Tag Archives: Hungary

Hungary Politics: Dismal Outlook

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Hungary’s Fidesz party came to power in May 2010 after winning two-thirds of the parliamentary seats in an electoral landslide. During its 20 months in power, the ruling party has stymied economic recovery and eroded democratic checks and balances. Despite this depressing performance, Fidesz looks unlikely to relinquish control of the government anytime soon. Even with an IMF deal, political risks will remain elevated.

The government has pursued a populist and nationalist agenda with little regard for international opinion. Most recently, parliament defied the IMF and passed controversial laws that effectively undermine the central bank’s independence (see here).

Previous policy moves have included the de facto nationalisation of private pension assets, a botched mortgage relief plan, greater media restrictions, curbs on the Constitutional Court’s powers and the hollowing of the Fiscal Council, a budgetary watchdog, among others. (See my posts: Hungary and Turkey: Political Parallels, Hungary’s Debt Relief Plan: From Bad to Worse and Hungary’s Ratings Downgrade is No Surprise)

So far, this policy strategy has paid off domestically as Fidesz remains the country’s most popular political party, as shown in Figure 1.

Figure 1: Despite falling support, Fidesz still holds a wide lead over its rivals


Source: Ipsos and Tarki

Economy watchers remain hopeful that an IMF deal is around the corner. Erste expects an agreement to be reached in Q2. UniCredit notes Hungary’s “limited FX and HUF government deposits” and says progress needs to be made in January. However, even if Fidesz swallows its pride and signs a new IMF deal out of economic necessity, don’t expect everything to become hunky dory.

Combative Relationship with the IMF

If reached, an IMF agreement would certainly be a positive for Hungary, helping to bolster investor sentiment and avert a sovereign default, but it would not be a panacea.  It’s unclear that the government would follow through and implement the tough conditions imposed by such an agreement. The government has had a turbulent, mistrustful relationship with the Fund, and this will not change overnight.

In July 2010, Hungary had a high profile falling out with the IMF due to the government’s unwillingness to reconsider its imposition of a controversial bank tax and to a lack of transparency over how fiscal targets would be achieved. (See Eastern Approaches blog post on the row.) Meanwhile, a number of Fidesz officials have made no secret of their disregard for the IMF, including Economy Minister Gyorgy Matolcsy, who said:

“We cannot attune [economic policy] to the IMF as they deeply object to all Hungarian decisions that are aimed at freeing the people from the shackles of the banks. This three-letter institution objects to every single measure we make, thus we are not attuning government policy to them, but against them.” (See Eastern Approaches: Where’s Gyorgy?)

Fragmented Opposition

Thousands recently took to the streets in a protest against the government. Nevertheless, the opposition in Hungary is unlikely to bring about political change. Support for Fidesz has fallen, but this disaffection has increased the ranks of undecided voters rather than bolstering rival parties, as seen in Figure 2 below. The only opposition party to see any noticeable increase in support is Jobbik, a far-right party known for its anti-Semitism. Fidesz looks reasonable by comparison.

Figure 2: Fidesz lost support in 2011, causing the ranks of undecideds to swell

*Polling was not conducted in March or August
Source: Median.hu

Changing the Rules of the Game

The next parliamentary election is not due until 2014 and Fidesz has already taken steps to retain its grip on power. For example, the party has enhanced its electoral prospects through gerrymandering (the redrawing of certain districts in its favour), which can only be altered by a two-thirds majority vote in parliament. (See Politics.hu article. For more in-depth analysis, read Alan Renwick’s excellent blog post on Hungary’s New Electoral Law or the guest post Hungarian Diplomatic Protest on Paul Krugman’s blog).

In addition to redrawing districts, the Fidesz administration has changed the rules of the game in other ways. (See FT op-ed by Philip Stephens: A Hungarian coup worthy of Putin) The effects of its power grab will likely endure for many years to come even if Hungarians vote the current administration out of office.

Bottom Line

Fidesz will remain Hungary’s dominant political party for the foreseeable future given the country’s weak opposition. Reaching a deal with the IMF will prove challenging given the government’s combative relationship with the Fund. Fidesz will likely balk at the conditions imposed. Even if a deal is reached, political risks will remain elevated as Fidesz is unlikely to fully implement IMF-imposed reforms.

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See My Previous Posts on Hungary:

Hungary’s Rating Downgrade Is No Surprise

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The Hungarian government’s erratic policies and populist rhetoric have come home to roost. Moody’s downgraded the country’s sovereign rating to ‘junk’ late yesterday, citing deteriorating growth prospects and a lack of clarity over how the government will rein in public debt. (See Moody’s press release.)

