Hungary has had a bad press lately

On April 28, 2010 I wrote an article entitled "The first signs of financial trouble." This was three days after the second round of the Hungarian national elections that resulted in a stunning victory for Viktor Orbán's Fidesz. As I noted, the initial international reaction to the two-thirds majority was positive. The Hungarian forint strengthened, reflecting the hope of investors that the new government's overwhelming majority would translate into resolute efforts to set the country's financial house in order.

However, I continued, Viktor Orbán's first few utterances made the markets jittery again. In the euphoria that followed the victory, Orbán made some very stupid remarks. He attacked the chairman of the Hungarian National Bank and indicated that András Simor had to go and, if that weren't enough, he defiantly announced that neither the European Union nor the International Monetary Fund is his boss.

At that time some people may still have thought that these were just initial missteps and that Orbán and his team would realize that the world is watching. Some people thought that surely Viktor Orbán wouldn't make the same mistakes he committed between 1998 and 2002. He is older and wiser and presumably more experienced. As it turned out, they were wrong. Orbán basically hasn't changed. He is the same headstrong, vain, power-hungry, vengeful man who is great at political intrigue but hopeless as a responsible leader of the country. He is especially dangerous when he has such strong parliamentary and, for the time being at least, public backing.

And there is another problem with Orbán and crew. Their hopeless provincialism. In my earlier article I wrote that Fidesz leaders like to talk about their knowledge of the world. We were told that they will be the ones who will lead Hungary to the High Street of Europe as opposed to the provincial Prime Minister Gordon Bajnai and Péter Oszkó, his finance minister. In April, after the first signs of problems created by Orbán's careless remarks, I commented that the road to the High Street of Europe seems to be bumpy. By now I'm convinced that Orbán's team is actually wandering around on some dirt road of a God-forsaken village somewhere in northeastern Hungary. Their clumsy games with which they hope to mislead the financial world become international news overnight.

Let's first talk about English-language media coverage. Lately there is a growing tendency among leading financial papers and even press agencies to hire local reporters who know the language and are familiar with the local political scene. The times when an English or American reporter was sent to Budapest maybe twice a year, spent a few days there, talked to some people who knew English, and then wrote something that was neither profound nor terribly accurate are over. Something happens in Hungary on Monday and on the very same day all the important online papers give accurate reports. A day later the article appears in their print editions. And pressure mounts. As a result, at least on one occasion, Orbán's busy sidekicks had to back down. I'm talking about the "media reform" bill that was almost a carbon copy of the media law of Putin's Russia. Whether the withdrawal of the proposal is only temporary we don't know, but foreign pressure certainly played a role in the postponement.

Although Orbán's economic minister György Matolcsy, who once already led Hungary down the economic garden path between 2000 and 2002, after a lot of pressure from abroad announced that after all the Orbán government will continue its predecessor's strict fiscal policies and will stick to the projected 3.8% deficit, this announcement didn't calm foreign investors' nerves. Simply because other announcements are constantly being made about hitherto unanticipated government spending. The government's efforts to paper over their plans to overstep the boundaries of their promised 3.8% deficit fail time and again. The careful observers stationed in Budapest who know what's up report faithfully.

Here is the latest effort at hiding the truth from the world. The government, using Antal Rogán, an ordinary member of parliament and mayor of a Budapest district, proposed a bill that would be "tantamount to window dressing the budget to meet creditor-approved deficit targets." Yes, it came to light because the cunning plan was reported by Reuter's Hungarian journalist from Budapest and because another Hungarian, a strategist at 4Cast Ltd in London, discovered it in no time. Gábor Ambrus in London was emphatic: "That's the realm of pure window-dressing, not just a PR maneuver." He added that "the risks of budget slippage remain high in Hungary."

