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Friday, December 19, 2008

As Hungary's Recession Deepens The Central Bank Cuts Rates In "Snails Pace" Mode

The fact that Hungary's National Bank did not decide to make an unexpected interest rate cut at its meeting earlier this week seems to have surprised some, but it really should not have done. According to James Morsink, head of the IMF delegation to Budapest, Hungary only has room to cut its benchmark interest rate at a “gradual and cautious” pace. The reasoning behind this view is simple, any more rapid reduction in the bank's benchmark rate risks being accompanied by a devaluation of the forint, and and any such devaluation would inevitably lead to a rise in mortgage defaults and problems for the banking system as holders of Swiss Franc forex loans find themselves unable to maintain their payments as unemployment rises and wages and salaries fall.

Thus it is that even though the Hungarian economy is now in its worst recession in over a decade the IMF representative finds the decision to cut the key policy rate for the second time in two weeks just before Christmas (by 50 basis points to 10.00%) “appropriate”. Such "snails pace reductions mean that over the last two months the central bank has now clawed-back only half of the 3% hike made back in October, a hike which was rapidly put in place in an attempt to mount a firewall defence around a Hungarian banking system faced with the imminent threat of financial meltdown at the end of October. The problem is, having put the firewall in place it is proving very hard to remove it, and Hungarian monetary is now well and truly trapped between the proverbial rock and a hard place.

The diificulty of this situation is implicitly recognised by András Simor, Governor of Hungary's central bank, who told Reuters this week that the 10.00% base rate needed to be lowered as fast as possible. Yes, but how?

“The Monetary Council has declared that we would like to lower the base rate as fast as possible because both real economy prospects and inflation prospects would justify a significantly lower interest rate level than the current level," Simor said.
The problem is that since the original sharp interest rate hike decision was taken largely in order to defend the forint, the question now naturally arises what will happen to the currency as the guard is now gradually lowered - and given the severity of Hungary's recession there is no doubt that the guard will have to be lowered. Personally I would simply express the hope that in the intervening period as many Hungarians as possible have had the good sense to make the currency switch from CHF to Forint for their mortgages - the opportunity for which was offered to them in an agreement the Hungarian government reached with the banks in October. Basically the steadily deteriorating trade data - see below - which is accompanying the collapse in internal demand will leave the authorities with no effective alternative but to let the currency slide, if they don't even provoke the slide themselves, that is.

So monetary policy has now been "relaxed" by 15 base points - but there is still a long road - a hell of a long road - left to travel.

The Hungarian government remember secured 20 billion euros in IMF-led loans back in October, and apart from the monetary tightening which has accompanied the "easy as she goes" IMF internal deflation strategy, there will be no fiscal support for the beleagured economy, since the other leg of the strategy is for Hungary to cut its fiscal deficit faster than previously planned in order to achieve a short sharp reduction in its financing needs. In fact Hungary seems to have complied with it's 2008 goal of cuuting the deficit to 3.4 percent of gross domestic product in 2008 and is now set to reduce it to 2.6 percent in 2009. Whether these two pro-cyclical squeezes count as a package of anti-crisis measures or not (certainly they bear little resemblance to what Barack Obama has in mind of the United States, or José Luis Zapatero is doing in Spain - to mention two other countries which are suffering the after effects of a "twin deficit problem"). But then here what is sauce for the goose obviously is considered to be something akin to caviar for the gander, and the Hungarian's must be patient, and simply grin and bear it like the long suffering people they undoubtedly are.

Sharp Economic Contraction Ahead In 2009

If we look at what has been happening to Hungarian GDP in recent quarters we will see that the weak performance of the economy is not of recent origin, and that headline GDP has been struggling to keep its head above water since the end of 2006, and this despite a surprisingly good harvest in 2008, and a reasonable export performance in the first half of the year to offer the only real bright spot support to what was otherwise a pretty dismal general horizon. So basically, when the global shock hit in October 2008, we were talking about a patient that was already severely weakened by both the underlying illness from which it is undoubtedly suffering (but what is the illness'') and some of the standard-recipe medicine which was being applied.

Even the briefest of glances at the recent evolution in household consumption should make the root of the problem abundantly clear, since Hungarian household consumption peaked all the way back in 2002 (just as it did in Portugal in 1998/99), and it has not rebounded - just as we have seen in the Portuguese case. Nor will it, in my humble opinion, ever rebound in the way that most analysts expect, since Hungary is now showing all the signs of being destined to add its name to that venerable list of export driven economies, a list currently so nobly and venerably headed by countries with such illustrious histories as Japan and Germany. And what exactly do these countries have in common: oh yes, they are in the throes of an economic trasition brought about by negative population momentum and rapid ageing.

Basically, weak as the momentum in household demand before October 2008 was - we have to be grateful for small mercies here - it was still positive, and it stayed positive all the way through to Q2 2008 - probably as a result of all those forex mortgages and "refis" which were being so avidly contracted.

Since October, however, we can now expect the "bird" to have been well and truly knocked of its perch, with the outlook for 2009 being undoubtedly negative, and possibly strongly so. Since there are a number of reasons why it is interesting to think of Hungary as being some sort of second Portugal (the similarities even extend to negative population shocks - since Portugal's population actually fell beck in the mid 1990s, partly because of out migration headed for other EU member countries), and since domestic demand in Portugal did not (and has not) recovered from the 2000/01 momentum shock (or adjustment process) people might like to take a look at the chart below.

