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Friday, March 27, 2009

Of Raising Rates and the Stakes

By Claus Vistesen: Copenhagen

WHO is Raising rates? The immediate answer to this question would seem to be; not many. On the contrary, most major central banks and now also their peers in the emerging world seem to have come to the conclusion that to counter the crisis, they need to apply both conventional as well as unconventional monetary policy measures. Especially, among the major central banks quantitative easing is the name of the game with only the ECB still clinging on to the fig leave. So, I ask you again who is raising rates?

Well, it is not yet a done deal but to show what it means to be stuck between a rock and a hard place it would serve us well to have look at Hungary which, even among its CEE comrades, look comparatively battered and bruised. To make matters worse, Hungary received another blow to the kidneys as Prime Minister Ferenc Gyurcsany announced on Saturday that he was resigning his position. On the face of it, it is difficult to blame the guy since with Hungary being the first economy in Eastern Europe to secure a loan from the IMF to the tune of 20 million euros the corresponding budgetary cuts demanded look almost cartoonishly unrealistic relative to the economic situation.

Even as he presided over a reduction of the budget deficit from 9.2 percent of GDP in 2006 to about 3.3 percent last year, Gyurcsany was criticized in February by some opposition parties and the central bank for his proposed 900 billion forint ($4.1 billion) tax shuffle to boost growth. Critics said more spending cuts were needed to stabilize the economy in the short run and boost growth in the long run.

“The government no longer had any room to maneuver,” Gyorgy Barcza, chief economist at KBC NV’s Hungarian unit, said yesterday. “Without new measures, the budget deficit would be more than the target.”Failure to continue austerity measures could result in a downgrade of the country’s credit rating, David Heslam, Director of Fitch Ratings’ sovereign team, said in a statement today. The agency rates Hungary’s debt BBB, the second-lowest investment grade, with a negative outlook.

The Socialist Party is less than half as popular as its biggest rival. Backing for the government started slipping when it introduced austerity measures to close a budget gap in 2006. The resulting economic decline was worsened by the global crisis, forcing the country to seek international aid. The party had 23 percent support last month, the lowest in 10 years, compared with 62 percent for the largest opposition party, Fidesz, pollster Median said on its Web site on March 18. Gyurcsany’s popularity fell to 18 percent, making him the most unpopular premier since communism. The poll of 1,200 people has a margin of error of 2 to 6 percentage points.

As Edward put it recently, it is difficult not to note a irrevocable pattern in the (unfortunate) countries subject to IMF intervention whereby they collapse under the yoke of the measures demanded in trade for the loan. Of course, we should not only shoot at the IMF since in the context of e.g. the EU one wonders the extent to which western Europe can just idly watch a country such as Hungary spiral into the abyss without extending some kind of bilateral help. Note in passing here that Gyurcsany's resignation marks the second case of government jitters in an IMF supported economy. The second would be Latvia where the government resigned recently.

As it could have been expected the market was none to happy about the PM's resignation which brings us to question of raising those rates. Consider consequently that the Forint which have already been pounded relative to the Euro completed a 2.6 percent drop to 308.62 against the euro (click on image for better viewing).

Consequently and following the Prime Minister's resignation the central bank was forced to move with comments that all tools would be deployed to avoid the Forint depreciation to spiral out of control. Now, I would not want to contradict myself here and let me very clear then; I think that a weak Forint is a fundamental part of whatever future Hungary may have but in the near term and with the rating agencies thoroughly marking the outlook for Hungary with the negative label it is a tightrope walk for policy makers not least because we still have the unresolved issue of translation risk whereby liabilities are denominated in foreign currency (mostly swiss francs though) and assets in Forints. Conclusively, it is difficult to see why, given the economic reality, the central bank would want to raise rates, but it is also difficult not to concur that they need to do something with respect to ensuring some kind of order vis-à-vis Hungary's stakeholders not to mention investors. Perhaps this duality more than anything shows us the almost impossible situation Hungary now finds itself in.

Raising the Stakes?

Meanwhile and moving across the pond for a minute it appears that US authorities have just raised the stakes in the dramatic jeux d'horrible that is the unfolding economic crisis. Thus and following the Fed's shock and awe treatment of the markets last week as Bernanke rolled out measures to buy treasuries (presumably) in the primary market we got the long awaited details in Timothy Geithner's plan on how to deal with those toxic assets and consequently how to restore confidence in markets so that we just might go back to normal whatever that is these days.

Quite naturally, the plan (see also here and here) which includes most notably a public-private partnership scheme designed to take care of about 1 trillion USD worth of toxic asset has been parsed by many of the most astute economic pundits. From the horses own mouth this is how it is described;

The Public-Private Investment Program will purchase real-estate related loans from banks and securities from the broader markets. Banks will have the ability to sell pools of loans to dedicated funds, and investors will compete to have the ability to participate in those funds and take advantage of the financing provided by the government.

The funds established under this program will have three essential design features. First, they will use government resources in the form of capital from the Treasury, and financing from the FDIC and Federal Reserve, to mobilize capital from private investors. Second, the Public-Private Investment Program will ensure that private-sector participants share the risks alongside the taxpayer, and that the taxpayer shares in the profits from these investments. These funds will be open to investors of all types, such as pension funds, so that a broad range of Americans can participate.

Third, private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets.

The new Public-Private Investment Program will initially provide financing for $500 billion with the potential to expand up to $1 trillion over time, which is a substantial share of real-estate related assets originated before the recession that are now clogging our financial system. Over time, by providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets. The ability to sell assets to this fund will make it easier for banks to raise private capital, which will accelerate their ability to replace the capital investments provided by the Treasury.