So, what is the proposed bill supposed to do that is advantageous to the Hungarian government's agenda of surreptitiously adding to the Hungarian deficit? The planned measures include keeping the losses of state-owned companies off budget accounts and loosening requirements for passing supplementary budgets. In 2008, at IMF's urging, a Budgetary Council, a kind of watchdog over the budget, was established. The Council is headed by György Kopits, a Hungarian-American citizen who received his Ph.D. from Georgetown University. Politically he is close to Fidesz, but he is first and foremost a responsible man who is outraged. He immediately gave a press conference which was then dutifully reported by Reuters. According to Kopits, an easing of the rules would dilute transparency and "the proposed changes would essentially recreate the status quo before 2008, when the rules governing budget planning were tightened." Kopits found the bill "a lamentable step backward." Reuter's assessment ends with the general impression that "analysts have warned there were implementation risks" in the government's promise to stick to the 3.8% deficit.

While the government is engaging in financial shenanigans with the national budget, it is also making irresponsible promises. The latest is that it is thinking about setting up a new fund to help borrowers whose loans are in Swiss francs or in euros. Because of Hungary's continued financial fumbling, the Hungarian forint is weakening rapidly. The forint has weakened against both the euro and the Swiss franc. Especially since the new government took over. Here are a couple of charts that show the seriousness of the problem.

Most of the loans are in Swiss francs. But the situation is not much better for those who took out loans in euros.

 

The Financial Times in an op ed piece gave some advice to the Hungarian government about the plan to set up a fund that would help troubled borrowers who find their monthly payments increasing. Chris Bryant, the author, wrote: "Under the plan, the government would set up a National Asset Management fund, which would purchase real estate put up as collateral from commercial banks, allowing mortage holders to rent the property." Bryant describes it as the plan of a government that is "crowd-pleasing." He adds that instead of setting up such a fund (for which in the first place there is no money at the moment) "the best thing [the government] can do to help foreign currency borrowers is to restore investors' trust in Hungary."

As far as I can see, the Orbán government in two short months managed to destroy the trust of the financial world in Hungary that the Bajnai-Oszkó duo managed to restore. Failure after failure, but they are not giving up on their games that are supposed to ensure their domestic popularity. But how long can these games be played before serious problems will beset the country? Not for long. Business Week reported on June 24 that "Hungary raised less than its target in a second straight auction of 12-month Treasury bills and the nation's cost of borrowing increased as concern mounted that Europe's debt crisis may escalate." And yet Orbán and Co., seemingly unperturbed, continue with one financial scheme after the other.

Comments

[Mark]

Undoubtedly the government doesn't know what to do about the economic situation, its leading figures have a political communication style that is frankly pathological, and they appear to be more interested in clearing their former political adversaries out of every public position they find and appointing their friends and family (probably soon looking at the calibre of some of the people they are appointing they will be appointing their pets soon) to the empty positions!

But much of the commentary and the above post lacks balance, because I think that it understates the problems any Hungarian government would have in this situation.

Firstly and fundamentally the HUF is overvalued against the Euro. Hungary will remain uncompetitive and thus growth will remain sluggish at best until this issue is addressed directly. Because HUF's value has been supported by the carry trade underpinned by high MNB base rates its exchange rate is vulnerable to attack, and this is fed by rational economic calculation. Sooner or later, either the government will need, or the markets will force a substantial devaluation (and what is more this has been pretty clear to me at least since 2007, so somebody could have done something to prepare the ground for this to take place in an orderly way).

The problem with this, of course, are FX loans - mortgages, personal consumer loans, business loans, and loans made to local authorities. Most of these are denominated in Swiss France - some 85% of Hungarian mortgages. Even without a devaluation of HUF, because of the ongoing turmoil in the Eurozone the Euro is weakening against CHF, which investors regard as a safe heaven, thus creating a perfect storm for borrowers. It is all very well for Chris Bryant to call a fairly modest (and pretty inadequate) rescue plan for such borrowers a "crowd pleasing measure", but in a devaluation in this climate large sections of the middle class, a slew of SMEs, and local authorities will be bankrupt. I don't believe a Central and Eastern European version of the US "sub-prime" crisis of 2008 is in anyone's interests, and therefore something is going to have to be done to rescue the situation. And that something will have to be radical.

And I don't think they grasp either the other fundamental problem, which makes Hungary's situation especially difficult. That is political legitimacy. The fact that a quarter of the votes went to parties that were insignificant or non-existent four years ago, both of which have programmes that are compatible with a liberal, market economy ought to be a wake-up call. Commentators have to realize that after five years of austerity the population have had enough, and I seriously question whether any government can persuade a majority of the population to accept reforms without giving those on average incomes some relief first. I've spent all but a few days of the past month in Hungary, and everything I've seen suggests that there is incredible tension and latent anger out there. I really dread to think what is coming next.