The strongest argument for assuming that we will get a bounce back in domestic demand in Hungary is the convergence argument, and the idea that it "has to be like that". The simple case of Portugal shows that convergence is not inevitable (you only need one negative case to falsify an inductive chain), and that it does not "have to be like that". This evidence alone, of course, does not mean that there will not be a recovery in the houshold consumption path, but it does mean that those who want to suggest there will be need to dig a bit deeper, and find some more arguments, arguments which can be subjected to empirical testing, and which can, should they not be the case, be falsified. Remember, Hungary was the native country of Imre Lakatos, not that I imagine too many contemporary Hungarian economic analysts are aware of the relevance of his work for how they do their job.

So, as I said, there is still some road to travel for the National Bank of Hungary in its rate cutting cycle, and one of the principal reasons that they have a long road to travel here is the competitive readiness of Hungarian industry to serve as an export machine to drive growth, a competitiveness which is currently being tried and found wanting. Some evidence to back my assertion in this regard can be found in the current level of Hungary's Real Effective Exchange Rate (see chart below).

The REER (or Relative price and cost indicators) is a tool economists use to assess a country's price or cost competitiveness relative to its principal competitors in international markets. The indicator is a useful one, since changes in cost and price competitiveness depend not only on exchange rate movements but also on cost and price trends. The specific REER used by the EU for its Sustainable Development Indicator (which is the one used in the above chart) is deflated by nominal unit labour costs (total economy) against a panel of 36 countries (= EU27 + 9 other industrial countries: Australia, Canada, United States, Japan, Norway, New Zealand, Mexico, Switzerland, and Turkey). Double export weights are used to calculate REERs, reflecting not only competition in the home markets of the various competitors, but also competition in export markets elsewhere. A rise in the index means a loss of competitiveness.

Another indicator - the Nominal Effective Exchange Rate (NEER or, if you prefer, the “Trade-weighted currency index”) of a country aims to track changes in the value of that country’s currency relative to the currencies of its principal trading partners. It is calculated as a weighted geometric average of the bilateral exchange rates against the currencies of competing countries. Changes in cost and price competitiveness depend not only on exchange rate movements but also on cost and price trends. The REER (or, if you prefer, the “Relative price and cost indicator”) aims to assess a country’s price or cost competitiveness relative to its principal competitors in international markets, which basically means it is the NEER deflated by nominal unit labour costs (total economy) and consumer prices (CPI/HICP). Which means, cutting through all the mumbo jumbo, that it is an extremely useful and powerful tool for assessing the state of competitiveness of any given country.

So if we come to look at the state of Hungarian competitiveness, and we do it through a comparison with what could be the benchmark value for aspirant export driven economies - and that is of course the German index - then we can see just how much the Hungarian position has been allowed to deteriorate, and all that loss with now have to be clawed back - if you want to have anything that half way resembles a modern pensions and health system that is. True the index measures relative price and productivity movements across all sectors (tradeables and non tradeables alike), and true Hungary's export oriented sector has performed much worse than the rest, but that is just the point, since the position of the non tradeable sector is even worse than the chart suggests, and a very large scale mis-allocation of resources into non tradeables has been going on, and one way or another this mis-allocation will now need correcting. And there are only two ways to do this correction, through a substantial internal deflation (not adviseable) or through an outright devaluation (my prefered path).

That the loss of competitiveness in the non tradeable sectors has been particularly strong is shown by the difference between domestic and export producer prices you can see in the above chart, since domestic producer prices have hardly budged since the early summer in y-o-y terms, a very bad sign indeed, I think. Domestic producer prices were donw by 1.3% in November compared with October but they were still 10.8% above those of November 2007. Export prices (measured in HUF) were up by 1.1% on October and by 4.4% on November 2007 - again the uptick is worrying. Combined producer prices for both domestic and export sales were thus up 0.1% on October and 7.1% on November 2007.

The sharp uptick in HUF export prices was undoubtedly the result of currency movements (and the fact that the euro value of the exports seems to have been held constant (which is not the best way of getting the benefits from devaluation), since the HUF was down by 2.8% against the EUR (and by 7.8% against the USD) in November (compared to October) following a 7.2% drop against the EUR (and a 15.4% one against the USD) in October (compared to September). What this seems to indicate is that exporters held their euro prices constant, rather than taking advantage of the cheaper forint to reduce them, although the move may have been seen as temporary, and we will have to wait to see how export prices evolve in the coming months.

Belgium's luxury lingerie maker Van de Velde is to close down its Hungarian factory in Szekszárd, business daily Világgazdaság reported on Thursday. The company's CEO said it is impossible to make textile goods in Hungary cost efficiently. The shutdown would put 345 employees on the street. Production is still on at the plant, but it will need to be stopped as in Hungary there is no way to produce textile goods cost efficiently, the CEO said. He noted that the same job can be done at one third of the costs in Tunisia therefore the entire Hungarian production will be moved there.

Construction Activity Stays Down At A Very Low Level

Although Hungarian construction activity expanded very slighly in October, output remains at a very low level. According to Central Statistic Office data, production was up 0.2% month-on-month, while the year-on-year reading fell back 2.2%. More to the point output has now been stuck since 2007 at a level first reached in 2003, and it is also worth bearing in mind that we have not yet seen the real impact of the October credit crunch.