This program to address legacy loans and securities is part of an overall strategy to resolve the crisis as quickly and effectively as possible at least cost to the taxpayer. The Public-Private Investment Program is better for the taxpayer than having the government alone directly purchase the assets from banks that are still operating and assume a larger share of the losses. Our approach shares risk with the private sector, efficiently leverages taxpayer dollars, and deploys private-sector competition to determine market prices for currently illiquid assets. Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience.

Macro Man offers nothing but a sigh, Paul Krugman is in despair, Calculated Risk also seems skeptical that this is the right approach and finally Yves Smith also chimes in with a "thumbs down". I tend to agree with the skeptics and even though I have not really studied the proposal in detail the principal problem for me is that the government is putting up money for assets of which some are surely worthless and others may be work significantly less than current book value. In this way, it does nothing to solve the underlying issue and the risk for the taxpayer seems substantial.

Ah well, perhaps I and the rest of the gang above are just party poopers. What is certain is that the markets liked it and in fact Macro Man may have hit the proverbial nail on the head when he recently, and once again, evoked March Madness (click on image for better viewing).

Of course, if there ever was something resembling a sucker rally it is this but so far things look as they are working. Also we cannot rule out that this initiative may just be what it takes to allow these assets to be marked to (a credible) market which would mean that we had taken one important step in moving forward. One thing which I do like by the activism in the US is that it is just that; activist which flies in the face of ostrich attitude prevailing on this side of the pond.

Rates and Stakes

So, what do Hungary and the US have in common here? Except being in the midst of their worst economic crisis of, arguably, all time not a whole lot I guess. However, they are both being forced to move into uncharted waters when it comes to fighting off the current mess in the global economy and her financial system. It will be very interesting to see whether raising rates as well as the stakes will bring forth the intended effects.

Hungarian Prime Minister Gyurcsány steps down - now what?

by Manuel Alvarez-Rivera, Electoral Resources On The Internet

Last Saturday's announcement by Hungarian Prime Minister Ferenc Gyurcsány that he was stepping down after almost five years as head of government may have come as a surprising turn of events, given that he had stubbornly clung to office despite his growing unpopularity over the course of the last three years. However, what turned out to be completely unexpected was the method he chose to end his mandate: a constructive vote of no-confidence in the National Assembly (Parliament) against his own government.

Under a constructive no-confidence motion, Parliament votes to replace a sitting prime minister with another person, rather than simply bring down the government. This mechanism was introduced in the former West Germany after World War II, in order to prevent a recurrence of the parliamentary deadlock that contributed to the demise of the 1919-33 Weimar Republic.

Constructive votes of no-confidence have been adopted by other European countries - Hungary being one of them - since they ensure cabinet stability by preventing Parliament from removing a government from office without having agreed upon a replacement; in Germany there has only been one successful constructive no-confidence motion, which took place in 1982 when the Bundestag voted to replace Chancellor Helmut Schmidt with Helmut Kohl, after the liberal Free Democratic Party - at the time the Social Democratic Party's junior coalition partner - switched sides and formed an alliance with the Christian Democratic Union/Christian Social Union.

However, Gyurcsány plans to use the constructive vote of no-confidence to install another Socialist-led cabinet, and his government - which has become the third casualty of the global financial crisis, joining the ranks of Iceland and Latvia - appears to have resorted to this unusual maneuver for one simple reason: to avoid an early election.

Gyurcsány's post-communist Hungarian Socialist Party (MSZP) won Hungary's 2006 general election in coalition with the liberal Alliance of Free Democrats (SZDSZ), but in September of that year a leaked tape revealed that the prime minister had lied about the state of the Hungarian economy to secure re-election. Gyurcsány never recovered from this revelation, which triggered widespread protests that degenerated into rioting. Despite mounting calls for his resignation after the ruling parties suffered a heavy defeat in municipal elections held the following October, Gyurcsány refused to step down and subsequently won a vote of confidence in the National Assembly.

The Socialist-Liberal coalition government then went on to impose fees for visits to the doctor, hospital stays and university tuition, as part of an austerity package intended to reduce the country's large budget deficit (the highest in the European Union as a percentage of GDP) and pave the way for Hungary's adoption of the euro as its currency. However, Gyurcsány suffered yet another stinging defeat when the measures were soundly rejected by voters in a March 2008 referendum. Shortly thereafter, the Liberals left the government after Gyurcsány sacked the SZDSZ-appointed Health Minister; nonetheless, the Socialists remained in power as a minority government with external support from the Liberals. Meanwhile, Hungary's already weak economy took a sharp turn to the worse, which left the country no choice but to take a $25 billion international rescue package from the International Monetary Fund, the European Union and the World Bank.

Recent opinion polls have Hungary's main opposition party, the right-of-center Fidesz-Hungarian Civic Union ahead of the Socialist Party by more than forty (40) points; not surprisingly, Fidesz continues to press for an early vote, while the Socialists are hoping that a new prime minister will turn the party's fortunes around before a general election is held by the spring of 2010 at the latest. However, barring some completely unforeseen development it is highly unlikely the Socialists will be able to overcome Fidesz's massive lead, although they could conceivably reduce it. At any rate, Fidesz's large advantage would almost certainly be amplified by the complicated electoral system used to choose members of Hungary's unicameral Parliament (reviewed in Elections to the Hungarian National Assembly), which combines French-style runoff voting in single-member constituencies with regional-level party-list proportional representation and a cumbersome top-up national list.

