Hungary Struggles To Apply Its Own Unique Version Of “Internal Devaluation”

Just what the hell is going on in Hungary? This is the question which even the most cursory inspection of the latest round of data coming out of the country leads me to ask myself. What the hell is going on and just what kind of correction is this the IMF are presiding over here?

In May, according to the latest data from the Hungarian statistics office, in the Hungarian private sector real wages were up, and employment was down. Meanwhile in the public sector, real wages were down, but employment was up (contrary to what was supposed to be happening). A recent programme to get workers off the unemployment roles and back to work seems to have had the perverse and contradictory impact of offsetting the fall in private sector employment by giving a sharp boost to public sector employment. So while total employment has remained more or less stable, the balance has shifted, and in the wrong direction. Meanwhile, in an attempt to stem the bloodletting in public finances (the economy remember will probably contract by about 7 percent this year) VAT was raised – by the significant margin of 5 percent (from 20% to 25%) on July 1st, giving consumption, which was already falling sharply, another sharp jolt downwards. Not only that, the Hungararian economy, in order to maintain the value of the forint more or less where it is (all those forex loans) was supposed to be having a major downward correction in wages and prices, yet inflation (which was already at an annual 3.7 percent in June) will surely now be given a hefty kick upwards. So, I ask myself, how does any of this actually make sense, and to who? And meantime the problem of the forex denominated loans remains, and goes jangling around (like any good jailor does) in the background, putting an effective stop on monetary policy just as fiscal policy switches over to complete contracton mode. This is why I talk of “internal devaluation”, since the Hungarian authorities (with the agreement of the IMF and the EU Commission) seem to have decided that, rather than resolving the issue of the CHF loans once and for all, they will down the same road that is proving to be so disastrous in Latvia, even though they have their own currency to devalue, should they choose to do so.

At the end of the day, the big question which we are all left with is, whether this structural shift in employment, away from the private sector and towards the public sector, and the increase in the consumer price index to be caused by the sharp VAT hike, plus the ongoing rise in real wages, really is the outcome the IMF support programme was intended to achieve?

Wages Up, Employment Down

Amazingly, with an economy contracting at at least a 7% annual rate, Hungarian real private sector wages aren’t falling, they are still rising. They were up (over and above inflation) by 1.7% in May. Evidently those who are still in employment say, crisis, what crisis?

Unsurprisingly Hungary’s consumer confidence index rose in July for a third month (to minus 63.1) after hitting a record low in April.

“Consumers’ perception of their ability to save in the short-run is what improved the most from June,” GKI said in their statement. Well certainly a 5 point hike in VAT is unlikely to encourage them to spend. In fact, paradoxically, saving is what Hungarians collectively really need to do, to reduce the ballooning government debt and pay down the level of net international indebtedness. But all this simply means is that to get the economic growth necessary to do all the required saving Hungary is going to need to export, and a lot more than it was doing previously, which is why the shift towards public sector employment is so serious.

As I say, private sector employment is down in Hungary, by 4.8% y-o-y. While industrial output was down 22.1% in May over a year earlier. Something just doesn’t seem to be working as it should be here.

On the other hand, public sector employment is on the up and up in Hungary, due to job creation under the short term stimulus programme, courtesy indirectly of the IMF, who have permitted a large than anticipated budget deficit. Don’t get me wrong, it’s not the stimulus I am quibbling about, it is what it is being used for. The outcomes we are seeing at present don’t seem to me to be producing a large structural change in the right direction.

Actually the rise in public sector employment is not a direct result of the increase in the IMF permitted deficit, but rather comes from restructuring funds earlier used to finance social assistance payments. The same ammount of money (at about 100 billion HUF) was used to provide public work opportunities for people who before April were entitled to receive social assistance for staying at home. Now those considered capable of working can only receive benefits if they are registered as public workers and if they are offered a job opportunity by local governent they are compelled to accept it. Thus, like so many things in Hungary, the intention was good even if the execution wasn’t.

Meanwhile, far from the current recession leading to a significant downward shift in wages and prices, real wages are – as we have seen – still rising, and Hungary’s consumer prices were still running year on year at 3.7% in June, down it is true from 3.8% in May, but still far to high to start restorting competitiveness. And of course, the July 1st VAT rise will give consumer prices another stout kick upwards, with some analysts suggesting that year end inflation could be running as high as 6%. If this is anywhere near accurate, and the HUF stays in the region of its current euro parity, then Hungary’s agony looks set to continue unabated into 2010.

And in case you had forgotten, here is what is happening to Hungarian GDP: while wages and prices are rising steadily, GDP is in freefall. Year on year it was down 4.7% in Q1 and Hungary’s government currently expects the economy to contract 6.7 percent this year, the most since 1991. My view is a total policy trap is in operation here, since neither monetary (interest rates are currently 9.5%) or fiscal policy are available, so there is little support to put under the economy at this point. The only way to break the circle in my opinion is to let the forint drop, bring down rates, and restructure the CHF loans.

