Danske Bank, Copenhagen

“All in all, the crisis seems to have been averted and even though it is no doubt a major shame that Hungary got to this situation, the authorities managed well in the rough waters, far better than Iceland (major policy mistakes in particular by the CB), Ukraine (political fragmentation still a major problem, currency peg had to be abandoned after failed interventions) and Romania where politicians remain ignorant even now, after the problems are more than evident. Bulgaria also does not seem to be prepared, though the currency board, the fiscal reserves and the significant budget surplus at least provide more cushion."
Gábor Ambrus, 4Cast, London

Of course, none of this comes free. In effect the IMF is providing Hungary with a 17-month stand-by agreement, and just the fee for making the stand-by available will be 0.25% of the total quantity per annum, according to information provided by Central Bank (NBH) Governor András Simor in a press conference this morning (Wednesday). The rescue package is available up to the end of March 2010, with 3-5-year repayment period and an interest rate of 5-6% per annum (fixed).

And then, of course, there are the conditions.

Conditions For The Loan

The International Monetary Fund (IMF) has effectively imposed two conditions on Hungary in exchange for the package, according to Prime Minister Ferenc Gyurcsány addressing a press conference yesterday (Tuesday).

1) The 2009 budget needs to be framed in such a way that even under a pessimistic scenario spending targets will not exceed the actual funds available (thus a new budget deficit target has been set for 2009 at 2.6% of GDP, under the assumption that Hungary will experience a 1% contraction in GDP - see more below - while the primary balance on the budget should produce a surplus of 1.8% of GDP. This is of course very strong stuff indeed in view of the looming recession);

2) Hungary should not embark on measures that could have a negative influence on the revenue side of the budget (e.g. extensive tax cuts).

Hungary's Finance Ministry has accordingly lowered its 2009 public sector deficit target down to 2.6% of gross domestic product, from the already previously reduced goal of 2.9%. In fact the Hungarian cabinet had recently rewritten the 2009 budget draft (which in any event still needed to go before parliament) due to the pressure on Hungary's financial system, lowering the deficit goal to 2.9% of GDP from 3.2%). Really all this does seem incredibly ritualistic, since I for one am hardly convinced that coming down from a 3.2% deficit to a 2.9% one is going to be all that earth shattering in terms of the economic results produced, although it will of course provide some nice red meat to feed to those ever so hungry external investors, who, if they think the fiscal deficit is at this point is the main issue in Hungary, far from being the shrewd and caluculating economic actors assumed by rational agent theory simply have no idea of what is going on at this point in time.

The fiscal problem arose much earlier in the day and Hungary's government has been struggling to put it right, operating a deficit reducing policy since the summer of 2006, and had managed to cut the shortfall to 5 percent of gross domestic product last year from 9.2 percent in 2006. The 2007 target has also already been reduced to 3.4% of GDP from 3.8%, so I can hardly imagine what positive macro economic benefits people expect to see from turning the screw even more on an economy which is already reeling under the extent to which the screw has already been turned.

The main problem facing Hungary right now, apart from its very large external funding requirement, is really the fact that the civil population have become addicted to taking out their debt obligations in foreign exchange - largely Swiss Francs - and the flow of these is now drying up as the banks get scared about the downgrades they can get from any write-downs they may have to do. So the what the Hungarian economy needs now more than anything else is external support to ease the economy off the external borrowing steroids which have been being pumped into the household sector, and it is not clear to me how the IMF package is going to help with this. At least at this point it isn't.

One way forward which many are considering right now across Eastern Europe is early euro adoption. The Hungarian government and the central bank have now pledged to meet euro- adoption requirements for the deficit, inflation and national debt by next year. Hungary still doesn't have a target date for the switchover to the euro, due to the earlier deficit overruns and ongoing inflation issues, but given that we are now likely to see sustained GDP contractions, deficit reductions and price deflation rather than inflation, I doubt Hungary will continue to have difficulty meeting existing EU/ECB criteria in the future. The issue is rather going to be, what sort of shape will the Eurozone itself be in when Hungary finally does get the opportunity to officially present its application form?

A PainFul Process

Naturally all these cuts and withdrawals of bank funding will have substantial consequences for the real economy and it is not without significance that Gyurcsány also stated yesterday that, in his opinion, the foremost challenge Hungary must now tackle is how to avoid mass employment layoffs, as corporates are cut back or suspend production in the face of the developing recession both within and without of Hungary's frontiers. He described what was currently happening in Hungary as “the gravest economic and financial crisis of the past 80 years", and for a country which has obviously suffered so much that is really saying something. The sad part is that I find it hard to disagree with him.

Gyurcsány also said Hungary should brace itself for a European and global environment where combating recession, rather than achieving growth, has become the watchword. “Hence neither will the Hungarian economy grow," he said, noting that the 2009 Budget has been drawn up under the assumption of a 1% GDP contraction during the coming year. Actually even this forecast appears to be optimistic, and Gordon Bajnai, Minister for Development and Economy, pointed out that the International Monetary Fund (IMF) had suggested "pencilling-in" a 2.5% GDP fall for 2009. This idea was obviously put forward with the idea of making a "worst case scenario" assumption on which there would have been no backsliding (thus getting all the bad news out of the way at once), but again unfortunately, the worst case scenario also appears to be a highly probable one at this point, and while really we should avoid getting into the game of bandying about numbers just for the sake of bandying them about, I personally have pencilled in a drop of between 3 and 5 percent in Hungarian GDP for 2009, since, among other issues not really being discussed at present, I am also expecting a very nasty shock to hit German GDP on the rebound from all the crises which we are seeing unfold in one country after another across Eastern Europe.

Obviously the IMF do not spell out the details of just how Hungary can make the sort of budget cuts which are now going to be required of it, but there is no doubt that they will be painful. Among the proposals which are being floated around are the scrapping of the 13th month wage civil servants receive and a halving in the 13th month pension.

Many observers have been surprised by the size of the loan, but as Lars Christensen (Danske Bank) notes, the size does gives us some indication of how the IMF see the financial crisis as being significantly greater in Central and Eastern Europe than most market participants have been willing to accept until now. Anne-Marie Gulde-Wolf, IMF's Division Chief at the Monetary and Financial Systems Department and Elena Flores, European Commission Director, both stressed - at a press conference organised by Hungary's Finance Ministry - that the EUR 20 bn facility was a credit line and Hungary would not necessarily be drawing on it if market and macroeconomic conditions were to improve or normalise (although since there is not much likelihood of this happening in the near term, it is not unreasonable to assume they will need to draw on a significant part of the loan). What they said in effect was that they wanted to give the markets a "strong sedative" at this point, one which was strong enough to make people think twice before acting.

Flores also stressed that the EU Commission had attached three conditions to Hungary's receiving the credit line. Hungary must:

- tame and cut expenditure;
- continue fiscal reform measures;
- continue structural reforms.

The 20 billion euro figure considerably increases the 17 billion euros of existing reserves available to the NBH for covering external payment obligations which for the next 12 months are estimated at around 32 billion euros. This 32 billion is, howvere, another worst case scenario, assuming that the foreign owners of the Hungarian banking sector completely cut access to financing (not totally improbable, or at the very least new financing is going to be greatly reduced) and that import levels remain unchanged despite an potentially contraction of exports (much less likely).

This line of thinking is reinforced by András Simor's statement today that the financial package is a credit line which if drawn on will boost Hungary's foreign currency reserves. Simor underlined that if Hungary draws the full amount available the bank's foreign currency reserves would more than double. Simor also stressed that any decision to use the credit would need to be taken by the government. In order to put the size of the loan into some sort of perspective Simor said it is: - twice as large as the stock of Hungarian government securities held by non-residents (currently around HUF 3,000 bn); - about five times as large as the country's external debt maturing next year; - about one third of Hungary's total government debt.

Why Do I Call This A Straight Jacket?

Basically Hungary is about to take some extremely tough medicine, medicine which in the short term will see GDP actually shrinking. To put this in perspective, I think we need to remember that Hungary is a comparatively poor emerging economy, with per capita incomes way below the EU average. Thus these cuts will really be felt, especially any cut backs on pensions or health facilities, since remember Hungary is already a rapidly ageing society, with a comparatively short male life expectancy (ie poor health among older males), and all these cuts will not make this problem any better.