[Mark]

Sorry, I mean incompatible with a liberal, market economy.

[wolfi]

Thanks, Eva and Mark for that analysis - now i think I understand why the Forint suddenly gave way again against the Euro last week - it doesn't look too good.

[PassingStranger]

Eva is right about the local Reuters/Bloomberg/AFP staff, who are all Hungarians. But the major news organisations still operate with their own correspondents, many of them do (understandably) not know any Hungarian. Bryant at the FT doesn't, but Nick Thorpe (BBC) and Adam LeBor (Times) do. The real problem is not their lack of Hungarian. Most of the non-Hungarian speakers hire local interpreters and stringers and let themselves be inspired by the newswires. The real issue is that newspapers are less and less interested in Hungary and have been withdrawing their correspondents from Budapest over the last ten years, posting them instead in Austria, Romania or Belgrade or eliminating them altogether. So all of the European newspapers were taken by surprise by Jobbik's victory in the EP elections last year. This year they all jumped on that bandwagon and missed the real story: Orbans two thirds win. But who knows, interesting times may yet make them change their minds.

[Paul]

"He is the same headstrong, vain, power-hungry, vengeful man who is great at political intrigue but hopeless as a responsible leader of the country."

you could be talking about gyurcsany and orban equally here, eva.

orban is not great, but his mob is a difinite improvement on the (more) corrupt bunch they replaced, who got us into this disastrous mess in the first place.

[Eva S. Balogh]

Paul: "orban is not great, but his mob is a difinite improvement on the (more) corrupt bunch they replaced."

Yeah, and that's why foreign analysts and observers have such a high opinion of him and his cronies.

[NWO]

I have been for a long time an advocate for an internal devaluation strategy (force a big recession on the country, but maintain the currency value) as a way to address the c/a and balance of trade problems. I believe to a decent extent this has worked and the Government balances are in a much healthier state that was the case in 2008 or before. Having said that, I realize now the full scale of the other side of the problem (individual debt and the banking system). This remains an intractable problem for which I do not see any viable solution. Competitiveness and economic growth will require a further slow but steady depreciation of the HUF (which will increase inflation and thus cause a rise in interest rates), but (as Mark said) this combined with the general Euro weakness will make the domestic mortgage problem intolerable, and threaten not only any notion of a recovery but of the banking system itself [whether it will cause domestic unrest is another question]. The problem will require either some sort of RTC solution (taking the mortgages off the banks' books) or some massive subsidy by the Government to convert these loans into HUF loans after a suitable write down. Neither is possible fiscally, however. But without unburdening Hungarian consumers from their substantially over leveraged situation and without recapitalizing the banks' balance sheets, there is no hope for restarting domestic demand and having a healthy economic recovery. Short answer: the Country is screwed (and it is not FIDESZ's fault-though they have no clue of what to do or how to manage the situation).

[whoever]

Yes, NWO. There really is no way out of this for the time being. The only rather paltry compensation is that as the international economic climate gets colder, Hungary will not be so exposed, compared to other countries in the region and indeed within the EU generally.

[Alias3T]

Well the "precautionary loan" from the IMF that Szapary was talking about looks like it's going to be their answer to this particular conundrum.

There are a lot of questions though. Presumably the fact they're talking about it means they're sure to get an extended credit line. But how much, for what duration and under what conditions?

Are they going to build on the bad bank idea, buying up defaulted mortgages from the original lenders? If this is the approach they take, then the bank tax looks like quite a good deal for OTP - they get the bad debt taken of their books in exchange for a banking windfall tax that will be rather smaller in size. But why the IMF should be paying to bail out Csanyi I'm not quite sure.

Or else do they stick to the original idea of converting outstanding CHF and EUR debt into HUF? And what are the cost implications of doing that compared to setting up a bad bank?

[NWO]

I have the sense that they would like to buy MKB back from the Germans (who are required by the EU to sell), and this may be the vehicle for cleaning up the banking system.

