Archive for September, 2009
Hungary’s economic correction still fails to convince. Indeed I am not the only one who remains unconvined by the viability of what is currently taking place it seems, since according to the opposition supporting local daily newspaper Magyar Hírlap, none other than the Hungarian Prime Minister himself may be having doubts, as he is reportedly thinking of leaving the helm of the struggling ship placed under his charge before the next general election, which is scheduled to take place sometime early next year.
If this version of events is ultimately confirmed it will only add to the IMFs growing problems out East, since events in Latvia are not going at all according to their liking – see FT Alphaville’s Izabella Kaminska’s “Another Latvian wobble” of last Friday – and indeed Latvia’s government rapidly cobbled together another 275 million lati ($575.6 million) in spending cuts for 2010 yesterday after EU Economic and Monetary Affairs Commissioner Joaquin Almunia called on Latvia on Friday to “renew a national consensus”, and Prime Minister Valdis Dombrovskis paid a flying vist to Brussels, following a parliamentary vote against sending a real-estate tax bill through to the committee stage, implicitly rejecting part of an agreement with the IMF and EU. How many times this year does that now make it that the national consensus has had to be urgently renewed under directives from either Washington or Brussels, could someone please remind me?
Further, Hungary’s main opposition party – Fidesz – which looks well-positioned to win next year’s general elections, are threatening to rewrite the current ever-so-carefully written 2010 budget when they comes to powe next year, according to the latest statements from party president Viktor Orban.
“This (the IMF text, EH) is the most dangerous budget of the past 20 years … never before has a budget put hundreds of. thousands, or even millions of Hungarian families at such grave risk,” Orban told private broadcaster Hir TV in an interview late on Friday. “This budget will not remain in place, we will draw up another one instead,” said Orban, a former prime minister, adding that if in power, his government would create one million new jobs in 10 years.
Well, things certainly do not look good either for Gordon Bajnai or for the EU Commission/IMF team who are behind the budget. Perhaps that is why the IMF’s representative in Hungary, Iryna Ivaschenko, told national news agency MTI yesterday that while the government was committed to its 2010 fiscal targets, there were economic and implementation risks on the nature of which she declined to elaborate.
As Political Pressures and Bad Loans Mount, While The Economy Retreats Underground, It Is Hard To See How The “Correction” Can Work
Clearly the above mentioned report about the PMs intentions does come from a rather biased source, but it is interesting to note that credibility is being given to it by normally more impartial sources like Portfolio Hungary, and as they themselves point out there has been no outright denial of the suggestion from government sources.
Perhaps even more astonishing was the statement by the Hungarian Finance Minister Peter Oszko to Dow Jones Newswire on Friday that the most difficult reforms to address economic imbalances have now been completed. “I believe the most difficult part of our job is done – our package creates not only short-term but mid- and long-term fiscal balances” he said. I say astonishing, since as far as I personally can see (take a look for yourself at the charts below) the changes that are needed haven’t even begun yet. The whole emphasis have been on cutting the deficit, with little serious thought being given about how the Hungarian economy can get back to growth – which is the only real way the fiscal balances can become stable – all that seems to have happened is a 5% VAT hike to squeeze domestic consumption even further, and some compensatory tax changes on the other side to stimulate employment, but the real economic imbalances have been left untouched. A supply side micro-economists paradise, whisper the words “long term steady state growth” to yourself three times, cross your fingers, and hope for the best.
However, the underlying mirky political realities may soon burst their way into the parlour room, to disrupt this happiest of happy families. Indeed everything may well now hinge on getting the budget through parliament and then disrcetely leaving by the side entrance, since Magyar Hirlap suggest that the Hungarian Parliament may well be dissolved directly after the vote on the 2010 budget – which is currently scheduled for 30 November. Apparently everyone’s calculations have been thrown awry by the early re-election of José Barroso, and the imminent reappointment of the EU Commission. Plenty of food for thought here.
The paper also suggests that Prime Minister Gordon Bajnai now totally accepts that the forthcoming electtions are inevitably lost – the only bit of realism I can see in all this – and as a consequence seeks to have them advanced to February from the currently probable date of April or May.