By resorting to a constructive vote of no-confidence, which will be submitted to the National Assembly next April 6 (with a vote scheduled for April 14), Gyurcsány has left President László Sólyom out of the process. Hungary's head of state has made it clear he favors holding an early election, noting that the new prime minister would be in office for at most one year before the next general election would have to be held; nonetheless, he cannot intervene unless Gyurcsány actually resigns.

In the meantime, the Socialist Party - still chaired by Gyurcsány - has proposed three candidates for prime minister: former National Bank governor György Surányi, former president of the Hungarian Academy of Sciences Ferenc Glatz, and András Vértes, president of the GKI economic institute. The Liberals have already indicated their willingness to support Surányi; poll findings suggest SZDSZ could be wiped out in the next election, so the party has little appetite for an early vote. The Socialists have also been courting the moderately conservative Hungarian Democratic Forum (MDF), whose votes could prove to be crucial if they can't secure support from SZDSZ.

While an early general election remains somewhat unlikely, it should be noted that voters will still go to the polls next June to choose Hungary's representatives in the European Parliament, and the outcome of that poll could be indicative of what lies ahead.

Saturday, March 21, 2009

Hungary Prime Minister Gyurcsany Resigns

Hungary's Prime Minister, Ferenc Gyurcsany, announced this morning (Saturday) his intention to resign as Prime Minister. Gyurcsany informed a congress of the Socialist Party of his decision following a sharp fall in the popularity of his government.

Gyurcsany will now inform the Hungarian Parliament of his decision (probably on Monday), and attempt to initiate a "constructive" no confidence vote, by which means it is hoped that a new candidate for PM will emerge. Early elections are currently thought to be unlikely, although it is not clear at this point how the minority coalition partners will react.

Well, we now have a clear pattern being established following the recent IMF interventions in Iceland, Latvia, Hungary etc - the government collapses under the weight of the measures. Basically, and as I said during the week, what we have unfolding before us in Hungary is a tragedy, since the rigid enforcement of the deficit ceiling without external fiscal injections from the EU, simply means that the economic contraction feeds upon itself.

I hear that I am the obstacle to the co-operation required for changes, for a stable governing majority and the responsible behaviour of the opposition," he was quoted as saying on Saturday by Reuters news agency. "I hope it is this way, that it is only me that is the obstacle, because if so, then I am eliminating this obstacle now. "I propose that we form a new government under a new prime minister."

Irrespective of whether or not Gyurcsany was part of the problem rather than part of the solution, and despite the fact that Hungary may benefit from having a new leader, the issue is a much bigger one than the office of Prime Minister.

Amongst other matters, this is the principle "bottleneck":
The source said talks with parliamentary parties would start next week to pick a new premier as soon as possible to pass much-needed budget measures with a stable majority.

Thursday, March 19, 2009

Hungary, Watching A Tragedy Unfold

According to Secretary of State at the Hungarian Finance Ministry László Keller Hungary will post a public sector deficit of HUF 332.9 billion in March, up from the preliminary forecast of HUF 329.8 bn made only a month ago. At the same time the Finance Ministry has left its full-year deficit projection of HUF 730.6 bn virtually unchanged from the one made a month ago HUF 729.9 bn. (In fact the entire Q1 deficit is expected to run to HUF 581bn or 2.2% of annual GDP. There is a strong seasonal component here, and for comparative purposes we could note that the actual deficit for Q1 was HUF 508bn or 1.9% of GDP, so while the situation is not good, it may not be as bad as it seems - see comments).

As the months pass the ability of the government to live up to its budget objectives seems more and more remote, despite constant reassurances from Keller that “The cabinet is in control of the situation" and that “The government wants to keep the budget deficit under 3.0% (of GDP) at all costs".

The root of the problem is that the slowdown in Germany and other customers for Hungary's exports is much deeper (and likely to be of longer duration) than was originally anticipated. As a result, the Hungarian government's growth forecast of a 3.0-3.5% contraction this year now looks rather high, with the median estimate of analysts in a Reuters poll published this week suggesting Hungary's economy will contract by 4.5% in 2009 despite pleas from Keller to “stop the race" in who can forecast a bigger economic contraction for Hungary. The most pessimistic prognosis in the current Reuters survey is for a 5.6% fall, and I'd have to admit, despite being reasonably positive about the export potential for the Hungarian economy in the mid term, that from the data I am seeing, the 5% to 5.5% contraction range doesn't look at all exaggerated.

Data like the fact that January gross wages in Hungary fell by a significant amount - 5.2% year on year. The most important reason for such a drop was a cut in wages in the public sector (bonuses and premiums) where salaries fell by almost a quarter (-23,7%)compared to January 2008. In fact most of this was due to a reduction in earnings rather than basic wages, since basic pay excluding bonuses actually increased by 5.1% (5.8% in private and 3.4% in public sectors). Equally important is the rapid deterioration in purchasing power, since in real terms earnings fell by 6.9% year on year which supports the view that the economy will contract pretty sharply in 2009, and especially given the constraints on government spending resulting from the IMF programme. Equally important is the haemorrhage in jobs from the private sector with employment down by a hefty 3.5% year on year.

And another of these data points comes from the announcement that Hungary's construction industry output dropped by massive 16% year on year in January 2009, following an almost recovery like rise of 3.7% in the previous month. Even more shocking is the month-on-month number that showed a 13.8% drop, seasonally and working days adjusted numbers. Hungary's construction sector is now well and truly back in a very deep slump.

All of which makes Angela Merkel's statement today that European Union countries that run into a financial crisis can count on international help sound pretty hollow.

