Hungary: Forint’s Rocky Road Ahead

Currency traders are seldom known for their forgiving natures. But in the case of Hungary they appear to be making an exception.

Hungary was considered something of a market pariah at the end of last year. A lurch towards authoritarianism under Prime Minister Viktor Orban alienated investors, who were already worried by the nation’s onerous debt burden. Yet the Hungarian forint has been among the strongest emerging market currencies so far this year, climbing roughly 10 percent against both the dollar and euro.

Investors may have been too quick to forget the reasons they shunned Hungary in 2011.

For a start, the nation’s finances look as precarious as ever. Its government debt — at about 80 percent of national income — is the highest in Eastern Europe. Hungary’s dependence on foreign creditors makes such high levels of debt even more of a problem. Foreigners hold about 40 percent of government bonds, leaving Hungary vulnerable to rapid capital flight.

To make matters still worse, much of Hungary’s debts are denominated in foreign currencies. Many Hungarians took out mortgages in Swiss francs. Unfortunately, since the start of 2008, the franc has surged about 35 percent against the forint — making it ever harder to repay loans.

Nor can Hungary rely on economic growth to reduce the debt burden, says Neil Shearing, chief emerging market analyst at consultancy Capital Economics. “This is a small, open economy, and exports to the euro zone account for about 40 percent of GDP,” he says. “The euro zone’s malaise makes life hard for Hungary too.” As a result, Capital Economics is expecting the economy to shrink by 1 percent this year.

The upshot is that Hungary badly needs outside help. Optimism that such help is on its way is part of the reason for the forint’s recent surge. In January the government announced that it was willing to restart loan negotiations with the International Monetary Fund, after they had collapsed the previous month. A 20 billion euro check was thought to be within reach. Still, this loan may not be in the bag, says Win Thin, a currency strategist at Brown Brothers Harriman. “Orban has shown a talent for making enemies,” he says.

The main tension with the IMF has been the government’s attempts to subvert the independence of the central bank — an issue dear to the heart of fund negotiators. By stuffing the interest-rate-setting committee with more government appointees, Orban appears to be seeking ever-greater power over monetary policy. “A feud between the central bank and government is the last thing investors want to see,” says Shearing. The government has also lowered the retirement age for judges, allowing it to appoint more politically friendly replacements. Orban and his colleagues have been reluctant to back away from such policies.

So investors should not expect talks with the IMF to be smooth. Only a few months ago, Hungary’s economy minister complained that the IMF staff members “deeply object to all Hungarian decisions” and boasted that Hungary’s government was “forming its economic policy against this three-letter institution.” Nor will an IMF deal, if one can be agreed on, be a panacea. Years of sluggish growth seem likely.

Currency traders may end up regretting their decision to give Hungary the benefit of the doubt.