Coming of age

IFR Emerging Europe and Turkey Special Report 2014
11 min read

Despite being the “poster child of contagion”, Hungary is moving towards steadying economic prospects.

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Thanks to its debt problems throughout the sovereign debt crisis, Hungary has been what Benoit Anne, head of emerging markets strategy at Societe Generale, called the “poster child of contagion”. But as he points out, that theme is three years old and it might be time to start thinking of the Central European country in a rather different way.

Let’s face it, the economic news is not too shabby. After a dire fall of 1.7% in GDP in 2012, Hungary moved out of recession in Q2 last year and posted growth of 2.7% in Q4. Even if that figure is slightly distorted by the public investment that came courtesy of EU structural cohesion fund transfers of US$6.7bn last year, growth in Q1 this year was still 2.1% and economists are predicting growth figures for all 2014 of about 2.2%.

The country’s debt-to-GDP figures have started to improve too, albeit slightly. From Q3 to Q4 last year the figure declined from 80.3% to 79.2%, according to Eurostat. Inflation has fallen sharply from the high levels of 2012 and is expected to stay below 3% this year. Unemployment is below the EU average at 8.6% and the forint has been resilient.

Love to hate

This is all a long way from the US$25bn emergency credit line Hungary needed from the EU, IMF and World Bank in 2008, so why the perennial gloom? Part of the bad reputation of Hungary comes from its politics.

“Hungary is the one country in Central Europe that people like to dislike because of politics,” said Marcus Svedberg, chief economist at East Capital.

At the beginning of April, incumbent Prime Minister Viktor Orban and his right-wing Fidesz party comfortably won the elections. There has been much carping from the opposition and the elections were considered free but criticised as not being fair. It is worth emphasising that Fidesz won on a landslide; taking 133 of the 199 seats.

As one economist said: “The problem is that Fidesz is popular. The previous socialist government was a disaster, but Fidesz is competent. The population might be annoyed by the party’s undemocratic drive, but there is no alternative.”

That is the nub of it. European commentators are vexed that Hungarians endorsed Orban’s blatant nationalism and state-centred politics. In a grandstanding speech just after the election and in front of thousands of supporters in Budapest this was put on display. Orban said he saw his job of the next four years as to protect Hungarians from “profiteers, monopolies, cartels and imperial bureaucrats” – an explicit dig at Brussels.

Achille’s heel

This has impacted on key aspects of Hungarian life. Last year, the domestic gas distribution business of German utility company E.ON was renationalised and given to the state-owned Hungarian Electricity Works. The prime minister has signalled his intention to increase Hungarian ownership of the banking system to 50%, made possible through a national buyout of foreign-owned banks that have suffered thanks to high taxes and non-performing loans. At 17%, according to S&P, NPLs are a distinct economic Achille’s heel.

Nationalism is not just apparent at a corporate level;it is obvious at a street level too. The nationalisation of the country’s tobacco kiosks in the spring last year, for example, has had the side-effect that the word ”Nemzeti” or “National” is emblazoned on every street corner.

There was a distinctly authoritarian flavour to Orban’s first term in office. Aside from a media clampdown, the government has also rewritten the country’s constitution, changed electoral rules and moved election boundaries in its favour. And with to two new nuclear generators in the central Hungarian town of Paks, which have been financed with a US$13.8bn loan from Russia, the prime minister’s eyes are increasingly turning to Moscow. It is notable that Hungary has not supported opposition or sanctions on Russia over its actions in Ukraine.

What has also driven European concerns is growing national support for the Jobbik party, the country’s far-right party, infamous for its anti-Semitism and anti-Roma rhetoric. And there has been much criticism that the EU has been toothless in these political changes.

“The EU has strong leverage over how accession countries should behave. EU accession is great as a reform drive. But the EU has proved unable to steer how member states should behave,” said Svedberg.

The Jobbik situation is by no means at the top of the problem list. As one economist in Budapest said: “Jobbik is a cause for concern, but it is not the biggest. The drift away from democracy and the creeping takeover of democratic principles is a greater concern.”

