Hungary - continuing to head for trouble?
There seems to be a recent rise in preoccupation about the large twin deficits in Hungary. The voices include last month’s IMF report(6th of June )
and today’s FT commentary by W.Munchau. Is the situation really so serious?
Figure 1. Hungarian forint against euro(left scale, red) and BUX stock market index (right scale, blue) in 2006. Dates marked by vertical lines(see text for more details) (19 April) - NBH governors comment, (6 June) - IMF report, (15 June) S&P downgrade. Source: Datastream
We have discussed the problems of Hungary already in April (Hungary – heading for trouble?) and the problems remain the same as the ones highlighted in the blog note (high current account and public deficit, high public debt ratio, more recently rapid credit expansion and a rise in inflation).
There are two main issues regarding the situation of Hungary – the first one being whether Hungary can deal with the problem and escape a crisis – and most commentators seem to suggest the answer is hardly positive.
A series of warning lights have flashed in the recent months – an April declaration from the NBH governor about forint being in ‘serious danger’ was followed by the troubling surge in yoy inflation in May, which reached 2.8%, well above the National Bank of Hungary estimates (report with estimates). Then the release of the earlier mentioned IMF report, critical of both the situation and of the governments plans to resolve it, that focus mostly on the revenue side, i.e. on tax increases. The report was also somewhat doubtful on whether there is sufficient will to implement long term reforms, and whether the proposed tightening was sufficient.
On June 15th S&P long term credit rating of Hungary was lowered (Bloomberg) from A-, where it has been since 2000, to BBB+. Not a week passed and an issue of three year government bonds failed to attract bidders (www.portfolio.hu). There are voices of asset price (mainly housing) bubbles and credit booms (especially foreign currency denominated, unhedged) – the last suggesting that a further ER deterioration would be painful.
The currency saw a depreciation in the recent weeks (see Figure) and the stock market was rather bearish, though admittedly so were the markets in Poland and Czech Republic and it was showing some signs of recovery in the last week.
But the growth forecasts have been revised downwards, and IMF foresees GDP growth to possibly fall below 3% already in 2007. This is the effect of the necessary fiscal and monetary tightening the country must go through in order to navigate away from a crisis.
The second issue is whether if the Hungarian economy were to suffer a crisis, what is the chance that it would spread to the neighboring CEE economies?
As for the rest of CEE-5 (Czech Republic, Poland, Slovakia and Slovenia) – the room for impact seems rather limited – both the fiscal and c.a. deficits are far lower in these countries, and growth prospects look much better. Czech R. and Poland show many signs of a recovery from a slowdown, and though Slovakia in the recent elections showed some discontent with reforms, the situation seems rather stable. In Poland some political turmoil regarding the (now ex-) Minister of Finance seemed a possible threat, but by now seems to have had no longer term effect. Thus in the near future the appointment process of new NBP governor – successor to Leszek Balcerowicz by the end of the year will be an important thing to watch.
Slovenia – seems by far most on the safe side, which should be confirmed once it joins the euro in a couple of months.
As for Bulgaria and Romania the first seems exposed to most risk, with credit markets booming and a large current account deficit, though EU entry expected next year should rather improve its situation.
And finally the Baltics with credit markets booming even more than in Hungary (see previous blog notes on credit booms) and very high current account deficits are suggested most vulnerable by Munchau. Their fiscal deficits lower or even in surplus (though arguably this gives them less room for maneuver) and their fixed exchange rates seem credible, having for instance survived the Russian crisis, so perhaps foreign currency loans exposure is ‘safer’ in these countries. The troubles would be resolved upon EMU entry, but this has been postponed because of (higher than entry criterion) inflation levels. The latter remains a risk, and the uncertainty related to future euro entry prospects certainly adds to it.
Overall, though there is some room for the ‘central European financial crisis’ that is a regional crisis sparking from Hungary and spreading to the whole CEEC region, this prospect should not, in my opinion, be over overvalued. These countries, albeit showing a large degree of co-movement in stock markets, are in quite different situations, their economic and trade ties to the old-EU often being higher than to each other, thus its Hungary’s problems that should be most focused on.