Instead of simply repeating what I have already written time and time again on this blog, I will quote extensively from 4Cast analyst Gabór Ambros, at this point, since I essentially agree with the points he makes:
“At the same time, there is no doubt that to ensure Hungary's long-term survival a major diet is needed (this is in fact true to every emerging country which experiences the same problem)."

“The thirst for debt financing, domestic or local, has to be drastically reduced and not just for a period of a year but for longer, given that credit markets are not going to be the same in the foreseeable future as they had been before the world 'subprime' become known outside the circles of the debt securitization market."

“This implies not only a reduction of the public debt but also the substantial reduction of the deficit of the current account which implies a major diet for consumers (how much is needed exactly is highly uncertain, given that the massive errors and omissions row on the C/A statistics render the C/A figures rather meaningless)."

“While the increased credit costs and the restricted credit availability will drive demand down, a key tool to rebalance the economy is the exchange rate. Hungary needs a week forint to ensure the sustainability of financing and in this anti inflationary global environment the NBH should in our view be ready to accept a slightly slower paced disinflation to allow the financing thirst to reduce and ensure the long term sustainability of growth."
Gábor Ambrus, 4Cast, London

So basically, and in a few words, domestic private consumption - which has already been very, very weak following the "austerity package" of 2006 (what I am calling the hair shirt) - is now going into full speed reverse gear, as all those personal consumption swiss franc mortgage loans come to a dead stop. Government spending is also going to go backwards, as the deficit is cut and cut, over a GDP which is itself reducing. And exports - the third platform of any economy - is also set to go full speed reverse, as Russia and the other EU countries all shoot off into what is probably going to be quiet an important recession.

As Gabór Ambrus says, Hungarian consumers are about to go on quite a drastic "diet", and the only way forward is through exports, which means a weaker forint (god, how I have been tirelessly arguing this on this blog since late 2006), which means all those swissie mortgages have to go (ditto), which means some of these banks will need to take a substantial haircut on the write-downs (good job the EU is on-board then). And on and on, or down and down we go. Of course, with population in decline anyway, when exactly will we see GDP growth again in Hungary????

Whither Monetary Policy?

Obviously one last point which is worth making on this most hectic of hectic days, concerns monetary policy. As we know the central bank base rate is currently at the ridiculously high level of 11.5%. But does this now make sense, and in particular if you want a weaker forint? Well some comments from central bank governor András Simor earlier today seem to suggest that changes may well be on the way.

“In this new situation monetary policy makers will need to rethink which way to go from here," Simor said.

The Central Bank Monetary Council, Simor noted in his press conference, is faced with a “new macroeconomic situation" in Hungary due to the changes that have taken place in the world economy. The rate-setting body he assured his audience will carefully analyse the processes and draw its conclusions in the coming one to two months. That is, you have been warned.

Well, I think that will do for now, but don't any of you dare complain that you haven't had the priviledge of living in "interesting times". Fascinating, I would say, especially for those of you with sufficient interest to learn from them.

Hungary Terminates Bond Auctions For The Time Being

Hungary's Government Debt Management Agency (ÁKK) announced today (Wednesday) that it was cancelling the auction of 5-year bonds it had scheduled for 6 November 2008 and that no further government bond auctions will be held during this calendar year.

“In order to assuage or eliminate the imbalance experienced on the government securities market", the ÁKK said in its statement. “With these measures the ÁKK intends to tone down supply side pressure on the secondary market so as to further improve the efficiency of price quotations and achieve that trading activity returns to normal."

“This step is an integral part of the series of measures jointly taken by ÁKK, the National Bank of Hungary (NBH) and the primary dealers aiming at restoring the normal operation of the government securities market and thus supporting the consolidation of the Hungarian money and capital markets".

The AKK had already announced a marked reduction of HUF government securities issuance (on October 10), which had meant that the only auctions to be held during the remainder of 2008 would involve the refinancing of maturing debt.

Basically the Hungarian government are trying to avail themselves of the relative calm that may be enjoyed in the wake of the IMF/EU/ World Bank loan decision to put some order into what had become a very troubled environment. Should the government need additional finance it can now decide to use part of the loan and HGB issuance could be further reduced next year, as the need arises.

Hungary's Unemployment Up Slightly In Third Quarter

Well, in amongst all this high powered technical and financial information we are all so obsessed with at the moment, the real economy goes on. And today we have just one more little data point to put in our log books. Unemployment in Hungary rose slightly - to 7.7% - in the third quarter, up from 7.5% in the June-August period, according to the latest labour market report from the Central Statistics Office (KSH) this morning (Wednesday). The number of unemployed was up by 10,500 from the previous three month period and by 20,800 from the third quarter of 2007.

KSH also reported that there were 327,700 unemployed and 3,924,300 people in employment during the July-September period. This compares with 3.914 million employed in June-Aug and 3.947 million in the same period one year earlier. So employment is up on the month, but down on the year. If we look at the chart for the numbers in employment (below) it is clear that the long term trend is down, with each annual wave peaking just that little bit lower.

This trend is, of course, not surprising, given Hungary's ageing population problem, and the numbers of people of working age continues to decline. One way round this issue would be to raise the employment rate of those in the 15-64 age group, but this is remaining pretty stationary, and was at 57.3% in the third quarter, as against 57.1% in the previous three months and down 0.4ppt from the same period last year.

The KSH said 50% of all unemployed have been seeking jobs for a year or more and that the average duration of joblessness was 18.8 months, down slightly from the 19 months registered in June-Aug.

Monday, October 27, 2008

Hungary Agrees To An IMF Loan

Hungary has reached agreement with both the International Monetary Fund and the European Union on a broad economic rescue package, including substantial financing, to stabilize the Hungarian economy which besides being shaken by the global financial crisis now faces serious population-ageing related macro economic and structural problems moving forward.

"A substantial financing package in support of these strong policies will be
announced when the program is finalized in the next few days," IMF Managing
Director Dominique Strauss-Kahn said in a statement that did not indicate the
size of the package.

Hungary (which is a member of the European Union but not the Eurozone), has been in talks with the IMF since early October in an attempt to sort out a package which will do something to restore confidence in falling markets.

Hungary's government and the central bank have taken a series of measures to shore up the currency and financial markets, and the central bank hiked interest rates by 300 basis points on Wednesday (to 11.5 percent) and offered support to local residents who wanted to transfer their debt obligations from Swiss francs to Forint.

Hungary's problem is that it relies heavily on foreign investors buying its bonds while its banks face difficulty in securing foreign currency financing as liquidity dries up in international and local money markets. The crisis has caused credit markets to malfunction so severely that many emerging market economies cannot quickly access the capital they need. The problem has been most acute in dollar funding markets as Western banks hoard money and refuse to lend to each other.

While we still lack details of the package, we are being assured by Hungarian government sources that it will be "of convincing size and force."

"The agreement contains standby access to resources, which will significantly reduce Hungary's exposure to foreign market financing," according to one anonymous source.

With Hungary's commitment to strengthened economic policies, Strauss-Kahn said he expected Hungarian banks and other financial institutions would be able to start lending. "The policies Hungary envisages justify an exceptional level of access to fund resources," Strauss-Kahn added.
We also learned yestreday that the IMF had agreed in principle to a $16.5 billion standby loan deal with Ukraine and that on Friday it agreed to a $2.1 billion deal with Iceland.

Portfolio Hungary points to the following sentence in the IMF statement - "The policies Hungary envisages justify an exceptional level of access to Fund resources" - and read it as suggesting that the IMF financial support to Hungary could be several times the value of the country's IMF quota. This see this assumption as backed up by the fact that the USD 16.5 bn facility to Ukraine is eight times as large as Ukraine's quota.

While Martin Blum, analyst at UniCredit in Vienna, say that - at least in terms of the information released so far - the package sounds positive in that the package is designed to ensure the external private sector remains on board and:

“The IMF/Hungary package could prove significant to the extent that it seems it will explicitly include EU and some EU govt funding. This is clearly positive for the rest of the EU27 including Romania and Bulgaria. Although big underlying problems remain, we'd remain flat EUR/HUF and Hu, Ro and Bg CDS into this weeks likely Hungary IMF financing announcement. In short, the big question now is the scale of EU/EU govt funding."

