Unrestricted Globalization of Capital Flows Consequence – Swiss Currency Strength leads to Impoverishment in Hungary

There has been reports of massive debt distress in Eastern European countries following the Global Financial Crisis.One of the major factors leading to this is the problem of foreign currency denominated loans.Most of the countries in Eastern Europe became truly independent after the dissolution of the erstwhile USSR.With weak institutions and nascent democracies,these countries became attractive investment destinations for banks in Western Europe looking for higher yields.

With the governance systems in these countries not mature and sophisticated enough to recognize the risks in foreign currency loans,most of the residents in these countries went on a debt fuelled binge.However the GFC following the Lehman bankruptcy in 2008 put an end to the global credit boom.With the currencies of these countries collapsing suddenly, these loans became expensive by a huge amount.This led to a sharp contraction in the GDP growth of Eastern Europe.The problems that these countries face have not abated as major currencies continue to fluctuate wildly with the Euro down almost 20% against the Dollar in a span of 1 year

The Swiss Central Bank has been unsuccessfully trying to control the appreciation of the Swiss Franc which has been going up against the Euro due to its perception as a safe haven currency.While the Swiss Central Bank is facing big losses on its Euro holdings,Hungary has become a surprise victim of the Swiss France strength.More than 80% of the foreign currency loans in Hungary are denominated in Swiss France.With Hungary’s local currency Forint depreciating by 27% against the France in 2010 alone,this implies that a Hungarian householder with a Franc denominated loan faces a 27% bigger loan than he did last year.Naturally this had led to an increase in debt defaults and a slowing of Hungary’s Economy.Note Hungary has been in the news for lying about its public accounts like Greece.

Swiss Franc Surge Compounds Hungary’s Headwinds – Businessweek

The Swiss franc’s surge to a record against the forint is compounding Hungary’s woes as the nation’s borrowers, more than 80 percent of whose foreign loans are in francs, struggle to service growing debt burdens, according to Nomura International Plc.

The franc touched a record intraday high against the forint on July 1 as investors, concerned the global recovery is faltering, turned to Swiss assets. The forint, in contrast, became the victim of a selloff last month after government officials raised the specter of a Greek-like crisis in east Europe’s most indebted nation. The franc’s gains will help reduce Hungarian growth by 1 percentage point next year, Nomura estimates.

Investors are looking for signs of recovery from last year’s 6.3 percent contraction. The government, in office since May 29, will impose a bank tax and public sector cuts to comply with the terms of a $25 billion International Monetary Fund and European Union loan. Those measures threaten to hamper growth in the EU member with the biggest proportion of franc debt. Hungary’s economy relies more on a stable franc-forint rate than on the euro, according to Nomura.

Deeper Recession

The surge in the franc, which has gained as much as 27 percent in the past year versus the forint, has deepened Hungary’s recession by about 2.5 percentage points, Nomura estimates. Gross domestic product will expand 0.5 percent this year and 2.5 percent next year, Nomura estimate. The economy grew 0.1 in the first quarter.