The result of all this botched policy – Hungary’s unemployment rate rose to the its highest level in at least a decade in May. The rate rose to a seasonally adjusted 10.2 percent, the highest since at least 1996. And the situation is more likely to deteriorate than improve, with the central bank forecasting lay-offs of around 180,000 in 2009-2010, nearly 5% of the total number of employed.

One of the important things to grasp about the current situation in Hungary is that this is not a constant size wheel running constantly around the same spindle. The long run outloook is steadily deteriorating as population falls and ages. The same is also true of the working age population, which has now been falling steadily for some years (see chart below).Unsurprisingly therefore the NBH now project that employment will fall by 3.2% this year, followed by a 1.7% contraction in 2010, notably primarily due to layoffs in the private sector.

Hungary’s industrial output fell at a slower annual pace in May than it did in April as stimulus plans in the European car industry added to demand, but production was still down 22.1 percent on May 2008 (following a 25.3 percent annual decrease in April). Output rose 2.6 percent over the month.

Hungary’s contraction seems to be more or less moving sideways at the moment, and the June PMI came in at 45.8, a slight uptick from 45.4 in May, but hardly a seismic shift. The output improvement was almost all due to the export sector.


Hungary recorded its fourth monthly trade surplus in May, and came in at 497.7 million euros as compared with 430.3 million euros in April and a deficit of 30.3 million euros in May last year.

Now good news is always good news, but it is important to understand that this result was almost entirely achieved via a dramatic drop in imports, which plunged 32.3 percent in May (following a 35.4 percent decline in April). It is impossible to talk of any marked improvement in exports, since these fell by an annual 24.1 percent, accelerating from a 29.4 percent drop in April. While in the short term this substantial drop in imports (and hence rise in the trade balance) is GDP positive, it is very negative for living standards in the longer term, and the whole situation needs to be reversed by a large boost in exports leading imports as the eurozone economy eventually recovers. But to be able to achieve this Hungarian industry needs to do more, much more, to achieve competitiveness.

Investment Activity

Hungary is suffering from a generalised drop in demand – domestic, export, government, and investment – for which it is difficult to see any short term remedy. In the first quarter of 2009 investments fell by 7.7% compared to the same period of 2008, while they decreased by 1.1% in comparison with the previous quarter (according to seasonally adjusted volume indices). Within this fall machinery and equipment decreased by 9.9%, while investment in manufacturing industry was down by 6.8%. Evidently the first sign of any real recovery in the Hungarian economy will come when investments stabilise and even start to increase, since that will be a reflection of the expectation of future demand arriving further down the pipeline.


Construction activity was down by 10.1% compared to May 2008. In the first five months of the year, output decreased by 6.9%. In comparison with April production decreased by 3.3%. Construction output showed a decreasing trend in connection with the global economic crisis in the past months. In fact there was a significant difference between the performance of the two construction branches, with buildings activity falling by nearly a quarter, while civil engineering works were up by 7.9%. On a seasonally adjusted basis, building activity was 8.6% lower in May over April, while civil engineering was up one percent on the month.

Retail Trade

Retail sales fell 3.4% year-on-year in the first four months of 2009. In April the fall in retail sales accelerated, and the volume index was down 4.1% compared with April 2008. Retail sales decreased by 0.3% over March according to seasonally and calendar adjusted data.

But the real problem is that Hungary’s retail sales are now in long term decline, and it is hard to see this situation turning round as the population declines. The peaked in mid 2006, and it has been downhill ever since. This highlights the important point that Hungary’s economic difficulties – like Italy’s, which bear some resemblance, are not of recent origin, but go back to the adjustment process that started following the mini crisis of June 2006, an adjustment which has never, at the end of the day, achieved the results which were expected of it, and the real question is, why not?

Monetary Policy Trap

Back in April, the Hungarian Finance Ministry were expecting a 155 billion forint budget surplus for the second half of this year, but since then the economic outlook has continued to deteriorate, and according to their latest estimate there will actually be a 149.6 billion forint deficit in H2. This anticipated shortfall is the principal reason why the IMF and the European Commission recently agreed to let Hungary raise its deficit target to 3.9% of GDP for 2009 from the 2.9% previously agreed. They did this in response to the larger-than-expected economic recession, thus avoiding the additional fiscal tightening measures which would have been needed to hold the deficit below the Maastricht 3.0% target level. The gap in 2010 is now expected to come in only a tad lower than this year at 3.8% of gross domestic product (although this number is subject to considerable revision given the levels of uncertainty facing the economy and hence government revenue and spending). As a result, the EU Commission in their latest forecast suggest gross government debt to GDP will reach 80.8% in 2009, and 82.3% in 2010, way above the 60% euro adoption level.

Nonetheless the Hungarian government is in bullish mood. According to Finance Minister Peter Oszko in a Bloomberg TV interview “Recently there has been a turning point……Financial risks are very quickly decreasing in terms of the whole budget. The Hungarian government is committed to implementing a reform program quite quickly.”

