Hungary Central Bank Takes Step to Boost Local Financing

Hungary’s central bank will transform its main policy facility to prod lenders to shift funds into government bonds, with the aim of cutting the country’s external debt and shedding a junk debt rating.

The Budapest-based National Bank of Hungary will from Aug. 1 convert its two-week bill facility into a deposit instrument with the same maturity, it said in a statement today. The facility, the basis of the country’s benchmark interest rate, will no longer be accepted as collateral by the bank and foreign investors will be barred from it.

Hungary, with the highest debt level among the European Union’s eastern members, wants to cut its reliance on outside debt financing to reduce its vulnerability to shifts in global risk sentiment. The central bank said the measure will lead to a drop in external debt, allowing it to reduce foreign reserves and paving the way for a credit-rating upgrade.

“The instruments to be introduced will provide sufficient stimulus to the banking sector to contribute to a reduction in the country’s external vulnerability and to a move by the Hungarian economy towards a healthier financing structure,” the central bank said in the statement.

The forint weakened 0.5 percent to 309.27 per euro by 4:48 p.m. in Budapest. It has dropped 3.9 percent this year, the fifth-worst performance among 24 emerging-market currencies tracked by Bloomberg. The yield on the government’s benchmark three-year forint notes fell 18 basis points to 4.33 percent, the lowest in almost three months.

Asset Shift

Lenders held 5.3 trillion forint ($23.8 billion) in the two-week facility as of yesterday and foreign investors held 756 billion forint of it in March, central bank data showed. Banks may shift as much as 1 trillion forint into forint-denominated bonds from the current two-week facility, central bank Executive Director Marton Nagy told reporters.

From June 16, the central bank will also start providing a forint interest-rate swap and an asset swap facility. The former will mitigate interest-rate risk for long-term forint assets “newly purchased or held,” while the latter will give banks access to foreign-currency securities in exchange for long-term forint-denominated securities, the bank said.

Of Hungary’s government debt, 42 percent is denominated in foreign currencies, according to data from the Debt Management Agency. Foreign ownership of domestic debt reached a record 5.2 trillion forint in July 2013 and stood at 4.76 trillion forint as of April 18, the data showed.

Debt, Auction

The central bank’s “program may boost the government debt market,” Gergely Tardos, an economist at OTP Bank Nyrt., Hungary’s largest lender, wrote in an e-mailed report today. “In the short term, it may put moderate depreciation pressure on the forint as foreigners are pushed out of the two-week deposit.”

Hungary raised 90 billion forint in a sale of 12-month Treasury bills today, more than the 60 billion forint planned. The average yield fell to 2.69 percent from 2.95 percent at the previous auction two weeks ago.

Hungary’s sovereign-credit rating is “constrained” by the high government debt level and policy unpredictability, Standard & Poor’s said March 2.

Credit Rating

S&P kept Hungary’s credit grade at BB, two steps below investment grade, after raising the outlook to stable from negative as economic growth accelerates and the government is projected to keep the budget deficit in check. The debt level reached 79.2 percent of gross domestic product at the end of last year.

“Hungary’s credit grade may improve with the reduction in external vulnerability, since credit-rating companies continuously highlight that the high gross financing need is an important source of vulnerability,” central bank Executive Director Daniel Palotai told reporters. “This may also reduce the expected risk premium on forint assets.”

Hungary has completed two-thirds of its 3.3 billion-euro ($4.5 billion) foreign-currency issuance plan for this year after selling $3 billion in dollar-denominated securities in March. The country has a “like-for-like” policy of refinancing maturing foreign-currency and forint-denominated bonds, the debt management agency, also known as AKK, said last year. The budget deficit is financed with local-currency issuance.

Bond Plan

The government may scrap the remaining 1.3 billion euro in Eurobond issuance planned for 2014 if there is strong demand for forint debt, Laszlo Andras Borbely, AKK’s chief executive officer, said by phone today. The debt agency doesn’t see the need to immediately amend its issuance plan as it can “flexibly adapt” to local demand, he said.

“There probably won’t be any more foreign-currency issuances this year and that will boost Eurobonds,” said Adam Bakos, head of fixed income at Aegon NV’s fund management unit in Budapest, who helps oversee 2 billion euros ($2.8 billion) in assets.

The yield on the dollar bond due March 2024 fell 11 basis points to 5.01 percent, the lowest since the securities were first sold March 18.

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