The other ratings agencies still place Hungary on the lowest rung of the investment grade ladder, but I expect that will soon change. The downgrade is no surprise. I’ve dedicated a fair number of posts over the past six months to describing Hungary’s economic and political problems. Some of the links are below:

Hungary’s last-ditch request for IMF help was too little, too late. As I previously noted, the government publicly trumpeted its interest in a deal before notifying its own central bank – or even the IMF itself – which suggests it was merely a ruse to delay a ratings downgrade. (See my Weekly Mishmash: November 22)

Despite the downgrade, the government does not appear to be coming to its senses. Disturbingly, it seems more out-of-touch than ever based on the Economy Ministry’s latest statement:

“Since the decision by Moody’s has no realistic basis, the Hungarian government can only interpret this as being part of a financial attack against Hungary.” (reported by Zoltan Simon and Abdras Gergely of Bloomberg)

There’s no doubt that eurozone turbulence has compounded Hungary’s already serious economic woes, but the real culprit here is the government and its policies. From the effective nationalisation of private pension assets to its ill-conceived mortgage relief plan, the government has consistently shown disregard for the country’s long-term economic health and an unwillingness to take any responsibility.

According to Bloomberg, the yield on Hungary 10-year yields jumped over 9.5%. This rise in borrowing costs and the slide in the forint will accentuate the country’s economic woes. As one reader aptly commented a few weeks back, Hungary is ‘circling the drain.’  Its significant reserve cushion diminishes the threat of a near-term default. However, the government has large chunks of debt coming due next year (see figure below).

Source: Hungary Government Debt Management Agency (AKK)

Will the government swallow its pride and agree to a condition-laden standby agreement with the IMF? It may, but the country is in need of major structural reforms, and I don’t see the current Fidesz-led government having the political will to implement them.

The Weekly Mishmash: November 22

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1. BRICs’ rapid growth tips the global balance
Jim O’Neill, Goldman Sachs

Jim O’Neill is best known for coining the term BRICs a decade ago, when he predicted Brazil, Russia, India and China would be the world’s future growth drivers. He highlights the critical importance of population dynamics in making his call: “Simply applying the most credible estimates of long-term demographic trends, especially for the working population, is the intellectual cornerstone of the argument for the BRICs’ potential.”

EM Muser: Demographics is an oft-ignored area of economics so it’s interesting to hear O’Neill cite it as a ‘cornerstone’ of his BRIC thesis. I think it’s paramount for long-term investors to look at a country’s population dynamics.

The demographic profiles of EMs vary greatly. Many countries in Eastern Europe have profiles similar to those of advanced economies. This will make it hard for them to avoid the public finance strain, productivity loss and slowing economic growth typically associated with aging populations. However, other EMs are still enjoying a demographic divided given their young and growing populations (eg. Brazil, Indonesia, Turkey).  (See my related post: The Double Whammy: Debt and Demographics)

2.  IMF Is No Cure-All for Hungary
Gergo Racz, WSJ Emerging Europe

Hungary surprised markets when it expressed interest in a new IMF agreement. The announcement marks a sharp U-turn from last year when the government abruptly broke off talks with the lender. Even if an agreement is reached, the post notes that the country’s fundamentals remain poor and its sovereign credit rating still teeters on the edge of ‘junk’.

EM Muser: This appears to be a ploy by the government to delay a sovereign credit rating downgrade. The fact that the government publicly expressed interest in an IMF deal before notifying its own central bank – or even the IMF itself – lends support to this idea.

Hungary wants an deal with no strings attached – that is, with no austerity measures. However, I find it hard to believe the IMF will go along without demanding some sort of structural reforms, which the country badly needs. In the meanwhile, the ploy may work, at least temporarily, as the mere prospect of a deal should help prevent borrowing costs from spiking dramatically. (See my recent posts on the country: Hungary’s Latest Debt Relief Plan: From Bad to Worse and Hungary’s Vicious Circle: Anemic Lending and Weak Growth).

3. Argentina: Balance of Payments Crunch?
Daniel Volberg, Morgan Stanley

Volberg describes the significant fall in Argentina’s international reserves, which have declined by more than $5bn since July. While he does not foresee a full-blown currency crisis, he does note several areas for concern, including the country’s deteriorating balance of payments and an acceleration in investors pulling money out of the country following the tightening of capital controls in late October.

Mr. Volberg believes the government’s currency policy could go one of two ways. The good scenario would involve a rise in interest rates to compensate investors for a weakening of the peso in an effort to keep capital from fleeing, while a bad scenario would feature a more severe tightening in capital controls along with a multiple exchange rate regime.

EM Muser: Argentina poses something of a conundrum. I discussed analysts’ widely varying perspectives on the country’s economic success last week. (See The Weekly Mishmash: November 13). On the positive side, the economy expanded by 7.7% in the year through September. However, this fast growth does not appear sustainable.

It’s increasingly clear that the administration’s policies are draining investor confidence and prompting capital to flee the country. President Cristina Fernandez Kirchner is due to announce her new cabinet in early December, which should give more insight into the government’s future policy direction.

