Economy 23 November 2020, 10:22am

How much is Hungary losing on separate bond issue compared to the EU recovery fund?

Portfolio

A week after Hungary sold EUR 2.5 billion in FX bonds, its government last week put a political veto on the European Union’s NextGenerationEU recovery fund, which would probably offer a loan at a lower interest rate. Why was it worth it to sell debt at higher interest and how much will Hungary lose on going it alone instead of the joint financing solution?

Cheap debt, but could be better

Hungary issued FX bonds on 12 November at more favourable terms than earlier. Half of the EUR 2.5 bn total was 10-year maturity and the other half was 30-year, with annual coupon of 0.5% for the former and a record low 1.5% for the latter. As the bonds were not issued at 100% face value, the actual yield is somewhat higher, 0.65% and 1.66% respectively. The low rates were mainly due to two reasons:

The global yield environment is very low, with central banks flooding the markets with money even at 0% interest rate.
The risk assessment of Hungary has improved markedly in recent years.

According to the Government Debt Management Agency (ÁKK), the bond issue was to pre-finance 2021 international debt maturities. However, speaking on the Friday following the issue, Prime Minister Viktor Orbán said part of the funds would be used for development projects already scheduled so that Hungary would not lose out on developments due to the veto of the EU budget and the recovery fund.

At first glance, there would have been cheaper options than the FX bond issue, as Hungary would be entitled to EUR 10 bn in loans and EUR 7.6 bn in grants from the NextGenerationEU recovery fund. However, Hungary vetoed both the fund and the EU’s next budget last week due to the rule of law conditions attached, although this has not been a final veto but rather a political one.

Why veto?

At present, no one know what the yield of the 30-year joint EU bond would be as investors would price Germany’s minus 0.2% as well as Italy’s 1.5% yield. However it is nearly certain that

At present, the EU would be able to go to market at a lower interest rate than Hungary.

The estimated coupon of the EU bonds would be 0.1% to 0.2% in the current environment, compared to the 1.66% Hungary will pay on its 30-year bonds, which means Hungary could sell debt much cheaper as it could access EUR 10 bn in loans at any time. Doing the math, Hungary will pay EUR 20.7 million in interest annually on the EUR 1.25 bn worth of 30-year FX bonds, compared to just EUR 1.9 mn for a hypothetical 0.15% EU loan.

The difference comes to EUR 18.8 mn a year, which is worth HUF 6.8 bn at current rates.

During the entire 30-year maturity, this translates to extra costs of more than HUF 200 bn. However, the HUF 6.8 bn annual figure is but a drop in the ocean compared to Hungary’s approximately HUF 1,000 bn annual interest expenses.

But why was it worth vetoing the cheaper EU fund and going to the market?

Debt management should of course never be seen from a purely financial aspect. If interest rate was the only consideration, Hungary would finance its debt through short-term FX bonds. There are two fundamental problems with the NextGenerationEU fund:

For one, the bond based on the fund has not been issued yet and its yield can only be estimated at present. Even if some kind of compromise is reached soon about the issue, funding would not become available before the middle of 2021. If Hungary needs funds before that date, waiting for the cheaper loan is not necessarily a good move. An USD 1.6 bn batch of FX bonds is set to mature at the end of next March, by which time the EU funds will certainly not be available yet. It is also nearly impossible to predict market conditions next spring when the joint bond would be issued, so there is a risk that the final solution will be less favourable than now estimated.
On the other hand, Hungary’ government has clear political concerns as it vetoed the plan due to the rule of law conditions attached. Meanwhile, the market does not set such conditions and prices any concerns it has regarding the rule of law.

To sum it up, Hungary could not wait for the joint EU bond issue as it needed funds earlier for pre-financing, while the government did not want to subject itself to rule of law conditions. It appears that resistance and the fattening of financial reserves is worth a few billions of forints a year to the government, which amount is negligible compared to the entire budget or to total interest expenses.

Cover photo: Getty Images