Global Insight Perspective | |
Significance | The National Bank of Hungary hiked interest rates by 300 basis points in an extraordinary session, hoping to stem the recent slide of the forint against the euro. |
Implications | The move seems to be one of desperation. It is increasingly likely that Hungarian authorities will need to avail themselves of all international pledged assistance to avoid a similar fate to Iceland. |
Outlook | Should a new IMF package come through to the degree rumoured, the country will probably have enough access to reserves and new borrowing to meet short-term debt obligations. However, investor sentiment is squarely against Hungary right now, meaning that financial markets and the exchange rate will remain extremely volatile for the foreseeable future. It is not likely that one single move will prove a panacea. |
The National Bank of Hungary (MNB) yesterday took extraordinary action, hiking its base interest rate by 300 basis points to 11.5%. The move took place just two days after the Monetary Council declined to change interest rates at its regular, monthly meeting (see Hungary: 21 October 2008: National Bank of Hungary Leaves Base Rate Unchanged). The day after the MNB's initial decision on Monday (20 October 2008) to hold interest rates steady, the forint plunged by 2.1% against the euro, ending Tuesday trading at 271.76 forint per euro—an all-time low. With confidence in the forint plummeting, the MNB announced the rate hike.
Alongside the MNB action, the Hungarian authorities announced an imminent new lending package with the IMF. According to the MNB’s Deputy Governor Ferenc Karvalits, while "we [Hungarian officials] don't have a date for it, it's in the near future”. Some observers estimate that the lending package, aimed at further providing the country with capital, could reach up to US$12 billion. This loan, along with Hungary's existing foreign-exchange reserves, would be relied upon to help roll over the country's short-term debts, staving off a wave of bankruptcies as seen in Iceland.
The constant comparison to Iceland is gnawing at Hungarian policy makers, who continue to insist that conditions are dissimilar with 90% of Hungary’s banking sector owned by larger, foreign entities that would not let a collapse happen to their own subsidiaries.
While the authorities' actions helped rally the forint initially, the exchange rate at the close of yesterday was down another 1.4% at 275.79 forint per euro.
Outlook and Implications
The interest-rate hike was a bold move by the MNB to try to demonstrate its commitment to prevent inflation and defend the forint. Certainly, a less-drastic change of the interest rate—say by 25 or 50 basis points—would have had little impact. However, save for a potential short-term boost to the currency, it is debatable as to whether this 300 basis-point hike will have any longer-term impact on settling Hungary's markets.
Foreign investors are increasingly looking past potential yields to their investments, and instead making decisions on the stability of the investments. To this end, slightly higher interest rates may not be able to overcome building investor sentiment that Hungary will indeed follow Iceland down.
It matters little at this time whether the estimate is accurate or whether Hungary is indeed more sound economically and financially than Iceland was. What matters is investors' perception. Unfortunately, this steep hike, particularly coming so close on the heels of the MNB's previous decision to hold interest rates steady, erodes the perception of stability in the country and makes the MNB seem desperate. The Hungarian authorities will undoubtedly have to continue to offer widespread reforms, likely making use of all of the pledged assistance to avoid a financial collapse (see Hungary: 17 October 2008: ECB Joins Hungarian Authorities in Effort to Stabilise Financial Markets).
Although it is possible the rate hike will have little impact on financial stability, the move will almost certainly negatively impact economic growth prospects for 2009. The sharply higher interest rates will make domestic borrowing significantly more expensive. Moreover, with the exchange rate continuing to slide, Hungarian banks have suspended foreign currency lending—the lifeblood of consumer credit in recent months.
As well as the tightening of already austere monetary policy, the government is clamping down. The financial crisis has allowed the government to gather enough support for a tighter 2009 budget, which is likely to pass in the next month or so. Monetary and fiscal tightening—both critical for any hope of avoiding a financial meltdown—will take a heavy toll on economic expansion in 2009.
Already, consumer spending has been falling consistently since the government began tightening fiscal policy in 2006. In January–August 2008, the Central Statistical Office reported that retail sales fell by 2.0% year-on-year. Retail trade has fallen in every single month against year-earlier levels since January 2007. The economic policy tightening will only enhance this decline. The expansion of GDP in 2009 could fall to 1% or below, based on the current tightening trends and anticipated further actions that will be needed to stabilise the country's financial markets.