“We will help member states that get into a financial emergency,” Merkel said today in a speech to the parliament in Berlin before attending an EU summit in Brussels. “We showed that in the cases of Hungary and Latvia. And if it hits other member states, we will do the same"....EU countries in financial straits “can count on our solidarity -- we’ve repeatedly made that clear,” she said.

Well, as I made clear in this post, the Hungarian economy is not as bad as it is being made out to be in the medium term, although what it now needs more than anything is "incubation". The current measures can't work, the 3% deficit is almost unattainable, and more cuts will be counterproductive. What Hungary needs isn't Balance of Payments assistance, but real economic support. Nice words don't help here, what we need are facts and deeds. A tragedy is about to happen, it would be more than a pity if it wasn't averted.

Sunday, March 15, 2009

Is The Condition of Hungary's Economy Really As Bad As It Seems To Be?

On the face of it Hungary's situation is pretty dire. As I keep reminding readers of this blog, even Angela Merkel recently claimed that "you cannot compare the dire situation in Hungary with that of other countries" as if the worst off you could be was where Hungary is now, effectively turning Hungary into the benchmark case for economic "badness" (at least as far as the EU goes, Ukraine is obviously "another country" in this respect). I cannot agree. As I have suggested time and again on this blog, although Hungary's situation leaves little to be envious of, it is not as bad as some are making out in the current "demonisation" process, nor are the other Eastern Economies (even those in the Eurozone as I argue here in the cases of Slovakia and Slovenia) really as sound as some have been making out. Indeed in my view the Hungarian economy is not the worst case in the EU27 (I would rather suggest that either Bulgaria or Romania will be battling it out soon enough for that dubious honour). Obviously Hungary is in the midst of a major correction, and has been for nearly three years, but during that time Hungary has made considerable progress along its appointed road, and now has an industrial export sector which no one should be sneezing at. The problem is simply that Hungary (for reasons to be explained below) is now an export dependent economy, and such economies are among the worst affected in the short-term by the present slump in European (and global) economic activity.
This simple fact was brought home only last week by January's export figures, which show the dramatic nature of the recent decline in Hungary's external trade, since both exports and imports were down at a rate of around 30% year-on-year. The decrease was slightly higher for exports than for imports, and consequently the trade balance was once more negative. Exports were down by 31% compared with January 2008, showing the extent to which Hungary's export driven economy has been affected by the recession in the rest of Europe.

Imports were also down, but slightly less than imports (minus 29% in euro terms). What is quite striking if you look at the chart below is how the drop in imports has been more or less tracking the drop in exports in recent months.

Most analysts were rather disappointed by the news, since they had been hoping for evidence of a decline in Hungary's external financing requirement, with the mechanism for this being an improvement in the foreign trade balance. In reality what we have seen in recent months has been a modestly increasing foreign trade gap.

Industrial Output Down

Hungary’s industrial production has also been slumping on the back of the decline in export demand. Output fell a workday-adjusted 21 percent year on year in January, following an annual 23.3 percent decrease in December. The December contraction had been the biggest since 1991. Output however was up 2.5 percent on December's horrible low point, even despite the gas crisis.

February's output level looks to be much the same, since the manufacturing purchasing manager index, despite coming back slightly from its all-time low of 38.5 in January to hit 39.7 in February, was still well below the 50 reading which marks the frontier between expansion and contraction.

The extent of the fall in output in the industrial sector since the start of 2008 can be seen in the seasonally adjusted output chart (see below).

Inflation Slows

January's export results are doubly disappointing since, as is well known, the forint has been falling lately, and is down around 25% since last summer, although the impact of the most dramatic fall - which was in February - is still to be noticed in the export numbers (that being said I am not especially optimistic at this point).

Unsurprisingly inflation surged in February, and was up 1.0% month on month over January even though the annual rate still nudged downwards, reaching 3.0% year on year, falling marginally from January's 3.1%.

The drop in the annual rate was less the consensus estimate (2.8%) and was most obviously a result of the weak Hungarian forint which brought a halt to the disinflation process, despite the very weak level of consumer demand.

In addition recent fiscal measures -like the VAT and excise duty hike- will likely put upward pressure on the inflation path from mid summer. On the other hand the month on month number is unlikely to alarm the NBH unduly at this point, since growth and financial stability issues are much more pressing concerns. Thus, from a monetary policy perspective the release is more or less neutral, with the future interest rate trajectory depending much more on financial market developments.

Shocking GDP Numbers

Hungary's gross domestic product dropped by 2.5% year on year in the fourth quarter of 2008 following an increase of 0.7% in the thrid quarter, according to revised data from the Central Statistics Office (KSH) last week. This is the worst performance since the turmoil experienced during the early days of the transition. The downward revision from the preliminary 2.1% estimate was largely the result of a lower evaluation of the performance of the financial intermediation and real estate sectors. Looking at the chart below, the collapse in Hungarian output expansion since mid 2006 could not be clearer.

In fact GDP was down by 1.2% in the fourth quarter of 2008 as compared to the previous quarter. Agriculture and construction activity actually increased (by 4.6% and 2.1% respectively), while industrial ouput dropped by 3.4% and services by 0.6%. Household consumption was down by 1.8% and goevrnment spending by 2.5%. The quarterly impact of external trade was positive, since exports (which declined by 6.5%) fell less than imports (which fell by 7.3%).

Within gross domestic product, industrial production dropped 8.5 percent on the year and financial services declined 7.8 percent. Household consumption dropped 3.3 percent, according to today’s figures from the statistics office. So the composition of the quarterly preformance is pretty worrying as the 2.5% output decline was accompanied by a 71% leap agricultural output, a result of excellent crops. If you strip agriculture out, you find that the rest of Hungary's economy contracted by nearly 5% in only one single quarter.