As can be seen from the chart below, the current data is more a reflection of the long-term stagnation in economic activity that followed the introduction of the austerity programme in late 2006 and is thus not a result of the recent financial crisis. Put another way, the impact of this crisis is about to be seen, but it will be operating on an economy which was already severely weakened, as such the end result may well not be any too pretty.

New orders placed in October give some idea of what we may expect, since new contracts for residential and commercial real estate were down by 41.1% year-on-year (and remember October 2007 was not that high a base reference).

Unemployment Rising Steadily

Hungary’s unemployment rate rose in the three months to November - to 7.8 percent, up from 7.5 percent in the three months to August and from 7.5 % in the three months to November 2007. Of the 329,000 currently unemployed, 49.6 percent have been out of work for at least a year.

The rise is not dramatic, but that is only because of the earlier weak position of Hungarian employment, and because the full impact of the slowdown in industry is only now about to bite. But if we look at the employment, rather than the unemployment, chart it is plain that the jobs trend is down, and has been for some time. Not only has the Hungarian economy not creating jobs, it has been losing them.

One of the reasons this poor job creation performance has not lead to more unemployment is, of course, because the Hungarian working age population has itself been steadily declining.

From Bloomberg

It’s 10 a.m. on a Thursday and Janos Oklos would normally be on the assembly line, installing dashboards at Suzuki Motor Corp.’s factory in northern Hungary. Instead, he’s in his slippers, taking out the garbage at the hostel where he and 300 co-workers live in sight of the car plant in Esztergom.......The gas crisis is a further blow to companies that were already shedding workers to cope with the global economic crisis......Gazprom’s Jan. 7 decision forced countries including Hungary, Slovakia and Bulgaria to restrict gas use by companies.

Suzuki shut the Esztergom plant the same day and told workers to return next week, spokeswoman Viktoria Ruska said...... Suzuki, Japan’s second-largest minicar maker, in November announced plans to eliminate 1,200 of its 5,500 jobs in Esztergom because of falling orders worldwide. The cuts also affect Slovakians who work at the factory, which is located just across the Danube River that divides the two countries. As the gas crisis forced the plant to shutdown, the fear of losing their jobs was on the minds of the dozen Suzuki workers huddled in the bar of the workers’ hostel for beers and a smoke as the car factory loomed silent down the road. Asked about the first word that came to mind on their day off, they said in unison: “Insecurity.”

Hungary..... may shed as many as 100,000 jobs in the slowing economy, raising unemployment by about a third, according to Prime Minister Ferenc Gyurcsany.

Consumer Confidence Continues To Slide

Hungary’s economic sentiment index plunged to a record in December as the onset of recession darkened the outlook for both businesses and consumers, according to the latest report from the GKI institute. The overall index fell to minus 36.7, the lowest since measuring began in 1996, from minus 33.3 in November, the Budapest- based institute said. The indexes for business and consumer confidence also fell to new lows. The outlook for industrial production and orders, specifically exports, led the decline in the business confidence index to minus 28.2 from minus 25.1 in November. Fear of job losses dragged down the consumer confidence index, which fell to a record low of minus 60.8 in December from minus 56.7 the previous month, GKI said.

Retail Sales Continue To Fall

Calendar and seasonally adjusted constant price retail sales dropped by 0.1% month on month in October, following a 0.3% drop in September, and fell 1.4% year on year. Combined sales of cars, car parts and fuel were down 5.6% year on year following a decrease of 2.1% in September.

Thus retail sales have been contracting steadily for some time now, basically since the middle of 2006 - as can be seen in the chart below - although as I keep stressing all of this predates the October shock, and we should be ready now for another sharp deterioration in consumer demand in the coming months. Also I now think there are good theoretical reasons for thinking that Hungarian retail sales may never attain the mid 2006 peak again (oh, I know, never is a long time, but I simply don't see how this declining and ageing population process is going to reverse itself, but then all of this is perfectly testable/falsifiable).

While Industrial Output Slumps

Hungarian industrial production declined the most in 16 years in Novemberber as western European demand plunged and Hungary's economy headed into what now looks sure to be its worst recession in at least 15 years. Industrial output dropped a working day adjusted 10.1 percent from November 2007, following a 7.2 percent year on year decline in October, according to data from the statistics office. Output fell 2.1 percent month on month.

As we can see from the seasonally adjusted monthly volume chart, Hungary's industrial output has now been dropping steadily since it peaked in February.

And the future looks set to get worse, since the stock of total orders grew by only 2.0% year on year in October, as compared with a near 10% increase in September. Domestic orders were down 2.4%, which compares with an increase of the roughly the same size in September.

This outlook is confirmed by the December Purchasing Managers' Index (PMI) which, while it recovered slightly from the lowest point ever achieved since records began in November (39.9 down from 42.8 in October) to hit 41, still showed a quite strong contraction taking place, since 50 is the dividing line between expansion and contraction on this type of index. The rebound was to some extent the result of an improvement in the new orders index, which rose 2.8 points from November to 39.9, although both the purchasing and production volume indexes also climbed in the month. But still we come back to the same problem, industrial output will not be pushed back up by domestic demand, only exports can now do that, but to push up exports we need to attract investment, build factories, and sell, and to do all that we need to get competitiveness back. Is all this so hard to understand?

