Visit Hungary Now!

Because they devalued the forint this summer, so everything is now about 7% cheaper.

Well, they didn’t actually devalue it. No. I mean, that would imply there had been a… devaluation. Ha ha, how silly. No, what happened was that the Bank of Hungary moved the band in which the forint was allowed to float freely. Whereupon the forint freely floated down from around 250/euro to more like 275/euro. So, it was a sudden fast downward change in the value of the currency caused by central bank action. Which is not a “devaluation” at all.

(The forint lost about 10% of its value in a month; you can see the graphic here. It has since clawed back about a third of that loss. Still, a Euro will go about 7% further than it would in May, and about 10% further than in March.)

Nobody seems to have paid much attention, but I think there are some points of interest here.

Hungary has some underlying macroeconomic problems. It ran up big deficits and big debts under the previous Socialist government. The current government, though nominally center-right, seems unable to deal with the problem; Hungary is still running big budget deficits, and the national debt is still growing. Meanwhile, like most transition countries, Hungary imports more than it exports. Both these things combine to put downward pressure on the forint.

(For those who like details, here’s the IMF’s last report on Hungary, done just before the devaluation, in June. It’s the IMF, so bring a grain of salt, but I think it covers the high points.)

So a devaluation may not have been a bad thing. Arguably it was (1) recognizing reality, and (2) helping to inoculate the forint against a speculative attack.

Devaluations are good for exporters, since they make their goods cheaper on international markets. They’re bad for importers, for industries that depend on imports, and for consumers who buy a lot of imported stuff. Which, in a small open economy like Hungary’s, is almost everybody. Because stores are full of imported goods, the devaluation will raise prices and tend to increase inflation. Fortunately, inflation in Hungary has been very low recently, so the economy can probably take the hit. Still, people will notice a rise in prices. Devaluations make people feel poorer, which is why governments tend not to like them.

Another problem is that a lot of debt in Hungary is denominated in euros. Imagine a company that borrowed a million euros to buy equipment. It may now have to pay back 475 million forints instead of 450 million. (On a much smaller scale, the same thing may apply to individuals who’ve taken euro-denominated personal loans.) This makes devaluations potentially dangerous; if they go too far, then loans don’t get repaid, because the debtors simply can’t generate enough forints. Then banks start collapsing. Whoops, you just lost a decade of growth.

As with inflation, though, it looks like Hungary’s economy can take it. The banking system is very sound and has plenty of liquidity.

I Am Not An Economist, but it seems to me that this was probably the right move anyway. The forint was going to fall anyway; better to let it fall under controlled circumstances. And the partial rebound after the initial crash suggests that investors are not yet running away from it. And a boost to exports is always welcome; exporting industries should increase production and start picking up employees. (There are some interesting questions about when and how the export boost should communicate itself to the general economy, but let that bide.)

The “macroeconomic maneuver as medicine” metaphor is a hoary cliche. Still, it may be helpful to think of a devaluation as a prescription-only drug that comes with big yellow warning labels: “May cause inflation. Do not take if you have a weak banking system. To be administered under the care of an independent central bank only.”

Anyway. Hungary was planning to peg the forint in 2009 and join the euro in 2011. That’s still possible, but it’s looking less likely. (To oversimplify, a key question will be whether the devaluation is a supplement to fiscal restraint, or a replacement for it.) The volatility of the forint will make it harder to hit the necessary targets, and so less likely that Hungary will join at the scheduled date.

If I were a policy maker in Hungary — or, indeed, in any transition economy — I’d be asking myself if this was really a bad thing. If the devaluation has the desired effect (still an open question, to be sure), then Hungary will have successfully used a medicine that’s just not available to countries in the Eurozone. The obvious example is Italy. Italy has a public debt that’s 50% bigger in proportion to GDP than Hungary’s, and its exports are suffering from competition with China. If they weren’t on the euro, a devaluation would be an obvious way out. But they are on the euro.

This connects to P. O’Neil’s recent post about a possible economic crisis in the Balkans. I think the devaluation makes this less likely, at least in the short term. But when these countries go on the Euro, they’ll have a lot less room to maneuver.

Meanwhile, it’s a great time to visit Hungary.

16 thoughts on “Visit Hungary Now!

  1. Nice post Doug, thanks.

    “I Am Not An Economist, but it seems to me that this was probably the right move anyway.”

    I agree with you, even if it was pretty ‘involuntary’. Flexible exchange rates which allow for adjustment are normally better than rigid ones (this is an underlying issue I have with the euro itself, Italy and Spain can’t adjust in this way).

    “Another problem is that a lot of debt in Hungary is denominated in euros.”