Politics aside, although there has been improvement in much of the economy, one of the difficulties for the international financial community is Gyorgy Matolcsy, head of Hungary’s central bank. “He is the king of unorthodox, and no one likes an unorthodox central banker,” said Daniel Hewitt, senior emerging EMEA economist, Barclays.

The former economics minister has caused concerns that his policies might come back to bite Hungary. He is known for his aggressive stance on interest rates. Rates have been cut 20 times in a row since August 2012. He reduced the base rate by 25bp every month until July last year, then cut it by 20bp a month for the next five months. This year has still seen cuts, though less extreme. In January and February he cut by only 15bp and then in March by 10bp to 2.6%. These are moves that have been welcomed by exporters, though it has been less enthusiastically received by those with foreign currency mortgages.

Also controversial has been Matolcsy’s Funding for Growth Scheme. The Ft2.75trn (US$12.4bn) programme is to provide cheap financing to small and medium-sized companies, which have been abandoned by traditional lenders. The central bank provides 0% refinancing to banks, which must then be lent on to Hungary-based SMEs at a maximum interest rate of 2.5%.

It has not been an unalloyed success. Take-up has been as little as Ft60bn, according to Barclays, and as one economist noted dryly: “If Matolcsy had dropped the Funding for Growth programme and stopped cutting rates, Hungary could have been out of vulnerability by now.”

Market-friendly policies on the rise

But counter-intuitively, it is the very fact of Orban’s landslide victory that gives hope for a more business-friendly future and international expectations are that the edges might come off some of Fidesz’s more aggressive measures against the private sector.

“Now that the political base is secured, international investors might be pleasantly surprised,” said one economist. “The moves might not be widespread and ambitious, but we will see more market-friendly policies at the edges.”

The canary down the mine has been any export-oriented businesses and more are likely to follow this trend. Last year, new FDI was pretty much zero. Hungary’s industrial production figures, though, were bolstered by car production, which is predominantly exported. Volumes were up by 21% in 2013, according to Barclays and, thanks to government softening, these figures are only likely to improve in 2014 following production increases announced by both German auto manufacturers Mercedes and Audi.

Hungary’s total exports are expected at just less than 100% of GDP this year versus around 80% in 2008, which have also been helped by an improvement in the eurozone.

What also helps is that Hungary’s debt needs for 2014 were a modest US$6bn, which it breezed through. Just over US$1bn had to come from supranational agencies, with the rest from enthusiastic capital markets. It sold a US$2bn 5.75% 10-year issue in November in a deal that was almost five times covered and with only a 15bp premium.

Hungary then completed its borrowing for 2014 in the first quarter with a snappy US$3bn dual-tranche deal towards the end of March. Thanks to specific demand from US investors, it decided against a euro deal and for its pains saw US$16bn demand. Both tranches were dominated by fund managers and were priced at a tight Treasuries plus 260bp for the five-year tranche and Treasuries plus 287.5bp for the 10-year portion.

What this means is that while Hungary does not need to come to the markets again this year, it certainly could and with no difficulty at all. Originally a sale of €1.3bn of euro bonds had been planned, but at the end of April, the debt management agency said it might put this sale on hold as a way of reducing external debt.

At the moment, the country is sub-investment grade at Ba1/BB/BB+ but an upgrade is expected soon. In a recent interview with a local newspaper, Gyula Pleschinger, National Bank of Hungary monetary council external member, echoed general sentiment when he pointed out that S&P had improved its outlook on the sovereign from negative to stable at the end of March and reckoned that “we will get to investment grade – as early next year”.

In its rating upgrade S&P praised the rebalancing of Hungary’s open economy and its steadying economic prospects. There is little doubt that for the rest of the year, the outlook is pretty good. Thanks to an improved eurozone, there is little external factors that can rock the boat. The only dangers are internal.

“The risks for Hungary are bad monetary policy not economic vulnerabilities,” said Hewitt.