Hungary Must Not Raise Rates as Forint Drops
Hungary may need to sell foreign- currency reserves to stem the forint’s decline to an all-time low versus the euro as lifting interest rates would be a “shot in the head” as the economy slows, Citigroup Inc. said.
The forint pared losses after plunging to a record yesterday, while the cost of insuring Hungary’s bonds against default rose to the highest since March 2009. The government sold a planned 40 billion forint ($172 million) of three-month debt after an auction of six-week bills failed yesterday. Standard & Poor’s last week warned it may cut the country’s credit grade to junk this month.
The Magyar Nemzeti Bank has been reluctant to cut interest rates, seeking to shield the forint. The currency’s drop as Europe struggles with its debt crisis forces Hungarian policy makers to weigh an emergency rate increase against “aggressive” sales of foreign currency, similar to tactics deployed by Turkey, Citigroup strategist Luis Costa said.
“The central bank hasn’t been fond of foreign-currency interventions but they have to basically drop this fear otherwise the next step is a hike,” London-based Costa said yesterday in a telephone interview. “I’m sure they’re not going to be pleased to hike in the middle of this massive contraction in domestic demand -- it would basically be a shot in the head.”
The forint, the world’s worst-performing currency since June 30 after sliding 15 percent against the euro and 21 percent against the dollar, weakened to as much as 317.92 per euro yesterday, a record low.
It traded at 313.90 at 12:32 p.m. in Budapest. Bonds fell, lifting the yield on benchmark government notes maturing in 2017 by 6 basis points, or 0.06 percentage point, to 8.695 percent by 11:25 a.m. in Budapest, the highest in more than two years. The yield jumped 48 basis points yesterday.
Policy makers of the rate-setting Monetary Council hold a regular meeting today. Interest rates are not scheduled to be discussed. A statement will be issued at 2 p.m. today. The next rate-setting meeting is planned for Nov. 29.
Investors are betting borrowing costs will increase to 7 percent or more by February from 6 percent at present. Forward- rate agreements fixing interest costs in three months rose to 7.46 percent today, a two-year high. The contracts traded 1.15 percentage point above the three-month Budapest Interbank Offered Rate to which they settle.
Central Bank Meeting
The central bank, which has kept its benchmark rate unchanged for the last nine months, projects the economy will grow 0.6 percent next year as tax increases aimed at containing the budget deficit slow expansion.
Gross domestic product rose 1.4 percent in the third quarter, compared with 1.5 percent in the second quarter, the Budapest-based statistics office said in a preliminary report today. The median estimate of 15 economists in a Bloomberg survey was 0.8 percent. The economy expanded 0.5 percent from the second quarter, when growth was a revised 0.2 percent.
While growth showed “unexpected resilience,” expansion is expected to slow in the coming quarters and the risk of a recession “is still uncomfortably high,” Zsolt Kondrat, a Budapest-based economist at Bayerische Landesbank’s MKB Bank Zrt. unit, said in an e-mail today.
S&P Downgrade Threat
S&P placed Hungary’s lowest investment grade on “CreditWatch with negative implications” on Nov. 11, saying the country’s “unpredictable” policies, such as levying extraordinary industry taxes and forcing lenders to swallow exchange-rate losses on loans, are harming investment and growth as the economic environment is deteriorating.
Fitch Ratings cut the outlook on Hungary’s BBB- credit grade to negative the same day.
Turkey joined Indonesia, India, Brazil and Russia in selling dollars to stem currency declines as concern that the global economy may be headed for recession reduces demand for emerging-market assets.
Its central bank sold more than $2 billion in October to prop up the lira, extending a two-month campaign to halt losses. The currency has gained 4.5 percent against the euro in the last month, paring this year’s drop to 18 percent.
Turkey had $84 billion in foreign-currency reserves as of Oct. 28, compared with $51.3 billion for Hungary as of Sept. 30, according to data compiled by Bloomberg.
Still, Turkey’s central bank has also pushed up borrowing costs by denying banks access to funding at the benchmark one- week repo rate of 5.75 percent on some days and instead providing it only through the overnight lending rate, at a cost of as much as 12.5 percent.
Turkey’s lessons show that Hungary may not be able to avert interest-rate increases and that market interventions may only slow the pace of declines temporarily, according to Neil Shearing, an emerging-market economist at Capital Economics Ltd in London.
“To the extent that Turkey offers any lessons for Hungary, it really reinforces the age-old adage that foreign-currency intervention by national banks tends to be relatively ineffective at drawing a line under the currency,” Shearing said yesterday by phone. “You really need to tighten monetary policy.”
2008 Emergency Increases
Hungary resorted to emergency rate increases in 2008 as the country obtained an International Monetary Fund-led bailout to avert a default. Prime Minister Viktor Orban, elected last year, has rejected a new IMF credit line even with Hungary now at the lowest investment grade with a negative outlook at all three major credit-rating companies.
Hungarian policy makers may not have the tools to fight the effects of a crisis as big as the one roiling the euro area, according to Win Thin, head of emerging market strategy at Brown Brothers Harriman & Co in New York.
A “game-changer” for the forint which would spare the country either a rate increase or market intervention and assuage investor concerns would be for the government to obtain an IMF credit line, Tim Ash, head of emerging-market research at Royal Bank of Scotland Group Plc, wrote in an e-mail today.
Orban and his Cabinet have ruled that out repeatedly because that may force them to reverse self-described “unorthodox measures.” Hungary wants to continue financing its debt from market sources at “all cost,” government spokesman Andras Giro-Szasz told state-run M1 television today.
“The markets would clearly appreciate” an IMF backstop “and this could well forestall the need to hike policy rates,” Ash said. “I don’t sense yet from the government’s body language that they are yet ready to cave in on the IMF front. This then leaves the forint center-stage, with the market still expected to want to test out the central bank and government’s willingness to let the forint find its own level.”