After 2010, the consecutive governments of Viktor Orbán pursued a strongly anti-foreign debt policy and rhetoric for over a decade: Fidesz politicians would regularly criticise the ‘left-liberal’ governments for accumulating large foreign debts. The high foreign currency ratio of government debt before 2010 did indeed make the Hungarian economy vulnerable to external shocks, and played a role in the severe impacts of the 2008 economic crisis.
The cabinet remained consistent for a long time: the Government Debt Management Agency (ÁKK) would increasingly transfer the debt stock onto the Hungarian population by expanding the offering of forint-denominated government securities, mostly issued to domestic investors, and keeping the foreign currency ratio low. The foreign currency ratio of government debt, primarily held by foreigners, decreased from 50 per cent to below 20 per cent by the end of the 2010s, with
However, a year later, a turning point would occur: on September 14, 2021, the Hungarian state issued a debt of unprecedented magnitude in a single day, in the form of long-term foreign currency bonds amounting to 4.25 billion USD. At the time, Finance Minister Mihály Varga considered this an “unprecedented success”, seeing this as a positive feedback for the Hungarian economy. Minister of the Prime Minister’s Office Gergely Gulyás stated that the dollar-denominated debt was necessary “to ensure the normal functioning of the state,” also mentioning that due to its disputes with the European Union, the government is currently unable to receive advances from the funds of the Recovery and Resilience Facility (RRF).
The foreign currency ratio of government debt continued to increase throughout 2022, which was eventually followed by changes to the regulations on foreign currency bond ratios in 2023: before the changes, foreign debt could account for 25 no more than per cent of total debts, while now, it is capped at 30 per cent. In its financing plans for last year, the Government Debt Management Agency (ÁKK) projected a gross foreign currency issuance nearly doubling the amount stated in the 2022 plan, amounting to HUF 2,974 billion. By the end of the year, according to the agency’s estimate,
Last year, already in early January, the ÁKK issued foreign currency bonds amounting to $4.25 billion (equivalent to 1,600 billion forints at the time), which proved to be a rather expensive step due to higher risk premiums than before. At the time, we concluded in our article that the increase in the foreign currency ratio would likely not have been necessary if the EU’s “free money” had arrived as planned. (Prime Minister Viktor Orbán had previously pointed out that if no money was to arrive from Brussels, the country would finance itself from the financial markets.) Another explanation by analysts was that amidst the raging energy crisis, Hungary needed significant foreign reserves, mainly to cover energy imports.
Energy prices decreased significantly in 2023, resulting in the trade balance turning positive by the middle of the year after the record deficit of 8.6 billion euros in 2022. With this, Hungary’s pressing foreign exchange shortage ceased in this regard. Additionally, in mid-December, the European Commission announced that Hungary would be able to access approximately 10.2 billion euros in EU cohesion (convergence) funds, while another EUR 1 billion had also become available from the RRF.
So at first glance, the situation seemed to have changed to a great extent. Nevertheless, in 2024, ÁKK continued the practice of the previous year: at the beginning of January, the agency issued USD 2.5 billion’s (around 860 billion forints) worth of foreign currency bonds, exceeding the planned 2 billion. ÁKK’s financing plan for 2024 reveals that the government agency anticipates a gross foreign currency bond issuance of approximately 6.7 billion euros (2579 billion forints) this year. While slightly less than the previous year’s amount, this figure is still significantly higher than the levels seen in 2022. (Of the 6.7, the net sum is 4.6 billion euros, representing new issuances, while the remaining 2.1 billion would finance maturing foreign currency debt.) A potential weakness in ÁKK’s plan is that it assumes a budget deficit of 2.9% of GDP, while the deficit in 2023 was 6.1%. As it stands, it seems unlikely that the government will be able to maintain the low deficit target, therefore,
What’s behind the push for more foreign currency debt this year, too?
Although the government has increased foreign currency debt since 2020, it has primarily continued the practice of directing the savings of Hungarian citizens into forint-denominated government securities. However, the global inflationary environment has changed significantly in the meantime, impacting Hungary in a shock-like manner. The forint weakened significantly against the euro, leading to a substantial increase in interest rates. The average inflation rate of 14.5% in 2022, coupled with the 26% rate on foodstuffs opened a Pandora’s Box of sorts: attracting more substantial household savings to the government bond market could only be achieved with much higher yields than before. Consequentially, the first series
However, this came at a significant cost: according to the Hungarian National Bank’s latest inflation report, in 2023, the country’s interest expenses nearly doubled, reaching over three trillion forints. Compared to the 2.3% in 2021, this caused approximately 4.3% of Hungary’s GDP to be spent on debt service, making it the highest value in the EU, surpassing even previous record holders Italy and Greece.