Year on year household consumption was down by 4.4%, but household consumption growth has long been in decline (see chart below) and is now more of a brake on GDP than a driver.

Retail Sates Just Keep Falling

And retail sales just keep dropping. Hungary's retail sales fell by an annual 3.9 percent in December based on working day-adjusted figures following a 2 percent decline in November. Food sales were down by 1.5 percent in December from a year earlier and fell by 1.2 percent in all of 2008. Non-food sales were down by 5.6 percent in December and 2.8 percent over the whole of 2008.

And in December - using seasonally and calendar-adjusted data - the volume of retail sales was down by 0.8 percent compared to November, when they fell 0.4 percent over October. In 2008 overall retail sales fell by 2.1 percent. In fact Hungarian retail sales have now been in decline since the summer of 2006 (see chart) and I doubt we will ever see the heady levels of July 2006 (in real, price adjusted terms).

The reason for this is simple - Hungary's population is in steady long term decline 8see chart below), and less people will evidently consume less, especially when you consider that the age structure of the population is steadily changing, and there will be a higher and higher proportion of elderly people to support, which means that real disposable income for the ever smaller working population will be progressively squeezed.

Employment Falling, Unemployment Rising

Some evidence for this hypothesis can be found in the recent Hungarian employment data. Hungary's rate of unemployment rose to 8.4% year on year in the November-January period, up from 8% in the October-December period. There were 3.838 million people employed, while the number of unemployed was 351 thousand. The first thing to notice, obviously, is that unemployment is rising, which is what we would expect with the crisis taking place.

According to Eurostat harmonised data (based on a slightly different methodology) January's unemployment rate was 8.6%.

Now participation rates in Hungary are historically low - the participation rate of the population in the 15-74 age group was 54.7% in Q4, down from 55.0% in the previous 3 month period and 54.9% in the same period a year earlier, and undoubtedly changes are needed in the tax and employment law to facilitate higher participation rates, but as we have seen in Germany and Japan, in ageing populations labour reforms which raise the participation rate among older less qualified groups has not had as great an impact on real personal disposable income and consumtion as many anticipated. And the working age population is now declining in Hungary much more significantly than it has been in either Germany or Japan.

While the number of those employed, while fluctuating seasonally, has been trending down.

GKI Confidence Index Falls To New Lows

Hungary’s economic sentiment index plunged to another record in February as businesses struggled with falling orders and consumers braced against job losses as the recession deteriorated, according to the GKI institute report. The overall index fell to minus 43, the lowest since measuring began in 1996, from minus 39.8 in January. Both the measures of business and consumer confidence also fell to new lows.

The outlook for industrial production and orders led a decline in the business confidence index to minus 34 from minus 30.5 in January. Fifty-eight percent of Hungary's exports are sold in the euro region, which is in its worst recession since the single currency began trading a decade ago.

Concern about future job losses dragged the consumer confidence index to a record of minus 68.5 from minus 66.1 in January.

Short Term Outlook Bleak, But With Adequate Reforms Exports Could Drive The Economy

As I am indicating, I am not optimistic at all that domestic consumption can ever return as a major driver of Hungarian growth. However with the right mix of reforms and inward investment, the situation could be turned round, at least to the extent of keeping imminent disaster away form the door. Hungary's economy is far from being what some would call a "basket case". Clearly education quality is vital, as is the fomenting of a critical spirit which can take maximum advantage of the declining numbers of young people Hungarian society has at her disposal.

Export driven growth is far from perfect, as we are seeing now in countries as diverse (and in some cases) distant from Hungary as Germany, Japan and China, who are all suffering severe slowdowns. It is however better than the perpetual threat of sovereign default, and breakdown in the pension and health systems.

The danger at the present time is that the sharp contraction in GDP can lead to continuing budget shortfalls at fiscal level which produce cuts in public spending which themselves fuel further contraction, and so on, in a vicious spiral which only works to drive up Debt to GDP levels and spreads on Hungarian sovereign bonds.

The greatest threat from the continuing pressure on the HUF is the danger of growing defaults on CHF denominated personal loans and mortgages, defaults which themselves only pile the pressure on the banking system and intensify the credit crunch. The difficult situation this problem puts Hungary’s central bank in was made even clearer last week when bank President Andras Simor said the bank was using loans from the European Union to buy forint for euros to support the currency. Simor declined to comment on the size and timing of the intervention. But the central bank did issue a statement on March 8 to the effect that it would start converting European Union grants on the currency market to support the forint - Hungary is expected to receive more than 1.4 billion euros in EU grants this year. Obviously things have to be pretty desperate when you get to this stage, since while the bank may be able to make an impact in the short term, it is unlikely to have significant long term impact, so a solution must still be found to the CHF loan problem.

Reports in the Hungarian daily Népszabadság on Friday suggested that a solution is now being actively sought. According to reports, the basic idea is that the state would share some of the costs of conversion. As ever in Hungary, politics are in play, since the idea was originally put forward by Viktor Orbán, President of Hungary's main centre-right opposition party Fidesz.

The government itself then stepped in and Socialist Prime Minister Ferenc Gyurcsány reacted to Orbán's proposal by saying “The need to convert foreign currency loans to forint loans is rather obvious; the Finance Ministry has been discussing it for weeks,". Really, given that the country is in the middle of a very significant crisis, it would be better for everyone if all the bickering about who had an idea first could come to an end, and people put their heads together to look for the answer. Again it is "rather obvious" that the costs of conversion need to be split between the state, the mortgage holder and the bank, but in what proportions, and through what mechanism. Come on, enough studying, let's have some answers and go to work on the problem, then the forint can quietly be left to find the level which is most appropriate for attracting investment into Hungary's export sector, so when Europe's economies start to recover the export sector can be up and running, and ready to sell.

