In a bid to “further improve" Hungary’s debt structure the central bank (NBH) has announced new measures on Thursday, saying “banks may contribute to the country’s self-financing by purchasing government securities."
The Government Debt Management Agency (ÁKK) will need to react to the central bank’s upcoming actions. In view of this response we can imagine two extreme scenarios:
1.) the ÁKK will not increase the volume of its HUF issuances, in which case yields will drop sharply (as a result of the additional demand from the banks)
2.) the ÁKK will increase the volume of its HUF issuances, in which case we should not expect yields to change so drastically, but it is possible that Hungary will not have to issue foreign currency bonds “ever again".
HUF 600-1,000 bn could be “ejected" - 08:55
NBH managing director Márton Nagy said the key impact of the replacement of the 2w MNB bill is that this measures will start an “ejection" from this benchmark instrument and the funds freed this way could flow into shorter instruments as well, e.g. overnight MNB deposit, but this would have both technical and cost-side counter-incentives. (It is clear that non-residents may no longer hold the 2w MBN bill as of 1 August therefore they will either reinvest their current holdings in this instrument into other local assets or these funds will flow out of the country.) The funds freed may also find their way into longer-maturity, forint-based government securities.
Nagy noted that in relation to this package of measures the NBH would tolerate a EUR 1-2 billion decrease in foreign currency reserves over a 12-month period. (Hungary’s international reserves are currently at around EUR 36 bn and according to the Greenspan-Guidotti rule the minimum level would be some EUR 28 bn.) He also said that the “ejection" from the 2w MNB bill could reach HUF 600-1,000 bn, accordingly. At the same time, they would be happy to see even a few hundred billion forint worth of instrument replacement, Nagy said, adding that the bank has no specific goal they would consider success if achieved. The aforementioned means that the NBH expects asset redeployments of HUF 600-1,000 bn to be brought about by the measures announced today.
Two-week MNB bill stock - 08:42
According to central bank data, HUF 804 billion worth of two-week MNB bills were held by non-residents. This stock is expected to diminish by 1 August, as the two-week MNB bill will be replaced by a two-week deposit facility, which only counterparties will be allowed to hold with the Bank, i.e. institutions based abroad will not be allowed to buy or hold this instrument.
Until then non-residents will gradually reduce their 2w MNB bill holdings, i.e. they will either invest in other HUF assets or the above sum will flow out of the country.
For some reason, foreign holding of the 2w MNB bill jumped in February. The end-January stock was hardly more than half of the February figure. Total stock of 2w MNB bills amounted to HUF 5,372 bn at the end of February, 15% of which were in foreign hands.
C.bank takes action to lower external debt - 08:30
Rationale
“Since the outset of the financial crisis, investors have paid particular attention to assessing the external financing position of individual countries: high external debt and reliance on external funding are recurring subjects of analyses conducted by international organisations and credit rating agencies.
“In Hungary, the current account surplus of more than 3% of GDP was also reflected in the decline in the country’s external debt in 2013. However, reducing the vulnerability of the Hungarian economy requires the further reduction in gross external debt. To this end, it is desirable that economic agents, including the government, should move increasingly towards a financing model based on domestic, forint sources of finance.
“Strengthening the role of domestic sources in financing the government debt will lead to a decline in gross external debt. Lower gross external debt in turn will result in a smaller external refinancing need and lower external rollover risks. At the same time, the shift towards forint-denominated debt issues will improve the foreign currency composition of government debt: the sensitivity of debt ratios to changes in the exchange rate will be lower; and the share of foreign currency debt within the total government debt may return faster to levels seen prior to the onset of the crisis. Lower external debt and a healthier debt structure may reduce the country’s risk premium and contribute to reducing the costs of debt financing.
“Bringing down the economy’s gross external debt is desirable as long as reducing foreign exchange reserves in a prudent way is possible, and therefore part of foreign exchange reserves can be used to further reduce the country’s external vulnerability.
“This means that, in order to refinance part of foreign currency-denominated government debt maturing this year with forint debt, the Magyar Nemzeti Bank is ready to provide the necessary amount of foreign currency from foreign exchange reserves if the state in turn increases the size of forint-denominated debt issues.
“The Magyar Nemzeti Bank is of the view that, in addition to the sharp increase in participation among households in recent years, domestic banks have significant potential to increase their activity in government securities purchases.
Expected results
“A successful shift towards forint financing will lead to a contraction in the MNB’s balance sheet, in addition to the reduction in the country’s external vulnerability, given the decline in sterilisation instruments as foreign exchange reserves fall. All this may result in savings of HUF 10 billion at whole-economy level.
Meanwhile, portfolios on the asset side of banks’ balance sheets may undergo a gradual rebalancing, i.e. assets vis-à-vis the MNB (sterilisation instruments) may be replaced by assets vis-à-vis the government (government securities). This, therefore, will not influence the operation of the Funding for Growth Scheme.
Actions ahead
“Following the Monetary Council’s decision, the Bank will encourage the shift towards domestic sources of finance and the resulting reduction in the country’s external vulnerability using its own instruments. Reducing external vulnerability is closely related to the stability of the domestic financial system. Therefore, the Bank, without prejudice to its primary objectives, may play a role in encouraging a shift towards domestic sources of finance.
“To this end, the Monetary Council has decided to make changes in the Bank’s monetary policy instruments, which will result in the following actions:
From 16 June 2014, the Bank will introduce a forint interest rate swap facility, which will enable the Bank’s counterparties to mitigate the interest rate risk of long-term forint-denominated assets newly purchased or held.
From 16 June 2014, the Bank’s potential instruments will include a floating-rate long-term collateralized forint loan facility, which will improve access to forint liquidity.
From 16 June 2014, the Bank’s potential instruments will include an asset swap facility. Under the new facility, the Bank’s counterparties will be able to obtain foreign currency-denominated securities in exchange for long-term forint-denominated securities, which will improve access to foreign exchange liquidity.
From 1 August 2014, the Bank’s main policy instrument will change: the two-week MNB bill will be replaced by a two-week deposit facility, which only counterparties will be allowed to hold with the Bank. Deposits held with the MNB will continue to be excluded from the range of eligible collateral for the Bank’s lending operations.
“In the Monetary Council’s judgement, the instruments to be introduced will provide sufficient stimulus to the banking sector to contribute to a reduction in the country’s external vulnerability and to a move by the Hungarian economy towards a healthier financing structure. These actions will significantly help to strengthen financial stability and to achieve more sustainable economic growth."
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