This all looks very interesting, and I am absolutely convinced that if Hungary is to continue to apply a rigourous fiscal policy in its own right, then some sort of external injection of demand (read cash) will be essential to keep the patient ticking over while it is on the life support system. I simply worry that with the problem now extending right across Eastern Europe, and the fiscal issues mounting at home for the foreign bank governments in the wake of their own massive "bailouts" then that there may be a danger of overstretch here, and that we could see the fical positions (read treasuries) in some of the theoretically funding countries coming under attack next as they reveal the size of their own fiscal on-costs. Remember, basically for ageing population commitment reasons, the EU countries had all agreed to try and balance budgets before 2011 and this agreement is now likely to get lost in the rubbish bin of history.

Also, and since Martin Blum comes himself from the much troubled Italian bank Unicredit, maybe we also need to be including the Libyan government in any multilateral support system, since their government now seems to be the second largest shareholder in Unicredit, and the bank seems to be maintaining its Tier I capital ratio only thanks to Libyan support.

Difficulty Selling Bonds

News of the Hungarian and Ukraine loans does not seem to have done much to unblock liquidity at this point, since Hungary's Government Debt Management Agency (ÁKK) have had to withdraw HUF 40 bn worth of discount T-bills (the auction was cancelled) which they offered for sale at a liquidity auction this morning, since they received no more than HUF 5.09 billion worth of bids. Last week the issuer was forced to do the same with a 6-m T-bill and a 3-yr bond auction.

The ÁKK scheduled a 3-m and a 12-m discount T-bill auction for this week, offering HUF 40 bn of the instruments on both occasions. Hungary's BUX Index slid 11 percent on opening this morning too, the seventh straight day of loses.

The National Bank of Hungary (NBH) has also announced it bought HUF 50 billion worth of government bonds at an auction today, the full amount on offer, according to a staement released on its website. The yields were extraordinarily high. The NBH purchased HUF 20 billion 2009/F bonds at an average yield of 14.05%, HUF 20 billion 2010/C bonds at 14.21% and HUF 10 billion 2011/C bonds at an average yield of 13.77%. At the last auction held on 17 October, the average yield on HUF 25 billion 2011/C bonds came in at 12.06%.

Also Ukraine's hryvnia fell to near a record low against the dollar this morning as the $16.5 billion International Monetary Fund loan failed to restore confidence in the country's ability to weather the global financial crisis. The hryvnia slid 1.3 percent to 5.9500 per dollar by 9:48 a.m. in Kiev, from 5.8750 on Oct. 24. It traded as low as 6.0812 last week, according to Bloomberg this is the hryvnia's weakest level since at least 1994, when they began tracking Ukraine's currency.

Christoph Rosenberg, Senior Regional Representative for Central Europe and the Baltics (who I respect as a really serious economist) is quoted by Reuters this morning as saying “It's a really good policy package." We'd just better hope it is, since we have no details yet. And Chris, if you are listening out there somewhere, any package which has as its kernal a tight fiscal stance simply won't work due to the depth of the recession it will produce. The Hungarian government need to put their own books in order (to keep the investment community happy), but they will need support from the EU or elsewhere to be able to increase spending in some way or another, otherwise..... weak exports (external european environment), plunging domestic consumption (no forex loans) and cut-backs in public spending only add up to one thing: a substantial deflationary recession, and more financial crises as we move forward. Hungary needs the forint down and spending in some part of the economy UP - a mix of greenfield investment and public spending in support of this would perhaps be the best option, and a cheaper forint would make wages in the export sector more competitive at a stroke.

News like the following are what we need, and the investors are going to need incentives in this environment:

Daimler has on Monday signed an agreement with Hungary's government to invest around EUR 800 million in a new plant in Hungary that will manufacture over 100,000 compact cars annually from 2012, and create up to 2,500 jobs. “Mercedes-Benz is building the plant in order to create additional production capacity in the compact car segment, where the model range will be expanded from two to four vehicles. The plant contributes to the profitability of the product portfolio extension," Daimler said in a statement.

Thursday, October 23, 2008

And So It Ends - Hungary's Government Announces Foreign Curreny Loan Wind-up Package

Hungarian Prime Minister Ferenc Gyurcsány announced this morning (Wednesday) that the government had reached an agreement with commercial banks intended to protect the interests of those who have taken out foreign currency loans.

The agreement, which is expected to be signed early next week, has three key components:

1) At the request of the debtor the banks will allow the duration of the loan to be extended (with fixed monthly instalments) so that the depreciation of the forint “does not place an unbearable burden on the debtors".

2) FX debtors who deem that exchange rate fluctuations carry excessive risks for them will be allowed to convert their foreign currency-based loan to a forint loan. In this case the banks “will accept this request and make the switch without extra charges".

3) If a debtor finds him- or herself in a position where he or she cannot pay the monthly instalments, e.g. due to becoming unemployed, the banks will be amenable to transitionally reducing the instalments or even suspending them entirely at the request of the debtor.

I say "agreement" here, but in fact the banks had little alternative, since Gyurcsány made it plain to them that if they did not agree then legislation would be introduced to enforce the government package.

So here, right now, and on 23 October 2008 in Budapest ends, in my opinion, a fashion for taking out non-local currency denominated loans, which lasted the best part of a decade and sewpt across half a continent, and especially in Central and Eastern Europe . Basically government after government in one CEE country after another will now find themselves with little alternative but to follow Hungary's lead, as the parent banks turn off the tap on the one hand and the citizens themselves grow more and more nervous on the other.

The situation is in fact a little bit complicated, since (unless there is some part of the fine print which has not been made public yet) we have to assume that the conversion rate be the going market one, which will mean that many of those who such mortgages will take some form of capital loss on the transfer, which can thus only be seen as some form of "late in the day" protection against subsequent falls in the value of the forint. Jiri Stanik at Wood & Co estimates that most bank clients took out their FX loans at a level of around CHF/HUF 170, so despite the fact that the forint has depreciated by some 30% against CHF over the last two months, its current level (HUF/CHF is about 185 at the time of writing) only represent s an 8/9% depreciation from the average client purchase price. Most of the risk and all the really bad news will come for these mortgage holders if the forint were to continue to depreciate further against CHF. Will this depreciation continue? Well, even we economists don't really know the answer to that question, and certainly Hungarian householders have no idea at all, which is one very good reason why most of these clients may decide to get out now. Cerainly they will probably be uncomforable with the realisation that they have suddenly all become day traders in the forward HUF/CHF swap market using their homes as security.

Also the rate of interest to be charged on the HUF morgtgages will be based (it would seem, again there are no details) on some mark-up or other over the current base rate of the the NBH, which was, we will remember hiked to 11.5% yesterday. So at the end of the day the people who make the transition will take a (small, at this point) capital loss, but at the same time their short term interest servicing payments will skyrocket (this is presumeably why Gyurcsány has insisted on their being able to extend the term of the payments) . Thus, in terms of the macroeconomic recession, here we go.

For this all to form part of a coherent rational policy (perhaps a very large assumption indeed at this point) , it can only suggest one thing, in my opinion: that the base rate hike is a TEMPORARY support for the forint while people move over (which we could expect to see in the form of a flood, rather than a trickle - see the point about "herd behaviour" below). Basically when you have half your army trapped in an excessively advanced position, you need the heavy artillery to lay on some cover while you pull them back.

Once the troops are safely back under cover, then, in my humble opinion, we should anticipate a rapid easing cycle on the part of the NBH, and a sudden tanking in HUF partities, since the looming priorities will be to ease distress on all the new HUF mortgage payers, and an attempt to "jump start" a new export-driven Hungarian economy. I think it is important to bear in mind that Hungary is now about to head into quite a severe recession, and the fiscal stimulus door is effectively closed. Monetary easing is the only real policy tool the Hungarian authorities have available. And remember, we are going into all of what is now to come with national morale severely weakened by two years of policy measures which didn't work, to cut a very long story down to a very, very short one.

In other words the current situation is like having your population distributed across two very high buildings, one of which is about to collapse (or at least disappear), and the Hungarian government has just thrown a plank across from one building to the other so that people can "move over" in single file, before the one which is about to go, goes. The people in the other building may suffer from overcrowding and shortage of food, but they will at least be "safe". But the big danger might be, just how many will get trampled in the rush?

Basically, and to cut another very long story down into a very, very short one, the building which is about to disappear is the one which was to have housed Hungary (and several other of the EU12) as a full member of the Eurozone. This, ever more distant possibility in recent months, is now about to move off into a much longer term futures, and it is this distancing, of course, which makes all the forex borrowing suddenly unsustainable. The man who has been hanging desparately over the parapet by his fingernails for two years, now finally lets go.