Current Account Deficit The Key

Now, as I am saying, one of the key factors we all need to think about here is just where future growth in Hungary is going to come from - and I think it very important to bear in mind that without growth the living standards gap simply isn't going to close. The main argument I have been advancing is that as far as all the evidence we have seen for the last 18 months goes you can forget about domestic demand as a driver of growth - and that was before the credit crunch shock wave hit. Basically Hungary now has to live (and pay the rising old age related health and pension costs) from exports, which is why it comes as no good news at all that the current-account deficit widened more than expected in the third quarter when compared wih the same period a year ago - as imports increased faster than exports and the income stream to external investors continued to rise.

The deficit was 2.49 billion euros, which compared with 1.68 billion euros in the third quarter of 2007, according to the latest data from the central bank. The goods trade deficit was 206 million euros, compared with a surplus of 47 million euros in the same quarter last year and a 169 million euro surplus in the second quarter. Due to a very health services surplus (582 million euros) the combined trade balance stayed in surplus (376 million euros), but all this hard work (and sweat) was undone by the continuing deterioration in the income balance - which is one of the core problems for Hungary (see chart below) - where there was a deficit of 2.51 billion euros (or nearly 6 times the combined trade surplus), up from the 1.73 billion euro shortfall registered a year earlier and the 2.12 billion euro one registered in the second quarter of 2008.

So payments to owners of Hungarian equities, and holders of Hungarian debt constitute a substantial, and growing, dead weight for the entire Hungarian economy now. Essentially this situation is a result of funding all those years of current account deficit (see chart below) with inward fund flows - these funds all attract interest, and they will eventually have to be paid back, even the recent IMF and EU loans fall into this category. So basically this is just one more reason why exports have become important, since Hungary now needs to move from being a CA deficit nation to a CA surplus one, and the only way to get to this position is to start borrowing (and consuming) less, and saving more. And this transformation has to come one day or another, and the later it comes the worse the correction will be. So maybe here one day is not as good as another, maybe tomorrow is, in fact, a good day to start.

Thursday, December 11, 2008

As Hungarian Inflation Drops, Is There A Deflation Risk?

Consumer prices in Hungary dropped 0.2% month on month and were up by 4.2% year on year in November 2008, falling well short of the 4.5-4.6% year on year consensus forecast. Seasonally adjusted core inflation fell to 4.1% year on year from 4.6% in October, according to the latest data from the Central Statistics Office. Month on month seasonally adjusted core CPI was up 0.1% as compared with 0.2% in October.

“The pace of disinflation in Hungary is astonishing given the Forint sell-off in Q3. November inflation collapsed to 4.2% from 5.1% previously, substantially undershooting the consensus at 4.7%. Falling oil prices were responsible for 0.5pp of the decline but other categories are also confirming that inflation is likely to fall further in Hungary."
Bartosz Pawlowski, Toronto Dominion Bank, London

As Bartosz Pawlowski says the rate of disinflation is really quite astonishing at this point, and this is clearly about much more than just oil prices. What we need to think about is the impact of the wage cuts in the public sector which will begin to lock in this month, and the sharp reduction in both internal and external demand, and on all fronts, and for all sectors next year. Hungary is obviously facing a very nasty recession (contraction in 2009 in the 3% to 5% range), and this sharp drop in demand is bound to have a negative impact on prices, so the threat of deflation is real, I would say, at this point. The problem is to stop negative price movement expectations locking-in (ie people expecting prices to go down rather than up, and this setting in over a number of years, as has happened in Japan). The normal recipe for this is some combination of near zero interest rates and quantitative easing from the central bank, but Hungary is a long way away from having the necessary conditions to run such an unconventional policy (like the one Bernanke is tooling up in the US right now), so the economy is virtually defenceless at this point, but no wonder the NBH is in a hurry to try and bring rates down.

If we look at the seasonally adjusted core index, which was still up a fractional 0.1%, but the curve below will rapidly show you that price increases have been flattening out since the early summer, and we are soon about to head down, in my humble opinion.

Tuesday, December 09, 2008

The NBH Cuts Interest Rates As Hungary Enters Its Second Recession In Two Years

Well, before I go any further, yes you read the header right, with the contraction of 0.1% in Q3 over Q2 (seasonally and working day adjusted data) reported by the national statistics office (KSH) today (Tuesday) the Hungarian economy has now entered its second recession since the start of 2007, since data revisions accompanying today's GDP detailed results from KSH show that they now estimat the economy contracted in both Q1 and Q2 of 2007 (by 0.2% in each case), thus satisfying the normal technical criterion for declaring a recession. Somehow I doubt the Hungarian press are filled today with headlines about this juicly little detail.

While the Q1/Q2 2007 detail is a purely technical recession, in the sense that it could just as easily disappear again in a subsequent data revision - the basis of the revision is undoubtedly the impact of movements in the seasonal adjustment parameters, produced in particular by the rather violent swings in agricultural output - there is a much bigger underlying reality to the detail, and that is that the Hungarian economy has now lost almost all growth momentum, and indeed we need to ask ourselves whether we will ever see robust output growth (neo classical steady-state-growth buffs beware) in the Hungarian economy again (Italy and Portugal would rather be the role models I have in mind here), especially with the increasing impact of ageing and declining population as we move forward in the next decade to think about, and robust growth before we enter the next decade is now an almost impossible outcome to hope for, especially when you take a long hard look at todays data in the light of what is now inevitably about to come.

