Economy 30 November 2023, 4:11pm

Hungarian gov't extends interest rate freeze - Should we laugh or cry?

Portfolio

It is both surprising and unsurprising that the government has again extended the interest rate freeze, which was to expire on 31 December, until 1 July 2024 for households and 1 April for SMEs. The extension will impose a further financial burden on banks in the order of tens of billions of forints, the exact size of which will be determined by the interest rate trajectory. The measure currently affects 300,000 loans to households, 30,000 SMEs, according to the government and 13,000, according to the central bank. The affected loan portfolios reach HUF 1,200 billion and HUF 650 billion, respectively.

Surprising, but not really

Gergely Gulyás, the Prime Minister's chief of staff, has told a press briefing on Thursday that the interest rate freeze will be extended until 1 April 2024 for small and medium-sized enterprises, and until 1 July 2024 for households. The measure was to expire on 31 December this year.

Why is it surprising? It is because the government has promised banks that when the central bank's base rate is cut to single digits - likely in February 2024 - it will phase out the interest rate freeze on variable-rate SME loans, and start the review of the interest rate on retail loans. However, it has now decided to keep in place the interest rate cap on both credits longer.
Why is it not surprising? The extension should not shock in itself, as the interest rate cap was to expire on 31 December, and it should have been kept in place for a couple of months for a review. The new deadlines indicate that the interest rate cap on SME loans will be phased out sooner than that on mortgages.

The benchmark interest rate levels of the two types of interest rate caps also show that in a declining interest rate environment, the level of the SME cap will be reached before the level of the retail cap. In addition, the latter, i.e. reaching a BUBOR level of just below 2%, is a distant prospect, so the government may also consider a gradual phasing out for the retail sector to avoid a repayment shock potentially affecting a few tens of thousands of households (see below). Currently, the relevant BUBOR rates are between 10.0% and 10.7%.

How many borrowers are affected?

The interest rate cap covered at the end of the first half 300,000 mortgage contracts to the tune of HUF 1,200 billion and 13,000 SME contracts worth HUF 650 billion, according to the central bank's Financial Stability Report. According to further data by the MNB:

The interest rate cap, which will remain in place until the end of 2023, covered 21% of the mortgage loan portfolio (HUF 1,200 billion) and 37% of contracts (300,000 contracts) at the end of June 2023.
If the measure were to be phased out, the potential increase in instalments would remain moderate for most contracts (see chart below).
While the typical (median) increase is expected to be around HUF 11,000 (27%), some contracts are considered more vulnerable in this respect:
26% of the contracts in the interest rate cap (77,000 contracts) would see an instalment increase of more than 50% or a nominal increase of more than HUF 50,000.

Almost all of these contracts are loans with a maximum 1-year interest-rate fixation period, half of which were concluded after 2010. Their interest rate sensitivity stems from the long residual maturity (median: 14 years), however their outstanding loan amount is relatively low (median: HUF 6 million) especially if we take into account the significant increase in wages in recent years.

The central bank estimates that the interest rate cap measures, which partly reduced interest income and partly reduced other comprehensive income, may have led to a loss of around HUF 112 billion for the credit institutions sector in the first half of this year. I the second half of the year and the first half of next year, the negative impact on earnings could be significantly more pronounced as BUBOR falls. It is safe to say that

the recent extension will impose a further burden on banks in the order of tens of billions of forints, the exact size of which will be determined by the interest rate path.

The parameters according to which the interest rate freeze works are set out in the table below.

According to the MNB's earlier assessment and Portfolio's own current opinion,

the interest rate freeze on variable-rate (up to one-year) residential mortgages in force since 1 January 2022,
and extended to 3 and 5-year mortgages and variable-rate SME loans in November 2022,

has a number of negative effects on the Hungarian credit market and financial culture.

These adverse affects include the following:

Weakens monetary transmission
Results in direct losses for banks, which may be further increased by the additional impairment ofthe contracts concerned, resulting from the potential sudden surge in instalments upon phase-out of the programme, instead of interest rate increases materialising gradually.
Has a negative effect on the domestic financial culture and increases the moral hazard.
Provides an unreasonably wide-ranging benefit to higher-risk, variable-rate mortgage borrowers.
There are still around 7,000 mortgage loan contracts with an interest period of more than 5 years whose interest period falls within the period of the interest rate freeze, but which are not subject to the interest rate freeze after the extension.

According to the government's new announcement, the interest rate freeze on retail loans will be with us for two and a half years, and the SME rate freeze for one and a half years.