Plus there is still the thorny little issue of just how Hungary is going to fund the conversions, and how much bad news there might be for the banks here.

“We think the most important announcement at this stage is the possibility to convert CHF loans to HUF. If households chose to do this it would ultimately mean a switch in FX mismatch from households to banks (who would then hold HUF assets but CHF liability). Banks in turn would then need to close their FX mismatch, through FX swaps (buying CHF).........It's not clear who would provide sufficient HUF liquidity to do this. Ultimately the NBH would presumably provide liquidity to avoid banks being left with a significant FX mismatch."
Martin Blum, Gyula Tóth, UniCredit, Vienna

At the end of August total housing loans were running at around 3,380 billion HUF or about EUR 12 billion equivalent at todays prices. Of these around 18 billion HUF (or 53%) were fx housing loans. Which means there are something like 6.5 billion euro in fx housing lonas which could be translated over. To this could be added another 1,500 billion HUF in mortgage financed personal loans (so say around another 5 billion euros to cover this). These numbers put the recent 5 billion euro loan from the ECB in some sort of perspective I think.

My impression is that this move by the Hungarian administration will soon be followed by one government after another across the other central and Eastern European Economies where forex mortgage borrowing had become so popular. So basically, the situation is that Hungary can, to some extent, protect its citizens from excessive exposure in times of turbulence, via this channel. The foreign banks who have been providing this service, and who in the main come from other EU member states, will then be left to pick up the exposure tab themselves, and my guess is that several of them will need to seek protection via the EU15 bank support scheme thrashed out in Paris on 12 October last, in just the same way that other financial entities have been receiving protection from the US Sub-prime write-downs.

In the meantime, we can expect to see the shares of the main banks involved coming under severe attack. Erste Group Bank AG, Austria's biggest publicly traded bank, lost 1.95 euros, or 8.8 percent, on Tuesday to hit 20.10, a five-year low, while Italy's Unicredit - another very exposede bank in CEE terms - fell to an 11-year low in Milan this morning (Wednesday) on market speculation the company will need to further strengthen its already recently "strengthened" finances. Italy's biggest bank by assets declined as much as 8.8 percent to 1.90 euros, its lowest price since September 1997. Unicredit is now down 65 percent since the beginning of the year and shares in the bank were again suspended from trading earlier today due to excessive declines.

A Ten Year Craze Comes To An End

As I say above "and so it comes to an end". A phenomenon which in many ways has served to characterise an epoch is now being drawn to a close, and as my own personal contribution to commemorating this pretty historic moment, I would like to take you all back a deceade or so to take a look at how the whole thing got started in the Austria of the late 1990s, since it was in Austria that the fashion for CHF mortgages really took off, and it is no coincidence that in Hungary it has been CHF and not euro denominated borrowing (as for example in the case of the Baltics or Romania) which has been the hallmark, since the Asutrian banks have played a key role in the Hungarian "transition". Dimitri Tzanninis explains the origins of Autrian CHF borrowing as follows:

The practice of borrowing in foreign currency (mainly Swiss francs) began in the western part of the country, where tens of thousands of Austrians commute to work in Switzerland and Liechtenstein. This partly explains why the share of these loans was higher in Austria, even during the 1980s. Word of mouth and aggressive promotion by financial advisors helped spread the popularity of these loans to the rest of the country. By the mid-1990s, newspaper ads placed by banks began to appear, fueling public interest.

Now Dimitri Tzanninis refers to this as an example of "herd behaviour" (see note at foot of post, and of course herd behaviour is the word, since his is about fads and fashions, and largely "non-rational behaviour - since if people understood the risk they were taking on board, then basically they wouldn't do it, and it is precisely herd-behaviour that we are now about to see in action again as people "unleverage" from the CHF as best they can). So, herd behaviour is essentially a non-linear process, and one which in this case is characterised by a lot of press and "word of mouth" driven "copycat"decision taking. The following charts of news stories in the Austrian press sum the situation up pretty well:

Herd Behaviour

For the record book I reproduce below the explanation of the herd behaviour phenomenon offered by Dimitri Tzanninis.

"Herd behavior occurs when people do what others do rather than rely on their
own (incomplete) information, which might be suggesting something different
(Banerjee, 1992). The suppression of private information could lead to
“information cascades” when decisions are made sequentially and a large enough
number of people choose identical actions. In such settings, the decisions of a
critical few people early on are enough to tilt group behavior toward a certain
direction. Mimicking the behavior of others might be rational because of
uncertainty about one’s own information as well as the need to economize on
information-gathering costs. Rational herd behavior is the subject of a recent
strand of behavioral finance (see Montier, 2002, for an introduction). "

Herd behavior can arise in a variety of environments, including in financial markets. However, it is difficult to disentangle empirically the effects of macroeconomic or other fundamental determinants from those caused by herd behavior. Herd behavior often results in volatility because it is susceptible to abrupt shifts or reversals, and thus has the potential to destabilize markets.

Empirical studies have shown that the dynamics of herd behavior often resemble an S curve: initially only a few adopt a certain behavior, but, past a certain critical mass, a take-off state takes hold where a rapidly growing number of people adopt this behavior. Toward the end of this process, a moderation of the dynamics takes place as the potential pool of adoptees is exhausted.


Banerjee, A. V., 1992, “A Simple Model of Herd Behavior,” The Quarterly Journal of Economics, Vol. CVII(3), pp. 797-817.

Montier, J., 2002, Behavioural Finance: Insights into Irrational Minds and Markets (Chichester: John Wiley & Sons Ltd.)

Waschiczek, W., 2002, “Foreign Currency Loans in Austria—Efficiency and Risk Considerations,” in Financial Stability Report 4, OeNB, pp. 83-99 (Vienna: Oesterreichische Nationalbank).

And to close this little commemoration of the closing of an epoch, here is a post I put up on this blog on 5 November 2007.

Swiss Franc Morgtages in Hungary

The use of non-local-currency denominated loans has become a widespread phenomenon in Eastern Europe in recent years. In Hungary the most common currency for such purrposes is the Swiss Franc and around 80% of all new home loans and half of small business credits and personal loans taken out since early 2006 have been denominated in Swiss francs. A similar pattern of heavy dependence on foreign currency denominated loans is to be found in Croatia, Romania, Poland, Ukraine (US dollar) and the Baltic States, although the mix between francs, euros, the dollar and the yen varies from country to country.

So let's look at the extent of the issue in Hungary, and some of the likely implications. First off, here's a chart showing the evolution of outstanding mortagages with terms over 5 years since the start of 2003. As we can see the outsanding debt is now over 5 time as big as it was then.

Now if we look at the growth of forint denominated mortgages over the same period, we can see that while they initially expanded very rapidly, they peaked around the start of 2005, and since that time they have tended to drift slightly downwards.

Then if we come to look at the growth of non-forint mortgages, we will see that since early 2005 the rate of contraction of such mortgages has increased steadily.

Finally, if we look at the distribution of non-forint mortgages between those in euros, and those in "other" currencies (which may contain some yen, and some USD mortgages, but in the main will be Swiss Franc ones) we can see that those in euro form only a very small part of the total.

It is perhaps also worth pointing out that the fashion for non-forint loans is not restricted solely to mortgages, car loans and other longer duration personal loans also tend to be denominated in Swiss Francs or other currencies. The reason for this is obvious, the rate of interest is cheaper. But this non forint loan predominance has two important consequences.

In the first place the Hungarian central bank does not have sufficient control over monetary policy inside the country, being to some significant extent influenced by monetary policy in Switzerland, a country we may note which is not even inside the European Union. Secondly, the difficulties which would present themselves in the event of any substantial reduction in the value of the forint would be considerable - the is known as the translation problem, and is ably reviewed by Claus in this post here - and as a result the central bank is one more time a prisoner of others in terms of monetary policy, since it cannot take interest rate decisions which might influence excessively the swiss franc-forint crossover rate.

The fashion for borrowing in Swiss francs really took off in Eastern Europe after the Swiss National Bank dropped interest rates to 0.75% in 2003 in order to stave-off a perceived deflation threat, a move which at the same time converted Switzerland into the cheapest source of loan capital in Europe. External lending in Swiss francs reached $643 billion in 2006, according to data from the Bank for International Settlements . The huge scale of the borrowing in fact drove the Swiss franc to a nine-year low against the euro, and has lead to an accelerating slide in its value over the last two years - even though by this point the Swiss National Bank had been busy raising rates (Swiss interest rates have now been increased 7 times since the 2003 trough). The extreme weakness in the Swiss Franc is in fact rather perverse (shades of Japan, of course, here), since currently Switzerland enjoys the highest current account surplus in the developed world (some 17.7% of GDP in 2006). At the same time the Swiss hold more than $500 billion in net foreign assets, making them in these terms the wealthiest nation on earth.

