A whistle stop tour of Hungary (speaking at Portfolio.hu’s Budapest Economic Forum) and Warsaw, clarified a number of important issues, said Peter Attard Montalto, economist at Nomura International in London, in a recent trip note. He said Hungarian policy makers and investors see an S&P downgrade as a “done deal", adding that the fact the government is openly talking about it is “a sign we must now ready ourselves for the event."
Locals are “more bearish than ever", both on growth and on policy, he noted, adding that the government’s headlong flight down the path of radical reform is leading to “increasing collateral damage". In Attard Montalto’s view the key question now is how much damage to the economy is likely to occur as a result and whether we reached crunch point.
Attard Montalto found the mood in Hungary “surprisingly bearish", with most people seeing a recession emerging next year (62% in a conference poll), and another two years of zero credit growth.
Also, a full 75% of investors saw the medium run outlook for the economy being mostly or very negative vs. the rest of the region and a high probability of both policy and external contagion getting worse. “By way of comparison we look fairly bullish, with a 0.9% growth forecast for next year," he said.
“It was particularly interesting to hear from banks, especially the foreign banks. Exasperation and gallows humour seemed to be the order of the day as the questioning around their position with respect to the government’s plans to rid the economy of FX debt," the analyst said.
In his view, their position has shifted “from believing a government could not be so reckless with policy to now a view they will need to bunker down for three years or so until the storm passes."
“Still seeing light at the end of a rather long tunnel, the banks are still in no mood to exit, understanding the costs both of exit now (a potential fire sale for assets) and the costs of eventually re-entering at some point in the future are very high," he said.
However, he noted that there were hints of fear that forced bank deleveraging from eurozone loss would make Hungarian operations prime candidates to be sold.
The economist underlined that no foreign bank he spoke to was considering any expansion of business of credit lending in the next 18 months. Local banks by contrast were “more bullish given the perception of a state backstop (in terms of guarantees and capital) to boost lending", however Attard Montalto still does not understand how this is possible on balance sheet now or how it would be workably off balance sheet.
Looking beyond collateral damage
In terms of the government’s plans, it seems “clearly fixated" on its goals of debt reduction, fiscal consolidation and on structural reform, “with speed being of the essence with the eurozone crisis bearing down."
Listening to some of the government rhetoric however, Attard Montalto fears “they misunderstand the support provided to them by bond inflows in the past as there were passive and the result of allocation adjustments."
“This same support is not available now, especially given what they are doing with their FX debt policy."
“One thing is clear though the line of "surely no government can do something so reckless" that we have been asked by investors over and over again since the election last year, has no basis now. We should fully believe that the government will do everything it can as quickly as it can, regardless of collateral damage, in order to meet its goals."
S&P downgrade seen as done deal
To this end a downgrade by S&P is “seen as a done deal locally, by both senior policy makers and by local asset managers and analysts," Attard Montalto said.
He noted that whilst as ever he does not like predicting such moves, he warned that we “surely must prepare for a downgrade" given even the Ministry of National Economy is openly talking about it.
His view remains that forced selling will be “very limited" following a downgrade (some convergence funds and some large global bond mandates only represent a small segment of the market), and whilst there may well be some market reaction on any move “it may well be largely priced into the market."
“The more important question is will it lead to a reversal of the very high participation of foreigners in the bond market."
No time for the perfect storm yet
This of course raises the following question, does current policy and a downgrade create a perfect storm of confidence for Hungary.
Attard Montalto still believes there are a “key number of steps to go" before we reach such a point, even after a downgrade.
In particular, “a more complete understanding that the central bank (NBH) is only a partial backstop for the currency is required; that the NBH may well be pressured into credit easing and that the fiscal position is unsustainable." In his view, this may still only come into next year.
Attard Montalto also noted that locals seem “equally overconfident" in the NBH’s eagerness to jump in and hike rates. His view remains that “a hike is actually further off than many think with a key trigger being that HUF needs to move in a disorderly manner in order to shift rates."
Also he continues to believe that “both the seeking external IMF support and the diametrically opposite policies of the IMF would require mean that the government wouldn’t turn to the IMF for assistance until after a blow up or balance of payments crisis."
There was also a lot of interest, in his view, that a balance of payment (BOP) crisis can occur in Hungary even with a current account surplus, “given the current bond market dynamics of high foreign ownership and high secondary market liquidity from foreigners."
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