4.  Brazil: ‘Pacification’ of Favelas Not Just a Media Circus
Fabiana Frayssinet, Inter Press Service

Last week, roughly 3000 heavily-armed soldiers and police took over Rio de Janeiro’s largest slum, Rocinha. Officials hailed it as a “recovery of territory” by the state.

The occupation is “part of a new security strategy that provides for a permanent community policing presence as well as services and projects for social improvement and infrastructure in favelas, replacing the traditional policy of head-on warfare on the drug gangs.” According to the article, Rio has some 750 favelas with 1.5 million people, about one-third of the city’s total population. The goal is to occupy 40 of them by 2014.

EM Muser: This is huge positive step forward for Brazil that hasn’t received much international attention. I lived in the country about a decade ago and still remember the power of the drug gangs. These are no common thugs. They have anti-aircraft missiles and were powerful enough to shut down Rio on a number of occasions – a pretty mean feat considering it’s a city of roughly 6 million people. In more recent years, they have managed to shoot down police helicopters.

Drug gangs effectively control large swathes of the city, and it’s encouraging to see authorities finally stepping in. In some ways, their hand has been forced. Brazil is hosting the World Cup in 2014 and the Olympics in 2016. These events represent a coming-out part of sorts for the country, and authorities can’t afford to let Brazil’s image be tainted by public security problems.

5.  Putin is booed at martial arts fight
Charles Clover, FT

The crowd unexpectedly heckled Russian President Vladimir Putin at a live televised fighting event. “Mr Putin was seeking to boost the popularity of the hegemonic United Russia party in forthcoming parliamentary elections on Dec 4, but the spectacle showed that the gulf between the regime and the people appears to be widening.”

EM Muser: This is not the first time one of Putin’s publicity stunts has gone awry. Last month, his spokesman admitted that Putin’s discovery of ancient Greek ceramic pieces on a dive in August had been staged (see here). Despite these stumbles, Putin still enjoys a 61% approval rating according to a recent poll and is expected to return to the presidency in 2012.

The Weekly Mishmash: November 13

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1. Commerzbank: a chill wind for CEE

Stefan Wagstyl, FT Beyond Brics

Commerzbank, Germany’s second-largest, is in the midst of deleveraging in response to the EU-wide imposition of stricter capital requirements. Central & Eastern Europe (CEE) is in the firing line. The bank has said that it will temporarily suspend new lending outside its core markets of Germany and Poland.

EM Muser: I warned about the potential for a credit squeeze in the CEE in a recent post and it’s now moving from possibility to actuality (See: Is CEE Better Prepared This Time Around?) Western European banks dominate the CEE banking sector via subsidiaries. Most will not fully withdraw, but many will scale back support for their subsidiaries (out of precaution or necessity).

The Commerzbank announcement shows this trend is already underway. However, in and of itself, the announcement won’t have much of an effect. The bank’s exposure to the CEE region was just under just under €21bn in 2010, and this was mostly to Poland where it will continue to extend new loans.

2. Argentina’s president irks U.S. pundits

Paul Katz, Salon.com

President Cristina Fernandez is popular domestically and recently won reelection by a wide margin, but she remains a controversial figure in the international media.

Katz provides an unusually balanced picture of Argentina’s administration. He acknowledges the government’s manipulation of official inflation statistics and its intolerance of criticism, but also points out that the economy is roaring. GDP has expanded by an average of over 5% annually since 2007. Meanwhile, unemployment has fallen by half since 2003, and income inequality has narrowed.

EM Muser: Mark Weisbrot of the Center for Economic and Policy Research argues that Argentina is actually a success story that provides important lessons for the weaker euro zone economies given its rapid recovery in output and employment following its 2001 default (See: The Argentine Success Story and Its Implications).

Weisbrot’s view contrasts with the many articles that focus on Argentina’s lack of access to international capital markets and paint a pretty bleak picture of the country’s economic future (see the FT). They note that capital is flowing out of the country and foresee a sharp slowdown in economic growth.

The naysayers chalk the country’s robust economic growth up to good fortune (high commodity prices and the robust performances of the country’s trade partners). Meanwhile, Weisbrot credits the government’s unconventional economic policies. In my view, the jury is still out. Argentina’s resilience in the face of the global downturn will prove telling. While no economy is likely to remain untouched by the downturn, those economies that are healthy and well-run are likely to recover the fastest. Will Argentina be among them?

3. South African Credit Rating Outlook Cut by Moody’s on High Political Risk

Andres R. Martinez, Bloomberg

Moody’s cut the outlook on South Africa’s credit rating to negative in a move that surprised analysts. The rating currently stands at A3, four notches above investment grade. The ratings agency is concerned that factionalism within the ruling ANC party will erode the government’s commitment to responsible fiscal policies.

EM Muser: Shortly after Moody’s announcement on Nov 9th, the ANC expelled Julius Malema, the leader of its youth wing, from the party. He has called for the nationalisation of mines, raising concerns among investors. It’s unclear whether his departure is a done deal and whether this will reduce political risk as Malema may still contest the ruling.