Capital Economics’ Neil Shearing isn’t so convinced:

But is this new-found optimism justified? Possibly. The National Bank will certainly take heart from the fact that the bond market is functioning once again following a complete freeze late last year. This adds weight to the case for interest rates to be gradually lowered, with a 50bps cut to later this month looking increasingly likely. But amongst all the euphoria, it is important to keep some sense of perspective. First, while the government managed to complete the bond auction successfully, it came at a price. At 6.79%, the yield on the new bonds is around 90bps higher than what existing 2014 euro-bonds currently trade at.

There is indeed a general feeling in the air that monetary easing is coming, and in fact three members of the central bank’s Monetary Council voted even at the last meeting to lower the key policy rate by 50 basis points, according to minutes of the 22 June rate setting meeting. The MPC is set to hold its next policy meeting on 27 July, and is widely expected to start a monetary easing cycle. My view: just watch out what happens next.

Basically the problem is the value of the forint. My opinion is that the recent recovery in the currency value (see chart below) has been almost entirely driven by yield differentials, and by self-fulfilling expectations (traders expect the currency to rise), rather than by any change in the underlying economic fundamentals, which as we have seen, has not taken place.

And if you are in any doubt about the extent to which Hungary has lost competitiveness since the start of the century, just take a look at the comparative REERs for Germany and Hungary below (REERs are trade weighted, and take account not only inflation but also movements in unit labour costs, ie productivity).

The problem the central bank and the Finance Ministry have to address is the ongoing issue of the mountain of Swiss Franc denominated mortgages (see chart).

These have stopped increasing in recent times, but still constitute a serious obstacle to any devaluation of the HUF, due to the non performing loans issue this would create for the banking sector. Not only has money been borrowed against homes for to fund house purchases, it has also been loaned for consumption (see chart below), so indeed the fact that even these loans are stagnating hardly bodes well in any way for domestic demand.

The thing is, as long as the interest rate differential remains as it is, there is no possibility of convincing people to take out HUF denominated mortgages. So domestic rates have to come down, but as they come down the forint will fall, and the number of distressed loans will spiral up. So the authorities are stuck in a real policy trap, where they have to wriggle uncomfortably around, carrying out what can only be described as a weird variant of voluntary internal devaluation, an intenral devaluation which again, as we have seen from the wage and price data, just isn’t happening.

Obviously the whole idea IMF idea here was some sort of long term “play” – moving the focus of taxation from employment to consumption (addressing the tax wedge issue). Initially this shift was supported by the argument, that, amidst a deflationary backdrop, businesses wouldn’t be able to pass the tax increase on to consumers in its entirety. At this point it would seem the Hungarian government has no real room for manouver and are desperate to implement the tax restructuring, therefore they opted for the significant VAT raise.

Part of the thinking which lies behind the present approach seems to be some new concept of financial orthodoxy. The IMF put it like this in the Hungary Standby Loan Report

In emerging market countries with debt overhangs, the “Keynesian” effect of fiscal adjustment is likely to be outweighed by “non-Keynesian” effects related to expectations and credibility. Non- Keynesian effects have to do with the offsetting response of private saving to policy-related changes in public saving. In particular, if fiscal adjustment credibly signals improved public sector solvency, a fiscal contraction could turn out to be expansionary, as private consumption rises based on the view that future tax hikes will be smaller than previously envisaged.
IMF – Hungary, Request for Stand-By Arrangement, November 4, 2008

So from Tallinin, to Riga, to Budapest, to Bucharest, the same sonata on a single note is being played, and the message is a clear one – cut spending and you will expand.

But with consumption sinking, government spending falling and exports insufficiently competitive to drive the necessary surplus, the whole thing is now becoming rather a mess, with no clear economic policy objective in the short term (except, of course, maintaining a strong exchange rate) and while in the long term the emphasis is rightly on export. But no one has any idea of how exactly to correct prices sufficiently with the CHF mortgages stuck in the middle.

And the new bond issue only makes things worse here, since as Neil Shearing emphasises:

it is worth noting that the latest euro-bond issue only adds to the mountain of foreign currency denominated debt that lies at the heart of Hungary’s current woes. With the banking sector still in deep trouble and fiscal policy set to tighten, the recession is likely to intensify over the coming quarters.

So, with the Hungarian government currently forecasting a GDP contraction of 6.7 percent,this year, and the likelihood being of further contractions next year and possibly even in 2011, something somewhere is going to give here.

And among the casualties, well why not Hungary’s unborn children, the ones she needs to start turning round that population decline I started this post with.

