As Retail Sales Wend Their Weary Way Downhill The NBH Cuts Interest Rates By Half A Percentage Point

Hungarian retail sales continued their long running decline in September, and fell by 0.3% month on month, according to the latest calendar and seasonal adjusted data from the Central Statistics Office. On a calendar adjusted basis there was a fall of 1.6% when compared with September 2007.

Retail sales were down in 2007 by 3.0% in annual terms, following increases of 4.4% in 2006 and 5.6% in 2005. In January-September 2008 the drop is 2.0% when compared with the same period in 2007. Which means that Hungarian retail sales actually peaked on a constant prices basis in August 2006, and since that time we have been falling, with the present level now below that registered on average during 2005. I don't give too many possibilities that we will get back above the 2005 level anytime this decade, and I wouldn't even be too sure about the next one, what with declining and ageing population and everything.


Combined sales of cars, car parts and fuel were down 2.1% year on year in September following against an 8.0% drop in August.

Interest Rates Trimmed 0.5%

In a surprise move which shocked most analysts (and possibly the IMF) Hungary's central bank cut its benchmark interest rate today by 50 basis points (to 11.00%). The Central Bank Monetary Council also reduced the reserve ratio from 5% to 2% to take effect from the December 2008 reserve maintenance period.

“Today's rate cut is not only surprising, but also somewhat reckless given the significant pressure seen recently on the Hungarian forint (HUF). Note that the NBH hiked its key policy rate on October 22 by 300bp in a move to stabilise the forint."
Lars Christensen, Danske Bank

Basically Hungary's economy is currently slowing quite dramatically, with inflation also falling sharply on the back of the slowdown. It seems the NBH monetary council was split on today's decision, which was possibly a knee-jerk reaction to the slowing growth. Put cutting rates (and basically by so little) so soon after raising them so sharply (and following so closely on a major bailout package) gives the impression of having little in the way of policy coherence.

“Market reaction to the rate decision today has been limited. Implied rates were already below the policy rate, and the move should in that sense not affect forward rates. However, looking ahead, we fear that the rate cut will not only be damaging to the NBH's credibility, but will also significantly increase the risk of a weaker forint. Today's rate cut in Hungary should further increase the chances of a rate cut in the other countries of the region."

This the decision would seem to reflect serious concerns within the MPC about the growth outlook (no coincidentally the growth forecast for 2009 has been revised from a positive 2.6% to a negative range between -0.2 and -1.7%) together with excessive optimisim that the IMF package will provide a sufficient anchor for investor expectations to avoid a sharp selloff in the forint. This way of seeing things may well come to seem exceedingly premature as both the ruble and the hyrvnia are in the throes of major downward corrections, while we may be just about to see a wave of devaluations across the EU10 East European states.


Inflation Heading Towards Deflation?


Hungary's annual inflation rate fell for a third consecutive month in October, and was down to 5.1 percent from 5.7 percent in September, according to the most recent data from the Budapest-based statistics office. Consumer prices rose 0.2 percent on the month.



Falling oil and food prices are slowing inflation, which has to date exceeded the central bank's 3 percent target since August 2006.

Construction Down And Wages Up In September

Output in Hungary's construction industry fell again in September - down 1.4% over the August level - although on a seasonal and working day adjusted basis it was up slightly (by 0.3%) over September 2007, according to data out this week from the Central Statistics Office (KSH).



Construction industry new orders on the other hand were down 9.0% over September 2007 following a 9.2% annual drop in August. New orders for buildings were down 20.4% while civil engineering orders were up slightly (3.6%). If we look at the seasonal and working day adjusted monthly index chart (which is the best general measure of output at this point - see below) we can see that output levels are now well below those of 2006, and there is little prospect of any substantial recovery in the foreseeable future.