4.  Don’t panic, China’s economy is not on the rocks yet

Michael Pettis, FT op-ed

Amid the recent bearish commentary on China, Pettis provides a reality check. While he acknowledges that there are tough times ahead for China as it attempts to move its economy toward a more consumption-led growth model, he does not see a banking crisis on the horizon.

“Beijing effectively guarantees the profitability and stability of the banking system by socialising credit risk and enforcing a high spread between the lending and deposit rates. As long as the government is credible, the banks will be solvent.”

EM Muser: Pettis’ argument makes a lot of sense to me. Unlike other countries (Iceland and Ireland, for example), the Chinese government has the resources to effectively backstop its banks. In October, the government’s investment fund moved to shore up the shares of four major state-owned banks, showing its commitment to stabilising its banking system (see here).

While China looks set to avert a banking crisis, the economy still looks headed for a slowdown, as Pettis acknowledges. The question is whether it will be a hard or soft landing. (See my post: IMF’s Latest Growth Forecasts for China Look Overly Rosy)

5. Hungary to Get Tighter Grip on Municipal Finances

Gergo Racz, WSJ Real Time Emerging Europe

“Hungary’s government approved a law that would substantially revise the operation of the local government system by reshuffling jurisdictions and keeping a tighter central watch on how much municipalities spend.”

EM Muser: Good economic news out of Hungary is few and far between. While this legislation is a positive step, it’s too little too late. Last week, Fitch slashed the outlook on the country’s sovereign credit rating to negative, while S&P placed Hungary on CreditWatch with negative implications. A downgrade by any of the three would push Hungary’s credit rating to ‘junk’. (See my earlier posts: Hungary: Finally on Investors’ Radar and Fitch Raises Hungary’s Outlook to Positive: Odd Timing)

Is CEE Better Prepared This Time Around?

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The EU summit this past week did nothing to address the underlying causes of the eurozone debt crisis, which leaves the global economy looking increasingly wobbly. Central and Eastern Europe (CEE) has particularly close ties to the eurozone and suffered a disproportionately sharp economic downturn in 2008-09. So how will the CEE region fare this time around?

Erste Bank argues in a new CEE Special report that the region is now better prepared to weather global turbulence. However, I see some major flaws in their argument.

Most egregiously, the author – Juraj Kotian – uses the eurozone as a basis for comparison, rather than other EMs, thereby painting a rosier picture of the region than is warranted. As the eurozone is in the midst of a battle for its very survival, it should be no surprise that the CEE economies appear resilient by comparison.

So why does Erste believe this time is different?

1) CEE countries are far less indebted than the governments or the private sector in the eurozone.

2) High current account deficits in the region have narrowed, and many CEE countries now hold bigger caches of international reserves.

3) CEE economies are in a different stage of the economic cycle. In 2008-09, these economies were running above potential (i.e. overheating). Now these economies are running close to potential or slightly below.

As a result, Kotian concludes that CEE economies “should do much better (relative to the Euro Area) than in the post-Lehman recession.”

There’s more to the story

Erste Bank is not a disinterested observer. As FT’s Beyond Brics notes, the bank has extensive operations across the CEE, providing it with an incentive to accentuate the positive. The author Juraj Kotian’s arguments can not be dismissed entirely, but there’s more to the story.

1) Yes, CEE economies are far less indebted than advanced economies, as Kotian notes, but…

…they have higher external debt burdens than other emerging markets, as seen in Figure 1.  In fact, external debt has increased, as a % of GDP, across all the five CEE countries surveyed since 2007.

Figure 1: External debt burdens remain higher than in other EMs

Source: National central banks, IMF, Emerging Market Musings

As for public debt, levels in the region are largely in line with those in other EMs, but CEE countries have added debt at a much faster pace. Levels are now significantly higher than before the onset of the global financial crisis, as seen in Figure 2 (Bulgaria is an exception). This negative trend is due, in large part, to the region’s sharp GDP contraction in 2008-09.

Figure 2: Public debt levels have risen sharply in most CEE countries since 2007

Source: IMF

2) Current account deficits have narrowed across the region, while international reserves have increased. But…

…the stock of external debt has also risen. This means that reserves coverage of the external debt has not changed significantly compared to pre-crisis levels. As seen in Figure 3, Hungary’s ratio has increased, but those in Bulgaria, Czech Republic and Romania have declined.

Figure 3: Despite increases in international reserves, the reserves coverage of external debt has fallen in several countries

Source: Emerging Market Musings, national central banks, IMF

Kotian has a point when he notes that current account positions across the region have improved. In fact, surpluses have replaced deficits in Bulgaria and Hungary. However, one of the main driving factors behind this improvement is weak domestic consumption (with the exception of Poland), which has limited import growth. In both Bulgaria and Hungary, consumption contracted on an annual basis in 2010. So, while the current account improvement is generally positive, it’s due in part to underlying economic weakness, which is not positive.

