Will Hungary be next?

“Economy Minister Matolcsy should step down to restore trust in the Hungarian government, otherwise even Prime Minister Orbán might have to perform a Berlusconi to keep the state solvent.”

“Forget Greece and Italy, Hungary will be the next to capsize.”

“Even if Hungary survives the next few months, interest in government bonds will remain so low as to cause financing problems from January on, the time to strike a deal with the IMF is now or never.”

These are just some of the more intelligent, if somewhat melodramatic sentences that have been written about the state of Hungary’s public finances in the past few weeks as the state debt crisis hit Europe. Of course, it is absolutely true that the forint has reached an all-time low, and the state indebtedness level is high. Yet, the latter is still 82% of GDP (at the end of Q3), while countries such as Greece and Italy had passed way over the 100% mark before the problem blew up in their faces.

While Hungary’s economy raises serious concerns, it is not in imminent danger of collapsing. The recent exaggerated reports on the state of the Hungarian economy by foreign analysts and bloggers are due to the fact that they are betting against the forint, says Equilor analyst Ákos Kuti. He foresees the forint significantly strengthening within the next few weeks, providing that Hungary’s credit rating is not downgraded to junk status. The first comments by the rating agencies are expected early next week.

The forint freefall started at the beginning of September, after the government announced its early FX repayment scheme and the HUF/EUR exchange rate stood at around 280. The weakening forint left space for speculative attacks. The government anticipated that when Prime Minister Viktor Orbán told Parliament in September that Hungary must be ready to fight speculative attacks on its currency as the euro zone debt crisis deepens. 

Some say that the government intentionally seeks a weaker forint or, at least, is in no hurry to intervene, in order to boost exports. Nevertheless, markets are waiting for the government and the Hungarian National Bank (MNB) to stop the turbulence. However, the MNB has very little room to strengthen the forint in times of a weak economic performance.

“The central bank raised the base rate by 300 basis points when the exchange rate last reached 317 HUF/EUR, however, we do not expect such a one-off, drastic decision this time,” Raiffeisen analyst Levente Blahó said. “While an increase of 100-150 basis points would be necessary to reach the inflation target, we foresee a maximum 50 basis points increase at the next meeting of the Monetary Council on November 29.”

The problem is that neither the government, nor the MNB has said anything about what to expect and what they think about current developments, Blahó said. The MNB is waiting for the government to say something, and vice versa. Blahó noted that the central bank and the government should have been a little more market-friendly in their communications efforts. 

On November 15, a few days after the forint hit a new all-time low of over HUF/EUR 317, the Monetary Council (MC) issued a statement implying that it is willing to increase the base rate, if necessary. “If the increase in risk aversion in European financial markets persists, it may prove necessary to tighten monetary conditions gradually.” The base rate has been at 6% since January 2011. 

Kuti described the statement as a weak effort to pacify the markets. The MC says that “the spillover of concerns over the sustainability of government debt in the euro area to the Hungarian economy and their downward pressure on the forint exchange rate are unjustified. In the MC’s judgment, the recent depreciation of the forint has been inconsistent with the fundamentals of the Hungarian economy.”

Market financing drying up?

Blahó stressed that there is no need to panic, as the market of government securities continues to be liquid, suggesting that there is demand in the market. The recent uncertainty, which was spurred by unsuccessful T-bill auctions, is unfounded, as the liquidity of the government is not at an imminent danger. However, if the upcoming auctions of five- and ten-year government bonds fail, Hungary will have to look for other financing options, such as reaching an agreement with the IMF. 

There is a danger that Hungary will be shut off from international financial markets, Ronald Schneider of Raiffeisen Capital Management said. Bigger foreign currency reserves could be of help, but the country might need outside assistance again from the IMF, he stressed. That would be interesting, as Orbán has reportedly said that he will resign if the IMF comes back.

The state of the economy in a nutshell

In an effort to ease worries, the MC outlined the strengths of the Hungarian economy in its statement, saying that Hungary’s current account and net financing capacity have been in persistent substantial surplus, due to significant growth in domestic savings. “The Government has strongly committed itself to keeping the fiscal deficit below the 3% target. The country’s sound fiscal and external positions create room to reduce its debt,” according to the statement. 

GDP growth

Hungary’s 1.4% GDP growth in the third quarter of 2011 came as a positive surprise, driven by agriculture and industrial exports. However, analysts foresee growth slowing in the coming quarters.

Inflation

Analysts put year-end 12-month inflation at around 4.1% after October CPI came in at a higher than expected 3.9%, driven by household energy and fuel prices. The MC stressed that exchange rate depreciation is leading to a deterioration in the outlook for inflation.

Current account and net financing capacity

Hungary had a current account surplus of €738m in the second quarter of 2011, according to preliminary unadjusted figures, up from a surplus of €385m in Q1. 

Hungary’s net external financing capacity, the combined surplus on the country’s current and capital accounts, came to €1.07 billion in Q2. Adjusted for seasonal effects, the external financing capacity was 3.3% of GDP.

Household savings

Net household financial savings reached HUF 202 billion or 2.8% of quarterly GDP in the third quarter of 2011, down from 3.9% of GDP in the second quarter and 3.4% in Q3 2010. The savings ratio was 4.5% in Q3. Excluding the pension assets transfer, households saved net HUF 1,124 billion or 4% of the period’s GDP in the four quarters that ended Q3 2011.

CDS spread

The cost of insuring Hungary’s state debt is again well above 600 basis points, climbing with the cost of insuring the state debt of eurozone members. A CDS contract valued at 600 basis points means that the cost to insure every €10 million bond exposure against default is €600,000 a year for the benchmark five-year horizon. Hungary’s CDS mid-spread peaked at 630 basis points in March 2009.