Hungary Between A Rock And A Hard Place
Literally within minutes of returning from an emerging Europe investment conference where the ad nauseam theme was that the ‘economic fundamentals are essentially sound’, I learn that the National Bank of Hungary has hiked its policy rate from 8.5% to 11.5% to prop up the currency. Well, the fundamentals must be sound if a central bank feels comfortable to hike rates by 300bps right?
Sarcasm aside, the move makes sense. The forint was pushing awfully close to a record low against the euro (having already hit that point against the Swiss franc) and the prospect of any further depreciation was draining what little confidence was left in the domestic banking system and by extension, domestic capital markets. Over 90% of household loans in Q1-Q3 of this year were denominated in foreign currency (mainly euros and Swiss francs) and the consensus is that any forint depreciation beyond 20% from the peak would pose significant repayment problems. If the level of household defaults were to spike owing to a currency sell off, this would be the tipping point for the highly leveraged banking system, in turn cascading into a systemic economic crisis. Under such a scenario, the risks of a Hungarian depression would be very real.
Flight From The Forint, Exchange Rate - HUF/CHF
This must have been the outlook staring the NBH in the face, because by hiking rates at a time when real GDP growth is 1.9% and the eurozone, UK and US are trending toward recession (and the rest of the planet is in a marked slowdown), they have effectively toasted the economy for at least the next two years. In other words, if this is the alternative the NBH has chosen, then my worries about the risks of a macroeconomic crisis from the problems in the banking system have been validated.
So, where do they go from here? This is a stop-gap measure that will not alleviate the fundamental downside pressures on the currency beyond the near term, especially in a foreign investment climate where everyone is trying to buy safety, not yield. Maybe though, a short reprieve is all that the NBH needs, to hold out in anticipation of a bail-out package from the IMF. The only solution to this problem is capital and the only capital out there is in the hands of foreign governments and multilaterals.