International reserves positions and current account deficits are important early warning indicators of a country’s susceptibility to a sudden stop in capital flows. (See my recent post: Which Emerging Markets Appear Vulnerable? A Look at Early Warning Indicators)

3) What about banking system health?

Kotian lists three reasons why the CEE should prove more resilient this time around. However, he overlooks an important weak spot – the banking system. Another credit squeeze is a very real possibility.

Non-performing loans remain elevated. Meanwhile, the persistence of high loan-to-deposit ratios leaves CEE banks reliant on external funding (see Figure 4), either from foreign parent banks in Western Europe or from wholesale markets.

Figure 4: High loan-to-deposit ratios signal CEE banks’ reliance on external funding to finance lending

Source: Fitch Ratings

Western European banks dominate the CEE market via subsidiaries. If the euro area debt crisis intensifies, these banks are unlikely to pull out of the region, but they will still likely scale back support for their subsidiaries. As the IMF notes in its latest Regional Economic Outlook for Europe:

“The most likely impact would therefore be a renewed credit crunch. Subsidiaries would see a measured but persistent funding drain from their parents, and nonaffiliated banks that rely on wholesale funding would have to struggle even more. Both would have little choice but to curtail their own lending activities.”

Signs of a credit squeeze are already apparent. According to the IIF’s latest Emerging Markets Bank Lending Conditions Survey, 81% of emerging European banks reported a tightening of external funding conditions in Q3 2011. This tightening will exert a major drag on economic growth across the region.

The Weekly Mishmash: October 24

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1. Internationalization of Emerging Market Currencies–A Balance between Risks and Rewards

By Samar Maziad, Pascal Farahmand, Shengzu Wang, Stephanie Segal, and Faisal Ahmed, IMF

This paper points to signs that a ‘slow but steady increase’ in the use of emerging market currencies in international transactions is underway. Nevertheless, the US dollar and euro continue to overwhelmingly dominate.

“Key EM currencies with potential for internationalization are the Brazilian real, Chinese renminbi, Indian rupee, Russian ruble, and South African rand. All these economies have significant regional importance and economic weight.” They conclude that, going forward, “it seems likely—if not inevitable—that emerging market currencies will account for a larger share of international reserves.”

EM Muser: Greater international use of EM currencies is a very slow-moving trend. But we’re living in an increasingly multipolar world, and movement toward a multi-currency system reflects this. Notably, not all EM currencies exhibit the economic size and financial depth to achieve internationalisation, but as noted above, a fair number do. (See my related posts: Forex Reserve Diversification: Is Mauritius a Trendsetter? and EM Currencies: Same Same But Different)

2. Hungary mulls porn tax to fund film biz

By John Nadler

The Hungarian government’s latest creative financing proposal,  put forward by MP Laszlo Simon, involves slapping a new tax on the porn industry to subsidize locally produced films.

EM Muser: Creative is one adjective I would use to describe Hungary’s government, although I can think of a number of less pleasant adjectives as well. In truth, a porn tax is probably not be a bad idea…nothing like a good vice tax to raise some revenue without losing popular support. However, I find parliament’s interest in this trivial issue at a time when government finances are rapidly deteriorating to be disturbing.

Hungary is walking a tightrope as its debt rating teeters on the verge of ‘junk’ status – a one-notch downgrade from any of the three major ratings agencies would do it. Yet, MPs seem to think now’s the time to advance their pet causes rather than implement real reform. Not a good sign. (See my related posts: Hungary’s Vicious Circle: Anemic Lending and Weak Growth and Hungary’s Latest Debt Relief Plan: From Bad to Worse)

3. Strong Domestic Demand Cushions Indonesia from Global Uncertainty

By the IMF Survey Magazine

The IMF sees relatively clear skies ahead for Indonesia, making it a bright spot in an increasingly gloomy global outlook.

“The outlook is very robust. In the near term we expect Indonesia to continue to grow above 6 percent both in 2011 and in 2012. We say this despite the global volatility we see because the domestic foundation of economic growth in Indonesia is so strong. We see strong credit growth, and despite lower growth in the rest of the world, we think that Indonesia is still going to grow at a strong rate.”

EM Muser: The consensus is that Indonesia is likely to show considerable resilience in the face of global market turmoil. This coincides with my own findings  (See related post: Which Emerging Markets Appear Vulnerable? A Look at Early Warning Indicators) and with what analysts Devi Tan and Seen Meng Chew at Morgan Stanley have also concluded. 

4. A Flat World Will Take a Long Time to Smooth Itself Out

By Pankaj Ghemawat, Bloomberg

Ghemawat notes that most people overrate the degree of cross border integration and he throws out some great statistics to illustrate his point and provide food for thought.