Remember, the third quarter (July - September) outcome was prior to most of the "financial chaos" which has now set the scene for the growth outlook over the months to come. So it was the last of the "good times", at least for as far ahead as we can see. And that being said, if we strip out agriculture, as Portfolio Hungary notes, almost every other component of the economy went into recession in Q3, before the financial meltdown close-call.

Output in agriculture, industry and construction combined grew by 6.1% year on year in Q3, but this was largely due to the 50.8% growth achieved in agriculture. Industrial output taken separately was down by 2.2% mainly due to a 3.2% drop in manufacturing while construction output dropped by 5.0%. Services output decreased by 1.5%. On the expenditure side of GDP, final households consumption increased 0.9%, mainly due to the increase in social transfers in kind from government, up by 5.8%, while private household final consumption expenditure rose by only 0.1% year on year, and government final consumption growth remained stagnant. As we can see in the chart below, domestic private consumption growth in Hungary is now more or less done, and what growth the Hungarian economy may manage to get in the future will be all about exports.

Gross fixed capital formation maintained the negative trend of recent quarters and was down by 1.5, largely due to a drop in investments in manufacturing and in transport, storage and communications. As far as external trade goes the recent improvement continued, albeit with reducing momentum, and the volume of exports and imports were up year on year by 3.5% and 2.8% respectively.

On a seasonal and working day adjusted basis Hungarian GDP declined by 0.1% in the third quarter of 2008 when compared to the previous quarter, with agriculture being the only sector to show real growth with a 5.2% increase over the quarter. Industry contracted by 1.7% on the quarter, while the services output was down 0.5%. Household consumption expenditure declined by 0.2%, although social transfers in kind from government were up by 1.4%. More preoccupyingly exports were down by 0.3%, while imports decreased by 1.5%.

Exports Falter Again In October

In October 2008, according to first estimates from the KSH, Hungarian exports were running at EUR 6,349 million, while the value of imports was EUR 6,425 million. The current price euro value of exports was thus down by 4%, and that of imports fell by 2% over October 2007. As a consequence the October trade balance showed a deficit of EUR 77 million, and a deterioration in the balance of EUR 180 million when compared with October 2007. As we can see in the chart below, given the difficult external environment, Hungarian exports are also taking a beating at this point, but it is from a recovery in this area that the only real hope for a Hungarian recovery actually lies.

The NBH Cuts Rates

The National Bank of Hungary (NBH) yesterday (Monday) announced that it was lowering its key policy rate by 50 basis points to 10.50%. The Monetary Council was scheduled to hold a rate-setting meeting on 22 December, and yesterday's meeting was not in principle intended to take monetary policy decisions. The 50 basis point cut thus came as something of a surprise to observers. The direction of the move however did not come as a surprise since following November's 50 basis point monetary easing the market had been expecting the MPC to lower rates further in December. Despite the potential for forint instability, the financial markets seem to have taken November's cut reasonably in their stride (especially with the big guns of the IMF, the ECB and the EU lined up just in case) and the HUF has remained reasonably stable. Quite another argument would be whether these current forint values are in the best interests of Hungary's export industries, given all that has been previously said about them now being the great white hope of the Hungarian economy.

Various arguments have been advanced to explain NBH thinking at this point, among these two seem reasonably plausible. In the first place November CPI figures showed a general global decline and there are signs that we are entering a deflationary trend both in Hungary and the CEE in general. Despite the very high inflation levels that have been registered recently in the CEE, the very rapid drop in demand in some countries does not rule out the eventuality that we may see a negative price trend and even possibly outright deflation in those countries which enter the deepest depressions. Hungary's Central Bank is therefore staring to position itself, just in case.

Additionally as inflation has fallen back, serious recession fears begin to come to the forefront of bank thinking, and especially in Hungary, where fiscal policy simply cannot contemplate measures that would foster economic growth. So, to give the impression that at least someone is trying to do something about what is really a very difficult situation, the NBH starts to cut.

The impotence of the NBH is pretty much evident in this situation. The loans from the IMF and the EU were simply that, loans. They offer financial stability, but they do not address the key problem facing Hungary today, which is how to get sufficient export competitiveness to push headline GDP growth up to levels that put the economy on a sustainable path. The only way to this achieve situation is by allowing the value of the forint to fall (devaluation). Substantial internal price deflation would be too long and too painful, and carries important risks of getting stuck in a deflationary spiral. But to devalue you need a plan for the CHF denominated loans. These need to be "translated" over to forint - by decree if need be, and the West European banks who conducted all this ill advised lending need to be sent to their home governments with the begging bowl, since Hungary is surely in no position to bail them out, or shoulder the burden of the inevitable write downs.

Andreas Simor more or less accepted that the forint was the big issue in his statement before the Economic Committee of the Hungarian Parliament on Wednesday. Hungary’s scope for interest rate cuts is “limited” because of the risk of a “very significant” devaluation of the forint, the central bank President said. He stressed that the Magyar Nemzeti Bank does not have an exchange-rate target and wants to avoid forint volatility and proceed with rate cuts as the balance of risks to the economy allow.

“If we were to lower rates faster, we would risk a very significant currency devaluation,” Simor said. “We will proceed as quickly as Hungary’s risk assessment improves.”

"We have to proceed on a very narrow path, but we will proceed. As to when and at what pace? At such a pace that is in line with an improvement in Hungary's risk assessment,"

So we will not reduce rates dramatically, or substantially, even as the recession grows and fiscal policy tightens. Fine. But do tell me, just how long does it take to drain an ocean with a teaspoon?