According to preliminary data from the stats office, in the first five months of 2009 38,964 children were born, 1.9 percent less than in the first five months of 2008. But that isn’t all, if you look carefully at the chart you will see that the number of children born fell substantially from about March 2007, just nine months after the first financial shock hit Hungary in June 2006. So here’s a nice prediction, if economic conditions do work as a short term influence on fertility, then we should see another sharp drop in Hungarian births starting in from July, just nine months after the last financial crisis hit the Hungarian economy. There, I bet you never imagined that the collapse of Lehman Brothers could have such far reaching consequences, now did you?

This entry was posted in A Fistful Of Euros, Economics and demography, Economics: Country briefings, Economics: Currencies by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

31 thoughts on “Hungary Struggles To Apply Its Own Unique Version Of “Internal Devaluation”

  1. nonsense! the reason why wages in Hungary have not been falling in annual terms is that the currency has depreciated. this is the “luxury” that Latvia could not afford. So Hungary does not struggle to apply its own version of “internal devaluation” because it simply had “normal devaluation”.
    In May, EUR/HUF was around 17% higher than a year before. Subtract that from wage growth and you will see where the correction of imbalances is coming from

  2. Hello decapitator,

    I’m sorry, the logic of your argument has completely lost me. The indicator against which you measure the purchasing power of wages is the price index, not the exchange rate. The rose 1.7% more than prices did in May (over May 2008), while private sector employment fell sharply. How does that help things.

    The currency is too high simply becuase Hungary needs to export, and has substantially lost competitiveness. Look at the interest rate. Do you call 9.5% normal for an economy contracting at an annual 7%. But they can’t drop the rate to say 2% or 3% like in Poland or the Czech Republic (who have had normal devaluations), because this would lead to a sharp drop in the currency value (normal devaluation) which would be a massive problem due to the extent of foreign exchange loans, and the impact of these defaulting on the banking system. Hungarian policy is in a self inflicted trap, and this is why we are seeing this ridiculous process of “internal devaluation” (at least as an objective, since in reality it isn’t happening, yet). Instead of wasting all this IMF money on silly ideas, the Hungarian government should be using it to restructure the debt of these households, and move them all over to HUF loans at reasonable interest rates.

  3. absolutely not. you are wrong and here’s why. the whole point of devaluation – be it external or internal – is to correct external imbalances. that’s why everybody’s talking about the need to devalue LVL and that’s why the HUF has suffered. The argument that real wages in Hungary increased has very little significance for the balance of payments if you do not consider exchange rate (and productivity growth and other things, too). and the possibility of a balance of payments crisis was the reason why the IMF came in the first place.

    And believe me that I am perfectly aware that real=nominal-inflation.

    it’s just that you’re blaming the IMF for supporting something that doesn’t work because real wages are growing. And the truth is that real wages are falling in EUR terms, which is how you should look at them if you even want to start analysing the whole devaluation concept.

    the second paragraph of your post is also not true. you say “The currency is too high simply becuase Hungary needs to export, and has substantially lost competitiveness.”. What does it mean? the currency is too high because Hungary needs to export? I think you’ve made a shortcut because this sentence is meaningless. And of course you are referring to the interest rate, which is too high given the domestic demand contraction, but you know perfectly well (I hope) that it was absolutely necessary to keep the exchange rate from blowing up.
    the rest of your post appears irrelevant. you have to understand that from the macroeconomic point of view it doesn’t really matter whether your currency depreciates or wages fall. the impact on balance of payments is the same (and even, as paul krugman argued, the path of lower wages is worse because it will also impact the small proportion of existing LOCAL currency loans).
    so don’t imply that Hungary is doing worse than Latvia just because wages in local currency are not falling. balance of payments crises have different logic

  4. Hello again,

    I’m not sure whether this is intentional, or just an accident, but:

    “the rest of your post appears irrelevant. you have to understand that from the macroeconomic point of view it doesn’t really matter whether your currency depreciates or wages fall. the impact on balance of payments is the same”

    The Krugman piece you mention is a link to MY argument, about Latvia. So obviously I am aware.

    I think the difficulty you are having is this one:

    “The currency is too high simply becuase Hungary needs to export, and has substantially lost competitiveness.”.

    What does this mean. It means quite simply this. Since domestic demand is now in virtually irreversible decline (look at the retail sales chart, this is the ageing and declining population effect) and since government debt to GDP is going over 80% next year, and you will therefore have to keep cutting back government spending, the only activity from which you can get positive economic growth and pay off all your debts is by exporting. In this sense the only valid exchange rate is the one which can generate a sufficient trade surplus (not the one now which is due to a collapse in imports) to enable you to do this. It is all very straight forward really.

    “the whole point of devaluation – be it external or internal – is to correct external imbalances.”

    Well, yes and no. I’m saying it is more than this. I’m saying since the booms generated by having so much forex denominated debt have now killed off domestic consumption, and since sorting out the mess is adding enormously to government debt, then exports are the only way to drive growth and the exchange rate needs to reflect this.

    Closing the imbalances without lowering the exchange rate (internally or externally) simply results in a huge contraction, as we are seeing now in the Baltics, Hungary, Bulgaria and Romania.