In this way Bajnai would be able to offer himself to replace the present Hungarian representative László Kovács, who is currently Commissioner for Taxation and the Customs Union. Bajnai, it will be remembered, has only been Prime Minister since last April, but then, with these sort of techniques it doesn’t take that long to put a country straight, now does it?
Advancing elections in a situation where the present budget proposals are massively unpopular may make perfect sense according to a certain democratic political logic, but the economics lying behind the idea must be making people in Washington and Brussels throw up their arms in despair.
More evidence to back the idea that the current programme is not working came in the latest report released by the committee which monitors the long term legalisation of Hungary’s underground economy. The process is not only not advancing – it has been thrown into reverse gear, it seems.
According to Committee president, and Central Statistical Office analyst, Csák Ligeti some HUF 100 billion (EUR 369.17 million) in tax revenues were lost in the first half of the year due to a ressurgence in the growth of the black economy. In his report he noted, by way of contrast, that during the previous two years the state budget had received around HUF 200-250 billion (EUR 738.1-922.6 million) in extra revenue due to the “whitening” process initiated in the autumn of 2006 as part of a programme to correct the large fiscal deficits the country was running.
On another front, the IMF warned last week that while Hungary’s banking sector had so far weathered the crisis reasonably well – thanks to the multilateral rescue programme – and now has sufficient capital buffers, asset quality still looks set to deteriorate steadily due to weakness in the domestic economy, and especially rising unemployment. This, of course, is another good reason why they should have been including a rapid return to export lead growth in the correction strategy, since obviously if you simply sit back and wait to see what happens, there will be no big surprise – the percentage of Non Performing Loans will just go up and up.
“Developments in the banking sector have been positive; so far so good, and in line with one of the main objectives of the (IMF) program to preserve financial stability,” Iryna Ivaschenko, the IMF’s resident representative in Hungary, told Down Jones in an interview on Thursday.
However she immediately added that the IMF projects the amount of non-performing loans, which stood at a “still moderate” 4.8% of overall loans at the end of June, “will peak and at least double in the first quarter of 2010,”.
This IMF warning follows a Standard and Poor’s one at the end of August. The financial profile of Hungarian banks is set to weaken over the near term as a result of the country’s ongoing recession, the weak and volatile national currency, and pressure on funding, according to the S&P report.
The report, which was entitled “Banking Industry Country Risk Assessment: Hungary”, followed the recent decision by Standard & Poor’s to revise its ranking of the Hungarian banking system to reflect increased economic risks in the country (BBB-/Negative/A-3) and structural weaknesses in the country’s economy and banking industry.
“Hungary’s significant external financing needs, which stem from high public-sector leverage and large external imbalances, represent a structural weakness that exposes the economy to the tight and expensive funding conditions in global markets,” according to Standard & Poor’s credit analyst Harm Semder, who wrote the report.
The report argues that nonperforming loans and depressed recovery rates are likely to cause a material rise in credit losses, which will in turn subdue bank profits and capital through 2011.
Credit risk is heightened by the rapid growth of unseasoned loans – particularly commercial real estate mortgages – over the past five years and a significant increase in loans denominated in foreign currency that lack the foreign currency revenues to service them.
The report estimates that cumulative gross problematic assets, which include restructured loans and repossessed collateral, could increase to 25%-40% of total loans during the course of the current domestic recession. It further suggests that the eventual recovery will be slow.
Which Way To Turn?
The entire situation in Hungary vis-a-vis wages, employment and inflation continues to be preoccupying. The country is in the midst of a huge correction, and depends on improving exports in order to attain economic growth.
Yet the correction is not proceeding as planned. Inflation – at an annual rate of 5% in August, is far too high in contrast to benchmark German inflation which remained negative in August (minus 0.1% ) to be recovering competitiveness. Real wages have continued to rise, and only sneaked into negative territory for the first time in over six months in July – with a 1.1% drop in the benchmark ex-bonus hourly rate in the private sector. Total employment is falling slowly, but even this process masques an important shift towards public sector employment, as the number of public employees has risen substantially in recent months while the number of employees in the private sector has continued to fall – exactly the opposite of what was meant to be happening. Meanwhile the country continues to get ever deeper in debt thanks to the relatively generous financing conditions offered by the EU and the IMF. The point is where does this all end? Where is the correction here?
