Economy
Ain't nothin' to see here folks! Hungary's forint fallin' as it's s'posed to
By István Madár
Hungary’s forint is doing what the central bank (NBH) wants it to do - it weakens. A permanent devaluation of the forint is a means of economic policy to foster economic growth. The question is whether it can be successful or not. Besides financial stability risks a pickup in consumer prices could limit the central bank’s maneuvering room in this respect. If the Bank fails to react in time, its credibility could suffer a serious blow.
The Monetary Council’s decision on Tuesday to lower the base rate by 15 basis points to a new record low of 2.70% (against the market’s call for a more cautious 10bp reduction) likely leaves no trace of doubt even in the minds of sceptical observers that the central bank does not oppose to a weak forint. Quite the contrary, it intentionally wants to devalue the forint. Monetary policy in itself gives little boost to the economy therefore monetary expansion must be done via the exchange rate.
Demand stimulation is fully in line with NBH Governor György Matolcsy’s economic policy thinking and his risk appetite in this respect also gained evidence now. As Economy Minister he tried fiscal -stimulus even in a fragile environment, but his attempt was thwarted by the European debt crisis and in part by the chosen tool (flat-rate tax). Amidst much more favourable capital market conditions Matolcsy can give economic stimulus another go - now from the highest chair of the central bank.
The central bank’s management was replaced in the first half of 2013. Since then HUF eased 10 clicks versus the euro. However, neither this, nor capital outflow from emerging markets could persuade the MPC to suspend the rate cut cycle. They only tried to stem HUF weakening by reducing the pace of easing.
Of course, this may be explained by the central bank’s inflation targeting. The consumer price index, which was pushed to a record low by the government-sponsored energy price reductions, could be reassuring but it itself it is not necessarily a good enough reason for taking the key policy rate to such depths. Not only is there no danger of deflation, but even the probability of undershooting the 3% inflation target is slim. Forward-looking inflation is so far from the goal which would already justify monetary easing already inducing stability risks. Not to mention that the central bank is admittedly driven by several objectives. Besides more emphasis on growth aspects it now takes fiscal issues into consideration too. Viktor Orbán’s government has received such assistance from Matolcsy’s NBH that it may not even want.
Varga resp
In view of the above we can rest assured the forint will persistently remain (well) north of 300 versus the euro. And make no mistake this is not because capital market shock or a stress situation triggered by the debt crisis. It is not even the consequence of the unorthodoxy of economic policy. This situation was deliberately created by monetary policy. It was its target. Therefore the easing of the forint in itself should be no reason for concern, even if we find it unusual.
Not that this would not raise questions. Discussing these in merit, however, would require a much longer piece than this article. Still, it is worth pondering about a few things.
I. How long, to what level does the central bank intend to weaken the forint?
I/A. Does this process have any risk for the capital market? Can it be managed without strong market turbulences and without burning up a great volume of foreign currency reserves?
II. Can we expect monetary expansion to lead to the desired growth impact? This leads to further questions:
II./A. If what the government so proudly advertises is true and the Hungarian economy is that competitive, why does the central bank (the cabinet?) needs this stimulus attempt via exchange rate weakening?
II./B. The real exchange rate of the forint was among those that devalued the most since the 2008 crisis even before the current depreciation spree. In light of this did Hungary really need a second wave of devaluation?
II./C. The negative output gap is likely to close towards the end of the year. Can monetary expansion gain justification in this case too?
II./D. If Hungary’s trade surplus is at an all-time high, why does anyone (c.bank, gov’t) need to surmise that the forint exchange rate that is in harmony with the (price) competitiveness of the economy is at weaker levels?
III. In view of the above, what adjustment processes a nominal exchange rate diverted from the balance could trigger? Real exchange rate may get adjusted also via high inflation, but it could equally happen that the devaluation attempt proves ineffective and because of the C/A surplus the exchange rate strengthens back. Or to avoid that situation the base rate will be kept persistently below the equilibrium real interest rate.
The answers to the questions in group III could be rather awkward for traditionally monetary policy. If the forint depreciates further, we might just get to know these answers pretty soon.