    “but you know perfectly well (I hope) that it was absolutely necessary to keep the exchange rate from blowing up.”

    But this is just the point. Why would the exchange rate blow up? Becuase the currency is overvalued, its obvious. The currency is being artificially maintained at its present high value by keeping rates at very high levels. This is unsustainable. All you are going to get this way is a lot of pain.

    “And the truth is that real wages are falling in EUR terms, which is how you should look at them if you even want to start analysing the whole devaluation concept.”

    Look, I’ve added the Real Effective Exchange Rate chart just below the HUF/Euro one in the post. Take a look at the comparison with Germany (which is the european benchmark) – the loss of competitiveness since 1999 is massive, of the order of 50%. I’m not saying you need 50% devaluation, but you need a large one, perhaps 30%, from your average 2008 exchange rate. Comparisons with European wages are ridiculous, if you don’t take into account productivity, which the REERs do. You can only raise wages by raising productivity. You can’t raise them just because you feel like it, then raise interest rates to ridiculously high levels to protect them, and then claim you have to borrow more and more money because you are steadily going bankrupt. I’m sorry, the world simply doesn’t work like that.

    One last point. You say:

    “the rest of your post appears irrelevant. you have to understand that from the macroeconomic point of view it doesn’t really matter”

    now I’m sure you mean well, and you want the best for your country, but there are obviously a lot of the underlying economic issues you haven’t yet grasped (no harm, you’re not an economist). But given that, I would recommend you being just a little more modest before you start people what they have and don’t have to understand from a macro point of view. As I say, the analysis Krugman was referring to as wonkish was effectively mine.

  5. Decapitator,

    The real question surely is whether the real Euro value of wages in the competitive sector of the economy is falling fast enough to restore competitiveness and permit a recovery. I think you are perhaps understating the extent to which wages need to fall (I would have said even with cuts in the tax wedge, by c.15-20%) to restore competitiveness. I know this is a difficult reality for Hungary to accept.

    You can do this through a large devaluation and a wage freeze for all workers; enforcing sharp cuts in wages through a range of means, or a combination of the two. As far as I can see some of your points, while having a certain validity, don’t really change the fact that Edward’s argument is a valid one.

    What the government appears to be doing is not addressing the underlying competitiveness problem in the private sector at all, but making public sector workers, pensioners etc. pay the full costs of meeting its fiscal targets. Hungary may not be in Latvia’s situation YET. But this policy package is as close to economic suicide as one could imagine, and it is pretty well guaranteed to fail.

  6. touche! excellent point on the post krugman referred to. i admit i missed the name because quite frankly i don’t care about names but rather rationale. but that’s even better that it was your argument!

    i’m also not sure why you are saying that i’m not an economist (because I am) and that i haven’t grasped some mysterious underlying economic issues… but i won’t comment on ad hominem arguments. maybe just a quick word on the way i write in English: “you have to understand” is not supposed to imply that you’re incompetent but it’s plainly a rhetoric figure very similar to “in my opinion”. so please concentrate on my arguments as I have been trying to do.

    however, you have been putting forward arguments about many things – retail sales, government debt etc. and you’ve presented a very detailed analysis of that, which i really liked. but in my view it just moved us away from the main subject. so let me just say that i agree with all your points about sustainability of the programme and the reason why the currency was overvalued. i simply don’t want to get distracted. what i meant from the very beginning is that you entitled your piece “Hungary struggles to apply (…) internal devaluation”. In my opinion this has never been the target in the first place. Naturally, net exports are the way to go amid collapsing domestic demand but this is a little bit of tautology. Additionally, I’m pretty sure that wages will start falling in Hungary, eventually.

    Anyway, you refer to your comparison to the wages in Germany, which I think is the crux of our disagreement. I have not been referring to that because then I would have to compare Hungary to e.g. Poland where wages in EUR terms fell much more. I was just talking about comparing the current situation with what was going on a year or so ago. And you have to admit that Hungary’s competitiveness HAS improved over the last 12 months. The bulk of that process has been possible because of the exchange rate so your implicit comparison to Latvia is invalid, in my opinion.

    Also may I just say that you’re accusing me of ridiculous comparisons of wages, which I didn’t do. You say
    “Comparisons with European wages are ridiculous, if you don’t take into account productivity, which the REERs do. You can only raise wages by raising productivity. You can’t raise them just because you feel like it, then raise interest rates to ridiculously high levels to protect them, and then claim you have to borrow more and more money because you are steadily going bankrupt. I’m sorry, the world simply doesn’t work like that.”
    And it is very obvious and does not contradict anything I said, so I don’t know why you brought it up. And one tiny detail – REERs do not account for changes in productivity but changes in price levels (of course, you could say that there is an indirect link).

    Again, apologies for not associating your name with the Krugman post but I think in today’s article you were a bit inconsistent with what you said back then. As an economist, I think you will agree that in many cases dynamics is far more important than the level, which makes comparisons to German productivity or mentioning the debt level not necessarily appropriate.

