ANALYST VIEW: What will Orbán do without growth in Hungary? - Nomura

Portfolio.hu: In your view, how do members of the investor community in London perceive Hungary? Is there enough long-term optimism for Hungarian assets? What is the reason for foreign investors’ large appetite for Hungarian bonds?

Peter Attard Montalto: People in London are neutral to slightly bearish on how they are viewing Hungarian assets at the moment. Some people look at it very simplistically, and they look at the large surplus; budget surplus and current account surplus this year, [they] see that as a positive. But people I think are thinking a lot at the moment about how the economy and how politics responds to moves in CHF/HUF, to the fact that growth will undershoot what the government is saying.

I think in general, in my view, and in that of investors, the core of the reform plan is actually not bad, since there are some very good elements to it: for example the incentives to go back to work. The key question is, how exactly does that work when you do not have growth and when you are close to the next election. That’s really where the questions are; they are not necessarily around the actual structural reforms. There is also a lot of disquiet about some of the revenue measures; one-off taxes, pension system changes. But investors are not overly negative on the reform plans, it’s on the ability to carry it out, implementation, and the risks around them.

I would say people are tactically taking up changes to buy Hungary on which they had been previously underweight. People are also thinking about how Hungary will respond to the risk event around a US downgrade and stress in Europe. Hungary, people perhaps think, may not be as bad as, say, Poland in terms of its reaction because of its current account surplus. It is certainly less vulnerable than it was in 2008.


P.: Hungary has the highest, if declining, debt-to-GDP ratio in the region. Do you think economic policy will be able to prevent the Eurozone crisis contagion from spreading to Hungary? Could Hungary get rapped by investors and grouped together with the most vulnerable Eurozone PIIGS countries?

P. A. M.: I think it is somewhat unfair to lump Hungary with the PIIGS countries in that the economy is developing still and it is at a different point in its two-element cycle. And one of the government’s core objectives, which is quite aggressive, is to reduce debt, which is very welcome, very laudable. But in some sense the issues are certainly the same, similar to what is going on in the PIIGS countries, about low potential growth, about competitiveness.


P.: What do you think Hungary should to do to fend off this contagion in the next one or two years? What steps should the government take in these years in order for Hungary to remain resistent to a negative external market environment?

P. A. M.: It could be interesting to look at Poland actually which has been very aggressively trying to establish a backstop against contagion in the last month or so. It is probably more than what Poland can do in a similar vein, so the central bank can start putting in place, or talking about liquidity measures, they could put in place SNB swap lines, ECB swap lines.

But Poland really has a slightly easier position because they could tap an FCL from the IMF while Hungary terminated its own credit line last year. It would be really very wise if Hungary were to have a stand-by or precautionary credit line, but that’s clearly not going to happen because of the fraught relationships.

Poland knows it is very vulnerable to a large periphery risk event and in the past it has been this risk proxy within the region, and now they are doing something about it. I think the risk then is that people look at the next weak link in the market after that, and that will be Hungary. On one side, Hungary’s current account surplus is positive; the flipside is the potential that people will look much more at Hungary during a sell-off. So Hungary does need to do more to ease pressure on the forint and limit extreme rate fluctuations. One such measure would be buying of the currency using EU structural funds, like Poland, in the open market rather than through the central bank.

P.: As concerns the 2012 budget, which is more important in your opinion: to reach deficit targets in order to allay market concerns, or to create a well structured budget and fully implement structural reform?

P. A. M.: This is a key question for Hungary. I look at my forecast vs. the government target, and the largest miss is actually next year - mine is 3.9% and the target is 2.5%, so more adjustment measures are needed in addition to those already in place if the government is really serious about meeting the targets.

I think in general investors are looking at the structural balance underneath more than at the headline deficit number, but of course meeting targets is still of very high importance.

There is basically a timing issue; the reform plan is back-loaded, so a lot of the structural reform is taking place in 2012 with a delayed effect. Meanwhile economic growth may be slower than the government target; you have key implementation risks, you also have the fact that a lot of it is reliant on growth which, I think, won’t be there. You can get people off benefits - that’s easy; but getting them into work is much more difficult. So what really cracks it next year is how the government can handle that lower growth and the stronger franc to forint if there’s going to be still no domestic demand. I think in either case they are not going to be able to boost growth enough by scaling back on the reform plan; there is probably more they can do on the tax side in terms of stimulating some more growth.

However in general I think the government recognises the importance of the 2012 budget to investors and is less concerned about lower growth becasue of fiscal drag next year. Reducing debt and being successful with implimenting reforms is more important for 2012 given the amount of political capital already put into these initiatives. For 2013 and beyond however I think growth will become more important for the government as we approach elections and hence I still have worries about long run reforms.

P.: What do you think about rating agencies’ approach towards Hungary? The country’s rating is on the verge of investment grade with all three major rating agencies, and two of them still maintain a negative outlook on Hungary.

P. A. M.: Rating agencies typically look at long-run sustainability in terms of debt path or structural reform. And of course they take the current account surplus into consideration as well. Just looking at it in terms of these, Hungary’s debt should arguably stay in investment grade. But with the policy implementation risks, they will probably want to see how the government will react to no growth and its impact on the budget. If those risks materialize, if the populism and the need for growth overwhelm the need for structural reform, that’s when you should downgrade. The risk is definitely to the downside in long term even if more evenly balanced in the short term.

P.: Rating agencies will probably also consider the fact that foreigners’ govenment bond holdings are at record levels. Do you think this is dangerous for Hungary and the HUF, or is money coming here just a natural phenomenon considering the Eurozone crisis?

P. A. M.: The level overall is not necessarily dangerous, it is the speed at which we have got there that is dangerous. But in a sense I think a lot of it depends on who has been buying. A lot of it has been real money buying, dominated by stable long-term investors moving back to benchmark. There has been some fast money buying but not on a major scale. What we have seen for months is that capital inflow has been stable and on a significant scale into emerging market bond funds, including the Hungarian market. When there is a major external shock, it is a big question how the market will respond, whether money will be removed from bond funds and consequently from Hungary. In normal times you don’t notice, but in stressed times you can get a much faster and more severe blow-up in rates because markets have become one-sided, pension funds generating stable demand have been removed from the market and liquidity is also lower.

P.: What should Hungary do in order to improve your assessment, as your comments are slightly bearish?

P. A. M.: Well, I think that a lot of people in London are turning more bearish on the medium run outlook - I mean, I have been bearish all the way through though tactically more positive on the short term, but I think a lot of other banks have turned slightly more bearish in recent months. In terms of what Hungary should do - I think there is probably a lot more to do at the local level, getting expenditure under control, and I think there is a need to establish a better backstop against external financial contagion, work on structural weaknesses, getting re-engaged with the IMF would be a good start. Consistently sticking with structural reform plans will certainly help improve investor confidence and removing some of the one off and distortive revenue measures that target investors. The govenrment could also be a lot more agressive about attracting new FDI.

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