Real Wages Continue To Rise In September

Real wages in both the public and private sectors continued to move up in Hungary in September, despite the evidently very difficult macroeconomic and financial situation of the country. Hungarian gross wages were up by 8.4% year on year in September, up sharply from a downward adjusted 7.1% in August. Real wage growth came out at an annual 1.6% in September (given that inflation fell to 5.7% and net wages were up 7.4%). The latest figure compares with near-zero levels in recent months. More importantly perhaps, the closely watched ex-bonus wage growth in the private sector was up by an annual 9.0% (from 7.6% in August) while in the public sector it came to 6.4% (from 6.2% in August). This means that real ex-bonus wage growth in the private sector was 3.3% (see chart below).



At the same time the number of people employed in companies with at least 5 employees fell by 4,000 people in September to 2.741 million, down by about 5,000 over September 2007. The biggest fall in private sector employment only came in October, so the current statistics do not yet show this impact. While the number of those employed in the public sector rose a little in September (a normal seasonal phenomenon) in annual terms there were 2.3% fewer people (725,000 employed) working in the public sector.

Hungary Creates a $3 Billion Bank Support Package

Hungarian banks will receive a rescue package of HUF 600 billion (USD 3 bn) from the USD 25.1 bn (EUR 20 bn) credit line provided to the country by the International Monetary Fund (IMF), the European Union and the World Bank, central bank (NBH) Governor András Simor told a press conference on Thursday.


The money is to give support to the Hungarian banking sector during the transition from Forex to Forint denominated loans for Hungarian households, and can only be seen (as explained in this post) as a preliminary step towards a lower CHF-Forint exchange rate to help the now bleagured export sector, and a looser internal monetary monetary policy to offer support to domestic demand, as the Hungarian economy enters one of its deepest rcessions in recent history.

What is not clear at this point is the precise accounting procedure which will be applied in order to determine the impact of such bank support on Hungarian government debt. This "grey area" should not really surprise us at this point, since none of the governments who have announced such rescue packages have (to my knowledge) spelt this out in detail at this point.

The support is based on a yet to be finalised agreement with commercial banks which will follow in broad outline the structure Hungarian Prime Minister Ferenc Gyurcsány announced two weeks ago (as covered in this post), namely that:

1) At the request of the debtor the banks will allow the duration of the loan to be extended (with fixed monthly instalments) so that the depreciation of the forint “does not place an unbearable burden on the debtors".

2) FX debtors who deem that exchange rate fluctuations carry excessive risks for them will be allowed to convert their foreign currency-based loan to a forint loan. In this case the banks “will accept this request and make the switch without extra charges".

3) If a debtor finds him- or herself in a position where he or she cannot pay the monthly instalments, e.g. due to becoming unemployed, the banks will be amenable to transitionally reducing the instalments or even suspending them entirely at the request of the debtor.

András Simor indicated that Hungary will not be offering this support to banks who are owned by parent banks in countires which have their own government bailout plans available (which is pretty much what I suggested might happen in my earlier post). So effectively, Hungary will receive fiscal support from Belgian, Italian and Austrian taxpayers, via a fairly convoluted mechanism which will presumeably leave things pretty opaque for those who are actually footing the bill. Following the wording (and hence the letter) of the October 12 Paris meeting, Simor stated that the biggest private Hungarian banks would be able to tap the funds, that is those who are deemed to be of "systemic" importance.

The banking sector package contains provisions for added capital and funds a guarantee fund for interbank lending. Funding will be divided between two separate funds - the Capital Base Enhancement Fund and the Refinancing Guarantee Fund - as follows.

Half of the HUF 600 bn package will be used for equity increases and the other half to provide a liquidity boost. The Capital Base Enhancement Fund will work to bring the eligible banks' capital adequacy ratio (CAR) up to 14%. In exchange for its aid on this front, the state will receive priority bank shares (non-voting, dividend preference shares). The aid will be available to banks with HUF 200 bn warranty capital.

The Guarantee Fund on the other hand will be tailored to wholesale funding requirements and guarantee the refinancing of the eligible bank obligations. The HUF 300 billion fund endowment will initially be invested in euro denominated government bonds of Euro area countries and managed by the NBH. Open for new transactions until end-2009, the fund$ will work to guarantee the rollover of loans and wholesale debt securities with an initial maturity of more than 3 months and up to 5 years, for which a fee will be charged and what are deemed to be appropriate securities will be required.