It is telling that only 14 per cent of the state’s interest expenses were tied to foreign currency debt, meaning that the overwhelming increase is mainly attributed to domestic, forint-denominated government bond issuances. In other words, the Hungarian government incurred debt in its own currency at a much higher cost than the rest of the EU. According to the Hungarian Fiscal Council (KT), moreover, the average interest rate on national debt stock is expected to rise even further in 2024.
Having to pay lower interest expenses would be highly beneficial to the government right now, while it also aims to stimulate household consumption through interest rate reductions. It is likely a deliberate strategy from the Government Debt Management Agency to cut back from the offering of forint-denominated government securities, compensated by an increase in the issuance of foreign currency bonds.
They want to limit forint yields even further, which can only be achieved if they issue more foreign currency bonds,
comments Dániel Móricz, Investment Director at Hold Fund Management, to 24.hu. We previously reported that since mid-2023, the government has been striving to reduce the yields of forint-denominated government securities and worsen the conditions of long-term bonds, while also attempting to reduce inflation. Households considering saving can expect an even more unfavourable interest environment in 2024. For instance, the yields of earlier issued PMÁP series align with 2023’s expected annual inflation of 17-18% at the beginning of their term, while the new series will pay a fixed annual interest of only 9.9%.
Regarding short-term government securities, a decrease in public interest is already apparent: in the first week of January, the 6-month Discount Treasury Bill (DKJ) auction by the Government Debt Management Agency performed so poorly that the 30 billion forints’ worth of securities attracted only 23 billion in purchase offerings. This is not surprising, considering that the average auction yield was 6.7%, whereas in the first half of the previous year, the typical range was 14-15%.
During the summer, it seemed possible that ÁKK was merely testing the market with lower interest rates. However, according to Dániel Móricz, by now it is evident that the government does not want to garner funds from the public at such high costs, but the demand for new, low-yield securities is significantly lower. Additionally, the government is struggling to keep up with public expectations, as when it comes to benchmark yields, the public typically looks backwards on the 18% matching last year’s inflation rates, instead of settling for the forward-looking, sub-10% figures.
Incurring foreign currency debt could prove to be a risky and costly endeavour
In January, ÁKK issued a 12-year dollar-denominated bond with an interest rate of approximately 5.8% – which at first glance seemed still more favourable for the government compared to its forint issuances. The debt management agency acted with good timing, as they might not have been able to issue at such low costs back in 2023. A significant decrease has taken place regarding the yield of long-term bonds issued by developed countries over the past two months; while bond premiums have also dropped somewhat. For comparison, the yield of ten-year Hungarian dollar-denominated bonds issued in January last year was around 6.5%, as the government had to contend with a yield spread of 280 basis points at that time. This year, this figure has decreased to 180 basis points – explained the investment director.
The reduction in yield spreads is mainly attributed to the fact that the beginning of last year was a rather stressful period globally, and amidst surging inflation rates and a severe energy crisis, investor expectations were unfavourable regarding Central and Eastern Europe. However, the region’s perceptions have improved with a decrease in risks this year.
According to the prevalent international practice, the yield on Hungarian foreign currency bonds is assessed by a baseline set according to the rates of U.S. ten-year treasury bonds, which the market considers, practically speaking, risk-free. The difference between the two yield levels is the risk premium, the most crucial element of which being country risk. Country risk encompasses macroeconomic trajectories, including GDP-to-debt ratio, credit ratings, as well as the sustainability of fiscal and monetary policies. Ultimately, it represents the risk of a country defaulting.
Based on bond risk premiums (CDS), compared to the current 4% on ten-year U.S. bonds, the Czech government would likely have to contend with yields of around 4.5-4.7% on its ten-year foreign currency bonds, with this figure being somewhat higher for Poland at roughly 5%. Hungarian taxpayers, on the other hand, are to face a rate of 5.8% – as pointed out by Dániel Móricz.
However, the real risk of foreign currency bond issuance comes from exchange rate risk. In the end, foreign currency debt could turn out to be more expensive for the government than if it had issued the new bonds in forints. To clarify, ÁKK swaps the dollar-denominated bonds through a currency swap, converting them into euros; therefore the country is exposed only to the fluctuations of the euro. At the moment, the forint is relatively strong against the euro, but should Hungary’s domestic currency weaken, the cost of interest and repayment would be complemented by currency losses as well – warned László Molnár, CEO of GKI Economic Research Plc.