The National Bank of Hungary is struggling to find an adequate monetary response. The bank lowered its benchmark interest rate by 50 bp to 8% last week, but this still represents a real interest rate of around 3%.
The move followed a surprise 100-bp rate cut at the end of July. While a month ago, the market was expecting 50 bp easing, this time there was no real surprise. As for the future, the National Bank of Hungary release uses standard central bankspeak that intentionally remains ambiguos and guarantees the Bank Council is not committed in any particular direction. As long as there is no change in the international environment over the coming months, the the Council will be most likely having to decide whether to cut a further 50 bp or more.
So while the bank has evidently eased policy considerably, monetary conditions are evidently still far too tight to stimulate dynamic activity in the private sector, which is almost literally wilting on the vine at the present time.
Meanwhile, in a further sign that the recession is settling in for the long haul, Hungarian retail sales extended their decline to 29 months in June as IMF/government measures to narrow the budget deficit continued to sap consumer spending.
True Love In The Eternal Embrace?
Well, despite the fact that many may think the expression “eternal triangle” in the present context refers to the Hungarian government, the EU Commission and the IMF, they would be wrong since one convenient way of thinking about what just happened in Hungary could be to use another kind of eternal triangle the one developed in Nobel Economist Paul Krugman’s model of the same name, which postulates that when it comes to tensions within the strategic trio formed by exchange rate policy, monetary policy, and international liquidity flows, maintaining control over any one implies a loss of control in one of the other two.
In the case of the Central Europe “four”, Poland and the Czech Republic opted for maintaining their grip on monetary policy, thus accepting the need for their currency to “freefloat” and move according to the ebbs and flows of market sentiment. As it turns out this decision has served them remarkably well, since the real appreciation in their currencies which accompanied the good times helped take some of the sting out of inflation, while their ability to rapidly reduce interest rates into the downturn has lead to currency depreciation, helping to sustain exports and avoid deflation related issues.
The other two countries (Hungary and Romania), to a greater or lesser degree prioritised currency stability, and as a result had to sacrifice a lot of control over monetary policy, in the process exposing themselves to the risk of much more violent swings in market sentiment when it comes to capital flows. Having been pushed by the logic of their currency decision towards tolerating higher inflation, they have seen the competitiveness of their home industries gradually undermined, and as a consequence found themselves pushed into large current account deficits for just as long the market was prepared to support them, and into sharp domestic contractions once they were no longer disposed so to do.
A second problem which stems from this “initial decision” has been the tendency for households in the latter two countries to overload themselves with unhedged forex loans, a move which stems to some considerable extent from the currency decision, since in order to stabilise the currency, the central banks have had to maintain higher than desireable interest rates, which only reinforced the attractiveness of borrowing in forex, which in turn produced lock-in at the central bank, since it can no longer afford to let the currency slide due to the balance sheet impact on households. Significantly the forex borrowing problem is much less in Poland than it is in Hungary or Romania, and in the Czech Republic it is nearly non-existent.
The third consequence of the decision to loosen control on domestic monetary policy has been the need to tolerate higher than desireable inflation, a necessity which was also accompanied by a predisposition to do so (which had its origin in the erroneous belief that the lions share of the wage differential between West and Eastern Europe is an “unfair” reflection of the region’s earlier history, and essentially a market distortion). The result has been, since 2005, a steady increase in unit wage costs with an accompanying loss of competitiveness, and an increasing dependence on external borrowing to fuel domestic consumption.
So, if we look at the current state of economic play in the four countries, we find two of them (Hungary and Romania) undergoing very severe economic contractions – to such a degree that in both cases the IMF has had to be called in. At the same time both of them are still having to “grin and bear” higher than desireable inflation and interest rates. In the other two countries the contraction is milder, the financial instability less dramatic, and both inflation and domestic interest rates are much lower. Really, looked at in this light, I think there can be little doubt who made the best decision.