A recent issue of the Bank for International Settlements publication Highlights of International Banking and Financial Market Activity has some revealing comments on the Swiss situation(the data used for the report came from 2006):

Total cross-border claims of BIS reporting banks expanded by $1 trillion in the last quarter of 2006. After more modest growth in mid-2006, a pickup in interbank claims accounted for 54% of this expansion. A surge in credit to nonbank entities contributed $473 billion, pushing the stock of cross-border claims to $26 trillion, 18% higher than in late 2005.

The flow of credit to emerging markets reached new heights through the year 2006. Claims on emerging markets grew by $96 billion in the final quarter of 2006, bringing the volume of new credit throughout the year to $341 billion. This amount exceeded previous peaks ($232 billion in 2005 and $134 billion in 1996), both in nominal value and in terms of growth. The current annual growth rate has risen to 24%, having surpassed for the sixth consecutive quarter the previous peak of 17% recorded in early 1997.

Emerging Europe overtook emerging Asia as the region to which BIS reporting banks extend the greatest share of credit. Since 2002, growth in claims on the region has consistently outpaced that vis-à-vis other regions. With a record quarterly inflow, emerging Europe received over 60% of new credit to emerging markets, bringing its share in the stock of emerging market claims to 34%. Less of the new credit went to the major borrowers (Russia, Turkey, Poland and Hungary) than to a number of smaller markets, notably Romania and Malta, as well as Ukraine, Cyprus, Bulgaria and the Baltic states.

The currency denomination of cross-border claims on emerging Europe tilted further towards the euro. In the stock of claims outstanding, the euro and dollar shares were 44% and 31%, respectively, but the gap in the latest flow data was more pronounced (61% and 5%). While the sterling share has remained close to 1%, the yen has lost ground to the Swiss franc, thus continuing a trend seen over the last six years. Yet there is little evidence in the cross-border data of unusual borrowing in Swiss francs that might correspond to Swiss franc-denominated retail lending in several countries. Borrowing in the Swiss currency remains on average below 4% of cross-border claims, and exceeds 10% only in Croatia and Hungary.

Nearly 20% of reporting banks’ foreign claims were in the form of funds channelled to emerging market borrowers. Claims on residents of emerging Europe continued to account for the largest share of these funds.

So, although the BIS find "little evidence in the cross-border data of unusual borrowing in Swiss francs that might correspond to Swiss franc-denominated retail lending", they do make an exception in the cases of Hungary and Croatia, where they note that lending in Swiss francs to retail clients reaches over 10% (and of course in the Hungarian case well over 10%) of the total retail loans in those countries. Indeed, as I indicate above, swiss franc loans now seem to account for over 80% of all newly generated housing related credit in Hungary. The reason why Hungary has gone for Swiss franc rather than euro denominated loans undoubtedly has to do with the role of the Austrian banking sector in Hungary, as is explained in my fuller posting on this topic linked to below.

Additional References On Swiss Franc Loans and "Translation"

For fuller examination of just why it is that Switzerland (or for that matter Japan) have such low interest rates, see my "Swiss Franc Loans and Ageing" post.

For an examination of the potential implications of the presence of all these foreign currency loans across the EU10 in the event of any generalised emerging markets crisis see Claus Vistesen "Translation Risk in the Baltics and Other Matters".

Balance Sheet Consequences: The Academic Research

Well, given what I am saying above about the rapid and imminent demise of foreign exchange loans among Central and East European nationals, it is clear that the topic which is now about to come back into fashion (and to replace the forex loans themselves as the centre of attention) - at least among theoretical economists) is that of the so called balance sheet cosnequences of excessive forex leveraging, so to give people some background, and a bit of a push start, I have hastily compiled a brief reading list on the topic.

Do Balance-Sheet Effects Matter for Brazil
? Felipe Farah Schwartzman, May 2003

The past ten years have seen a number of currency crises, typically followed by a sharp drop in output in the countries involved. An explanation advanced for both the crisis and the recession is that firms in these countries had a large amount of debt indexed in foreign currency (Krugman, 1999). The exchange rate devaluation left the firms insolvent, reducing credit and production in the economy. Apart from crisis, balance-sheet effects have been advanced as an explanation for the “fear of floating” detected by Calvo and Reinhardt (2000) in developing economies in normal times.

Krugman, P. (1999), “Balance Sheets, the Transfer Problem and Financial Crisis,” in: International Finance and Financial Crises, P. Isard, A. Razin and A. Rose (eds.)

For the founding fathers of currency-crisis theory ..........the emerging market crises of 1997-? inspire both a sense of vindication and a sense of humility. On one side, the number and severity of these crises has demonstrated in a devastatingly thorough way the importance of the subject; in a world of high capital mobility, it is now clear, the threat of speculative attack becomes a central issue - indeed, for some countries the central issue - of macroeconomic policy. On the other side, even a casual look at recent events reveals the inadequacy of existing crisis models. True, the Asian crisis has settled some disputes - as I will argue below, it decisively resolves the argument between “fundamentalist” and “self-fulfilling” crisis stories........ But it has also raised new questions.

One way to describe the problem is to think in terms of Barry Eichengreen’s celebrated distinction between “first-generation” and “second-generation” crisis models. First-generation models, exemplified by Krugman (1979) and the much cleaner paper by Flood and Garber (1984), in effect explain crises as the product of budget deficits: it is the ultimately uncontrollable need of the government for seignorage to cover its deficit that ensures the eventual collapse of a fixed exchange rate, and the efforts of investors to avoid suffering capital losses (or to achieve capital gains) when that collapse occurs provoke a speculative attack when foreign exchange reserves fall below a critical level.

Second-generation models, exemplified by Obstfeld (1994), instead explain crises as the result of a conflict between a fixed exchange rate and the desire to pursue a more expansionary monetary policy; when investors begin to suspect that the government will choose to let the parity go, the resulting pressure on interest rates can itself push the government over the edge. Both first- and second-generation models have considerable relevance to particular crises in the 1990s - for example, the Russian crisis of 1998 was evidently driven in the first instance by the (correct) perception that the weak government was about to be forced to finance itself via the printing press, while the sterling crisis of 1992 was equally evidently driven by the perception that the UK government would under pressure choose domestic employment over exchange stability.

In the major crisis countries of Asia, however, neither of these stories seems to have much relevance. By conventional fiscal measures the governments of the afflicted economies were in quite good shape at the beginning of 1997; while growth had slowed and some signs of excess capacity appeared in 1996, none of them faced the kind of clear tradeoff between employment and exchange stability that Britain had faced 5 years earlier (and if depreciation was intended to allow expansionary policies, it rather conspicuously failed!) Clearly something else was at work; we badly need a “third-generation” crisis model both to make sense of the recent crises and to help warn of crises to come.

In the paper which follows Krugman sketches out yet another candidate for third-generation crisis modeling, one that emphasizes two factors that had been omitted from previous formal models to date: the role of companies’ balance sheets in determining their ability to invest, and that of capital flows in affecting the real exchange rate. The model was at that point (and as Krugman himself says) quite raw, with lots of loose ends hanging about. However, it did seem to tell a story with a much more realistic “feel” than some of the earlier efforts. It could be hoped that now that he has had time to recover from the shock of his recent Nobel, he may get interested once more in this earlier centre of his attention, since the model badly needs updating, and in particular to take account of the shift in the risk away from the corporate and towards the household balance sheet.

Balance Sheet Effects, Bailout Guarantees and Financial Crises


This paper provides a model of boom-bust episodes in middle income countries. It features balance of- payments crises that are preceded by lending booms and real appreciation, and followed by recessions and sharp contractions of credit. As in the data, the non-tradables sector accounts for most of the volatility in output and credit. The model is based on sectoral asymmetries in corporate finance. Currency mismatch and borrowing constraints arise endogenously. Their interaction gives rise to self-fulfilling crises.