The big problem as I see it with the kind of package that is being introduced (apart that is from the considerable degree of uncertainty about how much Hungarian sovereign debt will increase in the process) is the fact that this structure does not necessarily get money straight through to the people who actually need it - Hungarian companies and households in the form of new lending. My impression is that - as for example seems to be the case in Italy - Hungary's internal credit system is seizing up, and money isn't moving to the parts where it is really needed to keep the machine oiled and running

The other important detail is the way in which banks based in other EU countries are being asked to get their home governments to step in and fork out. In this sense Austria's recent move to help its banks with state funds is instructive, since it seems to be aimed less at shoring up troubled lenders domestically and more at boosting credit and growth in emerging Europe, where its banks dominate and it could lose heavily from a downturn.

What used to be a lucrative grip on the financial markets of central and Eastern Europe - which contributed 42 percent of Austrian bank profits in 2007 - has now been transformed into a strong risk. The situation has even made it relatively more expensive for the Austrian government to borrow - since the spread over 10 year German bund has been sriven up - and has also driven up costs to insure against the seemingly unlikely even of an Austrian sovereign default.

Austrian banks are owed $290 billion by borrowers across the CEE, from Albania to Russia. Its exposure is much higher than that of Italy, Germany and France, and almost on par with what Spain has lent to Latin America, according to the Bank for International Settlements.

Relative to Austria's size, the exposure - roughly equal to its entire gross domestic product - is daunting.

Put another way, should the recent central European hiccup turn into a crisis of Asian or Latin American proportions, with currencies devaluing and debtors defaulting en masse, Austria would be in trouble, and more so than any other western country.

This underlying reality has evidently shaped how the Austrian government is using its 100 billion euro ($129 billion) banking package. The finance ministry last week agreed to boost the capital of Erste Group Bank by 2.7 billion euros, even though the bank, emerging Europe's third-biggest lender, is well-capitalized and funded.

The state money came cheaper and with fewer strings attached than similar deals in Germany or Belgium. There are few rules on how to use the capital - just enough to allow the government to present the measure as boosting domestic credit.

In reality, most of the capital is going to underpin lending in countries including Romania, where Erste owns the biggest bank, or Hungary, where it is number 6.

"That this is about providing credit to Austrian companies is just a pretense," said Matthias Siller, who manages emerging market funds at Baring Asset Management. "This move is a clear commitment to eastern Europe......But this has nothing to do with charity. Those (Austrian) banks are system-relevant banks in central and Eastern Europe, and if they had to withdraw capital from there, this would set off a landslide," he said.

A number of emerging countries in Central and Eastern Europe share the problem of having a gaping hole in their current accounts - one which they currently fill to a considerable extent through the funding that Austrian, Italian, French, Belgian and Swedish parent banks provide. Fears that they were about to choke off this lending simply because the parents themselves had trouble refinancing played a big role when investors dumped Hungarian assets in droves last month.

By tapping their home governments, the banks effectively lean on taxpayers in their home countries for refinancing countries with large current account imbalances - countries which apart from Hungary also include Romania, Bulgaria and the Baltics.

"If there is no EU-wide plan then it will be left to Sweden (in the Baltics) and Austria (on the Balkans) to take care of this," said Lars Christensen, an analyst at Danske Bank. "Obviously you can't have the Austrian government bailing out central and Eastern Europe," he added. "The problem in this situation is a lack of coordination between European Union governments about a stabilization plan for Eastern Europe."

Well, don't feel especially discriminated against in the CEE I would say, since there is no plan for Southern Europe either, and the problems in Italy, Greece and Spain are every bit as large. Indeed I would say that those responsible for policymaking across the CEE would do well to look at what happened to the Spanish economy after the external funding for the Spanish banks was effectively cut off in September 2007.