Friday, March 06, 2009

It's Official, The Hungarian banking system is sound

It all started as an idle conversation in the loo apparently. The next thing The National Bank of Hungary (NBH) and the Hungary's Financial Supervisory Authority (PSZÁF) had to come out in public to declare that they were closely monitoring the status of the financial system, adding that from what they could see from their monitoring the Hungarian banking system is sound, and depositors' money safe.

The problem was not the loose talk in the lavatory (at the Hungarian Banking Association apparently) but the fact that that august body then sent out a letter, warning its members about the existence of “groundless rumours" that banks were planning to freeze deposits on 13 March. Possibly this is the quickest way to start a run on bank deposits known to humankind.

Hence the PSZAF and the NBH had to stop in and stop the rot. As Portfolio Hungary point out, this is now the third time in a week that something inane has happened (first there was Prime Minister Gyurcsány's press conference in Brussels, then there was the joint declaration of bank regulators (which excluded Hungary) and now this. No wonder the forint dropped to a record low of 317.22 per euro today. Yields on Hungary's government securities also shot up today, especially at longer maturities in trading which Portfolio Hungary described as "non existant". According to Government Debt Management Agency (ÁKK) data, yields on the 3-yr benchmark leaped by 69 basis points to 14.35%; the 5-yr benchmark yield went to 13.44% and an 80-bp increase took the the 10-yr bond to 12.74%. The point here is that Hungary is looking at a 5% GDP contraction this year, and with yields like this we are evidently heading for no good place next year as well. What Hungary needs is some kind of external support that can break this whole dynamic, otherwise there is no only one way this can end. Is anyone listening there?

More theatricality was addded when Tamás Bánfi, who is a member of the National Bank's Monetary Council, came out and said that sovereign default was not an option, when you are reduced to saying this things are getting bad. I mean, did anyone in Hungary seriously think it was?

“There will be no sovereign default in Hungary because it cannot be allowed. It must be thwarted by policymakers and they do have the instruments that have a transitional or lasting effect in this regard," Bánfi, a member of the central bank's (NBH) rate-setting body, told local daily Népszava in an interview on Friday.

And Bánfi is not the only one to be trying to reassure here, since Government Debt Management Agency Deputy CEO László András Borbély was out doing it yesterday. "Hungary is not threatened by sovereign default either in the short or the long term", he said "partly thanks to the continuity of government securities issuances and partly because of the major international credit facility."

And this is undoubtedly true. The government can continue to borrow money, but can it ever pay it back, this is the real question. As if in response CDS's went heading on upwards today, and Hungary's 5-year CDS spread rose to a new all-time high of 619.9 basis points, up from Thursday's close of 618.6 bps and considerably above the earlier record high set at 605 bps during last October's financial crisis. The point is with selling bonds getting more expensive, insuring debt costing more, and the economy contracting, it is hard to see how you can square the circle here.

Especially if your industrial output is falling at an annual rate of 21% a year.

Unsurprisingly GKI's economic sentiment indicator fell to a record in February as businesses struggled with falling orders and consumers for more job losses.

The saddest part about all this is that I have the impression Europe's leaders have no idea at all how it is Hungary got into this mess, and worse, I doubt they are really going to take the trouble to actually find out.

Wednesday, March 04, 2009

How Not To Manage Eastern Europe's Financial Crisis (Part 1)

"Saying that the situation is the same for all central and eastern European states, I don't see that......you cannot compare the dire situation in Hungary with that of other countries."
Angela Merkel, Brussels, Sunday

"Happy families are all alike; every unhappy family is unhappy in its own way"

In Europe, leaders rejected pleas for a comprehensive rescue plan for troubled East European economies, promising instead to provide “case-by-case” support. That means a slow dribble of funds, with no chance of reversing the downward spiral.
Paul Krugman

Bank regulators from Bulgaria, the Czech Republic, Poland, Romania and Slovakia met today and issued a joint statement, ostensibly to reduce the some of the impact of what they term "alarmist comments" from the Austrian government about how the regional banking system is now in such a precarious state that it requires urgent action at EU level to prevent meltdown. The Austrian government are, of course, concerned about the impact of any meltdown on their own banking system. The result of this "reassuring statement" can be seen in the chart below (10 years, HUF vs Euro).

Within minutes of the joint statement Hungary's currency plummeted to an all-time low against the euro and to a 6.5-yr low versus the US dollar. In fact the HUF rapidly depreciated to 312 per euro from 307.50 before climbing back in later trading to 310. And the reason for this swift reaction? Hungary was not invited to join the statement. As the forint plunged, Hungary 's banking regulator hurriedly signed up to the statement, blaming the original omission on a communications mess-up, but the damage was already done.

“Each of the CEE Member States has its own specific economic and financial situation and these countries do not constitute a homogenous region. It is thus important first to distinguish between the EU Member States and the non-EU countries and also to clarify issues specific to particular countries or particular banking groups."

Well this just takes us back to Tolstoy, each of them have their own specific problems, but the underlying reality is that they all face problems, and are vulnerable, each in their own way.

Hungary's economic fundamentals are clearly much weaker than those to be found in the Czech Republic and Poland as things stand, but what about Bulgaria and Romania? And the Czech Republic and Poland are about to have a pretty hard time of it as a result of their export dependence on the West, and Poland has the unwinding of the zloty options scandal still to hit the front pages. So there is plenty of food for thought here before throwing Hungary to the wolves. A default in Hungary could very easily lead to contagion elsewhere, and then the impact in the West is very hard to foresee. We should not be playing round with lighted matches right next to our fireworks stock. "Hey, it's dark in here" and then "boom".

