Saturday, September 10, 2011

Frustration, failure, voluntarism

Hungary is still only a secondary front-line of the renascent crisis, not among the headlines and for a superficial observer (i. e. for most of them) it could seem justified. Although the slippage in this years budget (and the obvious: the flat tax was not capable to stimulate growth) could warrant some worry, the government is imitating action at every negative sign, this time announcing 100 billion HUF correction measures. Hardly credible (enhancing tax collection makes 40% of this amount, and a freeze on government purcheses another 40%) and hardly structural, but it didn't really disturb analysts. Not even the news that the execution of the Széll Kálmán-plan (the bouquet of austerity and supposed reform measures planned to bring 550 billion HUF savings next year and about 900 billion until 2013) suffers from serious slippages, and exactly at those fields from where the government expects the highest savings could shake the belief in these guys. They can at last claim that the government is devoted to the deficit figure and ready to apply new measures if necessary. (I would really like to know how long would they bosses at their banks tolerate if they would announce that they had managed to failed to achieve the planned profit in the first eight months of the year, but they are very committed to the planned number and are ready to make corrective measures.) Anyway, it was hardly the sensation of the week, especially in the light of the government's even harder commitment to the flat tax.

But the end of the week brought back the memories of last year, when hardly a week passed without events and announcement testing everyone's heart and patience. It turned out that something was cooking (besides the books) in the witch's kitchen run by the government, a new plan to save the fx-loan holders.

Well, the malicious will certainly point out that as a complete program with this aim was already implemented and started two weeks ago it was even more short-lived than this year's budget, another object of pride of the government. But as one of the reasons the government came up with this new idea was the not qiite spectacular success of the original program (there was no opportunity to show long queues, praising the government in the TV) it is worth to be mentioned. The other reason behind the new plan – at least in my opinion – is the complete failure of the flat tax and the resulting frustration with the economic policy. I'm sure they attribute the lack of internal demand not to the fact that the new tax system was a tax hike for most of the population and it favored the segment with the least marginal propensity to consume, but to the spiking mortgage rates due to the CHF based loans. I fear it is telling regarding the mind-set of the government that facing the obvious collapse of the whole of their economic governance they decided to stimulate their original stimulus, instead of changing the pattern of redistribution. (Furthermore, they will cement in this tax system with a two-thirds majority law.)

What is the problem with the proposal? Firstly, it is its aim: to „release” the income of households in order to make them spend more on consumption. Secondly, the set-up of the plan and the parameters applied. Not only is there a few evidence that the weakness of the forint was the main reason of the weakness of domestic demand* but it fails to address the major problem caused by the fx-loans: the effective fixed excahnge rate of the HUF. As long as hundreds of thousands has fx-loans the country can not devalue because it will immediately harm, cause pain to millions. But external devaluation would improve export competitiveness faster and with less pain (mainly thorugh import generated inflation) than the internal devaluation (austerity) executed by Fidesz. However, the government only hopes to bring redemption to a quarter of the 1,2 million households with fx-loans with their plan to enforce a conversion of the loans at an exchange rate of 180 Huf (50 forints weaker than last Friday's close), signaling that they do not really want to get rid of the effective peg in order to curve out more room for manoeuvre for the economic policy, but to fend of the popular pressure.

As for the second problem the plan lays the whole of the burden and the losses on the banks. However, the balance sheet of these banks is already full of hidden losses due to the non performing loans and the loss of value of the real estates serving as collateral fro these fx-loans. As long as they can keep their debtors afloat they not necessarily can declare these losses and they can manage „only” with setting up appropriate reserves. So, they can hope – and in this sense their interest is common with their debtors' interests – that at the end these loans will be payed back according to schedule and they can release the reserves set up to cover projected but at the end avoided losses. However, as soon as they are forced to accept the conversion of these loans (or the repayment in one sum) at 180 HUF exchange rate they will realize huge losses on these loans that has to be covered. According to preliminary estimates it can be as high as 1100 billion HUF. It will effectively force them to recapitalize. Even if their owners (Western Banks mainly) will provide them with the necessary capital – that is far from being certain – they will certainly try to find as much foreign capital as they can for this purpose. One option is to freeze lending and use the capital to cover losses. And on the long run they will certainly pay close to zero rates on deposits, as they won't need to accumulate capital this was because they won't lend. (There is of course the secondary effect of losing confidence in Hungary. As this move would be most probably illegal, violation of existing contract by a third party without interest in these contract, violation of property right and that way unconstitutional and against EU law if the government implement it it will be equal with the declaration that no investment and no property – remember the private pension funds! - is safe here.) Anyway, it could bring the banks to the decision to withdraw – gradually or even abruptly – from Hungary. It will certainly cause further reduction in lending and tighten already very tight financial conditions. And such events are rarely beneficial to economic growth, something the government desperately wants to deliver.

As the plan is clearly not part of a coherent one on how to free the Hungarian economy from constraints from which it can be disentangled it is hard to see how it could lead to positive result. It is not aiming to the solution of the most important problem, just for short term political gains. (And it is the expression of frustration as the information on the discussion in Fidesz's caucus suggest. The most important supportive argument against the objections of the more restrained members was that the banks caused this whole mess they should bear the whole of the burden.) Not that there wouldn't be place for an orderly and well balanced solution to the problem. There were even plans proposed by bankers. And even if those were rejected with the cooperation and advice of the IMF and the EU (and with their loan) a kind of bad bank or special financial vehicle could be set up in order to clear the bank's balance sheets, convert the loans and that way achieve simultaneously the re-ignition of bank lending to the economy (that was already constrained by the huge implied losses and the subsequent frenzy to collect enough capital to cover these probable losses) and the lifting of the burden of households. But it would obviously end the economic war of liberation so proudly waged by the government.

*According to the data of the Office of Statistics retail sales grew in this year m-o-m and y-o-y as follows:
               m-o-m        y-o-y
January     0,9% and   0,9%
February -0,3% and   0,1%
March     -0,5% and -0,9%
April       -0,3% and -1,2%
May         0,5% and   0,7%
June        -0,5% and -0,5%

Meanwhile the CHF-HUF exchange rate fluctuated between 220 and 205 HUF in January, between 203 and 214 HUF in February, between 201 and 214 HUF in March, between 200 and 210 HUF in April, between 204 and 221 HUF in May and between 214 and 228 in June. Funnily, retail sales declined in the month when the CHF was weakest.

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