beyondbrics

Hungary cancelled a bond swap auction on Wednesday as the forint hit a record new low against the euro and fears grew about the country’s planned bid for International Monetary Fund/ European Union financial aid.

Gyula Pleschinger, a senior economy ministry official, did nothing to calm markets by telling the WSJ that “it would not be a tragedy” if there were no IMF/EU deal. The forint fell below 320 to the euro before recovering a little to 319 to trade about 1 per cent down. These are dangerous times for Hungary – and for its CEE neighbours.

As Charles Robertson of Renaissance Capital pointed out in a note, the risks of contagion in the region are growing. “The market implications are obvious. Within CE3, favour Poland/Czech over Hungary. Within EM, favour anywhere over CE3.”

The bond exchange auction – in which the government offers new debt for old – was called off after yields rose further, increasing the pressure on the debt-laden country and government. With Hungarian bond yields over 10 per cent, just look at these Reuters data to see how much more Hungary is paying for its debt compared to Poland and the Czech Republic:

Czech treasury bonds
7-yr T-bond CZ6YT=RR  +2 basis points to +157bps over German bund benchmark
10-yr T-bond CZ10YT=RR  +4 basis points to +215bps over benchmark

Polish treasury bonds
5-yr T-bond PL5YT=RR  +1 basis points to +445bps over benchmark
10-yr T-bond PL10YT=RR  +2 basis points to +398bps over benchmark

Hungarian treasury bonds
5-yr T-bond HU5YT=RR  +9 basis points to +957bps over benchmark
10-yr T-bond HU10YT=RR  +13 basis points to +852bps over benchmark

The central bank is expected to raise its key interest rate by 50 basis points from above the current level of 7 per cent later this month. But another plunge in the forint – which has lost 17 per cent against the euro since the summer – could prompt far more drastic action.

There are signs of panic in the Budapest government, which must repay around €15bn of debt this year, some of it to the IMF. Central bank officials fear that one way the government might try to make repayments is by raising the foreign exchanges reserves, which stand at €33.6bn.

Soon after Pleschinger’s comments were publicised, Figyelo, a weekly magazine, released excerpts from an interview due to be published on Thursday with Tamas Fellegi, the chief negotiator. According to Bloomberg, Fellegi said Hungary wanted an IMF/EU financing agreement “as soon as possible” to restore investor confidence.

Budapest expects talks with the Fund to restart on January 11. But the real difficulties may be in Brussels, where the EU is particularly concerned about prime minister Viktor Orban’s new central bank law, adopted last week, which the Hungarian National Bank says hits its independence.

Whereas the IMF deals with all sorts of governments all over the world, the EU is a club of democracies with independent institutions. So its concerns about the central bank extend well beyond the economic and financial sphere into politics. A key European Commission ruling on the central bank law is due in the next few days.

As Benoit Anne of Société Générale wrote in a note on Wednesday:

We are very near boiling point in Hungary with a crisis that may escalate into something much more serious than a simple macroeconomic crisis (which mind you is already pretty bad). For I fear this crisis now encompasses many dimensions beyond the short-term view on HUF assets. On the currency side, the HUF is now trading at record lows and given the huge financial stability risks that this raises, the central bank is now quite likely to go ahead with an emergency rate hike, November 2008-style. But the crisis has also become political. The EU is extremely concerned about the latest political developments and the potential EU response will – no doubt – be harmful to investor confidence.

Orban’s reaction in a crisis has often been to dig in. His government has a two-thirds majority and, with the opposition in disarray, the ruling Fidesz party retains widespread backing. But domestic support alone cannot see him through this. Investors will want to see Hungary’s international partners coming to the rescue – or they too will abandon Budapest.

Further reading:
Hungary dismisses concerns over new constitution, FT
Hungary: new year, more debt problems, beyondbrics
Hungary: nobody understands us, beyondbrics