    Yep, and it isn’t only companies, there are a lot of private individuals who have mortgages denominated in euros (in fact they may be a majority of the recent ones). When the forint looked likely to peg this didn’t seem important (and obviously they could get some interest benefit by borrowing this way, there is, however a currency risk, and this is what we are now seeing). So this can really become an issue. The problem isn’t what happens to the banks when individuals default, it is what happens to the individual’s consumption before they reach default. That is, internal private consumption can take a hit next year, just as the government is doing fiscal tightening. So rather than grow the economy may well shrink, even if only slightly.

    Will this encourage young people to out-migrate in the short term, in search of better job opportunities? This is the question. Hungary’s population is already declining more rapidly than Germany’s is (Germany -0.2% pa, Hungary -0.5% pa). This could make things worse for them in the longer term if they lose people now.

    Of course, they could get some benefit from rising exports if they really have been investing wisely rather than financing current consumption, but the thing is next year seems to be a year when storm clouds may be gathering globally.

    So, bottom line, Hungary isn’t Argentina, it can devalue (and we may see more decline next year if there is an important recession), but on the other hand its demographics mean that unlike Argentina (which is now recovering nicely thanks to China) it is challenged in the mid-term, and seriously.

    “Anyway. Hungary was planning to peg the forint in 2009 and join the euro in 2011. That’s still possible, but it’s looking less likely.”

    I agree. Indeed they seem to have already abandoned that target. Last week they were talking about 2013, but as most of the commentators have been pointing out that’s when most of the big demographic strain will start hitting the fiscal system, so it looks like it won’t be then either.

    Mind you, by 2013 there are a lot more people (and people inside the zone itself) who will be well outside targets, so who know’s what will happen. Interesting times coming, in the Chinese sense, of course.

  2. “Hungary has some underlying macroeconomic problems. It ran up big deficits and big debts under the previous Socialist government. The current government, though nominally center-right, seems unable to deal with the problem; Hungary is still running big budget deficits, and the national debt is still growing.”

    Actually, while there was a cabinet coup back in late Summer ’94, it’s been the same Socialist-Liberal coalition since the ’02 elections. This doesn’t really matter in substance – every major party in Hungary (and pretty much in Europe) is socialist – but given the level of partisanship over here it is a detail that shouldn’t get missed.

    Also plus, forex-denomiated debt to the household sector may actuall be bigger than to the corporate sector, or in any case is big and structured poorly enough that it could be a *major* problem if the ft/eur rate goes where I think it’s going. But hell, I’m Not an Economist either.

  3. Wolfgang Munchau has a related piece in today’s FT. He looks in particular at Sweden’s extremely strong recovery from the early 90s crisis and assigns devaluation a central role in it. But the devaluation was huge (it ended up being 30%) so Hungary is not far enough down that road yet. However, the message is that devaluation, if managed properly, works. The column is behind subscription but he draws partly on this study of Sweden and Finland.

  4. “Also plus, forex-denomiated debt to the household sector may actuall be bigger than to the corporate sector”

    This is what I feared. Were they encouraging people to take these loans out by offering cheaper, ECB refi rate-related rates (2 or 3 percentage points above refi or something)to encourage the customers, do you know?

    Homeowners can only survive this adjustment if there is substantial forint price inflation in the housing market. But if they *deflate* by keeping interest rates up and slashing public spending (which seems to be what they are promising to do, of course actually doing it will be something else) then there’s no way they are going to be able to get this sort of house inflation and these people are going to feel the pain.

    I mean the normal thing when you hit recession is to loosen interest rates to ease things off a bit, but they won’t have this option. (Lets just hope the US consumer recovers quickly).

    “Sweden’s extremely strong recovery from the early 90s crisis and assigns devaluation a central role in it.”

    Yes, but as you yourself suggested in your post, Italy also left the EMU in 1992 to do the same, and look where they are now.

    So, devaluation can help, but there’s nothing automatic. Like so many other things, it depends.

    So the question is: will Hungary be Sweden or Italy?

  5. Just returned from a short holiday to Hungary this very morning. It was indeed a great time to visit. The weather was wonderful, the lángos was lovely, and the home-made pálinka was very potent. We didn’t manage to get to the Sziget festival this year but our friends who did had an excellent time. So yeah, visit Hungary!

  6. Pestiside — nice to see you!

    You’re right about the current Hungarian governments. D’oh! I will not say which country I had you confused with…

    Currency risk: yes, exactly. It must be noted, though, that this is the third, fourth or fifth devaluation (depending how you count) since Hungary started its transition back in 1990, and the possibility has been in the air since late 2003. So the risk was not exactly concealed.

    Consumption will take a hit, indeed. But I will be surprised if the economy shrinks. Growth has been chugging along in the 3%-4% range for three years now… not heroic, but better than most developed countries. I could see a slowdown, but shrinkage strikes me as unlikely.

