10th January 2012
As Mindful Money blogger Shaun Richards points out here, Hungary has fallen prey to the familiar emerging market problem of borrowing too heavily in foreign currency, in this case Swiss francs. In a scenario well-recognised by students of emerging market history, the domestic currency weakens and the debt balloons.
Hungary has now resumed talks with the IMF to try and restore confidence. This piece in the FT shows the severity of the situation: "Hungary has about €4.6bn of foreign debt maturing this year and probably sufficient resources to get through to the third quarter. But its financing costs have risen to unsustainable levels and the forint suffered a sell-off as conditions in the eurozone, its main export market, deteriorated and growth prospects dimmed.
"It has suffered, too, from deleveraging by foreign banks that dominate its banking system, severely constraining credit. The government has kept its official 2012 growth forecast at 0.5 per cent, but many market economists forecast a recession."
The original talks with the IMF and EU broke down in December over concerns on new laws that hurt the independence of Hungary's central bank and Fitch commented on the Hungarian government's ‘unorthadox' economic policies. Markets are yet to be reassured that Prime Minister Viktor Orbán can implement the necessary reforms to ease Hungary's debt burden.
There is considerable scepticism over the trustworthiness of Orban, which is also proving to be a stumbling block in resolving Hungary's crisis. Cicuka from the FT community comment boards says: "I can also imagine that Orban accepts IMF conditions, but then fails to carry out the proposed measures, so the stand-by arrangement will unravel in a matter of few months. He just wants to buy some time. The cynicism and recklessness of this man is to be reckoned with by imf/eu negotiators."
Fitch recently became the latest of the rating agencies to downgrade the country's debt to junk.
Hungary's weakness might not be an issue in itself. It is certainly a further blow to the Eurozone expansion project, but Eurozone policymakers have greater problems to resolve. However – as Richards has pointed out – it is a significant destabilising force for the European banking sector and one more headache for the Eurozone.
Robert Peston tackled this subject last week. In his blog he points to recent analysis by the BIS showing that Hungary is one of the emerging economies more vulnerable than most to what it calls "sudden capital withdrawals through the banking system": "Because foreign banks supply four fifths of credit in the country and around half of this was delivered from outside the country rather than being funded locally by the foreign-owned banks."
This means foreign banks have considerable exposure to Hungary's weakness with perhaps the biggest hit to be taken by the Austrian banks: "Austrian banks are the most exposed to overall Hungarian debt, according to the latest data from the Bank for International Settlements, with $41.6 billion on their books, followed by Italy with $23.4 billion and Germany with $21.4 billion. Italian and German banks, in turn, are the most exposed to Austrian debt with $110.9 billion and $90 billion respectively."
This is not just theoretical: Hungarian exposure has already had a material effect on Austrian banks: "Erste, Hungary's second largest bank, is set to close some 43, or nearly a quarter of its 184 Hungarian branches in the next three months, and lay off 15 per cent of its staff citing what the bank calls "limited income opportunities" caused by the economic crisis, an "extremely high" banking tax and "immense losses" resulting from government measures to allow early repayment of forex mortgage loans at below market rates." As Mindful Money discussed last week, the weakness of Hungary is also largely responsible for Unicredito's weakness.
This is having an knock-on effect on Austrian government debt auctions: "Yields on Austrian 10-year bonds rose to 120 basis points above those of similar-maturity Dutch securities at the end of last week, from 72 basis points on Dec. 30. Austrian debt lost 3.1 percent this year through Jan. 6, compared with a 0.2 percent decline for the Netherlands, indexes by Bloomberg and the European Federation of Financial Analysts Societies show. Hungary's bonds lost 1.2 percent."
This demonstrates the ongoing vulnerability of the Eurozone. Whenever one problem is solved, another emerges. Eurozone policymakers need to do more than stick their finger in the dam.
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