    In the second post New European writes:
    “I think you are perhaps understating the extent to which wages need to fall (I would have said even with cuts in the tax wedge, by c.15-20%) to restore competitiveness. I know this is a difficult reality for Hungary to accept.”
    First of all, I never said anything about the level so don’t assume anything. I just said the situation has improved. I’m pretty sure that the adjustment in the labour market will deepen. And secondly, I get the impression that you think I’m Hungarian, which I’m not. I just happen to be moderately familiar with the economic situation over there.

    If you decide to respond to this post, accept my apologies for a delayed comment – it’s simply very late now so good night 🙂

  7. Hello Decapitator,

    I’ll reply later on today to your more detailed points, but first of all let ME apologise for perhaps being a little strong at the end of my last posting. It was certainly not my intention to be rude, but you must admit it was a bit strange to have my own arguments being quoted at me as something I didn’t understand.

    Basically there are styles of argument which help people understand each other, and styles which don’t. I guess you were, if not angry, when you wrote your first comments, at least irritated with me. This I can understand, since I am saying things which are pretty different from the norm in Hungary, and after all, you may say, what the hell right do I have to say these things.

    On “you have to understand” – it is very similar to the Spanish “tienes que entender”, so I get you completely, but it does sound quite strong, and school masterly in English.

    There is plenty of meat in your latest response, so I will chew it over and come back later this afternoon.

  8. From the long tirade of Decapitator I do not understand anyway how the competitiveness of Hungary on global markets will be restored versus economies as PL/CZ which are devaluating massively, versus DE and FR which are popping everything with enormous internal stimulus packages and gigantic export subsidies for agriculture, to US and other countries where interest is negative? The change in position wrt EUR/HUF by far does not mean improvement in competitive power, if others are doing the same and more.

    Between HU and LV there are very minimal similarities. Latvia is not competing in overcrowded markets as HU must do. Cornerstone industries for LV as Cargo are in very good state, the Latvian Rail is now a bigger carrier as the Hungarian MAV. In Latvia 90% of the problems are caused by the banking crisis. However, the high share of FOREX loans as in the whole CEE are adding big risks to the banking system.

  9. Edward, putting previous misunderstanding asside (I admitted my mistake on the quote :)), I’m very much looking forward to your reply.

    Govs from Latvia: the Czech koruna has outperformed the region massively during the crisis. and again, i’m just comparing the situation in hungary to what was going on last year and acknowledging the improvement (also note the cut in the tax wedge, which will boost competitiveness and the best situation when it comes to cyclically-adjusted fiscal balance within the OECD). and Latvia is in a much worse shape than Hungary – just look how imbalances had been developing in both countries over the years.

  10. Czech koruna has fallen in February 2009 for 20% compared with pre-crisis times. The fact that after maximum of the financial crisis they revaluated, has only minor importance. Decisive is what happened at the epicentre.

    Of course, Latvia has much worse a situation as Hungary, because Latvia is trying to hold the silly currency peg.

  11. Dear Blue Monk, look at the graph for the hell on the earth period Dec 2008 – Feb 2009. You will see very well how HUF and CZK were chasting mutually each other.

  12. govs,

    the chart holds no proof for massive depreciation of CZK as you have stated. Also, check the 5 year period, which shows what happened since EU enlargement.

  13. 5 year period is totally unimportant, we are speaking here about present financial crisis culminating in CEE Dec 2008 – Feb 2009.

  14. Hello Blue Monk,

    Well the five year chart is interesting in general. The strong difference between the Zloty and the CZK on the one hand and the HUF on the other is clear. The HUF in fact has been traded around the 250 to the Euro mark over a long period of time due to the presence of a currency band.

    In this sense the whole “band” mentality is what is in question, since it goes from Russia to Ukraine, to Hungary, and then is implicit in the pegs in Latvia, Estonia, Lithuania and Bulgaria. This must represent some old Siviet Block type mentality (or maybe education of bankers and economists in those years), since obviously the economic rationale for this kind of approach is truly slender, for the simply reason that it produces inflation, and this is what we absolutely saw in all the aforementioned countries, and what we didn’t see in Poland or the CR.

    Now, in part these latter two countries were using the real appreciation of their currencies as a monetary policy device to soak up inflation, and to some extent this worked. But this also illustrates the limitations of monetary policy, because, of course, if you simply try to soak up the inflation by allowing real appreciation without correcting the underlying cause of the inflation (labour shortages, wages rising faster than productivity because of marketing for the Balassa-Harrod-Samuelson effecet) then in the end you get another headache – Dutch disease – as your industries become uncompetitive.

    Who ever said economic management had to be easy?

    In the end, Poland and the CR were luckly, since the global crisis hit before all this had time to build up into a serious issue, and they were able to let their currencies fall, and lower their interest rates, in order to try and ease the recession and improve export prospects.

