Vote of confidence?

The IMF has just released its latest assessment of Hungary (news release, detailed report).  It’s interesting and sobering reading — this is a country where the budget deficit nearly hit 10% of GDP last year and which is still spending 4% of GDP a year on public debt service.  In Ireland we know how this can end badly: if interest rates go up, debt service suffocates everything in the budget and you’re screwed.  Anyway, one bit of uneasy reading comes from the assessment’s assurances that the banking system is “profitable and well-capitalized”.  Isn’t this the assurance that is given to every banking system right before it tanks?  The profits come from huge leverage and “well capitalized” is just relative to the usual standard for thinly capitalized banks.   So good luck to Hungary.  There is a tricky balancing act of getting the public debt under control while not destabilizing the system that has a big share of mortgages denominated in foreign currency.  At least all the USA’s problems are in dollars.

3 thoughts on “Vote of confidence?

  1. I feel sorry for them, too, since it could easily happen. The Euro Bank’s main priority is fighting inflation, so if any of that returns, then they get hammered when they raise rates.

  2. I think three issues are mixed up here.

    Hungary has a well-capitalized and currently well-run banking system which is not involved very much in financing Hungary’s public debt and which is not owned by the Hungarian state. Although the fiscal imprudence of the last Hungarian governments makes economic life dreadful in Hungary (extremely high taxes to repay this debt, high forint rates due because the governments takes up all borrowings in the country) have nothing to do with mortgages.

    It is very odd that Hungarians take on mortgages in foreign currencies, especially in Francs. The euro mortgages made sense a few years ago: after all, Hungary was to join the euro area in a few years, and if you have a 30-year loan out of which 25 years of repayment will be made in euro you do not take too much of a foreign exchange rate risk with denominating your credit in euro, and you can avoid some of the risks of how the country will enter the zone.

    So far the higher Franc and euro interest rates are still very mild compared to the Hungarian ones, due to the reckless spending of the government and drives up interest rates in forints.

    Should foreing investors not tolerate the spending of the government and abandon the forint bonds of the government, the exchange rate of the forint would collapse. In that case, the people would not be able to pay their euro-based mortgages with their devalued forint wages.

    However, the government was rather successful to dismantle the time-bomb it put in the economy. With very unpopular measures it brought down the yearly deficit from 10% of the GDP to around 3,5%. If it can follow this path (facing an election with a historic-low popularity) than the forint will be saved and the households may survive with their mortgages.

    I think you have to keep your fingers crossed for the forint. In a global financial crisis a small, open economy can face a currency crisis any day. Just look at Iceland.

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