How does a dispute over judges’ retirement age turn into a potentially massive banking crisis? When one of the parties in question is the Hungarian government, of course.
On Tuesday afternoon, the European Commission launched legal proceedings against Budapest over the government’s controversial new measures on central bank independence, data protection and judicial appointments, torpedoing negotiations with the European Commission and the IMF over a financial rescue commission.
According to wire reports, disagreements over the central bank and data protection were close to being resolved, but, for some reason, a row over the appropriate age limits for the judiciary is the sticking point. Hungary has just one month to change tack or be taken to the European Court of Justice.
Fears are growing that prime minister Viktor Orban is seeking to flout EU treaty legislation by forcing judges to retire early in order to ease the passage of controversial bills. We will leave it to country specialiststo speculate why Orban is going down this route.
But, suffice to say, the country is in desperate need of cash, and the longer the disputes last, official talks regarding external financial assistance will remain frozen.
After opting for a sticking-plaster approach to government finances last year – raiding private pension funds, imposing Europe’s highest financial sector tax and forcing banks to bear the brunt of households’ FX losses – Hungary needs a new funding deal to prevent a market crisis.
“We are entering crisis mode, Hungary is just playing for time now,” William Jackson, emerging markets economist at Capital Economics, a London-based consultancy, told Emerging Markets.
The junk-rated economy faces vanishing portfolio and FDI investment, a weaker forint – raising foreign currency debt-servicing costs – and negative sovereign-bank feedback loops in Western Europe.
Against this backdrop, Hungary can finance itself for the next six months, before going bust, Jackson calculates. In the meantime, with his back against the wall, Orban might solidify his reputation as an anti-market agitator by exerting pressure on the central bank to finance government deficits, as well as forcing domestic banks to take on the FX losses borne by corporate debt issuers, Jackson said.
Although the Hungary’s benchmark 2022 government bond hit 9.5% on Tuesday and the forint sold-off, markets are still betting that the consequences of negotiation breakdown are so enormous that there is a chance that an eleventh-hour policy response may be found. Of course, this may prove to be wishful thinking.
In any case, even if an EU/EU/IMF deal is fleshed out, the real risks lie in the banking sector. Hungarian banks’ dependence on foreign credit has heaped on external financing risks, with banks facing some €19 billion of maturing external debt next year, mainly in the form of intra-bank credit lines.
“I think we could see a massive banking crisis this year,” the Capital Economics analyst warned.
In the same vein, if Western European banks are no longer willing or able to roll this debt over, then the chances of an agreement with multilateral authorities increases, as would the government’s acceptance of the IMF’s lending conditions.
Here’s more on rising banking risks, courtesy of Nomura’s energetic emerging markets economist, Peter Attard Montalto and team, back in November:
| “Countries risk fire-sales with deleveraging where there is a lack of willing buyers or where there are no “liquid”, open markets for bank asset portfolios. In general, this is the case in smaller SEE countries and where assets are severely impaired or where there is significant regulator uncertainly (e.g. in Hungary).
In general we believe we the “business rotation” we saw in 2009 to the present can continue. By this we mean that parent companies slowed new lending business in countries with lower growth, rapidly rising NPLs and lower profitability in favour of stronger growth, more profitable alternatives such as Poland and Turkey in particular. Countries like Czech Republic and Hungary suffered as a result.”
... Hungary worries us because one bank (Banco Populare) has already publicly said it wants to leave and cannot find a buyer for its assets. The risk of a fire-sale is therefore quite high. At the same time, Hungary has a financial sector with increasing asset losses being pushed on it by the government’s FX mortgage policy aims.
We therefore think the risk of capital flight and asset sales is high, as we do not believe foreign banks will fully recapitalise losses here. That may well be the most likely form of deleveraging with respect to Hungary. Equally, with no real backstop in place the risks to reserves are all the greater. Any more meaningful deleveraging that is possible would prompt rate hikes too.” |
Montalto and team speculate that the government will seek to beef up its domestic development bank, MGB, to buy assets in any deleveraging process this year, but its capacity is limited, while local lender OTP could come under political pressure to recapitalize peers.
In sum, it seems like there are two scenarios:
1. Hungary secures a credit facility from the IMF and European Commission, market confidence hopefully improves, pressure on the forint eases and capital flight might reverse.
2. No agreement materializes, markets tank and the banking system crashes.
Betting between the two is not for the faint of heart.
Further reading:
Austrian Banks Have $ 41.0bn Exposure in Hungary – Austrian Business & Financial News
Playing Chicken And Rooster With Hungary - A Fistful of Euros