    It is clear to me that the HUF, Bulgarian Lev, Romanian Leu and all the Baltic currencies need substantial devaluation vis a vis the Euro. The Czechs and the Poles can decide for themselves on the … Read morepartity they want, since to some extent they are still in favour of their own affairs.

    Slovenia and Slovakia will have no alternative to internal devaluation. Whether the Germans and French will be happy with this is neither here not there, since it is totally unavoidable now. And the EU and the ECB will need to “ready up” some pretty substantial bailout funds to pay for the conversion of all those forex loans. Then maybe we can get back to where we were in 2004, before this all got so badly out of control.

  15. Edward,

    Not sure if it is Soviet block mentality, there is a peg in Croatia (undeclared, but you can check the rate and central bank governor always puts priority on kuna rate) and earlier in Serbia, both were outside Soviet block.
    It was an easy tool to build confidence after serious inflationary episodes after collapse of “socialist” economies.
    Hungary actually had “automatic” devaluation in 90s, the trading band was inspired by ERM and introduced around 2001. I’m not sure if it would be better for Hungary not to have that band, if the consequence would be EURHUF rate of lets say 180 by 2008. Not sure even that lower HUF rate in that period would be so great.
    As for CZ and PL, I think there is no free lunch. CZ temporary government now talks about structural budget deficit of around 5%, PL’s budget seems to be falling apart(and they still have some GDP growth). For me it is hard to believe that you can push rates down when your budget deficit goes out of control here on eastern side. I would say it can go on probably for one year. What happens next will depend on politicians and what I can see now is not promising, especially for Poland.


    well, it would be irrelevant if crisis are just dropping from clear sky, but it is more probable that something happened in last few years which caused the mess we can see now.

  16. Blue Monk:

    “Not sure if it is Soviet block mentality” – well OK, bad choice of words. We could say Eastern Block, but then we would need to think about China (as P O’Neill illustrates in his latest post), and Vietnam. Equally we could talk about the urge to centrally control something which can’t be centrally controlled, any more than the market price for housing. You can minipulate the price for a time, but then the whole thing falls apart, with much larger problems than those you were trying to avoind.

    My point would be, having a currency policy – eg allowing real appreciation to soak up some inflation, or devaluing as an alternative to wage deflation, are policies that can only be used to give short term relief, and such problems need to be accompanied by substantial core reforms that address the underlying problems.

    In the case of laabour shortage driven inflation, you need a mid term inward migration policy (as indicated in the World Bank report from Red to Grey) and serious measures to increase long term fertility.

    On the devaluation restoring competitiveness front, you need major structural reform to make new greenfield investment projects (for factories, for exports) really attractive.

    In this sense the long term thrust of what the IMF is trying to do in Latvia is fine, but becuase of these peg obsessions, all the energy is going into highly conflictive short term spending cuts.

  17. Hello Decapitator,

    Sorry I have been so long with my comments, but yesterday was a long, hot day, in many senses.

    “what i meant from the very beginning is that you entitled your piece “Hungary struggles to apply (…) internal devaluation”. In my opinion this has never been the target in the first place. Naturally, net exports are the way to go amid collapsing domestic demand but this is a little bit of tautology. Additionally, I’m pretty sure that wages will start falling in Hungary, eventually.”

    I think at the end of the day, we are not really so far apart. I don’t know if you have read Claus’s piece, but maybe this makes some things clearer. I deliberately used the title in a provocative way, since really I know they are not consciously trying to carry through an internal devaluation, but what they are doing is tantamount to that. This is what I want to say.

    And all this becomes important if we try to imagine (as surely we should do as responsible people) a world in which the pegs in the Baltics and Bulgaria are gone.

    The the important distinction will be between Romania and Hungaria on the one hand, and the CR and Poland on the other. The two former countries, until and unless they address the forex loans issue will be stuck where Latvia and Bulgaria are now.

    Actually, something Govs said in a Latvia post comment made me think.

    “One important issue – EU package does
    not provide ressources for peg maintenance, at least not direct ones. If IMF moves away BoL will have to defend the peg only by its
    insufficient ressources.”

    This made me think of the NBH, and how a large part of the IMF money is simply going into reserves. So really, even though the money doesn’t evidently do anything, even Hungary can’t get away form the IMF so easily, since without the war chest, the HUF would be much more vulnerable to attack.

  18. Also, Blue Monk,

    “As for CZ and PL, I think there is no free lunch. CZ temporary government now talks about structural budget deficit of around 5%, PL’s budget seems to be falling apart(and they still have some GDP growth). For me it is hard to believe that you can push rates down when your budget deficit goes out of control here on eastern side.”

    Definitely. I never said that CZ and PL were in perfect condition, simply that they were in the least bad state, and that having some control over monetary policy was important. So at the end of the day, we also need to ask ourselves why the panorama is so neagtive, right across the whole CEE region?

