Thursday, January 5, 2012

Hungary: bad policies gone awry

Hungary is the only EU member who received IMF help back in 2008 ($15.7 billion loan) and has been in discussions with IMF to get a second helping of aid. In mid-December, the IMF pulled out of these talks with the Hungarian government.  The dispute centered around concerns that Hungary's proposed new legislation would take away their central bank independence.
Budapest Business Journal: Talks between Hungary and delegations from the International Monetary Fund (IMF) and the European Commission on a financial assistance package broke down, a spokesman for Vice President of the European Commission Olli Rehn told MTI on Friday. Amadeu Altafaj Tardio said the talks were broken off because of a proposed amendment affecting the National Bank of Hungary.
In late December the S&P downgraded Hungary to junk.  This new legislation passed at the end of December and is now sparking international concerns.
MarketWatch: International investors are most troubled by a law based on the new constitution and approved on Dec. 30, which amends the structure of the country’s central bank, Magyar Nemzeti Bank. The law strips current MNB President Andras Simor of his power to appoint deputies, expands the interest rate-setting committee and makes room for a third vice-president.
Now that the new legislation has actually passed, IMF has no interest in even resuming talks to help Hungary.
Voice of America: The European Union's executive body says it and the International Monetary Fund have no plans yet to resume talks with financially troubled Hungary over multi-billion dollar assistance, amid concerns that new laws will lead to a government take-over of the Central Bank and other previously independent institutions.
Anti-government protests spark currency selloff.
WSJ: Crowds gathered outside the Opera building here Monday evening to stage a protest against what they saw as an antidemocratic new constitution just as the Hungarian government hosted a gala event to celebrate it.
USD/HUF -Hungarian currency (Bloomberg)
Investors are becoming concerned about other populist legislation, in particular the one dealing with mortgages that are denominated in euros.  Mortgages denominated in foreign currencies have plagued nations whose currencies were devalued (for example Argentina).  So Hungary told these borrowers they can pay back their mortgages at a fixed exchange rate (rather than the market FX rate) - spooking lenders who are often foreign institutions (particularly in Austria). This is what some call a "soft default" by the mortgage borrowers.  The more HUF depreciates, the less principal Austrian banks are getting back.
MarketWatch: Under the initiative, the many Hungarians who took out foreign-currency mortgages can repay the loans at a fixed exchange rate, roughly 20% to 25% below market rates. The country’s banks are expected to absorb the losses. With the forint in sharp decline, the scheme is likely to cost the banking sector billions.
In spite of the turmoil Hungary sticks with its debt issuance schedule and of course the last bill auction fails.
Businessweek: The government sold 35 billion forint ($140 million) of one-year bills, 10 billion forint less than targeted, data from the Debt Management Agency on Bloomberg show. The average yield rose to 9.96 percent, the highest since April 2009, from 7.91 percent at the last sale of the same-maturity debt on Dec. 22.
Yields on short-term paper immediately spike,

Yield on 1-yr Hungarian bills (Bloomberg)

and Hungary sovereign CDS widens.

Hungary 5yr sovereign CDS spread (Bloomberg)
Default is now becoming increasingly more likely.  One might of course ask the question: who cares about Hungary in the overall scheme of the eurozone crisis, given that the nation is not even a part of the euro?  The answer of course is Austria, whose banks are highly exposed to Hungary.  Austrian bond spreads to Germany promptly widened on the back of the Hungary developments.

Austria 5yr spread to Germany (Bloomberg)
Now that we are in the eurozone with Austria, other sovereign bonds sell off, with French, Spanish and Italian spreads all widening.

The moral of the story here is the tremendous vulnerability of the eurozone.  Even a nation outside the euro area can shatter investor confidence and send shock waves throughout the region.
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