Forgoing the EU’s RRF loan will cost Hungary hundreds of billions of forints
Debt skyrocketing – No more wanted?
Last year, Hungary’s debt rose to 80.4% of GDP according to preliminary data from 64.7% in 2019 as a result of the coronavirus pandemic and the crisis it caused. This broke an eight-year falling trend, and the debt rate suddenly returned to the historic high of 2011.
The government does not expect a sharp decline in coming years as the latest convergence programme calls for 79.9% of GDP in 2021, while the 2022 budget bill calls for 79.3%, and the debt rate is expected to be 73.1% in 2025, so the 2019 low will not be achieved again in the foreseeable future. Under the Stability Act, debt must be reduced at least slightly each year, except in years when the economy shrinks.
This year’s outlook reveals why the government does not want to access the EU fund’s loan facility, as there is a very small difference between the 80.4% debt rate at the end of last year and the 79.9% projected for 2021, which means debt reduction could be jeopardised by even a slight hiccup in the economy or a small movement in the price of the forint.
From this aspect, the government’s aversion to the common EU loan is understandable, but it is less justified if we take into account that
interest on the RRF loan would most likely be much lower than that of market-based or intergovernmental loans of similar maturity.
We will put specific numbers to the interest cost of foregoing the EU loan below and also offer some considerations that may throw a different light on the issue.
How much will Hungary lose on not taking the EU loan?
First, let’s look at the financing opportunities of the RRF fund compared to market loans. Hungary last entered the international bond market in November, when the Government Debt Management Centre (ÁKK) sold 10-year and 30-year euro bonds. The coupons were 0.5% and 1.5%, respectively, but the bonds were sold at a discount so the actual yield was 0.64% and 1.66%.
The European Union is certain to secure loans at a lower interest rate than that. Although the bonds that will finance the RRF have not been issued yet, there are already some examples. As part of the Support to mitigate Unemployment Risks in an Emergency (SURE) fund, the EU floated bonds of similar maturity (10 to 30 years) in recent months, typically at an interest rate between 0.2% and 0.4%, so we can use 0.3% as a basis for comparison for the RRF.
Based on the above,
financing could have been 0.85 percentage point cheaper than last November’s long-term bonds.
Last autumn, Hungary took out a EUR 2.5 billion loan to secure this year’s foreign currency requirements. If Hungary had been able to use the RRF loan instead, it would have saved EUR 21.3 mn (HUF 7.7 bn) a year during the entire maturity of the loan. Although this does not seem like a significant amount, this is the annual difference in interest, which will have to be paid for 10 or 30 years. This means the difference over the full maturity of the loan could have been HUF 150 bn compared to last November’s bond issue.
Looking ahead, with some major simplifications, we can say that if we project the interest difference between this January’s 30-year SURE bond (0.13%) and Hungary’s November 30-year bond issue (1.66%) to the entire EUR 9.7 bn RRF loan facility Hungary has forgone,
the interest premium comes to HUF 53 bn a year, or HUF 1,600 bn over 30 years.
Of course, Hungary would not take this huge loan at once but rather over several years, provided it would need the entire amount at all, and some of it would be for much shorter maturities than 30 years, so calculating the exact amount of extra interest paid is impossible, but it wouldcertainly come to hundreds of billions of forints.
Difference even bigger for Paks 2 and Budapest-Belgrade railway
If we compare the cost of the RRF loan with intergovernmental loans, the difference is even larger. One such agreement in recent years was a loan from China for the reconstruction of the Budapest-Belgrade rail line. Hungary will receive HUF 577.5 bn at an interest rate of 2.5% in USD for 18 to 20 years.
Compared with the 15-year SURE bond, Hungary will lose roughly 2.2 percentage points a year on the Chinese loan, which translates to HUF 12.7 bn. For the entire maturity, over 18 years
Hungary will pay nearly HUF 230 bn more in interest to China.
The gap is even more stunning in the case of the Paks 2 nuclear power plant project. According to a law passed by Parliament, Hungary will take out a EUR 10 bn loan at a tiered interest rate between 3.95% and 4.95%. Assuming an average interest rate of 4.5%, an RRF loan of similar size could be more than 4 percentage points cheaper in theory. Using the entire Russian credit line would result in extra interest payment of HUF 150 bn a year, or HUF 4,500 bn over 30 years.