Monday, November 24, 2008

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.

Wednesday, November 19, 2008

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.

Thursday, November 06, 2008

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.

Wednesday, November 05, 2008

Hungarian Exports and Manufacturing Contract, As Global Activity Plummets

Hungarian manufacturing continued to contract in October following a shocking performance in September, while exports drop sharply in the midst of a looming global manufacturing recession. All of which indicates that the real economy impacts of the recent financial turbulence is now about to make its presence felt. I think we are in for a real shocker in Hungary.

October PMI Down

Hungary's manufacturing industry contracted sharply in October, according to the latest PMI reading, which fell 5.2 points to hit 44.7 in October - a historic low, and 0.8 points below the previous worst reading registered in October 1998, according to the latest data from the Hungarian Association of Logistics, Purchasing and Inventory Management (HALPIM).

Sharp Industrial Output Contraction In September

Hungarian industrial production dropped the most in more than 16 years in September as the global financial crisis hit the economy and slowing growth in western Europe curbed demand for exports. Production was down 5.3 percent from a year earlier on a working day adjusted basis, following a 1.2 percent drop in August. This was the rapidest annual decline since August 1992, according to the national statistics office (based on preliminary data).

Output was down a seasonally and working day adjusted Output 2.4 percent month on month.

Output also fell for a fourth month for the first time since 1992 as the euro region, which buys 57 percent of Hungarian exports, looks set to enter its first recession since the launch of the single currency and crimped demand for Hungarian assembled products like Audi cars and Nokia phones. The economy of the 15 countries contracted in the second quarter for the first time since the common currency's creation, and it is a pretty sure bet it continued to contract in the third one.

“Preliminary September industrial production data was yet another stark reminder that Hungary is feeling the pain from the global slowdown. Although output “only" fell by 0.7% y-o-y according to unadjusted data (versus the huge, 5.9% drop seen in August), working day adjusted figures showed a much darker picture: on a workday-adjusted basis, output fell by a whopping 5.3% versus the 1.2% decrease observed during the last summer month. The month-on-month figure was just as dreadful, exhibiting a precipitous, 2.4% fall (contrasting the 0.8% pick-up seen during the preceding month)."
György Barta, CIB Bank, Budapest

“Headline GDP growth in Q4 could be well below zero even including the beneficial impact of farming. In light of the most recent data, the -1.0% GDP forecast of the 2009 budget draft seems at the very optimistic end of the possibilities as the joint effects of the fiscal and monetary shocks aggravate the growing problems of the real economy."
Gábor Ambrus, 4Cast, London

Hungary's export-driven economy is expected to contract by 1 percent next year as a result of the global economic decline, according to the latest government estimates, although as Gabor Ambrus notes, even this number now looks pretty optimistic. If things continue like this, a contraction of GDP in the 3 to 5% range would not surprise me. The crisis, which recently forced the country to line up 20 billion euros ($26.1 billion) in emergency loans, have now long since dashed hopes for a recovery from 2007's 1.1 percent growth rate, already the slowest growth in 14 years.

August Exports Drop Year On Year

The national statistics office confirmed during the week (Wednesday) that Hungary posted a trade deficit in August - running at a revised EUR 76.1 million (down from the prelim EUR 103.7 million). The January-August balance was a EUR 24.8 million surplus (as compared with a prelimary EUR 2 million surplus), and this compares positively with the deficit of EUR 457.2 m clocked up in the same period of 2007.

Exports in August 2008 totalled EUR 5,366.3 m (vs. prelim EUR 5,378.3 m), down 0.9% year on year, compared to a growth of 8.2% in July. The export volume growth of 4.2% in July turned into a decline of 6.8%, a far cry from the year to date average of a 7.7% increase. Negative export growth had not been seen in Hungary for five years.

Imports stood at EUR 5,442.4 million, revised up by nearly EUR 40 m from the preliminary estimate. The 12 month running total was also revised from the preliminary -1.9% to -2.6%. Imports were up in July at 12.4% year on year as record oil prices boosted the total. In volume terms Hungarian imports plunged 8.5% year on year in August as compared with a 8.3% increase in July.

The JP Morgan Global Manufacturing Index Plummets Too

The October manufacturing contraction in Hungary really forms part of a much larger global picture, since the current dramatic events in Hungary have, above all, a global backdrop, one which the current dependce of the Hungarian economy on exports only serves to highlight.

Manufacturing output fell in October in one country after another, and indeed the latest JP Morgan Global PMI report really does makes for quite depressing reading.

The world manufacturing sector suffered its sharpest contraction in survey history during October, as the ongoing retrenchment of global demand and further deepening of the credit market crisis negatively impacted on the trends in output, new orders and employment. The JPMorgan Global Manufacturing PMI posted 41.0, its lowest reading since data were first compiled in January 1998 and a level below the no-change mark of 50.0 for the fifth month in a row.

Output, total new orders and new export orders all contracted at the fastest rates in the survey history in October. With the exception of India, which again bucked the global trend, all of the national manufacturing surveys posted declines in output and new orders. The impact of the downshift in global market conditions also had a far-reaching effect on international trade volumes. Although new export orders fell at a slower rate than total new business, all of the national manufacturing sectors covered by the survey (including India) saw a reduction in new export orders.