Yesterday it was Latvia's turn, and the cost of protecting against a Latvian default (Latvia is the first European Union member priced at so- called distressed levels) rose to a record following the announcement that the unemployement level rose from 8.3% in December to 9.5% in January, the highest level in nearly nine years. In fact credit-default swaps linked to Latvia increased nine basis points to an all-time high of 1,109 basis points, according to CMA Datavision in London. The cost is above the 1,000 level, breached last week, that investors consider distressed, and is now about 270 basis points above contracts linked to Lithuania, the next-highest EU member.

So two countries are being systematically detached here - Latvia and Hungary - and statements by EU leaders are unwittingly aiding and abetting the process. But we should all remember, after they have eaten Latvia and Hungary for breakfast, the financial markets will undoubtedly chew on other luckless countries over lunch (Romania's Q4 GDP data was out today, and it was a shocker, and S&P have already said they are "closely monitoring" the situation), before perhaps moving on to bigger game for supper.

And we should remember here, no one is too big to fall, and I have already been warning about the gravity of Germany's situation, with a rapidly ageing population, a hefty bank bailout of its own to swallow, and total export dependence for GDP growth. Final data from Markit economics out today showed that Germany's composite PMI fell to 36.3 in February from 38.0 in January. That was the lowest level registered since the series began in January 1998. And it means that the German economy - which is highly interlocked with the whole of Eastern Europe (Austria holds the finance and Germany the industrial exposure) - is certainly contracting more rapidly in the first quarter of this year than it was in the last quarter of 2008, and may well contract in whole year 2009 by something in the order of 5%. So maybe someone over there in Germany should be reading the poem you will see below aloud to "our Angela" right now (Oh, and if you don't speak German, you can find a translation here).

Als die Nazis die Kommunisten holten,
habe ich geschwiegen;
ich war ja kein Kommunist.
Als sie die Sozialdemokraten einsperrten,
habe ich geschwiegen;
ich war ja kein Sozialdemokrat.

Als sie die Gewerkschafter holten,
habe ich nicht protestiert;
ich war ja kein Gewerkschafter.

Als sie die Juden holten,
habe ich geschwiegen;
ich war ja kein Jude.

Als sie mich holten,
gab es keinen mehr, der protestieren konnte.

What Last Weekend's EU Summit Did And Did Not Achieve

Well reading the press on Monday morning it would have been fairly easy to reach the conclusion that nothing really happened yesterday in Brussels, and that a great opportunity was lost. The latter may finally be true, but the former most certainly is not.

Let's look first at what was not decided on Sunday. The leaders of the 27 member countries in the European Union most certainly did not vote to back a proposal from Hungarian Prime Minister Ferenc Gyurcsany for a 180-billion-euro ($228 billion) aid package for central and eastern Europe. They did not back it because it was not even seriously on the agenda at this point. These people move slowly and we need to talk them throught one step at a time. So what was on the agenda. EU bonds for one, and accelerated euro membership for the East for a second. And once we have the EU bonds firmly in place, then that will be the time to decide how we might use the extra shooting power they will bring us (boosting the ECB balance sheet would be one serious option they should consider, see forthcoming post from me and Claus Vistesen). That is when the emergency blood transfusion Gyurcsany was rooting for might come into play, but on this, as on so many items, the details of how we do what we do as well as the "what we do" will become important, so the moves we do take need to be well thought out, and systematic, they need to get to the roots of the problem, and not simply respond to problems on a piecemeal, reactive basis.

As Paul Krugman puts it "In Europe, leaders rejected pleas for a comprehensive rescue plan for troubled East European economies, promising instead to provide “case-by-case” support. That means a slow dribble of funds, with no chance of reversing the downward spiral." Amen to that!

But let's look at little bit deeper at what has been decided, or if you prefer, at what has been floated, and may be "decided" at the next meet up. Well for one, we have promised not to be protectionist, and for another, The World Bank, The European Bank for Reconstruction and Development (EBRD) and The European Investment Bank (EIB) have launched a two-year plan to lend up to 24.5 billion euros ($31.2 billion) in Central and Eastern Europe. This sounds a bit like trying to drain an Ocean with a teaspoon, and it is, so predictably the financial markets were not too impressed, expecially when they learned that not much of what was promised was going to be new money (as opposed to theacceleration of existing commitments), and especially when we take this sum and compare it with the likely quantities which are needed to "take the bull by the horms". EBRD President Thomas Mirow (who is more likely to give a low side estimate than a high side one) recentlly told the French newspaper Le Figaro that in his view Eastern European banks could need some $150 billion in recapitalisation and $200 billion in refinancing to stave off the risk of a banking failure in the region. At least.

"(It) sounds like a lot of money, but when (commercial) banks have lent Eastern Europe about 1.7 trillion dollars, 25 billion is peanuts," said Nigel Rendell, emerging markets strategist at Royal Bank of Canada in London. "Ultimately we will have to get a much bigger package and a coordinated response from the IMF, the European Union and maybe the G7."

So let's now move on to the positive side of the balance sheet, since as we know our leaders are a slowish bunch when it comes to grasping what is actually going on here, and an even slower group when it comes to acting on that knowledge once it has been acquired. The biggest plus to come out of last weekend's thrash is most definitely the fact that the idea of accelerating membership of the eurozone for the Eastern countries has now started to gain traction, if with no-one else then at least with Luxembourg Prime Minister (and Finance Minister, he is a busy man) Jean-Claude Juncker, aka "Mr Euro", who was quoted by Reuters on his way into the meeting saying he did not expect any early change to accession criteria for the single currency.

