The land of the Magyar is far from the European periphery, but potential for high temperament can be both engaging and infectious.
The acronym formerly used for Portugal, Ireland, Greece and Spain has been updated to include market focus on Italy and to improve political correctness, so we reorder the letters and call this new coterie GIIPS; the muddle that markets see there is the same. Greece will eventually default, goes the narrative, and Portugal and Ireland are next, but in fact these latter two countries are under the umbrella of the European Financial Stability Facility (EFSF) at least until end of 2013.
Spain and Italy are more critical; the latter’s sovereign debt was just downgraded by Standard and Poor’s from A+ to single A with a negative outlook. The European Central Bank (ECB) is buying these nations’ government bonds to lower the interest rates. Beyond the GIIPS, market participants consider Belgium, with a government debt-to-GDP ratio above 100%, and France, also with negative debt dynamics, as potentially critical.
Germany, the Netherlands, Finland and Austria are presently the only countries not disturbed by the euro crisis. But actually, the next bout of indigestion could come from a source which has previously simmered very calmly: Hungary.
There, between 2004 and 2008, some HUF 4 trillion worth of mortgages and consumer loans were ladled out in Swiss francs because households wanted to profit from the comparatively much lower CHF interest rates. Today this debt composes 60% of all Hungarian mortgages and 16% of Hungarian GDP. Similar situations exist in Poland and Croatia but are not as extreme.
The problem with these Hungarian mortgages is that back in 2008 the CHFHUF exchange rate was at 160, while today it is at 240. Thus the franc and the value of CHF-denominated mortgages and consumer loans have increased by 50%. Indebted Hungarian households are under stress; someone put way too much paprika in the goulash.
To ease households’ debt burden temporarily, Hungary recently introduced an exchange rate fixing scheme. Interest payments are thereby made at a fixed exchange rate of 180, i.e., 25% lower than the current market rate. To fill the gap between this fixed exchange rate and the spot rate, banks issue bridging loans, to be repaid after 2014. Now Austria enters the fray, and to a lesser extent Germany.
Eurozone banks expanded heavily into Eastern Europe in the last decade. The Bank for International Settlements reports that today some 80% of Hungary’s banking sector is foreign-owned, with Austria accounting for 27% and Germany 21%. A large part of Hungary’s CHF-denominated debt was served by Austrian banks; German banks accounted for a lesser amount. Assuming that a large portion of the currency exposure was not hedged – which one must, since otherwise the interest rates on the Swiss franc loans wouldn’t have been so tasty – foreign and particularly Austrian banks are now at risk of a surge in non-performing loans. To spice the dish even more, the Hungarian government just announced the option for borrowers, if they can come up with the cash, to repay their mortgage at the favorable rate of 180 and let banks assume the loss in the gap.
Austria can well support its banks should the current situation cause discomfort. Nevertheless, if the story gets too hot, market participants may take such contagion as further evidence of the deepening debt crisis, inducing a reassessment of Eurozone safety as a whole.
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