"October manufacturing PMI data reinforce the stark retrenchment that the sector is currently facing, with production, total new business and new export orders all falling at record rates. The latest Output Index reading is consistent with a fall in global IP of almost 8%. The only positive from the surveys was a decline in input prices for the first time since August 2003."
David Hensley, Director of Global Economics Coordination at JPMorgan

Economies across the Eurozone are being affected. In Italy manufacturing activity contracted at the fastest rate in at least 11 years in October according to the latest Markit/ADACI PMI survey out yesterday (Monday). The Markit Purchasing Managers Index fell to 39.7, its lowest since the series began in 1997, down from 44.4 in September. The Italian manufacturing PMI has now not been above the 50 mark separating growth from contraction since February and the latest data showed activity falling at an accelerating pace as demand shrank while jobs were shed at the fastest rate in the history of the survey.

Other recent indicators from Italy have also been far from encouraging, with October business confidence hit its lowest point since September 1993, when the economy seized up after Italy was rocketed out of the European Exchange Rate Mechanism a year earlier.

Germany's manufacturing sector contracted in October at the fastest pace in seven years as incoming orders and output experienced their sharpest declines in more than 12 years. The headline index in the Markit Purchasing Managers Index for what is Europe's biggest economy fell in October to 42.9 from 47.4 the previous month, well below the 50 mark that separates growth from contraction.

The French manufacturing purchasing managers index was revised down to a series low 40.6 in October, down from both the 'flash' estimate of 40.8 and September's 43.0 figure, Markit Economics said in a press release issued on Monday.

Disaggregating the figures, the output component fell to an all-time low of 37.8 from September's 41.7 level, while new orders slipped all the way to a series low of 34.9 for the month, down 2.6 points from September's 37.5 level. Purchase quantities and new export orders also saw some new record lows in October, falling to 33.7 and 38.5 respectively.

Spain's manufacturing sector continued to shrink at a record pace in October - possibly the fastest among all those included in the JPMorgan index - with both output and new orders contracting and employers shedding jobs at a near record pace, according to the latest Markit Economics Purchasing Managers Index published yesterday (Monday). The Markit PMI for Spain dropped to 34.6 in October, the lowest reading registered by any eurozone economy since the series began in February 1998 and down from the already rapid 38.3 point contraction in September. As we can see, according to this indicator Spanish manufacturing has now been weakening steadily since the start of 2006.

Central and Eastern Europe

Apart from the Hungarian decline, output also contracted elsewhere in the CEE. In Poland the ABN Amro Purchasing Managers Index fell for the sixth month running to 43.7 (down from September's 44.9) a record low and well below the neutral reading of 50, according to Markit Economics yesterday. In the Czech Republic, manufacturing output contracted for the seventh month in a row, and the index hit an all-time low of 41.2, just above the revised euro zone figure of 41.1. As the Eurozone itself contracts, these economies which are heavily dependent for exports to the zone will be buffeted, especially now that forex loans for their domestic housing markets have all but dried up.

US Manufacturing

The US manufacturing PMI dropped back to 38.9 in October from 43.5 in September, indicating a significantly faster rate of decline in manufacturing when comparing October to September. It appears that US manufacturing is experiencing significant demand destruction as a result of recent events. October's reading is the lowest level for the US PMI since September 1982 when it registered 38.8 percent. On the other hand inflationary pressures are evaporating rapidly, and the Prices Index fell to 37, the lowest level since December 2001 when it registered 33.2 percent. Export orders also contracted for the first time in 70 months.


China's PMI dropped to lows not previously seen in October, confirming that the economy of the so-called factory of the world is now decelerating along with everyone else. Two international surveys measuring the PMI independently corroborated the evidence of a cooling Chinese industrial economy.

According to a survey complied by securities firm CLSA, China's PMI fell to 45.2 in October, its third consecutive drop, from 47.7 in September, as new orders and exports, as well as pricing power, were squeezed by the global financial crisis.

"The very sharp fall in the October PMI confirms that China is more integrated into the global economy than ever. Chinese manufacturers are seeing their order books cut, both at home and abroad, as the world economy falls into recession," said Eric Fishwick, CLSA's head of economic research, in a report released Monday. "Costs are falling but so are output prices. The coming 12 months will be difficult ones for manufacturers, China included."

The government-backed China Federation of Logistics purchasing managers' index - published on 1 November - also showed a strong contraction, falling to 44.6 in October, the lowest level since the data began in 2005, from 51.2 in September

Russian manufacturing contracted in October at the slowest pace in over two and a half years as the global financial crisis cut demand, according to the latest reading on VTB Bank Europe's Purchasing Managers' Index, which fell to 46.4 from 49.8 in September. This was the third consecutive month in which Russian industry has been contracting.

Business conditions in the Brazilian manufacturing worsened in October for the first time since June 2006. The headline seasonally adjusted Banco Real Purchasing Managers’ Index (PMI) posted 45.7, down from 50.4 in September, pointing to a sharp contraction -the fastest in the survey history in fact. The PMI was driven down by accelerated declines in output and new orders, as well as falls in employment and stocks of purchases.