    I also doubt that we’ll see more Hungarians leaving, but that topic probably deserves a post of its own.

    Pestiside — are people taking much notice of the devaluation there? What’s the public reaction (if any)?

    Doug M.

  7. “but shrinkage strikes me as unlikely.”

    Sorry, I should perhaps qualify this, the technical definition of a recession is two quarters of negative growth (or shrinkage). If they go through with the cuts then I think this is quite possible at some stage during 2007.

    The worry is that with the debt dynamics this could drag on a bit if things go the wrong way.

    This is the sort of shrinkage the US had back in 2000/2001. There is another kind of shrinkage coming at some point of course, the shrinkage caused by population decline. At that stage you will simply need to add productivity and subtract the reduction in the workforce to see what growth will be. At some stage the second factor will dominate, and then the big shrink will begin, unless of course they attract a lot of Ukrainians or Russians or whatever. But anyway they will be far from alone in this.

    But we are some years away from all this at this point (2013-15??). As you say the EU coupling momentum (and the technology catch-up factor) more or less guarantees growth, its after this that the tricky part starts.

  8. This week’s Economist discusses the Swedish growth experience, in the context of the election, but doesn’t say much about the devaluation.

  9. As this is my first post to AFOE,I regret being pessimistic, but I wanted to weigh in on the situation in Magyarorszag (Hungary). The problem of forex denominated debt to the houshold sector is worse than you can imagine- one of the first things Hungarian workers in my company do upon getting an employment contract is run out and get a consumer loan in Swiss Francs or Euros. This is not used for appreciating assets like housing stock. Rather, this is usually a consumer loan used for holidays, flat screen TV’s etc.

    As the Forint winds its way down to its natural floor (worst case as low as 300 HUF/Euro), workers demand wage inflation in keeping with their loan obligations. Unfortunately, productivity is not accelerating at the same pace. In short, Hungary is in for a real squeeze. I suspect Pestiside will agree on the political front: there are only two parties with strong representation: the Euro-socialists (ex- communists) and the Nationalist-socialists (ex-anti communists; neither of whom have an answer to the Hungarian population who demand the same wages, work hours, and retirement and health benefits of French and German workers without agreeing to any real increase in productivity or recognizing the gap in skills. Old Europe trade unions fear low wage competition from the new member states. The truth is the new member states are already priced out of the productivity game.

    I promise to be more optimistic next time…

  10. i have to say i noticed a recent spike in prices, but that is mostly due to the higher taxes that took effect september 1st. i think people here right now (like myself) are too worried about the increase in income tax and consumption tax to notice the relatively small effect that the devaluation had. For example, as a self-employed worker, I have to pay about 50% more for income tax this month than last. and im one of the luckier ones.

    yeah, im getting off topic. but to combine this idea with previous posts…i’ll be surprised if Hungary’s 3-4% growth can survive this onslaught of different “attacks”. we shall see…

  11. The good news is that Hungary is heavily invested in export industries – it’s becoming a significant producer of cars and also electronics for export to the EU and beyond. I recall travelling through western Hungary back in 2002 and being impressed by the amount of industrial development going on in the Vienna-Budapest corridor. So, if the economy is export specialised, it ought to benefit from the devaluation.

    Mind you, that still doesn’t beat the deathless quote from the British exit from the ERM, that “the Bank of England has ceased supporting the pound and it is floating downwards to find its own level”. Gordon Brown reused it on John Major as “the Chancellor has ceased supporting the Prime Minister, leaving him floating downwards to find his own level.”

    Curious how things change, no?

  12. What will be the implications of this on Hungary’s convergence to EU average income? At this moment, Hungary is close to 66% of EU average income and progressing towards the significant 75% barrier. For the past 2-3 years, however, it’s growth of 3-4% has been lower than other countries in its income group, such as Czechia, Slovakia and Estonia. While these countries are on the steady path towads 75%-convergence, will Hungary remain where it is? Consider that Hungary’s macroeconomic problems may be more significant than those of Sweden and Italy considering that Hungary’s economy is not yet as strong as those countries. Still, devaluation is step in the right direction – even though I believe in the euro politically, I think that the longer the new member states can delay eurozone entry, the better their economies will fare. A country is only really ready to join the euro once it has near-converged to EU average income and thus has a different growth/inflation profile than the new member states.

  13. There’s a piece in the FT today which is pretty relevant to all of this. The IMF in their latest Global Financial Stability report warn that investment flows to many of the East European transition states could prove to be unsustainable, and they talk about the risk of “severe corrections” at some point in the future. Unfortunately the whole piece is behind the great firewall, but the principal issue is clear from the extract available online (see below). This links in with what P O’Neill argued in his earlier post. Personally I think Turkey’s future in the mid-term is not as problematic as some have been suggesting, but the rest are going to be seriously challenged for the sort of reasons that I have been flagging.

