Credit growth in Hungary is depressed and stands in sharp contrast to the credit booms underway in other emerging markets. A precarious combination of rising nonperforming loans, unpredictable government policy and municipal woes will keep bank lending anemic for the rest of 2011 and likely beyond. This anemic lending, in turn, continues to hold back the economic recovery, leaving it ‘creditless’. As a result, Hungary finds itself in the midst of a vicious circle from which it will be difficult to emerge.
Figure 1: After contracting dramatically in 2009, lending activity shows no sign of picking up
Source: MNB (Central Bank of Hungary)
The Economic Growth-Bank Lending Nexus
Hungary’s problems are more than just cyclical as demonstrated by the fact that the economy has not rebounded from the global downturn in 2008-09. Even though growth has returned, real economic output remains well below pre-crisis levels, as seen in Figure 2 below. This stands in contrast to the strong V-shaped recoveries seen in most emerging markets. Anemic bank lending is both a contributing factor to, as well as a symptom of, this economic malaise.
Research indicates that the credit supply can have a significant effect on real economic activity (See analysis on VoxEU by Cappiello, Kadareja, Sorensen and Protopapa). With no major turnaround in bank lending on the horizon, this does not bode well for Hungary’s economic growth outlook.
Figure 2: Real economic output in Hungary remains below the 2006 level
Why a Major Turnaround in Lending is Not on the Horizon
According to the latest quarterly survey of senior loan officers released in late August, Hungarian banks do not plan to increase lending to households or the corporate sector in H2 2011. The following factors all contribute to the weak lending outlook:
- High levels of problem loans
The percentage of non-performing loans (those over 90 days overdue) continues to rise, as seen in Figure 3. The rise is particularly pronounced amongst foreign-currency denominated loans.
Figure 3: Non-performing loans jumped sharply in H1 2011 to over 10% of total loans
Source: PSZAF (Hungarian Supervisory Authority)
Hungarians have engaged heavily in unhedged foreign currency borrowing. As of June 2011, 68% of total household borrowing was in foreign currencies, mostly Swiss francs. For the six months through August, the Swiss franc gained over 13% against the forint, causing household debt burdens to balloon in local currency terms, which is making it difficult for households to pay back their debt.
The loan portfolios of Hungarian banks will likely experience further deterioration in coming quarters even if the Swiss franc stabilises as a result of the Swiss National Bank’s decision to enforce a fixed target rate against the euro. (See related Bloomberg article: Swiss Franc Ceiling May Fall Short of Healing Eastern Europe Mortgage Pain.) The ongoing rise in non-performing loans constrains Hungarian banks’ capacity to lend.
- Unpredictable government policy
The Fidesz government unexpectedly imposed a windfall tax on the financial sector, amounting to HUF187bn (roughly US$1bn), in 2010. As a result, the banking sector’s pre-tax profits for 2010 were less than a quarter of those registered in 2009. The tax will be in place through 2012 and “will impair the ability and willingness of banks to lend and will act as a drag on economic recovery, ” according to the central bank’s latest financial stability report (see p. 9).
The government’s recently announced mortgage relief programme, set to begin this month, also contains a number of elements that are bad news for banks. See my related post: Hungary Mortgage Relief: Another Move to Delay the Pain. Policy uncertainty is likely negatively affecting banks’ willingness to lend.
Moreover, the uncertainty surrounding government policy could spur foreign parent banks to shift funding from their Hungarian subsidiaries to others in the region with a better earnings outlook. For example, in the wake of the bank tax, Erste Bank CEO Andreas Triechl warned the government: “We’ll have ways of showing that you can’t do everything with us. We have other countries where we can invest more.” Such a reallocation of funds would further constrain bank lending.
- Municipal woes
A large number of banks reported sharp deterioration in their municipal loan portfolios, according to the latest quarterly survey of senior loan officers. While banks’ exposure to municipalities was roughly HUF 1,000 billion, or 5% of total bank loans at end-2010, this is still significant. Almost all banks surveyed plan to tighten lending to local governments in H2 2011.
Local governments are facing problems paying back their debt due to the fact that they have borrowed heavily in foreign currencies, particularly the Swiss franc, and due to the fact that the typical 3-5-year grace periods for the principal repayment of the large chunk of bonds they issued in 2007-08 (amounting to HUF 550 bn) started to expire at the end of 2010. Nearly half of the bond exposure is estimated to expire by the end of 2011. Lower revenue growth is also a factor in local governments’ predicament. According to the latest senior loan officer survey, the ratio of restructured municipal loans and bonds may reach 10% of banks’ total exposure to the sector by the end of 2011.
At least two separate local government associations have requested a partial moratorium on loan repayments, according to a story in the Budapest Business Journal. This adds to the environment of policy uncertainty and highlights the inability of many local governments to meet their debt obligations, which in turn makes banks less willing to lend.
- Another Complicating Factor: External Events
Hungary’s loan-to-deposit ratio remains high in international comparison, well over 100%, and is a major vulnerability. The ratio highlights the banking sector’s heavy reliance on borrowing to finance lending, rather than retail deposits, which are a much more stable source of financing. As a result, the banking sector is vulnerable to a liquidity squeeze caused by external events. If wholesale funding dries up, as occurred during the height of the global financial crisis and as may occur during an intensification of the eurozone crisis, then Hungarian banks will need to shrink their balance sheets and won’t be able to lend, which in turn will drag on economic growth and exacerbate any potential downturn.
Hungary is in the midst of a creditless recovery. While GDP growth returned in 2010, real economic output remains below pre-crisis levels and bank lending remains anemic. Research shows that creditless recoveries tend to be slow and shallow (see VoxEU analysis by Claessens, Kose and Terrones), with average growth about a third lower than during a “normal” recovery (see IMF paper on Creditless Recoveries by Abad, Ariccia and Li).
The government can aid the credit recovery process by making its policy toward banks more predictable and by the implementation of structural reforms contained in the convergence programme, which include greater central government control over borrowing at the municipal level.
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