Hungarian GDP – The Big Slide
The looming problem of what will happen as and when some of the other Eurozone economies eventually start to recover while the Spanish one languishes in decline is finally starting to make the columns of the global financial press. Yesterday Thomas Catan had an article in the Wall Street Journal entitled Spain’s Struggles Illustrate Pitfalls of Europe’s Common Currency while Emma Ross-Thomas and Gabi Thesing also had a similar sort of piece in Bloomberg, under the heading Europe’s Two-Speed Economy Complicates ECB Rate Plans.
So the difficulty Spain could represent for the rest of the Eurozone is now it seems becoming the “Topic du Jour”.
As Thomas Catan says:
Even as France and Germany begin to show signs of economic recovery, weaker members of the European common-currency union remain mired in recession. Without painful overhauls, euro-zone countries such as Spain, Italy, Greece and Portugal seem set for years of meager growth, making their debts harder to pay. That raises the question: Could the divergent economic fortunes of euro-zone countries pose a problem for the currency union itself?
Or, as the Bloomberg columnists say:
Europe’s economies are rebounding at different speeds, complicating the European Central Bank’s efforts to put the region back on a more stable footing.
Even as the global economy recovers and Germany and France return to growth, the European Commission yesterday cut its forecasts for Spain and Italy. Deutsche Bank AG says some of the economies that were once motors of growth and job creation across the 16-nation bloc may stay mired in recession next year.
So what is the background here? Let’s look at what has happened in Spain. The Spanish property bubble started to slowly puncture throughout 2006 (well before the outbreak of the Sub Prime crisis) as the ECB steadily started to tight monetary policy and raised interest rates – the biggest weakness, and greatest vulnerability in the Spanish domestic economy is the way Spanish mortgages are overwhelmingly (85% plus) of the variable interest rate variety. That makes Spanish consumption exceptionally dependent on ECB interest rates. Thus, when these are lowered, as has happened over the last nine months, the relief is virtually instantaneous (as can be seen in the recent surge in the consumer confidence index) but when they are raised the squeeze on spending power is acute.
Spain’s construction industry was the first to notice the change, and activity slowed as the prospect of higher interest rates loomed. In fact by the time we reached last July the construction industry had already been contracting for three years, and from the July 2006 peak activity was down by 30.5% – that is it is the industry had shrunk to 70% of what it used to be.
The decline in construction was followed by a decline in industrial output and job creation, which both peaked in June/July 2007 – with production having fallen by 33.45% from the peak by last July. That is industrial output has now been falling for over two years. Then, as the economy slowed domestic demand started to fall, and retail sales are now down a little over 10% from their November 2007 peak. So, as we can see, the whole economy is steadily sliding down, as first the builders, then households, and then finally companies steadily reduce their spending, and the drift is relentless.
Russia’s central bank this week lowered its main interest rates for the seventh time since April 24 – lowering the refinancing rate a further quarter percentage point. The decision came hard on the heels of the announcement that the Russian economy suffered a record economic contraction in the second three months of the year and refelect the growing recognition that the country now faces a painfully slow recovery. Just how painful things might become will form the subject matter of this report.
You can also download the full text in PDF if you prefer to print and read – Bank Rossii Eases Further As Russia’s Economy Contracts At A Record Rate.
Risks Rising On All Fronts
Bank Rossii cut the refinancing rate to 10.5 percent from 10.75 percent (following a quarter point reduction on August 10), and lowered the repurchase rate charged on central bank loans to 9.5 percent from 9.75 percent, effective from tomorrow. The bank has now cut the rates six times since April 24. Nonetheless Russia’s benchmark refinancing rate is still the second-highest in Europe, after the 12% on offer in Serbia and Iceland – meaning ruble denominated assets remain an attractive carry pair with either Euro or USD, and that with inflation stuck around the 12% mark the problems for central bank monetary policy are legion.