"I don't think we can change the accession criteria to the euro overnight. This is not feasible," Juncker told reporters as he arrived for a summit where non-euro eastern countries are due to call for accession procedures to be accelerated after their local currencies have taken a hammering on markets.

While in the news conference following the meeting he said that there was now a consensus that the two-year stability test required for a currency of a country hoping to join the euro zone should be discussed.

"I can understand that there may be a slight question mark over the condition that one needs to be member of the monetary system (ERM2) for two years, we will discuss this calmly," Juncker told a news conference after a meeting of EU leaders.

So something actually went on during the meeting, even if we are largely left guessing about what. Angela Merkel also left a similar impression that movement was taking place. "There are requests to enter ERM 2 faster," Merkel is quoted as saying. "We can have a look at that."

Now I have already spelt out at some length why I think the Eastern Countries should be offered accelerated membership of the eurozone forthwith (see this post) as has Wolfgang Munchau (in this FT article here).

The Economist, in a relatively sensible leader which I have already referred to, divides the Eastern countries into three groups. Firstly there are those countries that are a long way from joining the EU, such as Ukraine, Turkey and Serbia. As the Economist points out, while it would be foolhardy practically and hard-hearted ethically to simply stand back and watch, European institutions are pretty limited in what they can do apart from offereing some timely financial help or some sound institutional advice, and it is entirely appropriate that the main burden of pulling these countries back from the brink should fall on the International Monetary Fund.

Then there are those East and Central European Countries who are themselves members of the Union, and here it is the EU that must take the leading role. A first group of these is constituted by the Baltic trio (Estonia, Latvia and Lithuania) and Bulgaria, who have currencies which are effectively tied to the euro, either through currency boards, or pegged exchange rates. Simply abandoning these pegs without euro support would both bankrupt the large chunks of their economies that have borrowed in euros and deal a huge psychological blow to public confidence in the whole idea of independent statehood. Yet devalue they must (either via internal deflation, or by an outright breaking of the peg) and either road is what Jimmy Cliff would have called a hard one to travel. As the Economist itself suggests, these countries have suffered the most painful part of being in the euro zone—the inability to devalue and regain competitiveness—without getting the most substantial benefits of participation, so although none of them will meet the Maastricht treaty’s criteria for euro entry any time soon (and since they are tiny - the Baltics have a population of barely 7m, and Bulgaria is hardly bigger), letting them directly adopt the euro ought not to set an unwelcome precedent for others and should certainly not damage confidence in the single currency (any more than it already is, that is).

On the other hand unilateral adoption of the euro is a rather more difficult issue for the third group of countries, those who are EU members, are not in the eurozone and have floating exchange rates: the Czech Republic, Hungary, Poland and Romania. None of these is here and now, tomorrow, ready for the tough discipline of a single currency that rules out any future devaluation, and they are large enough collectively (around 80 million) that their premature entry could expose the euro to more turbulence than it already has on its plate. But so could simply leaving the situation as is, since if these economies enter a sharp contraction (more on this in a coming post) then the loan defaults are only going to present similar problems for the eurozone banking system as their currencies slide. The big vulnerability for Western Europe from the Polish, Hungarian and Romanian economies, arises from the large volume of Euro and CHF denominated debt taken on by firms and households, mainly from foreign-owned banks. As the Economist puts it "what once seemed a canny convergence play now looks like a barmy risk, for both the borrowers and the banks, chiefly Italian and Austrian, that lent to them".

So we now have several EU leaders opening the door for the first time to the possibility of fast-track membership of the eurozone. As we have seen German Chancellor Angela Merkel said after the summit that we "could consider" accelerating the candidacy process, French President Nicolas Sarkozy said that "the debate is open", and Luxembourg Prime Minister Jean-Claude Juncker, who heads the Eurogroup of eurozone finance ministers, said he was willing "to calmly discuss" such a possibility. So the debate is open. When will the next meeting be? On Sunday I hope. A week in all this is a very long time for reflection in this hectic world. We need proposals, and concrete ones for how to move forward here. Especially since at the present time all our attentions seem to be focusing on the East, and there is also the South and the West (the UK and Ireland) to think about. Perhaps our leaders will be able to make time from their crowded agendas for a series of mid-week meetings on this topic.

And while the leaders dither, the markets react, and as Bloomberg reports the dollar surges as everyone seeks a safe haven during the coming storm.

The dollar rose to the highest level since April 2006 against the currencies of six major U.S. trading partners.... and .... The euro dropped to a one-week low against the greenback as European Union leaders vetoed Hungary’s proposal for 180 billion euros ($227 billion) of loans to former communist economies in eastern Europe. The Swedish krona fell to a record versus the euro on speculation the Baltic region’s borrowers may default, and the Hungarian forint and Polish zloty tumbled.

The Hungarian forint led eastern European currencies lower today, falling 3.1 percent to 243.86, while Poland’s zloty lost 3 percent to 3.7796. The forint fell to a 6 1/2-year low of 246.32 on Feb. 17 as Moody’s Investors Service said it may cut the ratings of several banks with units in eastern Europe. The zloty touched 3.9151 the next day, the weakest since May 2004.

EU leaders spurned Hungary’s request for aid at a summit in Brussels yesterday. Growth in Poland, the biggest eastern European economy, will slow to 2 percent, the slackest pace since 2002, the European Commission forecasts.