Even in India the seasonally adjusted ABN Amro India Manufacturing Purchasing Managers’ Index dropped steeply in October, falling to a record low of 52.2, down from a reading of 57.3 in September suggesting another sharp deceleration in growth, even if Indian industry managed to keep expanding. The biggest fall was in the new orders sub-index, which dropped to 54.4 in October from 62.6 in September. Perhaps the saving grace in the Indian survey is that most firms said demand remained strong in domestic markets, while it had been international orders which had waned. This can also be seen from the new export orders sub-index, which contracted to 49.7 for the first time in the history of the series. That fits in with the latest data showing that Indian year on year export growth slowed to 10.4% in September. Thus the Indian expansion is still hanging on in there, by its fingernails, but it is hanging on in.

Monday, November 03, 2008

Hungarian Business and Consumer Sentiment Fall Sharply In October

Well, you don't need to be especially adept at reading tealeaves to know which way things are about to move now on the Hungarian economy front. But just in case any of you did have some last, lingering doubts, the latest edition of the GKI sentiment index should have wiped them smartly away. In fact the GKI economic sentiment index declined in October to a record low as the financial crisis made businesses and consumers "dramatically more pessimistic'' (according to the institute) about Hungary's growth outlook.

The overall index fell to minus 25, the lowest since measuring began in 1996, from minus 17.9 in September. Business confidence declined to minus 14.8 from minus 9.3, also a record.

``Businesses of every kind and consumers became dramatically more pessimistic about the outlook of the Hungarian economy as the international and domestic financial environment deteriorated by the day...... The industrial confidence index fell ``significantly'' on the predictions for orders, specifically for exports, while the estimate for industrial production ``visibly deteriorated. Expectations for employment also fell significantly.

Consumer confidence also dropped, falling to a six-month low of minus 54.0, from minus 42.5 the previous month. Consumer sentiment has in fact been plumming the bottoms since the middle of 2006, when Prime Minister Ferenc Gyurcsany had to raise taxes and cut state subsidies under the impact of a financial crisis which forced him to narrow what was at the time the largest budget deficit in the EU. Since that time the Hungarian economy has effectively been limping forward.

Sentiment In Europe Also Turns Down

European economic confidence saw its biggest ever fall during October as the global bank crisis generated the bleakest business outlook since the early 1990s, according to the findings of this months European Commission economic sentiment survey. The survey results give us just one more dramatic glimpse ino the devastating impact the financial turmoil is having on the real economy. Pessimism across Europe has risen dramatically on all fronts - from manufacturers' expectations about exports to consumers' fears about unemployment.

These gloomy results now make it almost a certainty that the European Central Bank will cut its main interest rate by at least half a percentage point to 3.25 per cent when it meets later this week. The European Union executive's "economic sentiment" indicator for the 27-country bloc fell by 7.4 points in October to 77.5 points. The latest index reading was the lowest since 1993 and marked the largest month-on-month decline ever recorded. Readings were down right across the individual EU economies.

And as the external environment deteriorates, sentiment inside Hungary not unnaturally falls right behind it.

Manufacturing Contracts In October

The most obvious area where the deteriorating export potential is to be found is in industry, and as was to be expected Hungary's manufacturing industry contracted sharply in October, according to the latest manufacturing purchasing manager index (PMI) reading, which dropped 5.2 points to hit 44.7 in October - a historic low, and 0.8 points below the previous worst which was registered in October 1998, according to the latest data from the Hungarian Association of Logistics, Purchasing and Inventory Management (HALPIM), the publisher of the index, has reported on Monday. On these indexes any reading below 50 indicates contraction.

More Budget Details

The Finance Ministry has now made available the latest version of next year's Hungarian budget - which is based on an anticipated 1.0% GDP contraction in 2009. The forecast assumes that wages in the private sector will not grow by more than 1.6% on average during the year, while there is to be no increase in the public sector. The combined result is a 2.6% average decline in real wages. Wage-related austerity measures and an expected 0.6% decrease in employment are projected to lead to a 3.7% contraction in household consumption.

Exports are expected to grow by 3.9% and imports by 2.4% (in both cases revised down from an earlier 4.1%). Based on the above, the government expects the public sector deficit (ESA-95) to come to 2.6% of GDP instead of 2.9%.

Swiss Franc Mortgages Hit Record High In September: The Rise Before The Fall?

Forex borrowing by Hungarian households hit a historic high in September, the month before the crisis, and before the termination or restriction of this practice by a number of significant banks, so this was in all probability one last fond farewell by Hungarians to the practice of local FX borrowing. The monthly statistics of the National Bank of Hungary (NBH) published on Friday also represented, as Portfolio Hungary comments - the calm before the storm in the area of FX loan costs. The average APRC (annual percentage rate charged) on forint loans to households was up, but very slightly slightly overall, while the average APRC on Swiss franc loans remained broadly unchanged compared with August. Next month we will see the result of the substantial (3%) rate hike by the central bank in the middle of the month enter the data.

The seasonally adjusted volume of new loans to companies and households continued to rise in September with both forint and Swiss franc housing loans rising slightly. Also worthy of note was that while the monthly average interest cost of CHF-based household consumer loans remained stationary in September, the value of new loans has risen moderately

Total loans of households rose HUF 296 bn to reach HUF 6,8880 bn in September. But it is important to note that HUF 175 bn of this was the result of the weakening in the forint, and only HUF 121 bn was the result of new transactions, with these being almost exclusively in FX loans. The forint fell by 2% versus the euro, 3.7% against the CHF and 9% against the JPY in September.

As a result of the revaluation effects produced by the forint depreciation the ratio of FX loans to total loans rose hit a record high of 62.3% in September.