Economy 9 December 2015, 3:00pm

Hungary recovers from a long-term sickness

Portfolio

Although Hungary’s public debt remains sizeable it no longer causes problems because the local market has undergone positive developments over the last few years, Morgan Stanley has said in a recently published Global Emerging Market Fixed Income Outlook. Although in CEEMEA it continues to favour Hungary, it projects forint weakening for the first half of 2016, expecting the central bank to cut its key policy rate further from the already record low of 1.35%.

Morgan Stanley has a maximum overweight (max OW) rating on Hungarian bonds, i.e. the U.S. bank’s London-based analysts expect Hungarian yields to keep on dropping in 2016. Pasquale Diana, who covers Hungary at MS, projects the yield on Hungary’s 10-yr government bond to fall to 2.9% in the first half of next year from around 3.5% currently. At the same time, his rating on the HUF is underweight, saying the central bank’s (MNB) measures will be the foremost reason for HUF weakening.

“Should the ECB and BoJ fail to benefit from higher inflation or growth (or both) in the US, and instead see economic deterioration, they could increase their own asset purchase programmes. This is already our base case for the euro area, and a risk in Japan. Such a move would likely offset some of the tightening by the Fed, and could offer some support to EM," Morgan Stanley’s analysts write.

As regards local rates, they project that countries linked to the euro area and Japan could see a rally in the front end and curve steepening.

“Poland, Hungary and Korea could all be outperformers," they said.

“This scenario should take some pressure off EMFX, but this positive factor is likely to be offset by concerns about global growth. That said, carry trades should be attractive, as the ECB and BoJ QE should keep the long end of US Treasuries in check."

Hungary continues to go along the improvement path: Although the stock of debt remains high in Hungary when compared to peers, it has already undergone a significant deleveraging and is no longer cause for concern," commented Diana in the report.

In his view, Hungary’s key transition will likely be from a creditless recovery to one where growth is perhaps slower (around 2-2.5%Y) but credit aggregates recover.

Meanwhile, external debt is not as big a worry as the stock implies, he added.

Diana noted that Hungary has been disciplined in its budget execution and he expects 2016 to be no exception.

“Under the assumption that the Treasury will not issue any hard currency bonds, we expect slightly lower net issuance but higher gross issuance in 2016. The spending on the immigration issue could be a wild card, as the HUF 60 billion spending on immigration in 2015 represented 0.2% of GDP."

The Hungarian government and the Government Debt Management Agency (ÁKK) have been emphasising for months that there is no intention to issue foreign currency bonds in 2016 either and that expiring FX debt would be financed by HUF issuances. In its baseline scenario MS projects that this goal will be met and gross local currency bond issuance will be HUF 2,324 bn in 2016 after this year’s HUF 2,125 bn. Net issuance, however, is expected to drop to HUF 1,100 bn from this year’s HUF 1,126 bn.. The analysts forecast 86% of the issuances to be fixed rate bonds and only 14% to be other types. As regards the maturities, 69% of the bonds are projected to be up to 5 years, 27% in the 5yr to 10yr range and only 4% longer than 10yr. The ÁKK is expected to publish its financing plan for next year in the coming weeks and then we can find out whether the debt manager shares such views or not.

Diana noted that Hungary is likely to get upgraded in the near term, adding that “foreign holdings have fallen substantially, so there is scope for an upgrade to drive inflows, supporting local rates and FX."

In his view, an upgrade is largely in the price on the credit side.

“Hungary is among the credits that have already completed most of its adjustments, as seen by the large current account surplus, lower fiscal balance and stabilising debt levels. The aim of not issuing any more external debt is also a positive technical. However, we believe this is largely in the price, even if Hungary succeeds in regaining IG status, as it already trades significantly inside IG. Positioning, at multi-year highs despite being slightly underweight, further reinforces our view of limited upside," Diana said.

MS also published an interesting chart on the foreign ownership of local bonds.

This clearly shows that there were periods since 2010 when Hungary had the largest ratio among the countries examined, while by not Malaysia and Poland have taken Hungary over in this respect. Poland’s foreign ownership ratio was well below Hungary’s even 12 months ago. The chart also suggests that if the favourable trend continues, Hungary will be able to “beat" several countries, including Indonesia, Peru, Mexico and South Africa that are already very close.

“Hungary remains our favourite long," Diana said, adding that he expects the central bank to cut rates by 35 basis points in 1H16 versus 7bp priced in the market.

“The MNB has been creative in its unconventional tools to support local demand for HGBs. We won’t be surprised if it announces further measures. We favour frontend receivers, flatteners in bonds and asset swap tighteners," he added.

His outlook on the forex market is not so upbeat, though, projecting moderate weakening in the HUF along with several other CEE currencies for the first half of 2016.

“We think the headwinds to HUF strength that played out this year will continue to delay HUF strength for much of 2016. The authorities’ self-financing programme and desire to reduce the FX share of debt in addition to the non-resident holdings of local debt - while a positive for the medium-term stability of HUF - may also lead to more financial account outflows. In addition, more dovish policy is a risk for HUF. We think HUF is undervalued, but we do not recommend positioning for strength yet," Diana said.

He forecasts EURHUF at 320 at the end of Q1 and Q2, 316 for the end of the third quarter and 312 for the end of next year. If we add that along with other investment banks MS also projects USD appreciation versus the euro for 2016, the Hungarian forint’s underperformance could be even more apparent.

MS is upbeat not only on Hungary by the entire Central and Eastern European region, saying this area is a lot more protected from external risks than other emerging markets therefore a Fed rate hike or China’s slower growth and the related commodity price decrease can have a less dramatic impact on CEE. Poland has been upgraded to market weight, whereas MS remains bearish on Romania and has an underweight recommendation for Romanian assets, saying fiscal and political risks have increased there.