Did you know that only 3% of the world’s people actually live outside the country in which they were born, and only 2% of university students study outside their homelands? Or that only 2% of telephone calls are international, and less than 18% of Internet traffic crosses national borders? He also points out that FDI makes up a paltry 9% of all fixed investment globally.

EM Muser: There has been a lot of focus on the process of globalisation over the past few years, and a general assumption that the pace is fast and furious. I love this piece because Ghemawat provides a reality check and argues that we’re still really not all that integrated. It reminds me that it’s always a good idea to question and evaluate our assumptions.

The Weekly Mishmash: October 9

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1.  Why China won’t conquer the world

By Xué Xinran, Telegraph

Ms. Xinran provides a personal account of the growth challenges facing China. She’s a Chinese expat who describes the frenetic pace of life in her homeland and goes on to criticize the education system, saying it ‘stifles rather than encourages creativity,’ an important ingredient for entrepreneurship. She agrees with Larry Hsien Ping Lang, a finance professor at the University of Hong Kong, who fears that China’s ‘bubble economy’ is on the verge of bursting. They believe China’s economy must slow down to give time for its education system and society to catch up.

EM Muser: This article adds to recent commentary (see Patrick Chovanec and Jim Walker) that chips away at the image of China as an unassailable economic giant. While it’s unclear to me how much China will slow and the exact timing, growth forecasts showing Chinese growth continuing at over 9% on an annual basis in coming years look way too optimistic. (See my recent post: IMF’s Latest Growth Forecasts for China Look Overly Rosy)

2. Megatrends for Investors

By Dr. Shane Oliver, AMP Capital

Dr. Oliver  points to strong commodity prices as a key long-term investment trend. “After a 25-year bear market into the end of the last century, commodities are now just over a decade into a secular bull market driven by strong structural demand on the back of industrialisation in China and other emerging countries, all at a time of still- constrained supply. notwithstanding cyclical fluctuations, the longer-term trend in commodity prices is likely to remain strong, possibly accentuated by a continuing long-term downswing in the US dollar and other major advanced country currencies.”

EM Muser: I share a similar view to Dr. Oliver. A growing world population, combined with greater challenges in producing commodities (due to scarcity or climate change in the case of agriculture), make me a believer in the medium- to long-term commodities story. But I think commodity prices will fall in the near-term, particularly given slowing demand from advanced economies.

3. Hungary’s new path is the hidden danger to Europe

By Ian Bremmer, FT

The president of the Eurasia Group writes a scathing critique of Hungary’s political direction in his latest FT op-ed and asserts that the government’s efforts to wear away the country’s democratic institutions have the potential to taint the EU’s image. “The Fidesz government has leveraged its ability to warp the constitution, cementing institutional and democratic rollbacks into the rule of law. Mr Orban’s consolidation of power at the expense of democratic institutions exposes a fundamental challenge for the EU as a whole – it cannot enforce the very credo that spawned it. Hungary’s disregard for democracy and civil liberties could threaten the European brand in the eyes of potential new members and the world at large.”

EM Muser: I agree with Bremmer and have a written a number of posts on Hungary’s underlying political and economic problems. (See Hungary and Turkey: Political Parallels, Hungary’s Latest Debt Relief Plan: From Bad to Worse, Hungary’s Vicious Circle: Anemic Lending and Weak Growth, Fitch Raises Hungary’s Ratings Outlook: Odd Timing). I find Hungary’s ongoing swing away from democracy particularly unnerving considering how unnoticed it has been by the international community.

4. Colombia: Ready for the Worst

By Daniel Volberg, Morgan Stanley

Mr. Volberg  lays out two key reasons why Colombia’s economy is in relatively good shape to face global headwinds: 1) solid balance sheet (strong international reserve cushion, a modest current account deficit, and access to the IMF’s flexible credit line), and 2) significant room for monetary and fiscal stimulus.

EM Muser: This piece is short and to the point. I looked at Colombia’s economy in a recent blog post and came to similar conclusions as Mr Volberg. In addition to the excellent arguments that Volberg makes, I believe Colombia’s strong domestic demand orientation and its resilience during the height of the global financial crisis in 2008-09 also provide room for comfort. (See: How Exposed is Colombia to a China Slowdown.)

The Weekly Mishmash: September 30

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1.   Indonesia: Cyclical Stress from Funding Linkages, but Structural Story Remains Intact

By Devi Tan & Seen Meng Chew, Morgan Stanley

Tan and Chew look at the ways a global growth slowdown could hit Indonesia. They conclude trade linkages are unlikely to be a major conduit given Indonesia’s strong domestic demand orientation. But the economy remains vulnerable to global risk aversion (albeit less so than a few years ago). Despite the possibility for near-term turbulence, they remain bullish on Indonesia’s medium-term growth prospects.

