The Hungarian government’s pledge to lower the budget deficit below 3% of GDP in 2011 needs to be taken with a grain of salt. Officials have frittered away credibility with contradictory statements and verbal blunders. The latest miscommunication occurred in August when the government said it would reopen talks with the IMF in autumn, but later said it has no plans to seek a new IMF loan. Consequently, it is hard to take government statements at face value.
The Hungarian banking sector is generally less fit than its regional peers —with a higher-than-average loan-to-deposit ratio and a below-average capital adequacy ratio—and considerable challenges lie ahead. The main risks relate to asset quality. Non-performing loans (NPLs) as a percentage of total loans jumped from 4.7% at year-end 2008 to 10.1% at year-end 2009. The deputy CEO of OTP, Hungary’s largest bank, says the NPL ratio will keep climbing as long as lending declines, and this state of affairs looks set to continue.
We’ve been examining Turkey’s widening current account deficit, a trend that looks new but is actually a post-recession return to business as usual. Amid last year’s sharp economic contraction, Turkey’s current account deficit receded to 2.3% of GDP, and the issue largely faded from the spotlight. However, the issue is now coming back to the fore, given the fast expansion of the deficit, and we explore the structural deficiencies behind it in a new RGE Analysis, available exclusively to clients. RGE believes the 2009 narrowing was due to exceptional circumstances—i.e., a plunge in domestic demand during the global financial crisis—and we expect the deficit to reach 4.4% of GDP in 2010.
Turkey’s dependence on foreign sources of energy is one of its structural weaknesses and means that the country’s current account is vulnerable to rising oil prices. Turkey’s large manufacturing sector depends on imported energy for production, and rising oil prices push imports higher and widen the current account. Not surprisingly, in June 2008, when oil prices averaged over US$130 per barrel, Turkey’s deficit hit a record-high, exceeding US$5.5 billion for the month.
Current Account Balance (US$ Million, lhs) and Spot Price of Oil (rhs)
Source: CBT, EIA
A little less than a month ago, RGE’s Mary Stokes and Michael Hendley published an analysis reflecting on the Hungarian Fidesz party’s rise to power in the country’s April parliamentary elections. Despite generally positive market reactions to the party’s strong mandate, Stokes and Hendley urged RGE clients to take a cautious stance toward Hungary, given the Fidesz party’s “hazy policy agenda,” and noted that “Fidesz does not look wedded to continuing the previous government’s tight fiscal stance.”
Eastern Europe will likely feel reverberations from Greece’s fiscal woes. While the possibility of contagion via trade and FDI channels is limited, transmission via the financial channel is a real risk in Bulgaria, Romania and Serbia, given the strong presence of Greek banks in these markets. Any direct spillover effects will likely be limited to these South East European economies, but the potential for indirect effects must also be taken into account. On the positive side, Greece’s fiscal crisis highlights the comparatively better fiscal positions of EU newcomers in Eastern Europe. Nevertheless, troubles in the eurozone periphery could further curtail global risk appetite and delay euro adoption, which could weigh on emerging European assets going forward.
Amid the global financial crisis, several European countries faced serious economic distress and turned to external creditors, including the EU and IMF, for emergency financing. This multilateral support relieved investors and calmed worries of full-fledged balance of payment crises. Nevertheless, these economies are not out of the woods. As first noted in an RGE note in October, political developments could push loan programs off track, reigniting crisis fears. Iceland, Latvia, Romania and Ukraine are cases in point. The derailment of any of one of these IMF programs could lead to a greater focus on political risk in the other program countries.
Editors Note: The Following is an excerpt from RGE premium content, “Turkey Fiscal Deterioration: More than Just Cyclical?” which is available to paid clients. Turkey’s fiscal consolidation earlier this decade is an impressive success story. In the wake of the 2001 financial crisis, the government managed to cut the public debt-to-GDP ratio from a high […]
Fears of a full-fledged regional financial crisis across Eastern Europe have eased, calmed by a strong IMF presence, hefty external assistance to those in need, and a general improvement in global risk appetite. Nevertheless, the region is not out of the woods. The specter of a Latvian devaluation still looms, banking stress continues, and rising political risk in several countries with IMF programs is a concern.
The Good: Bright Spots Have Emerged
Risks may linger, but bright spots have emerged. The second quarter upturns (q/q) in France and Germany—key export markets and important sources of foreign capital for Central and Eastern Europe—are a positive sign, but the jury is still out on the strength of the recovery. Meanwhile, the improvement in global risk appetite cannot be underestimated. As the saying goes, “A rising tide lifts all boats.” For now, investor appetite for Eastern European sovereign debt has picked up compared to earlier this year, which has alleviated external financing risks.
The Improved: Contagion Effects from a Latvian Devaluation Likely To Be Limited
Turkey’s central bank cut its policy rate to a record low 7.25% in September 2009. Since October 2008, the bank has slashed rates by an extraordinary 950 basis points. Given Turkey’s negative growth picture and slowing inflation, most analysts expect further cuts. But ongoing fiscal deterioration could dampen the effectiveness of additional monetary easing.
Bottom line: Without an IMF program in place, further rate cuts may bring more risks than rewards.
Slowing Inflation, Slack Domestic Demand Support Rate Cuts
Turkey’s real interest rate is now below those of emerging markets like Brazil and Hungary. Despite the easing streak, there have not been major outflows from Turkish markets in search of higher yields thanks in part to an improvement in global risk appetite. In fact, the Turkish lira has strengthened in recent months. From a low in March 2009 (of around 1.80 against the USD), the lira has strengthened more than 20% in the period to mid-September.