In the last two decades, many middle-income countries have experienced boom-bust episodes centered around balance-of-payments crises. There is now a well-known set of stylized facts. The typical episode began with a lending boom and an appreciation of the real exchange rate. In the crisis that eventually ended the boom, a real depreciation coincided with widespread defaults by the domestic private sector on unhedged foreign-currency-denominated debt. The typical crisis came as a surprise to financial markets, and with hindsight it is not possible to pinpoint a large “fundamental” shock as an obvious trigger. After the crisis, foreign lenders were often bailed out. However, domestic credit fell dramatically and recovered much more slowly than output.

This paper proposes a theory of boom-bust episodes that emphasizes sectoral asymmetries in corporate finance. It is motivated by an additional set of facts that has received little attention in the literature: the tradables (T-) and nontradables (N-) sectors fared quite differently in most boom-bust episodes. While the N-sector was typically growing faster than the T-sector during a boom, it fell harder during the crisis and took longer to recover afterwards. Moreover, most of the guaranteed credit extended during the boom went to the N-sector, and most bad debt later surfaced there. Our analysis is based on two key assumptions that are motivated by the institutional environment of middle income countries. First, N-sector firms are run by managers who issue debt, but cannot commit to repay. In contrast, T-sector firms have access to perfect financial markets. Second, there are systemic bailout guarantees: lenders are bailed out if a critical mass of borrowers defaults.

And please note the last sentence: "lenders are bailed out if a critical mass of borrowers defaults", this, I imagine, is what we are about to see happen next.

A Balance Sheet Approach to Financial Crisis
Mark Allen, Christoph Rosenberg, Christian Keller, Brad Setser, and Nouriel Roubini :

The paper lays out an analytical framework for understanding crises in emerging markets based on examination of stock variables in the aggregate balance sheet of a country and the balance sheets of its main sectors (assets and liabilities). It focuses on the risks created by maturity, currency, and capital structure mismatches. This framework draws attention to the vulnerabilities created by debts among residents, particularly those denominated in foreign currency, and it helps to explain how problems in one sector can spill over into other sectors, eventually triggering an external balance of payments crisis. The paper also discusses the potential of macroeconomic policies and official intervention to mitigate the cost of such a crisis.

Wednesday, October 22, 2008

Hungary's Retail Sales Continue To Fall In August

Hungary's central bank doesn't have an exchange-rate goal and considers the recent slide of the country's currency unwarranted in terms of Hungary's economic fundamentals, according to bank governor András Simor.
Hungarian retail sales remained stationary month on month in August, following a 0.1% drop in July from June, according to calendar and seasonally adjusted data out today (Wednesday) from the Central Statistics Office (KSH). According to calendar adjusted data there was a fall over August 2007, versus a 1.8% decline in July and a 3.5% drop in August 2007. Basically sales continue to fall even if the rate of decline is slowing, due in part to the low-base effect.

The seasonally adjusted index was unchanged at 137, and if we look at the course of sales over the last 18 months in the chart below, we will see that the decline is now continuous. If the underlying fundamentals of the Hungarian economy really are sound, then I personally don't know where I should be looking to find them, I really don't.

Panic Gets A Grip On The Hungarian Authorities As Base Rate Is Hoisted And Large Spending Cuts Planned

Wow, this is BIG news:

The National Bank of Hungary (NBH) has on Wednesday raised its benchmark rate by 300 basis points to 11.50% i a bid to shield the forint from speculative attacks. According to a statement released by the central bank, Hungary's two-week deposit rate is 11.50% as of 11:00 CET 22 October.

Let me be absolutely calm, cool and clear at this point: THIS IS NOT THE WAY.

In addition Economy Minister Gordon Bajnai is also promising not to be shy when it comes to spending cuts.

The government has postponed tax cuts aimed at boosting growth from a 14-year low to focus on reducing reliance on external financing as investors shun riskier assets. It plans to narrow the budget gap to 3.4 percent of gross domestic product this year and 2.9 percent in 2009 from last year's 5 percent. The earlier goals were 3.8 percent for this year and 3.2 percent for next year.

According to Prime Minister Ferenc Gyurcsany Hungary's government, which submitted a revised 2009 budget draft to parliament last week, is ready to rework the details again if economic conditions warrant it:

``If we need to act, we will act immediately, like we have in the past 10 days,'' he said in an interview on state-run Magyar Radio late yesterday. ``If there's a consensus among analysts and evaluators that the pressure on Hungary is bigger then we previously expected, then we'll have to work through one or two nights again and redo the budget one more time.''

The government have pledged to reduce the budget deficit faster than previously planned to reduce Hungary's reliance on external financing. My feeling is that they are getting absolutely the wrong advice here. Alone, of course, they have no alterative, since the markets are obsessed with this point and will crucify them if they don't make at least a symbolic effort to reduce the fiiscal deficit, but this is why they need EU support on the fiscal side. Hungary is an EU member, isn't it????? Or do Europe's leaders in Brussels want to see one (and then two, and three, and four.......) "Argentinas" inside the Union's frontiers?

Also, the deeper the recession in 2009, the less tax revenue there will be, so we could get into a vicious circle here. And an 11.5% base rate at exactly the time the supply of foreign credit dries up means you can say bye bye to internal consumption for the foreseeable future. What the hell is the ECB up to at this point? Didn't we all use to say when we were young, "no return to the 1930s", yet this seems to be precisely the kind of policy mix Hungary is facing at this point.

Bajnai apparently said in an interview with CNBC television that the forint and stocks are under attack from ``speculators". This may or not be the case, but it is not the principal problem. The main problems are associated with the weak underlying fundamentals which have long characterised the Hungarian economy, and the fact that people have been drwan into taking out foreign exchange currency loans when the economic fundamentals (and excessive internal inflation) mean that the currency is almost bound to be weak, and trend steadily downwards until a strong, export oriented and competitive economy is built. This will need some years, and in the meantime Hungary needs to survive.

Hungary does not need another bout of significant spending cuts, on the contrary it needs a strong injection of FISCAL support from its EU partners, to try to underpin domestic demand while the Fx loan dependency unwinds. At the same time it needs substantial support from the IMF to allow the currency to move downwards in an orderly, and not a disruptive fashion. There are lots more things needed in the mid term like labour market, pensions and health system reform, but the patient is on life support, and needs to be kept alive, to live to fight another day.

Simply sending Hungary off into a long and deep deflationary recession is not the answer, and the sooner people come out of denial and try to address some of the longer term problems (including the demographic one) the better for all concerned.

At the moment I am knee deep in work from other areas - most of Eastern and Southern Europe it will be remembered is dropping into recession at this very point (not to mention Germany) - but I will try and find time for a longer and much more reflective post on Hungary at the weekend.

Monday, October 20, 2008

Hungary Central Bank Keeps Interest Rates On Hold - What Else Could They Do?

Hungary's Central Bank Monetary Council left its benchmark interest rate (the two week deposit rate) unchanged at 8.50% at Monday's meeting. The decision was completely in line with market expectations.

According to Magyar Nemzeti Bank Governor András Simor speaking after the meeting, leaving rates unchanged was the only scenario discussed. Hungary's central bank has now left its benchmark interest rate unchanged and at a three-year high for the past five meetings.

``At today's meeting, we discussed mainly the global situation, the resulting risk revaluation, the shortage of liquidity and their Hungarian effects,'' Simor said. ``In this situation, keeping tight monetary conditions was warranted.''

Hungary's forint weakened to a two- year low against the euro today while the benchmark stock index fell to its lowest level in more than four years.

The forint weakened 3.6 percent to 280.29 per euro, the second-worst performance internationally, behind only the Zimbabwean dollar. The BUX index fell 2.7 percent to 12,339.56, more than any other benchmark except Argentina's. OTP Bank Nyrt., the nation's largest lender, fell again today, a further 10.1 percent to reach 2,650 forint.

So far this month the forint has dropped 15 percent against the euro, the BUX is down 35 percent and OTP has fallen 57 percent, wiping 968.8 billion forint ($4.6 billion) off the lender's value. Hungary's central bank today distributed 107 billion forint ($511 million) in its first offering of loan instruments aimed at resuscitating the country's debt market, including 30 billion forint, the full amount available, of six-month loans at a rate of 9.16 percent,

Hungary's central bank doesn't have an exchange-rate goal and considers the recent slide of the country's currency unwarranted in terms of Hungary's economic fundamentals, according to bank governor András Simor. I really am not sure where he is getting the nerve to say the fundamentals are sound from, since growth is about to fall through the floor as far as I can see, especially if people are unable to keep up their payments on the Swiss franc mortgages. I think we are all agreed that what Hungarian's now need is some realism and some policies which are based on sound arguments and can offer hope. This doesn't sound like one of those to me.