According to the research institute’s estimate, the coming years can be expected to bring about an annual 3-4% depreciation of the forint. Due to the weakening of Hungary’s national currency, the annual interest on foreign currency bonds may creep as high up as 9-10% instead of 6%, resulting in approximately the same interest expense as the latest PMÁP retail forint bond series.
This could prove quite expensive for the government; it was not without reason that the Hungarian National Bank (MNB) has long kept foreign currency indebtedness in check,
László Molnár is assessing.
GKI’s analyst suggests that the depreciation of the forint is to be expected, as the Hungarian currency’s exchange rate does not reflect the inflation that characterised this last period. The euro exchange rate started the year 2022 at around 370 forints, currently fluctuating at the 380–385 mark – the sustained annual depreciation did not even reach 3%. In contrast, the internal value change of the forint, representing average inflation, was 14% in 2022 and approximately 18% last year, adding up 32%, or 34% when calculating with compound interest. Overall, this is the amount the forint should weaken by to remain competitive in export markets. Naturally, one must consider foreign inflation as well; the Eurozone experienced an average inflation of around 15%, but even taking this into account, the forint should have depreciated by at least 20%. As this has not been the case, the export-oriented companies driving the Hungarian economy have experienced a significant deterioration in efficiency, as they now receive approximately 20% fewer forints per euro.
Due to this, we don’t think that a policy fixated on a strong forint can be sustained for long,
the analyst explains, adding that the competitiveness of agricultural exports has drastically deteriorated recently. If the exchange rate policy does not change, the government and the central bank will likely have to face, among other things, the fact that a relatively large mass of agricultural producers is going bankrupt. At the same time, multinational manufacturing companies, constituting the most important exporters, may also view these processes unfavourably — and this group of foreign giants is of paramount importance to the government; in the past, Hungarian exchange rate policy was set to align with their operations.
On a slightly different note, GKI’s forint exchange rate forecast can be considered only slightly pessimistic within the analyst consensus. An expert from Hold Fund Management also expressed the opinion that while not necessarily during the next year, but Hungary’s economic policymakers will eventually be forced to weaken the forint in the long run. Currency depreciation is a realistic risk, but it is not certain that it will actually happen within the next few months, he added.
In his view, the scale of the planned 2024 foreign currency bond issuance by ÁKK and a foreign currency ratio below 30% in total national debt are not especially risky. The process could become dangerous if the quantity of issuance and the prescribed foreign currency ratio are further increased. It is a commonly observed phenomenon that significant foreign currency debt paired with populist economic policies can eventually lead to the devaluation of the domestic currency, causing a debt spiral that is very difficult to overcome – for example, Argentina is currently struggling with such an issue.
The national budget requires new sources Brussels has given the green light for European Union funds to Hungary, but in 2024, the amount will only be enough for a more favourable governmental presentation of Hungary’s budget situation to investors and credit rating agencies. In reality, less funding will arrive than last year when the still remaining sum of 3 trillion forints of cohesion funds from the 2014–2020 period was transferred to Hungary to offset previous government payments. The resources of the new support cycle, however, will be limited; based on announcements, only 20% of cohesion funds are paid in advance. Thus, approximately 700 billion forints’ worth of sources will be financed by the European Commission this year.
This forecasts a significant decrease, rather than an increase, on the revenue side of the national budget regarding EU invoice traffic. This year’s budget will have to compensate for this loss, just like how it has to make up for the revenue lost due to the reductions in special taxes,
Molnár warns. Currently, it is not clear how the government plans to reduce the much higher than planned budget deficit. Meanwhile, several large-scale plans are on the agenda that would significantly burden the expenditure side of the 2024 budget, while the revenue side is still not quite on stable footing. To highlight a few:
- The repurchase of Ferihegy Airport could cost around 1500 billion forints according to estimates.
- The government is planning more than a trillion forints in transportation development investments, including the completion of the M76 motorway.
- The state support for battery factories and the BYD project in Szeged could cost around another trillion forints over a three-year period, while an additional amount of the same magnitude may be spent on infrastructure support related to the plants.
The budget will have to ensure the coverage of the announced salary increases in law enforcement agencies, as well as the announced salary increases for teachers and healthcare professionals, which will impose further burdens. Before the EP and municipal elections, additional welfare measures are expected: it is not out of the question that the government will pay pension premiums in advance. These expenses add up onto the already increased list of expenditures. To generate liquidity, the government may either increase the tax burden on businesses again or initiate new foreign currency bond issuances — the CEO of GKI speculates.