EM Muser: This story applies to other EMs as well, with Brazil and Turkey fitting a similar mold. Like Indonesia, they are big emerging markets with large populations and strong domestic demand. And, like Indonesia, they remain vulnerable to global risk aversion, at least in the near-term.

Turkey, in particular, looks vulnerable to external funding shocks. The ratio of short-term external debt to fx reserves is close to 100%. Indonesia has a high ratio by ASEAN standards at over 30%, according to Tan and Chew.

2.    Unprecedented situation in Hungary’s bond market

By Portfolio.hu (free registration may be required)

“Hungary’s State Debt Management Agency (ÁKK) received only HUF 30.2 billion in bids for a proposed HUF 40 billion debt issue in 12-month zero-coupon treasury bills (D120822) on Thursday. This marks a historic record low bid-to-cover ratio for the 12-month facility since January 2000 (since when data are available) and the lowest volume of total bids since April 2003…”

EMMuser: Not looking good for Hungary. As I’ve detailed in a number of posts, the economy has a host of longer-term structural problems, accompanied by a government in denial, and investors seem to finally be waking up to that fact.

3.    Copper Rout Outpaces Analysts Focused on Shortages: Commodities

By Maria Kolesnikova and Agnieszka Troszkiewicz, Bloomberg

(Hat tip David K.)

“Copper, which reached a record $10,190 on the London Metal Exchange in February, sank to $6,800 on Sept. 26, a 14-month low. The contract traded at $7,067.50 today, taking this year’s decline to 26 percent. The metal is on track for its second- worst year in almost a quarter century, exceeded only by a 54 percent retreat in 2008.”

Blogger Barry Ritholz shows a nice chart that suggests copper’s downturn is one more signal that we’re headed for another global recession.

EM Muser: While the sharp fall in copper prices may signal global recession, it will have a more direct effect on certain EMs, particularly Chile, which is still very much copper country. Chile is the world’s largest copper supplier, producing roughly a third of global supply. (See my earlier post: Chile: Latin America’s Wunderkind)

4.    Poland’s elections: cause for concern

By Jan Cienski, Beyond Brics

“[R]ecent opinion polls are showing steady growth for the right-wing opposition Law and Justice party, threatening to introduce an element of political risk to assessments of the Polish economy and the Polish currency. A new opinion poll has Civic Platform, headed by premier Donald Tusk, with 36 per cent support, with Law and Justice (PiS) just behind at 32 per cent…PiS’s tumultuous two years in power from 2005-2007 were marked by populist economic policies and by bitter fights with Brussels, Berlin and Moscow that left Poland marginalised in the EU.”

EM Muser: Poland’s economy has shown remarkable stability in recent years. It was the only EU economy to avert recession in 2008-09 so one might think the ruling Civic Platform party would be a shoe-in, but it’s not.

This story provides a good reminder of why we should not take political risk for granted. Hungary’s a case in point. Commentators did not expect much of a shift in economic policy when the Fidesz government came to power in 2010, and that was a mistake.

 

Hungary’s Latest Debt Relief Plan: From Bad to Worse

Posted on by emmuser
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Hungary’s government just passed an ill-conceived plan to help households saddled with foreign currency debt on September 9. Disturbingly, more than two-thirds of lawmakers (277) voted in favour. This follows in the wake of an earlier plan announced in May (See: Hungary Mortgage Relief: Another Move to Delay the Pain).

While the earlier proposal from May had some flaws, the bill just passed is downright reckless. It will do nothing to help the economy. It won’t even provide relief to the indebted households that really need it. The government appears to have hatched this plan with little consultation or warning, marking the latest in a string of erratic policy moves. Below I detail the bill and some of its many problems.

What is the Latest Mortgage Relief Plan?

According to the bill, Hungarians will be able to repay their fx-denominated mortgages in one go, at well below market exchange rates. However, they must do so by the end of this year. Banks will become the fall guys, getting hit with the exchange rate difference.

Figure 1:  Roughly 65% of the mortgage loans outstanding are foreign currency-denominated, mostly in Swiss francs

 Source: MNB (National Bank of Hungary)

As seen in Figure 1, the majority of outstanding mortgage debt is denominated in Swiss francs. Under the plan, households who borrowed in Swiss francs will be able to repay their mortgages early, in one lump sum, at a preferential rate of 180 forints per CHF. Meanwhile, euro borrowers will get the same deal, but with the exchange rate fixed at 250 forints per €. As seen in Figure 2, these exchange rates are well below current market rates.

Figure 2:  Exchange rates in the bill are far below market rates

 Source: Oanda

Preface

Before I delve into the multitude of flaws in this mortgage relief bill, I want to make a few things clear. First, I am not an unyielding advocate of banks. If anything, I’m quite the opposite. Banks in Hungary lent heavily in foreign currencies to households earning in forint. This was clearly unwise (aka downright stupid), but everyone seemed to ignore the flashing warning lights and there’s plenty of blame to go around. Banks, as well as households, should have known better. Meanwhile, the regulators proved to be asleep at the wheel.