In the report that follows I will argue how the steady and systematic long term mismanagement of Russia’s monetary policy has now created a veritable Procrustean bed of problems for Russia’s economy and society. Failure to address the underlying inflation problem between 2005 and 2008 meant that large structural distrortions were accumulated in the economy, including a massive problem of commodity export dependence, a problem which effectively turned the country into a veritable disaster waiting to happen if ever there should be a protracted lull in the secular rise in energy prices. That lull has now arrived, and it is not at all clear just for how long we will all need to get to learn to live with it.In a more or less reasoned analysis Capital Economics suggest that oil prices could fall back to somewhere around $50 a barrel in 2010. If this forecast proves anywhere near correct, the Russian economy is going to be subject to major downside risks, due to the difficulties posed by:
i) financing the fiscal deficit ii) rising unemployment iii) growing bad loans in the banking system iv) refinancing external debt v) the continuing high level of consumer price inflation and the difficulties this poses for monetary policy at the central bank
Added to all this, the economy will clearly not rebound as easily as many seem to foresee, adding to the risk element on all fronts. The Russian Economy Ministry seem to be getting ahead of themselves at the moment, since following a period when they have tried to get the bad news all out up front, just last week they decided to raise their 2010 forecast to a growth of 1.6 percent – up from the previous 1 percent forecast. This growth, if realised, would follow an anticipated shrinkage of some 8.5 percent this year, based on the September 9 estimate of Economy Minister Elvira Nabiullina that output may grow 3.9 percent to 4.5 percent in the second half of this year compared with the first six months – such strong optimism I find hard to accept, unless the turnround in global economic activity turns out to be much stronger than the one we are currently seeing.
Is The Worst Really Behind Us?
Latvia’s economy shrank a revised 18.7 percent in the second quarter of 2009 over a year earlier in what was the second-steepest drop in the entire European Union (worsted only by Lithuania) according to detailed data released by the statistics office yesterday. The contraction, which is now the largest since quarterly records began in 1995, was revised down from a preliminary estimate of a 19.6 percent annual drop. And Latvia’s problem can easily be seen in the above charts which show the most recent movement in exports, and quarterly data for constant price imports and exports. The Latvian economy grew driven by domestic consumption and increased borrowing during 2006 and most of 2007, but then the country ran out of extra sources of cash, and so imports slumped, followed by exports as the global economy entered crisis. Now its time to pay back, which means the lines we see in 2006 and 2007 will now need to be repeated, only this time with exports on the top and imports below. Of course, really doing this will only be possible once the global economy recovers. But the key question is, will Latvian export capacity be ready when that critical moment comes, or will Latvia’s agony continue, stuck in a horrid “L” shaped “non-recovery”? The most recent data on foreign trade, which saw exports fall and the trade deficit once more widen suggest that the latter danger is far from being a mere theoretical one.
And I am not the only one to be raising it, since according to the latest report out from Nordea Bank, Estonia, Latvia and Lithuania, may well suffer deeper economic contractions than previously estimated as government austerity measures simply serves to sap domestic demand while export growth remains muted.
So well done Nordea! But please permit me to say that this discovery does come as a bit rich from analysts who have persistently remained in denial that the key to Latvia’s recovery was a substantial reduction in the price level in order to facilitate exports (on my view better achieved by formal devaluation, but by the express desire of the elected political leaders of the Latvian people now being carried out via a convoluted and painful process known as “internal devlauation”).
Still, it is interesting to see mainstream analysts starting to question the current orthodoxy that fiscal prudency will (due to the impact on investor confidence) lead to recovery in Eastern Europe, while here in the West our leaders have just re-affirmed the need to maintain fiscal stimulus, given the fragility of even those earliest signs of recovery.
In the following monthly report I will examine just what evidence there is for the idea that Latvia’s economy has actually bottomed out.
The Fall In GDP Continues
Latvia’s economy shrank an annual 18.7 percent last quarter, following a drop in gross domestic product of 18 percent in the first quarter. The charge downwards was lead by a decrease in private final consumption which fell an annual 23.21% (year on year – see chart). Government final consumption dropped bya mere 6.9%, but expenditure on gross capital formation (which includes the critical investment item) crashed by 38.1% – with construction (which forms part) down 29.5% (see chart below). Goods exports (63.6% of total exports) was down by 19.1% and the export of services by 15.7%. The slump in imports was, of course) even worse with the volume of goods imports (78.8% of total imports) down 39.4%, and the volume of services imports by 38.2%.
But Slows On A Quarterly Basis
Sovenian GDP fell by 9.3 percent in the second quarter of this year when compared to the second quarter of 2008. This was the third quarter in a row which has seen a fall in Slovene GDP, and the was the deepest annual drop so far in the current economic crisis. In the first half [...]