Oct 29, 2008 | 21:09 GMT

8 mins read

Hungary: Just the First to Fall?

The International Monetary Fund (IMF) announced Oct. 29 that it will join with the European Union and the World Bank to give Hungary a 20 billion euro ($US25.5 billion) loan. The size of the loan — and the coordination among the IMF, the European Union and the World Bank — shows just how hard the global financial crisis has hit Hungary and how much fear there is that the financial contagion could spread from Hungary to the rest of emerging Europe.
The International Monetary Fund (IMF) announced Oct. 29 that it will join the European Union and the World Bank to give a 20 billion euro ($25.5 billion) loan to Hungary — the largest such loan since the global financial crisis began. The IMF will contribute 12.5 billon euros ($15.7 billion), the EU 6.5 billion euros ($8.1 billion) and the World Bank 1 billion euros ($1.3 billion) in what is the first coordinated effort to bail out a state in the current financial crisis. The 20 billion euro package follows the Oct. 16 loan from the European Central Bank (ECB) for 5 billion euros ($6.75 billion), for a total aid effort of 25 billion euros ($32.3 billion). The enormity of the IMF bailout — and the IMF's coordination with the EU — illustrates the severity of the crisis in Hungary and the fear that the crisis could spread to the rest of Central Europe and the Balkans, where countries face fundamentally the same problems as Hungary. The rapid influx of foreign capital into these economies, combined with the largely foreign ownership of their banking systems, makes for an unstable liquidity situation in light of the global flight of capital to safety. Foreign banks in the region — particularly Italian, Swedish, Austrian and Greek banks — have multiple assets that may be lost when Central European and Balkan customers can no longer pay their loans due to depreciating currency, which will only encourage the crisis to spread further and faster. Hungary has the distinction of being the first Central European economy to feel the full effects of the crisis because of a combination of the government's economic mismanagement, which has allowed the budget deficit to balloon to 5.5 percent of gross domestic product (GDP), and particularly heavy reliance on foreign denominated loans — particularly in Swiss francs. The Austrian and Italian banks that dominate Hungary's banking sector, along with Hungary's biggest domestic banks, made loans denominated in low-interest Swiss francs the primary method of financing consumer and mortgage debt in Hungary. Since 2006, nearly 90 percent of all mortgages have been denominated in Swiss francs. On Oct. 15, Austrian banking giants Raiffeisen and Volksbank restricted foreign currency lending. MKB Bank (the Hungarian arm of Germany's Bayerische Landesbank) followed suit, and on Oct. 29 so did CIB Bank, the Hungarian subsidiary of Italy's Intesa. Swiss franc loans account for approximately 40 percent of both the total mortgage and total consumer debt market. The fear in Europe is that with the possible collapse of the Hungarian forint — which is down more than 17 percent since the start of October — loans denominated in foreign currency such as Swiss francs and the euro will become unserviceable for Hungarian customers. To fight off the collapse of the financial system, Hungary has already used part of the 5 billion euro loan from the ECB to fight off speculative attacks against the forint and on Oct. 22 raised interest rates 3 percent. The problem with the rate hike is that it could spur further hikes throughout Europe as countries compete for the ever-dwindling amount of free capital, in a situation reminiscent of the interest rate hikes that accompanied and fueled the East Asian crisis in 1997. Between competitive rate changes and a depreciating currency, the danger of contagion is palpable. The countries most at risk are those similarly exposed to foreign loans: Romania, Croatia, Bulgaria, Serbia and the Baltic states. Italian, Austrian, Greek and Swedish banks that dominate the region could then face collapse and transmit the financial disease into the eurozone and thus the rest of Europe. The IMF, World Bank and EU are therefore hoping to nip the crisis in the bud with their massive rescue package. The idea is to shore up the domestic and foreign currency liquidity so that Hungary can fend off speculative attacks and prevent the forint from further depreciation. Money will also be made available to the banks so that they do not freeze lending as their foreign currency loans become threatened with default. The IMF is hoping that the package will assure that the crisis does not spread to the neighboring emerging markets that have so far held out on the basis of better macroeconomic policies (Romania has, for example, used its $35 billion foreign exchange reserves to fight off speculative attacks on the leu, but this will not suffice if a massive flight of capital occurs). The attempt to shore up Hungary is the best shot the IMF has at limiting the crisis to Hungary. Unfortunately, the rest of the region faces fundamentally the same problems Hungary does and thus is likely to see similar currency and banking sector collapses. Hungary was the first to buckle because of its particularly poor economic management, but its neighbors are just as vulnerable to the global credit crunch. Here are just some of the economies STRATFOR is looking at right now:
  • Romania: Standard & Poor's lowered Romania's foreign currency debt rating to "junk" Oct. 27. The Romanian Central Bank is intervening in the currency market to stave off speculative attacks.
  • Bulgaria: Banks are restricting mortgage lending. The Greek, Austrian, Hungarian and Italian banks that dominate the banking market are worried about the possible depreciation of the leva. The government announced Oct. 28 that it would spend US$3.44 billion on infrastructure projects to stave off recession. A high budget surplus will help (3.4 percent of GDP), but an astronomical trade deficit will not (21.4 percent of GDP).
  • Serbia: IMF officials arrived in Belgrade on Oct. 28 to participate in the drafting of Serbia's 2009 budget. A loan agreement will be negotiated as well. Serbian government has wisely been running a surplus, but its trade deficit is one of the largest in Europe at nearly 13 percent of GDP.
  • Baltic states: Standard and Poor's lowered credit ratings for Lithuania and Latvia to BBB/A-3 on Oct. 27, which indicates a possibility that — due to the financial crisis — borrowers may not be able to meet their financial commitments.
  • Croatia: A budget deficit (1.6 percent of GDP) and trade deficit (8.6 percent of GDP), combined with the foreign ownership of more than 90 percent of the country's banks and high involvement in foreign currency lending, mean that Croatia is as exposed to the crisis as Hungary is. Croatia could be the next country to turn to the IMF.
  • Poland: A slowdown in industrial exports combined with a budget deficit (2 percent of GDP) and a government debt of 45 percent of GDP could leave the largest Central European economy exposed if its neighbors begin collapsing.
  • Slovakia: Reliance on the automotive industry for growth will leave Slovakia exposed as the recession severely cuts demand for cars in Europe. An almost entirely foreign-owned banking system and a budget deficit (2.2 percent of GDP) do not help.
  • Czech Republic: A small trade deficit (3 percent of GDP) will help, but its budget deficit (1.6 percent of GDP) and the foreign ownership of more than 90 percent of its banks spell trouble. The Czech Republic is also highly dependent on exports — 76 percent of GDP — which will lead to a recession as global demand for goods drops.
From emerging Europe the crisis could spread through foreign-owned banks to Western Europe. Banks that STRATFOR is keeping a close eye on are:
  • Italy: Intesa and UniCredit are European giants, but are also exposed heavily to the region. Trading in shares of Intesa and UniCredit stopped Oct. 28 due to excessive losses (Intesa fell 9.31 percent, with UniCredit down 12.12 percent). Intesa is particularly exposed to Slovakia, Croatia and Serbia and UniCredit is exposed to Croatia, Bosnia, Bulgaria, Poland, Kazakhstan, Ukraine and Russia. Furthermore, Italy's economic fundamentals are poor. The budget deficit is 1.9 percent of GDP and the external government debt is 104 percent of GDP.
  • Austria: Raiffeisen and Erste Bank are Vienna-based financial giants that have, over the last decade, made a strong push into Central Europe and the Balkans. Joining them in the region are Volksbank, BAWAG P.S.K and Bank Austria Creditanstalt (also part of Italy's UniCredit). Austrian banks rely on Central European markets for a whopping 35 percent of total profits and are most exposed to Croatia, Hungary, Slovakia, Romania and the Czech Republic.
  • Sweden: The Swedish government announced Oct. 20 that it will guarantee more than 1.5 trillion Swedish crowns (US$205 billion) of borrowing by banks and financial firms. Sweden is worried that its enormous exposure to the Baltics (Estonia and Latvia have liabilities to Swedish banks in excess of 100 percent of their GDP, and Lithuania is close behind) will collapse the country's banking system.
  • Greece: Besides its exposure to Bulgaria, Romania and Serbia, Greece has weak economic fundamentals. It has a budget deficit of 2.8 percent of GDP and a government external debt of more than 90 percent of GDP.

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