Hungary’s forint is doing what the central bank (NBH) wants it to do - it weakens. A permanent devaluation of the forint is a means of economic policy to foster economic growth. The question is whether it can be successful or not. Besides financial stability risks a pickup in consumer prices could limit the central bank’s maneuvering room in this respect. If the Bank fails to react in time, its credibility could suffer a serious blow.
The Monetary Council’s decision on Tuesday to lower the base rate by 15 basis points to a new record low of 2.70% (against the market’s call for a more cautious 10bp reduction) likely leaves no trace of doubt even in the minds of sceptical observers that the central bank does not oppose to a weak forint. Quite the contrary, it intentionally wants to devalue the forint. Monetary policy in itself gives little boost to the economy therefore monetary expansion must be done via the exchange rate.
Demand stimulation is fully in line with NBH Governor György Matolcsy’s economic policy thinking and his risk appetite in this respect also gained evidence now. As Economy Minister he tried fiscal -stimulus even in a fragile environment, but his attempt was thwarted by the European debt crisis and in part by the chosen tool (flat-rate tax). Amidst much more favourable capital market conditions Matolcsy can give economic stimulus another go - now from the highest chair of the central bank.
The central bank’s management was replaced in the first half of 2013. Since then HUF eased 10 clicks versus the euro. However, neither this, nor capital outflow from emerging markets could persuade the MPC to suspend the rate cut cycle. They only tried to stem HUF weakening by reducing the pace of easing.
Of course, this may be explained by the central bank’s inflation targeting. The consumer price index, which was pushed to a record low by the government-sponsored energy price reductions, could be reassuring but it itself it is not necessarily a good enough reason for taking the key policy rate to such depths. Not only is there no danger of deflation, but even the probability of undershooting the 3% inflation target is slim. Forward-looking inflation is so far from the goal which would already justify monetary easing already inducing stability risks. Not to mention that the central bank is admittedly driven by several objectives. Besides more emphasis on growth aspects it now takes fiscal issues into consideration too. Viktor Orbán’s government has received such assistance from Matolcsy’s NBH that it may not even want.
Varga resp
In view of the above we can rest assured the forint will persistently remain (well) north of 300 versus the euro. And make no mistake this is not because capital market shock or a stress situation triggered by the debt crisis. It is not even the consequence of the unorthodoxy of economic policy. This situation was deliberately created by monetary policy. It was its target. Therefore the easing of the forint in itself should be no reason for concern, even if we find it unusual.
Not that this would not raise questions. Discussing these in merit, however, would require a much longer piece than this article. Still, it is worth pondering about a few things.
I. How long, to what level does the central bank intend to weaken the forint?
I/A. Does this process have any risk for the capital market? Can it be managed without strong market turbulences and without burning up a great volume of foreign currency reserves?
II. Can we expect monetary expansion to lead to the desired growth impact? This leads to further questions:
II./A. If what the government so proudly advertises is true and the Hungarian economy is that competitive, why does the central bank (the cabinet?) needs this stimulus attempt via exchange rate weakening?
II./B. The real exchange rate of the forint was among those that devalued the most since the 2008 crisis even before the current depreciation spree. In light of this did Hungary really need a second wave of devaluation?
II./C. The negative output gap is likely to close towards the end of the year. Can monetary expansion gain justification in this case too?
II./D. If Hungary’s trade surplus is at an all-time high, why does anyone (c.bank, gov’t) need to surmise that the forint exchange rate that is in harmony with the (price) competitiveness of the economy is at weaker levels?
III. In view of the above, what adjustment processes a nominal exchange rate diverted from the balance could trigger? Real exchange rate may get adjusted also via high inflation, but it could equally happen that the devaluation attempt proves ineffective and because of the C/A surplus the exchange rate strengthens back. Or to avoid that situation the base rate will be kept persistently below the equilibrium real interest rate.
The answers to the questions in group III could be rather awkward for traditionally monetary policy. If the forint depreciates further, we might just get to know these answers pretty soon.