Monetary policy makers still have tools they can use to affect the currency, Simor added, presumeably intending to threaten intervention in the currency markets. He also said, however, that an intervention to counter the forint's 15 percent drop so far this month would be "unjustified,'' since he felt it was unclear just how long the decline will last.

"At the moment, we view intervention as being unjustified,'' Simor said. ``We don't look at short-term price moves, but long- term trends. It can't be seen right now if this is a long-term trend or a short-term swing. Intervention is an important tool that we don't use much, but we do have it.''

Really the National Bank of Hungary is trapped at this point. Domestic demand conditions indicate that a substantial interest rate easing is called for in order to provide some stimulus to the economy, especially in an envoronment where exporting will be hard and fiscal policy will be towards contraction rather than towards expanison. However, given the forints vulnerability this is impossible, and most analysts seem to expect that monetary policy will tighten as we go into the recession. This can only mean one thing, as far as I can see: a sharp contraction in the economy and pressures towards wage and price deflation which will only serve to put all those who have recently taken out Swiss Franc mortgages with high LtV's on 2007/08 property values under even more pressure.

Nonetheless, betting on interest rate increases seems to be where the money is going at the moment, and forward-rate agreements are showing that investors have given up expectations of lower rates in the next six months. They now foresee the rate rising more than 75 basis points, compared with a projection of a rate cut a month ago. The three-month money market rate is at 8.93 percent, or 43 basis points higher than the central bank rate. That compares with 9 basis points a month ago.

Well then, what is it they say on the reverse face of the dollar: in God we trust, and heaven help us if they are getting all this wrong!

Hungary August Construction Output Up On July, But Continues To Fall Year On Year

Hungary's construction industry expanded month on month in August, according to seasonally and working day adjusted data, and regisered a 3.8% month-on-month increase, as against a 2.6% contraction in July. However output decreased by 4.3% year on year (on a working day adjusted basis), following a 12.8% decline in July.

The corresponding figure at buildings was a decrease of 19.5% and while civil engineering was up 1.6% (year on year). The stock of new orders in January-August was down 10.4% for the whole sector, while there was a 31.7% year on year contraction for new buildings and a 22.1% increase for civil engineering works.

In part the decline in the rate of annual decrease in August is deceptive, since we are now moving steadily into a zone where the low base effect will become important. Thus, as we can see in the seasonally adjusted output index chart below, levels are now well down on those of late 2006/early 2007, and look set to remain there or even decrease further.

Saturday, October 18, 2008

Hungary's Stocks Take a Pounding

Hungary's benchmark BUX stock index fell 2.4 percent on Friday following a 19.5 percent decline over the previous two days. The forint fell to an almost two-year low before recovering to trade at 267.06 per euro at 6:04 p.m. in Budapest, compared with 267.72 on Thursday.

The global financial crisis is hitting more vulnerable emerging markets as investors withdraw from riskier assets. The MSCI Emerging Markets Index plunged 28 percent this month and Russia's Micex Index fell 42 percent. Poland's benchmark WIG20 index fell 6.3 percent today.

Central European stocks droppedgenerally, led by banks, after Goldman Sachs Group Inc. lowered its economic forecasts for the region and Fitch Ratings cut Hungary's foreign- debt rating. Hungary's OTP declined 150 forint, or 4.6 percent, to 3,150, (its lowest level in 5 years) extending this month's loss to 48 percent. HSBC cut its recommendation on the shares to "underweight'' from "overweight'' and slashed its price projection for the bank 62 percent to 3,500 forint.

Komercni Banka AS, the third-largest Czech bank, fell the most since 1999. Bank Pekao SA, Poland's biggest bank, posted its steepest drop on record. The NTX Index of 30 companies in the region retreated 4.4 percent to 951.42, the lowest in almost four years, even as stocks in western Europe rose after a two-day selloff. The PX Index's drop was the biggest fluctuation among equity markets included in global benchmarks, while Poland's WIG20 Index lost 6.4 percent and Austria's ATX Index declined 3.3 percent.

All shares quoted on the Budapest Stock Exchange have now plunged when compared with both their 12-month and their historic highs. Compared to the 12-month highs of individual stocks Richter and Émásy have fallen the least, but even these are well down (38% and 40%, respectively). The drops have been among smaller entities like Synergon, Fotex and econet, but as we have said OTP is now not far behind

If we look at the MSCI Standard Core Index for Hungarian stocks, we find the index was down 1.4% on Friday, 44.96% so far this month, 59.63% in the last three months, and 61.24% so far this year.

Also, while I am here, I found this old chart on my excel sheet which is quite relevant at this time. It shows how net household saving as a source of potential finance has declined tremendously since the mid 1990's, and you can get some idea of the net external borrowing requirement from the shaded area under the main axis.

Friday, October 17, 2008

Fitch Lowers Hungary's Long-Term Issuer Default Ratings

Fitch Ratings has on Friday revised the outlooks on Hungary's Long-term Issuer Default ratings (IDRs) to Negative from Stable. Its ratings are affirmed at foreign currency IDR 'BBB+', Short-term foreign currency IDR 'F2', and Long-term local currency IDR 'A-' (A minus). Its Country Ceiling is affirmed at 'A+'.

"The revision of Outlook reflects Fitch's view that shocks from global financial turbulence and the likelihood of recession in the euro area have heightened downside credit risk given Hungary's high external debt stock, wide current account deficit and large external financing requirement," said David Heslam, Director in Fitch's sovereign team.

“The deterioration in global, and particularly European, financial conditions have heightened the risks for economies with large external financing needs and reliance on bank financing. Hungary's gross external debt amounts to 99% of GDP, one of the highest levels in Central and Eastern Europe,"

Financing of Hungary's current account deficit - which stood at 6.4% of GDP in 2007 (based on revised official statistics) - is “sensitive to strains in international capital and banking markets, with a significant proportion of financing dependent on flows to local banks from their western European parents."

“Heightened risk aversion has led to strains in government debt and inter-bank markets and to a weakening of the HUF, which if exacerbated would increase debt servicing requirements and place strains on loan portfolios of the domestic banking system, where foreign currency-denominated loans account for over half of private sector credit."

In addition, the global economic slowdown, and particularly the likelihood of a recession in the euro area - the destination for over half of Hungary's exports - “has weakened an already subdued growth outlook, increasing the challenges facing the government in its attempts to continue to narrow the fiscal deficit."

“At 66% of GDP the government's gross debt remains high relative to the 'BBB' median of 28% and low economic growth will make it difficult for the debt burden to fall, while external markets are an important source of financing, including through substantial non-resident holdings of HUF-denominated debt."

George Bokros Goes Live On Hungarian TV

Now I am not either an unreserved, or an uncritical admirer of George Bokros, but I do think he talked a lot of sense when he went on Hungarian TV this morning. The Hungarian banks are no longer at risk, they are guaranteed by the Hungarian State. It is the Hungarian State which is now at risk, since ultimately it is the state who is going to have to underwrite all the debts. This is why you need full IMF support, urgently in my view. Get in there first, before you have to wait your turn in the queue behind the rest of them.

I don't mean to create panic, but chances of a national bankruptcy and a currency crisis are bigger than of a banking crisis in Hungary, said Lajos Bokros, Chief Operating Officer/Professor of the Central European University (CEU), on Friday.

Hungary's former Finance Minister told public television on Friday morning that, in theory, there are three kinds of crisis: fiscal, bank and currency crises. Fiscal crisis is when a state is unable to finance itself, it cannot renew government papers or acquire funds to cover budget spending.

Bokros believes chances of this scenario and of the forint being blown away are higher than of banks going bust. Bar Hungary's largest bank (OTP) every major financial institution in the country is in foreign hands, he noted.

While the big, well-capitalised parents of these banks may incur losses, it will be their shareholders rather than the deposit holders that will get the short end of the stick, Bokros added. Bokros said he would not be concerned about the fluctuations in OTP's share price either, as stock prices always have ups and downs.

Bokros noted that savers are secured by the Deposit Insurance Fund that has enough capital to guarantee bank deposits. He is less upbeat about the situation of the state (and the local currency), saying that - without any intention to induce panic - a fiscal crisis could hit more easily. Bokros said the structure of the budget is bad and due to mistakes made by the government Hungary meets none of the Maastricht criteria (needed to join the euro zone).

