The Turkish lira is not the only currency hitting lows this week - the Hungarian forint has joined in, analysts at Commerzbank wrote in a research note on Friday. Like the lira was until recently, the forint too is characterised by a negative real interest rate. The precise exchange rate dynamics may not be the same - the lira spiral was driven by current-account and inflation problems; Hungary has a sizeable current-account surplus and below-target inflation. However, external debt can be Hungary’s Achilles’ heel, and inflation can potentially accelerate too. If this dynamic gets going, the central bank will have to come out of its semi-retirement, the analysts added.
To be fair, a number of emerging market currencies have sharply depreciated because the Fed is continuing with its rate hikes - the Mexican peso and the Brazilian real are in similar positions and the South African rand is not too far away, analysts at Commerzbank noted.
What makes the Hungarian move significant is that the currency has weakened to a new low versus the ultra-weak euro (see chart below) and the move shows signs of accelerating.
“Eastern European exchange rates often exhibit high-beta characteristics with respect to the euro - hence, the forint move is not entirely a surprise - MNB’s ultra-loose monetary policy and systemic risks around the euro zone, ranging from Italian to German politics, are impacting the currency," the analysts said.
They noted that the forint has not weakened dangerously yet and could still stabilise on its own if euro zone risks were to calm down. But, the move may continue, which is why this is the right time to recapitulate HUF-specific macroeconomic risks.
Turkey’s currency crisis was fuelled by a wide current-account deficit and high inflation - these factors are not a major danger for Hungary - the country enjoys a nice 3% of GDP current-account surplus. But, Hungary’s vulnerability is the still large external debt: at the end of last year, this stood at c.120% of GDP (for a peer group comparison, see chart). More recent data show that debt/GDP could have declined closer to 100%. Still, this is a high number.
In recent years, a practice has emerged of looking at ‘net’ external debt statistics: Hungary scores much better on this measure - net external debt is less than 15% of GDP.
The analysts underlined, however, that loose monetary policy is indeed a common factor with Turkey.
“The reason the forint has been exposed to depreciation pressure this year is the central bank’s ultra-loose monetary policy stance.
The MNB has signalled that rates are likely to remain on hold through 2019, while further monetary easing could be undertaken using unconventional policy tools - the central bank already conducts prominent swap market operations to achieve the latter. As a result, interbank interest rates (3m BUBOR) are just 0.15% at the moment. Inflation is 2.8% headline, and 2.2% core (MNB target: 3%) - inflation is expected to accelerate modestly in coming months. Hence, the real interest rate is somewhere in the -2.4% range. Compare this to a central bank such as Poland’s NBP, which has 1.5% policy rate and 0.5% core inflation - therefore, a positive real interest rate.
The analysts also pointed out that FX liabilities increase when the forint weakens.
“The channel via which forint depreciation could feed back to become a spiral is external liabilities. External debt service obligations for 2018-19 will total around EUR 7-10bn each year, which is larger than the EUR 3.6bn current-account surplus. Forint depreciation increases the net external financing requirement in local currency terms. This, in turn, warrants a weaker exchange rate and higher real interest rate. Meanwhile, the weaker exchange rate is already boosting inflation and bringing the real interest rate down, which feeds back to weaken the exchange rate again, therefore calling for an even higher interest rate to break the spiral."
As regards the implications for monetary policy, the analysts noted that the benign EM risk environment of recent years allowed EUR-HUF to trade sideways for the most part.
“MNB’s ultra-loose monetary policy did not have a noticeably adverse effect. This year, with UST yields rising, EM assets are under strain and the HUF has begun to depreciate. The ultra-loose policy stance of MNB has the potential to escalate this into an FX spiral," they warned.
In their view, things have not yet escalated that far.
But as headline inflation reaches and exceeds the 3% target, which it will likely do over the coming quarters, the market may lose confidence that the central bank has full control - in this situation, the market would test MNB’s willingness to raise rates, just as it did with CBT.
The analysts believe that the Hungarian central bank will probably act in pre-emptive manner to hike rates. But, because of its well-known dovish bias, the market may demand ‘proof’. This is why we heard Deputy Governor Márton Nagy warn last week that MNB will be ready to hike rates.
“The message needs to be louder and clearer," they concluded.