Hungary now finds itself in an FX debt mess. Debt levels in local currency terms have ballooned as a result of the forint’s depreciation against the franc, which is constraining consumer spending. As households struggle to repay their loans, the number of defaults is on the rise, constraining banks’ ability and willingness to extend credit, which in turn further weighs on the growth outlook. (See: Hungary’s Vicious Circle: Anemic Lending and Weak Growth)

However, this bill addresses none of these problems and manages to create new ones.

Problems with the Bill

  • Unlikely to Help Borrowers Most in Need

The most glaring problem with this mortgage relief bill is that the borrowers most likely to take advantage of it are those who least need help to repay their loans.  As I noted above, only those who can repay their mortgages in one lump sum by year-end 2011 qualify.

Those who are more than 30 days in arrears with debt repayments (eg. those who are struggling the most) would be disqualified, according to Portfolio.hu. Basically, anyone unable to beg, borrow or steal the money would be left in the lurch. Some may be able to borrow in forints to repay their fx-denominated debt, but again, those most likely to get such loans would be those less in need of debt relief. According to news reports, the Economy Ministry only expects 10% of borrowers to participate in the programme.

  • Risk to Financial Stability

As economic research firm GKI notes, good debtors will likely take advantage of the plan to repay their loans at preferential exchange rates. This will reduce the outstanding stock of mortgage loans.  Meanwhile, the rest will struggle. As economists at CIB note (via Bloomberg), the struggling households could actually emerge worse off due to the weakening of the forint, which will increase their debt burden in local currency terms. As a result, bad loans (as a percentage of the total) will likely rise. This will likely dampen lending and undermine the already stunted economic recovery.

More directly, the bill forces banks to swallow the losses from fixing the exchange rate at below market rates. This will trigger serious bank losses, the size of which hinges on the number of borrowers who participate in the plan. These losses will further constrain lending and could result in financial instability if banks fail (or come close to failing) as a result.

  • Potentially Big Fiscal Costs

The bill runs the risk of deteriorating public finances in at least two ways. First, there is a good chance that the European Court of Justice will rule that the plan is illegal. According to portfolio.hu, the Justice Ministry believes Hungary may have to compensate banks for any incurred losses. This would add to Hungary’s already substantial public debt burden, which topped 80% of GDP at end-2010.

Second, Hungary’s sovereign credit rating is teetering on the edge of ‘junk’ status. All three major rating agencies rate Hungary at the lowest level still considered investment grade. S&P and Moody’s have Hungary on negative outlook, making a downgrade more likely than an upgrade in the near-term. Analysts at S&P have already expressed concern about the effects of this bill. If Hungary is downgraded to ‘junk’, it could be disastrous given the country’s hefty debt burden as it would likely trigger a big jump in borrowing costs, making it harder for the government to sustainably meet its debt service obligations.

  • Underscores Erratic Government Policy

Investors are starting to realise just how unpredictable the current Fidesz administration can be. Since coming to office in April 2010, the government has engaged in a private pension fund grab (see here) in addition to implementing temporary ‘crisis’ taxes on the banking, energy, retail, and telecom sectors (see here). These policies were implemented with little to no consultation or warning.

This bill fits with the government’s typical modus operandi as it was unexpected and launched with little advance warning. All of this makes for a very erratic policy environment that is starting to spook investors. Notably, balance of payments data showed a net outflow of direct investment in Q1 2011, even before this plan’s announcement.

Bottom Line

The Fidesz government may find this plan politically beneficially, at least initially, since  it makes the government look like it’s standing up to the banks in the defense of debt-laden households. However, this mortgage relief proposal offers few, if any, positives for struggling households, the beleaguered economy, or the health of the banking sector.

The households that are struggling will continue to have difficulty repaying their foreign currency-denominated debt (and could experience even more difficulty if the forint continues to weaken). The losses banks suffer as a result of the exchange rate fix could endanger financial stability. Lending is already stagnant, and this bill will further dampen banks’ ability and willingness to lend, which will constrain already slowing economic growth. Meanwhile, investors – concerned by the government’s erratic policy moves – are likely to direct their funds elsewhere. Overall, this bill is a lose-lose proposition.

Related Posts

Hungary’s Vicious Circle: Anemic Lending and Weak Growth

Hungary: Finally on Investors’ Radar

The Double Whammy: Debt and Demographics

Hungary Mortgage Relief: Another Move to Delay the Pain

Fitch Raises Hungary’s Ratings Outlook: Odd Timing

Hungary’s Vicious Circle: Anemic Lending and Weak Growth

Posted on by emmuser
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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


Source: Eurostat

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.

Bottom Line
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.

See Related Links:

Hungary: Finally on Investors’ Radar

Hungary Mortgage Relief: Another Move to Delay the Pain

Fitch Raises Hungary’s Ratings Outlook: Odd Timing