[Alias3T]

So they turn the MKB into the bad bank, clean it up, and hand it to Simicska?

Or am I just being malicious?

[wolfi]

What I really would like to know - Where did all that money go ?

Or, put differently:

Wo gave all those Swiss Francs to the banks to finance those loans ?

If I understand it correctly, Hungary still has a trade surplus. So someone must have been selling Forints and can buy them back now much cheaper ...

Who are/were those people speculating on the downfall of the Forint ?

Could someone explain or just give a hint ?

[Mark]

wolfi: "Who are/were those people speculating on the downfall of the Forint ?"

This isn't about speculation at all - which doesn't mean that no-one will make a profit, especially if they foresaw the eventual fall of HUF. It is just to say that financial speculation may piggy-back onto the problem, but it is very far from being the fundamental cause.

The banks borrow CHF on the wholesale money markets to convert into mortgages for Hungarian borrowers. The calculation that those who invested in those loans made is that with European integration and the investment boom that was underway in CEE in the mid-2000s, they would eventually reap substantial profits. Their calculations have failed, and the issue now is who should bear what share of the costs from the various failed calculations. Should the borrowers pay for their mistakes in borrowing in CHF without properly calculating the translation risk? Should the banks bear the cost for making the loans? And how far should those advancing the capital on the wholesale money markets pay? And perhaps what is economically most important, what are the economic consequences?

In the final analysis the Forints were supplied by the National Bank - they control the conditions under which HUF is made available to the market, and in order to create the conditions to finance the increasing state debt they were pursuing a tight monetary policy during the middle of the decade. Furthermore the rise in CHF mortgage lending produced capital inflow, and this tends to inflate the values of currencies of countries that are beneficiaries. Equally the more short-term "carry trade" investment in HUF has similar effects.

It is considerably more of a mess than a conspiracy, and far more people are going to lose money than gain it.

[Mark]

NWO: "I have the sense that they would like to buy MKB back from the Germans (who are required by the EU to sell), and this may be the vehicle for cleaning up the banking system."

This is very interesting, and not a little worrying. I assume it would involve the state using MKB like the Irish NAMA (http://www.nama.ie/index.php), and I guess it would involve some form of IMF loan to take bad debts off the banks and consolidate them by adding them (at least temporarily) to the public debt. This is what I have long suspected someone would try to do, but we need to be clear that it involves the banks being bailed out and every adult Hungarian paying for it for the rest of their working lives.

[NWO]

Mark

The question would be at what price the loans are transferred to the State bank. If they are transferred at par, then the Hungarian State/Taxpayer pays for this for ever. If they are sold at closer to their "real value", then the banking system will need to be recapitalized even more than is now the case.

I cannot imagine the State would take them at or near par. It would be insanity, and it would be a huge wealth transfer from Hungary to the foreign shareholders of the banks that made the loans.

If they were thinking long term, the State should be using the threat of the asset tax to "force" banks to start writing down their assets rapidly. Only after that, should there be a discussion about taking the loans off the banks' books.

Even if this is all done,there of course will still be a significant subsidy that Hungarian taxpayers who do not have CHF loans will need to provide to those who do have them and get them eventually restructured. Time for a Hungarian Tea Party movement.

[Alias3T]

The bad bank appears to be the government's return favour to OTP in exchange for Csanyi not opposing the banking tax.

But the Austrian banks haven't dropped their objections. They continue to lobby against the banking windfall tax, even wheeling in the Austrian central bank governor to reinforce their complaint.

That does seem to imply there's a construction under consideration that favours OTP while placing the Austrians at a disadvantage.

Making that kind of distinction would be illegal under EU law, unless there were some specific feature of the structure of OTP's loan portfolio that doesn't apply to the Austrians' lending, and that the bad bank legislation was likely to be drafted in a way that bears this in mind.

Now, is there some structural feature of OTP's loan portfolio that makes this possible? Or do I have to do a laborious run through the annual reports?

[Gábor]

Alias3T: "Now, is there some structural feature of OTP's loan portfolio that makes this possible?"

Definitely. They have important Hungarian
a politicians on their balance sheet and in their books. ;)

[Alias3T]

:)
Oh, I thought there'd be a more elegant solution....