Monday 23 April 2012

Hungary - Balance of Payments - Trade surplus to remain positive after a shaky 2012

Although Hungary posted its highest ever annual current account surplus of EUR 1.43bn at the end of 2011, with a weak macroeconomic outlook at home and external conditions continuing to hamper demand for investment, there are significant downside risks to this current account surplus in 2012 but figures should improve from 2013 onwards.

Net export figures are the biggest cause for concern, with export growth in Q411 falling to 3.6% y-o-y, having been 20.7% a year earlier in Q410. Import growth also slowed to just 3% y-o-y in Q411, down significantly from 20.4% in Q410. This downward trend in growth was also similar across the trade in services. While a trade surplus typically tends to point to an increase in exports, it is clear that the recent surplus figures from Hungary are the result of weakened import demand in the light of recent domestic austerity measures including significant cuts in benefits and the public sector.

Trade Surplus Maintained Through Falling Imports
Total Imports, Exports and Trade Balance (EURbn by quarter)



Considering forecasts for contractional GDP growth in Hungary in 2012, import demand is set to remain low throughout the year. Beyond 2012, assuming the Hungarian government eventually agrees to the deficit targets which will pave the way for the IMF/EU for the funding deal to go ahead, domestic growth will continue to remain depressed and keep imports figures at the current level. In 2012, the contraction in the eurozone, will hurt Hungarian exports considerably as goods exports to the eurozone currently account for aound 55% of total exports. However, beyond 2012, as the eurozone growth improves again, export demand will pick up again considerably.

With the Forint having sold off sharply at the end of 2011 and reaching a record low of 321.73 against the Euro at the beginning of January, the weaker currency is also likely to add a further negative impact on import growth this year. Although the currency has been depreciating steadily since its brief recovery in February 2012, a deal with the IMF/EU – which looks to be unavoidable before the year end - should see the currency return to the previous levels of around HUF270/EUR. Despite expectations for the Forint to appreciate, with exports bolstered by Eurozone growth from 2013 onwards, this should still result in a growing trade surplus.

Room for HUF to Appreciate After Securing IMF Deal
EUR/HUF Exchange Rate



Following changes to the constitution which raised concerns over the independence of the judiciary and the Hungarian Central Bank and the resultant downgrade to junk status by all the three major Credit Rating Agencies at the end of 2011, Hungary saw a steep sell off of its financial assets which resulted in substantial net portfolio and other investment outflows in Q411. However, because securing IMF funding will be inevitable for the government given the soaring borrowing costs and upcoming debt repayments of nearly five billion euros of external debt, plus repayments of an earlier IMF/EU loan from 2008 due this year, the financial account surplus – of which portfolio investment has typically been a key component should increase once the deal is in place and investor confidence returns.

Portfolio Investment Outflows Drive Financial Account Narrowing
Hungary – Breakdown of Financial Account, EUR millions


Although Hungarian 5-year CDS spreads fell in March this year, they have since been creeping up as negotiations with the IMF continue to be stalled. These spreads will continue rising towards the high of 720 basis points seen at the start of January until formal talks begin. Once this safety net of external financing in place, we expect risk to be re-priced and for CDS spreads to fall in line with this. Similarly, 10-year government bond prices which have stabilised at around 87 basis points in the last month are set to rise once the deal is in place and the current yields which have reached nearly 9% start to fall.

Positive Outlook for Hungarian Assets
Hungary 5 Year CDS Hungary, bps
       


                                        10 Year Government Bond, bps                                                
On the back of the financial account surplus, the income account deficit has fallen from EUR-5,366 million in 2010 to EUR -6,317 in 2011, largely weighted by the outflow of direct investment income resulting from the high levels of Hungary’s external debt. Outflows are likely to be exacerbated in the year ahead as the weak Forint pushes up interest payments, and with debt levels set to remain high, the financial account is set to remain in deficit for the foreseeable future.

High external debt levels maintain direct investment outflows
Hungary – Breakdown of Income Account, EUR millions


While Hungary’s trade surplus looks stable beyond 2013, the outside risk that financing from the IMF/EU will not go ahead would result in unsustainable debt levels and borrowing costs for the government, and capital outflows could fall to dangerously low levels. To avoid such a scenario, giving in to the IMF’s demands for policy change and finalising a deal for financial aid is the only course of action for the government and I'd expect this to happen before Hungary’s markets sell off any further this year.

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