    The Short View: Central and Eastern Europe

    By John Authers, Investment Editor

    Could Central and Eastern Europe be the new powder keg of global emerging markets? The International Monetary Fund’s latest Global Financial Stability report warned that investment flows to the region could prove unsustainable, and warned of the risk of “severe corrections”. It said: “Current account deficits are large in the Baltics, Bulgaria, Hungary, Romania, the Slovak Republic and Turkey; fiscal deficits are high in some other countries such as Hungary; and the ratio of private sector credit to gross domestic product has risen particularly strongly in the Baltics, Bulgaria and Slovenia.”

    Meanwhile in Asia and Latin America, current accounts are either in surplus, or show a manageable deficit. But little concern has shown up in prices. Quite the reverse. According to the latest performance data from Hedge Fund Research of Chicago, Eastern Europe/CIS hedge funds have beaten all other strategies so far this year. By the end of August, they were up 23.3 per cent, twice the return of any other sector – even energy funds had made only 11.75 per cent.

  14. Well, “some point in the future”. Huh.

    Prediction: we won’t see a “severe correction” within the next 15 months in Bulgaria, Romania, the Czech Republic, Slovakia, Macedonia, or Croatia. Hungary and Poland, hmm, unlikely IMO but could just maybe happen. Baltic states I don’t know enough.

    But in those first six countries, no “correction” this year or next.

    I got ten euros. Who wants a piece?

    Doug M.

  15. “I got ten euros. Who wants a piece?”

    Sorry I took my time getting back, obviously I’m not prepared to put my money where my mouth is :).

    No. It isn’t exactly that, the issue is that at the end of the day I don’t disagree. Hungary has already had a ‘correction’ and I doubt there will be another big one next year. Since they let the currency drop in many ways this makes the correction softer.

    Another question is whether Hungary will have a recession or not in 2007. This is much harder to call. I think it might, but this depends in large measure on what happens to housing in the US, and this is far from clear. To quote Dave Altig yesterday.

    “What does this all add up to? Pretty simple,really. The economic environment is a total murk, and everyone is just guessing. In other words, nothing unusual.”

    This reticence isn’t simply being shy, these things are really hard to call, and anyone who things otherwise doesn’t understand much about economics IMHO.

    On the other hand what we have are such a diverse set of countries. Bulgaria and Romania are likely to get ‘coupling impetus’ from EU membership (assuming that comes) so should be fine in the short term, but since Bulgaria has the Lev peg, when any correction does come it could be significant.

    Czech Republic looks not bad to me. Baltic states look to be problematic, but not tomorrow.

    I think here there are going to be winners and losers. I think those who can attract labour will do comparatively well, and those who lose it will not. Obviously those who get into higher level economic activities can leverage their price differential with places like France and Germany for some time to come. You won’t make a fortune out of either textiles, or electrodomestics, or cars.

    Poland and Hungary are clearly the ones to watch say 2006 – 2010 in my book. I just read this from Poland which is interesting (in the sense that if Polands is not like Ireland or Spain – and I’m pretty sure it won’t be – then a lot of people are going to get stung. Also my guess is also that if they are talking about low interest rates, then these will also be euro denominated loans):

    Foreigners spur housing boom in Poland

    House and apartment prices in Warsaw and other leading Polish cities have spiraled upward since the eve of the nation’s 2004 entry into the
    European Union — a boom driven by low interest-rate mortgages, housing shortages and foreign speculators snapping up real estate as investments.

    “The market is very hot,” said Bogumil Rutkowski, a manager at the Knight Frank real estate agency in Warsaw. “We’ve had a boom since the second half of 2003, but it’s just been accelerating more and more lately.”

    In 2005 alone, real estate prices in Warsaw rose 30 percent in prime locations, and between 10 and 20 percent in other areas amid the strong demand, according to Knight Frank. Now, for example, a one-bedroom apartment of 700 square feet in central Warsaw runs between $90,000 to $325,000.

    “The demand is generally driven by local people but there are buyers from Spain, the U.K. and Ireland buying new constructions in bulk — 10, 20 or 30 apartments and sometimes even more,” Rutkowski said. “They compare Poland to Ireland and Spain of 20 and 25 years ago, and they believe the price appreciation in residential property there will happen in the same way in Poland.”

    But as housing prices in this former communist country rise, wages for most Poles remain low compared to western European levels — making much of the housing stock unaffordable. Last year, gross domestic product in Poland was at $15,000 per capita, significantly lower than Ireland’s $41,000 or Britain’s $35,000, according to Polish government figures.