Wednesday, 11 August 2010 13:40

Hungary: The Little Big Elephant in the Room

While the focus for most of 2010 has been on PIIGS and related sovereign debt, counterparty exposure, and credit issues regarding western European nations and banks, Hungary appears prepared to steal the spotlight.  Over the past couple of weeks, Hungary has opened Pandora’s Box in regards to dealing with the IMF.  No longer is the only question in regards to Europe is whether the IMF will provide aid, but now Hungary has opened a new debate.  What happens to nations that turn down IMF aid and austerity measures?  As credit spreads on sovereign and corporate debt widen, Hungary has both public and private funding issues to deal with in the near term.

Hungarian Prime Minister Viktor Orban has surprised markets with his actions since taking office in May.  On July 22nd, he announced that Hungary would break off aid agreements with the IMF and move toward an economic plan that emphasizes a domestic agenda over austerity measures to curb public programs.  Regardless of political motivations behind rejecting IMF proposals, the current aid agreement ends in October.  In addition to pushing away the IMF, the new regime has made movements toward decreasing formal independence of the central bank, Magyar Nemzeti Bank.  At the same time, policymakers are still attempting to save face globally, as after IMF talks broke down, Prime Minister Orban stated that Hungary will regain its economic sovereignty, yet at the same time maintain deficit to GDP targets at current levels negotiated with the IMF.

Figure 1: Courtesy of Magyar Nemzeti Bank, Orange Yield Curve is June 2010, Blue is May 2010, Purple is April 2010

Rising yields on government securities in Hungary as well as a slight flattening of the curve have indicated rising risk premiums on Hungarian debt.  The ultimate lagging indicator, Moody’s Corp, has put Hungary on outlook negative with potential to drop their debt to junk status after reassessing their rating.  With sovereign CDS spreads widening, and an estimated default rate of 21% (still not even in the global top 10 highest default probability), Hungary has become the poster child for the changes needed in Eastern Europe.

If any of the issues facing Hungary as a sovereign entity appear to be merely of moderate credit risk to you, or that you would categorize short term investment in Hungarian interest rates as “prime”, then you probably work for Moody’s.  After news of the breakdown in IMF negotiations, Moody’s announced it was putting Hungarian public debt on credit downgrade watch with the potential to move the securities into junk territory.  The Hungarian economy has approached expansion, and Magyar Nemzeti Bank has reached a breaking point, where it must raise interest rates to fight rising bond yields, or leave interest rates at recent lows to allow the Hungarian economy to continue its forecasted growth.


Figure 2: Courtesy of Dismal Scientist via National Bank of Hungary

Considering that Hungary is not yet part of the EMU, the possibility of the Forint being inflated (again) into brightly colored toilet paper featuring men with funny hats to “pay” off bondholders is growing more likely.

Hungary appears near the top of the list for most official/formal defaults, at seven, and this time does not appear to be any different.  Even though 10 Year maturing debt is still priced below a yield of 8%, Hungary looks like a perfect candidate for a stressful 2010, as some sort of debt restructuring or agreement must be made.  However, it seems more likely that Hungary will use the printing press.

A few scenarios are possible in the event Hungary fails to fill the funding gap once provided by the IMF (and IMF induced investors).  One possibility is austerity, albeit it is incredibly unlikely.

Figure 3: Courtesy of The International Monetary Fund

Figure 4: Courtesy of the International Monetary Fund

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Last modified on Wednesday, 11 August 2010 13:40

2 comments

  • Comment Link shaun noll, CFA Thursday, 12 August 2010 12:46 posted by shaun noll, CFA

    why do you think inflation is likely? if they start up the printing presses they will have serious trouble rolling over their short term debt. take a look at the term structure of their debt as a % of GDP per year over the next few years. It is a huge disaster. Impossible to say but if I had to guess I'd say they have to come back to the IMF eventually to get their debt rolled over and the only way they can do that is if they eventually restructure their debt as that burden is crushing them. Could go either way though, very complicated situation. One thing for sure though, Orban is a complete idiot with little understanding for what he is doing.

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  • Comment Link Mark Hankins Thursday, 12 August 2010 10:28 posted by Mark Hankins

    Perhaps they're taking a page from Argentina, which has given the IMF the Rahm Emanuel salute for what, ten years now?

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