Hungarian forint on the brink

Hungary’s FX-denominated debt reached Ft3,500 billion ($15.7 billion) in the first quarter of 2013, or 11.5% of GDP.

The bulk of the stock was lent out between 2006 and 2009, with the vast majority – more than 80% – denominated in Swiss francs as Hungarian households sought to take advantage of low Swiss interest rates to fund their mortgage payments ahead of the financial crisis.

 

As with other carry trades, such as those denominated in the low-yielding yen, the wave of deleveraging sparked by the financial crisis quickly wiped out the yield advantage enjoyed by Hungarian households as the value of the funding currency, in this case the Swiss franc, soared.

Indeed, the average exchange rate in CHFHUF at which funds were lent was around Ft160 between 2006 and 2009. Since then, the forint has weakened by more than 50% against the Swiss franc, and stands around Ft240.

Adding to the woes for Hungarian households, the interest rates on those Swiss-franc-denominated loans have also risen sharply. That has been driven by an increase in Hungarian CDS spreads, which sent the cost of refinancing soaring, and by banks gradually increasing the margin on their existing stock of loans to maintain profitability.

Thus a weaker forint and higher interest rates have increased the burden on Hungarian households. That has seen the non-performing loan ration of households rising above 16% – a threat to financial stability.

However, Tibor Navracsics, Hungary’s deputy prime minister, said last week the government was looking to ease the burden of indebted households with foreign currency loans.

“We are reviewing the possibility, the constitutionality, of whether there is a way to modify the conditions of foreign currency loans with general effect via legislation,” he said.

Navracsics argued that nobody could have foreseen the exchange-rate movements and the massive and permanent depreciation of the forint, and thus the blame should not be put on borrowers who are unable to pay monthly instalments.

That has raised speculation that the Hungarian government intends to alleviate the burden of FX debtors to gain favour with voters ahead of elections in the second half of 2014, a move some believe could come as early as this week.

However, András Balatoni, strategist at ING, says news of a haircut on FX loans could trigger serious consequences for Hungary.

“It would likely endanger financial stability and push asset prices into a new bear trend,” he says.

“While the government has already prohibited the lending of new FX-denominated loans since 2010, the new measure would be effective retroactively on the existing stock of FX loans.”

Since taking office in 2010, the Hungarian government under Viktor Orbán has taken several measures to mitigate the potential damage of Hungarian households’ FX loans.

Balatoni says while some helped to ease the burden on the indebted, some proved a hindrance.

He says one of the most economically harmful packages was the early repayment scheme of FX loans in full and on a fixed rate, which ran from October 2011 to March 2012 and resulted in a Ft260 billion loss for the banking sector, a 0.8 percentage point loss of Hungarian growth in 2012 and a 5% depreciation of the forint.

“The latest rescue package can have very similar consequences,” says Balatoni.

“The scheme aims to decrease the outstanding amount of FX loans of households and banks may have to swallow the loss households realized due to the weaker forint.”

ING estimates that depending on the extent of the haircut, the banking sector might have to face a massive loss, somewhere between Ft150 billion to Ft1,000 billion.

“We expect that banks may be allowed to deduct their losses from the bank levy, but even with the deduction, the sector could easily face a massive one-off loss,” says Balatoni.

“The programme may accelerate the balance-sheet adjustment process, and is highly likely to moderate the GDP growth rate in 2014. EURHUF can easily break above Ft300, halting further monetary easing and upset one of the best-performing local bond markets this year.”

Developments in Budapest might well call for a greater risk premium in Hungarian assets and renewed pressure on the forint.