  19. Edward,

    this is all very interesting. But note that “his excellency” Almunia said not so long ago that the Latvian peg (why don’t people call it a currency board by the way?) should be defended at all cost. I think that the EU will support the fx regime as long as it takes because otherwise they would create the precedent for Ireland, Spain etc.

    And you say that the whole problem is about fx mortgages. It is true but if you dig deeper you will see that the most important issue is about so-called basis swaps because despite the highest interest rate in the world, Hungary actually has been suffering from negative carry. The situation has improved lately but it is still far from normal. And to restore normality you need to see a much bigger involvement of international financial institutions on the money market (providing EUR in swaps). Only then will the currency become more stable, which will lead to lower rates and will enable people to convert their loans. I don’t really see another possibility.

  20. Dear Decapitator,

    what Almunia said during culmination of crisis or during the first run Lat in June 2009 is not necessarily reflected in the present amendment and supported with practical steps. Almunia has to think about his reelection, this is priority No 1 for him.

    Of course, the contagion problem is very serious in Baltics, and it can switch to Southern Europe. This is actually the worst thing regarding Latvia as there is a very serious banking crisis, at the same time real economy is in better condition as in Estonia and Lithuania.

  21. Lithuania has proposed a law exactly of the type I wrote before – by changing the law of the Central bank in the parliament and moving away the Currency board from the Central bank.

    Be carefull, this is very serious issue. Taking in account the dominance of Lithuania on food market in the region, the problems due to the devaluation of zloty, this can be very hard issue for the Iron Magnolia.

  22. How is it not relfected in the presente amendment or supported with practical steps? I mean the EU IS giving money and the IMF is not. The EC’s arguments are purely political

  23. Why do you think that EC requirements are purely political?? What is EU politics??

  24. Do you really believe that EU thinks that keeping the peg is the best thing for the economy???

    EU politics is to keep the EMU. I’m not saying that their requirements are political. I’m saying their arguments are political. Purely. Why else could you explain keeping the peg?

    The peg in Latvia is the primary reason why the country is now in deep trouble. FX mortgages are just a natural consequence and should not be blamed directly. In my view, the EU is sacrificing a potential recovery of the Latvian economy on the altar of stability in the EMU.

  25. At first, sorry, I was not correct dating the first run on lat. The first run was in Nov 2008, in Jun 2008 it was the second run.

    Regarding the Latvian peg and keeping the EMU, at first, the EMU does not even require a fixed peg, just +- 15% band. However, even using the full band is now causing hysteria at BoL and ECB. Because that will cause immediate consequences for Estonia and Lithuania. Contagion danger is extreme, because Estonia’s manufacturing sector is becoming totally uncompetitive, and for Lithuania import substitution in Latvia will cause extreme pain. If all the Baltic will exploit the upper limit of the band, that will cause extreme discomfort for Poland’s agricultural and consumer goods sector, which are now the cornerstone of the relative stability in PL. So PL will devalue further, disbalancing the Central Europe. Counteracting that, I suppose, is anyway an economic argument by the EU.

    Political argument will be something relating Baltic with e.g. Southern Europe. It is difficult to prove that this political argument is so powerful, I do not know the situation in SE. As from Latvia I am strongly confident, that the devaluation in Bulgaria will play here very marginal role. So it is not evident that the political argument really is deciding.

    Anyway keeping the peg is the most silly and painful solution for Latvia, no doubt here.

  26. Portfolio Hungary this morning (evidently the message is getting through somewhere, since Mirrow at one point was one of the strongest defenders of the “robustness” of the banking situation in East Europe.

    Crisis-hit Eastern European economies face a severe rise in non-performing loans and corporate defaults that could further destabilize their banking systems, European Bank for Reconstruction and Development President Thomas Mirow said.

    Speaking at a conference in Vienna to mark the 20th anniversary of the lifting of the Iron Curtain, the EBRD chief warned former communist bloc countries on Thursday that they must restructure private debt, address bloated foreign-exchange exposures and adequately capitalize their banks to avoid a second wave of financial crisis, Dow Jones reported on Friday.

  27. The only small question – where to get funds for all the tasks enlisted by the T. Mirrow? A new Marshall plan is needed for that.

  28. Mirrow’s ideas, after reading the full article, are somehow strangely packaged. There are at least 3 main open questions:

    1) Who will recapitalise banks in Baltics where no one independent bank is left? Sweden +Norway?? Who will recapitalise in CE? Unicredit + Commerzbank? Banks as Nordea and Danske are acting as branch offices in Baltics. Nordea has enough nonperforming loans.

    2) If it is expected that CEE countries must recapitalise alien banks, then it is at least a suboptimal strategy for them. Much more optimal strategy would be the creation of new public and governmental banks, letting the alien banks go insolvent. Deposit amounts are anyway declining, and model as PAREX shows that costs for deposit insurance are 10% of the full recapitalisation costs.

    3) Are there any calculations of goodwill write-offs by mother banks immediately pending after even a single of their CEE subsidiaries will go bankrupt with a big noise?

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