It is important to stress that this is just a theoretical calculation.
The cost of the Paks loan is much lower as it can be repaid any time at no extra cost using loans from other sources. Hungary has done exactly that so far, converting the amounts accessed from the Russian credit line with other, cheaper loans from the market and prepaid the loan to Russia. As a result, Hungary currently owes nothing to Russia even under the re-negotiated repayment conditions, the Finance Ministry said last week.
The logic behind maintaining the Russian credit line is probably that there could be situations during its maturity when even the 5% interest rate is favourable as Hungary would only be able to finance itself from other, more expensive sources.
However, assuming the above situation will not come to pass and Hungary keeps converting the entire EUR 10 bn credit line using cheaper loans, under current market conditions the roughly 1 percentage point interest gap between the RRF and market-based loans would result in extra costs of HUF 35 to 40 bn a year. As a result,
the Paks 2 project would cost HUF 540 bn more over 15 years even using theoretical loan conversions compared to the RRF funding.
Of course, it is impossible to foresee financing conditions 10 or 20 years from now, so the above interest rate differences could develop very differently. However, if we had to make a bet on the direction interest rates will change, the current extremely favourable financing costs will probably move upwards as the period of zero policy rates and massive bond purchases by central banks will not last forever.
But why not use the EU loan then?
Based on the above, Hungary could access loans from the RRF under much more favourable conditions compared to market or intergovernmental loans. However, in order to actually save hundreds of billions, an ‘involvement condition’ would have to be met. Intergovernmental agreements are typically for a single specific project, which means both China and Russia are offering a credit line for the projects outlined above. On the one hand, this is flexible because Hungary only has to draw the required funds as they are used, and on the other hand there are no conditions on the use of the funds. RRF funds can also be used for specific purposes only, but it comes with constant EU monitoring on how it is spent. Meanwhile, the Chinese and the Russians expect to be part of the projects themselves as well, so that part of the money flows back to them. And it seems the Hungarian government believes it is worth a few tens of billions of forints a year to keep up good relations with China and Russia and become even more attached to them.
As a result of the above, RRF funding is not suitable for replacing the costly intergovernmental loans, which can partly be converted to market-based loans.
Let us assume that Hungary’s investment plans do not depend on the financing sources available, and it simply wants to carry out a project package from Paks and Belgrade to higher education and health care. The government will therefore seek out the cheapest source of funding. From this aspect, taking out the RRF loan is virtually mandatory as it can be used to convert more expensive loans. Not doing so does actually equal throwing hundreds of billions of forints out the window.
The situation can be complicated further if RRF funding cannot be used for the projects the government is planning. This may happen when domestic projects are not in line with the EU’s goals, as is the case with the more than HUF 1,000 billion in EU funding the government wanted to use to reform higher education. So either the government cannot find a project for which it could use the cheap EU funding, or the EU does not want to see community funds in projects lie the strange foundation structure now introduced in higher education.
If Hungary cannot secure funding for the planned investments, it can do three things in the short term:
- Undertake extra investments for other purposes. The problem with this is the debt trajectory mentioned at the beginning of the article, as the government cannot finance to many projects form loans if it wants to decrease debt. The other problem, although one that has not really bothered the government in recent years, is that Hungary’s investment rate is nearing 30%, which could overheat the economy. This, in turn, would lead to higher project costs, eliminating the advantage of cheaper RRF funding.
- Change investment priorities. In order to secure cheap funding, Hungary could first carry out the projects that can actually be financed from cheap EU sources. This is also an option that the government, which envisions investment-driven growth, does not use for some reason. The background cause is probably that the EU would oversee the use of these funds, something the government would like to avoid.
- Postpone the projects that can be financed by cheap loans but then draw on the RRF funds sometime before 2023. We would not be surprised to see this scenario play out eventually, as the government may have forgone these funds only temporarily to support its own communications, and it could eventually want the RRF loan, or most of it, once it thoroughly reviews and rethinks its projects.
Cover photo: Getty Images