Therefore, speculators regard Hungary as the most vulnerable in the region. It is the only country of the ten EU newcomers (that joined the block in 2004) with government debt at 66% of GDP, he added.As Slovakia is to adopt the single European currency in January 2009, speculators have been avoiding it (the SKK has not produced so heavy swings during the crisis, either). Bokros urged further spending cuts and a reform of the tax regime. Tax rates may be reduced only if the government manages to boost the number of taxpayers, he said.
Bokros As Hungary's Cavallo?

Domingo Cavallo is perhaps best known to economic history as the financial supremo who leaped to the headlines during his term as Argentina's Economy Minister in 2001 when he battled with the looming economic crisis which finally burst in January 2002. On 23 November 2006 I published the post which follows on this blog. So when people tell you that what is happening now could not have been forseen, don't believe them. I could see this coming, and I don't think I was the only one.

(Not everyone of course shares this view and an alternative point of view on Domingo Cavallo can be found here).

As Robert Barro noted:

In March, 2001, President Fernando de la Rúa's new Economy Minister, Ricardo López Murphy, failed when a reasonable program of curtailing public spending hit a political roadblock. Now there is talk in the markets of default on Argentina's foreign debt.

Out of desperation, the President has turned to his political rival, Cavallo, to save the economy a second time.

Now it seems Lajos Bokros is offering himself for a somewhat similar role in the context of Hungary's growing economic crisis. Of course, the parallels do not end there, since Cavallo was also the architect of Argentina's economic reform process during his tenure at the Ministry in 1991:

Things changed in 1991, when Domingo Cavallo took over as Economy Minister. His reforms were pro-market and featured fixing the peso at 1-to-1 parity with the U.S. dollar. He also pushed trade liberalization and reforms of public finance and the banking system. Despite the recession of 1995, induced by the Mexican peso crisis, Argentine per capita GDP grew at an average rate of 4.8% during the Cavallo years, through 1996.

And of course Lajos Bokros - currently Chief Operating Officer and professor of the Central European University (CEU) - was Finance Minister and father of an aggressive austerity package back in 1995:

Lajos Bokros, Hungary's former Finance Minister and the father of an aggressive but inevitable austerity package in 1995, said he would assume the position of Prime Minister if he was allowed to execute his own adjustment programme.

Bokros, who is currently Chief Operating Officer and professor of the Central European University (CEU), also said the country is in a political and moral crisis in respect of the fact that the governments which had been overspending and pushed the country into indebtedness can hardly ask for sacrifices from the people.

In an interview with weekly Heti Válasz, the former World Bank Director reiterated that Hungary needed a multi-insurance model in healthcare a market-based higher education and sweeping reforms in the pension regime.

With regards to the pension system Bokros said it could not be allow leaving one third of the population wrapped in cotton and let the working people carry all burden. The current system even encourages people to withdraw from the labour market via early or disability retirement, he added.

With respect to the tax cut plans of main opposition party Fidesz, Bokros said taxes would need to be reduced but that it could not be done without holding back spending more than presently.

At a conference of the central bank (NBH) Bokros said on Wednesday that what is currently hanging over Hungary is not the threat of bankruptcy or a financial crisis but the shadow of falling behind.

Growth is hampered by Hungary's huge twin deficit and the fiscal adjustment package will make Hungary the slowest growing emerging market next year, he added.

Bokros stressed the importance of structural reforms and pointed out the quality and availability of public services have been eroding, which undermines social solidarity.

Now the parallels with Argentina's situation in 2001 do not end here. Both countries share the problem of finding themselves on an unsustainable economic path, and in need of urgent measures which go beyond what the incumbernts are (or were) offering.

In Hungary's case Bokros is right to draw attention to the fact that tax increases will only add to Hungary's problems in terms of attaining the growth which is needed to support public services. He is also right that Hungary's health and pensions systems are at the heart of the problem.

But here the situations differ. Argentina had a currency peg, while Hungary's forint is, at least in theory, free floating. However since Hungary badly needs to retain foreign investment, and also needs to keep inflation in check, there is little alternative to relatively high interest rates, but these precisely (at least for the time being) maintain the forint at a relatively high level, which of course produces the same problem in exporting which Argentina suffered. These high interest rates also make the cost of servicing the government debt rather high, and this fact alone, as we have seen here, contributes to the difficulties in reducing the deficit.

The other big difference between Hungary and Argentina is the demographic one. Argentina was a comparatively high fertility developing economy, with, by and large, the phenomenon known as the demographic dividend out there in front of it. Hungary unfortunately belongs to that group of countries who went through a large part of their demographic transition before they became economically rich. As such the future lying out in front of Hungary is inevitably a complicated one, with or without the present economic conundrum. Fertility is at the lowest-low level (or see the file linked to here) and Hungary is set to age rapidly as the currently low life expectancy rises and rises. So the demographic changes which are facing Hungary involve more of a demographic penalty than a demographic dividend.

And Bokros is right to draw attention to the social spending dilemma which Hungary faces. He is also right that the pension and health systems badly need reform. The question is, as people enter a necessary private pillar, where does the money come from to finance the earlier PAYGO system, and how do you prevent the quality and availability of public services from eroding (which Bokros says he wants to do) if what you are going to do is reduce spending on them significantly? Somehow the numbers here just don't add up.

At the end of the day all comparisons are rather limited in their value. But what worries me most here is that I just can't see a sustainable path for Hungary to take hold of, and that, believe me, is the most worrying thing of all. Simply telling people that what they need is an austerity package if you have no clear idea of how the hell it can all work is only likely to mean that you end up as Cavallo did, only as I said Hungary isn't Argentina, and the end product of all this prevarication won't be a pretty sight.

OTP Bank Placed On S&P Watchlist, 2009 GDP Forecast Slashed By Government

Credit Rating Agency Standard & Poor's has placed its 'BBB+' long-term and 'A-2' short-term counterparty credit ratings on Hungary's OTP Bank and OTP Mortgage Bank on CreditWatch with negative implications.

This rating action follows the similar CreditWatch placement of the ratings on Hungary (BBB+/Watch Neg/A-2) 15 October, which in turn reflects S&P's concerns over mounting financial-sector funding pressures and their potential to raise general government debt materially.

“The ratings on OTP reflect its dominant domestic market position, strong and soundly managed business and earnings diversification in Central and Eastern Europe (CEE), and strong profitability. These factors are partly offset by the potentially volatile and risky operating environment in CEE countries, credit risks from rapid loan growth and significant domestic foreign currency lending, and the bank's moderate capitalization," S&P said late on Thursday.

GDP Forecast Slashed

Hungary's Finance Minister János Veres announced this morning (Friday) that he was slashing the official 2009 economic growth outlook to an annual 1.2% from the present 3.0%. My feeling is that this is still far to optimistic (growth is likely to be negative in 2009) but it is at least in the right direcetion.

Veres announced the new estimates for the 2009 Budget at a meeting of the National Interest Reconciliation Council (OÉT). The latest projection for 2009 inflation is 3.9% against the previous 4.3%.

Veres also confirmed earlier announcements that the budget deficit target was brought down to 2.9% of GDP from 3.2% for 2009. Given everything which is happening out there, and the sharp slowdown in GDP growth which is to be anticipated, I can't see how they can possibly hope to stick by this, but still, the credibility problem is their's, not mine.

Ferenc Gyurcsany Promises Measures to Help Hard Hit CHF Mortgage Payers

Also, this morning (Friday) in Bloomberg:

Hungary is drawing up proposals to help borrowers whose foreign currency-denominated loan payments rose as the forint weakened, Prime Minister Ferenc Gyurcsany said. The government is in talks with banks and will present proposals next week that will “significantly ease” the burden of borrowers, Gyurcsany said today in a public television interview. The forint has been battered along with Hungarian stocks and bonds as investors sold off riskier emerging market assets. Foreign currency borrowing by local businesses and consumers, along with slower growth and a wider budget deficit than elsewhere in eastern Europe, make the country a target, economists said.”

This is the bail-out Hungary will need, a battery of measures to help those with CHF mortgages pay-down their debt, or transfer them over to (subsidised) HUF ones. Hungary, given the fiscal straightjacket she is now in, and the very large costs of population ageing that are now about to hit simply is not able to generate the resources to make this transition alone, and that is why the IMF will have to help.