A few days ago I saw a report that the IMF was breaking off negotiations with Hungary regarding a debt package. I knew what was next: a weakening currency and more downgrades. The downgrades came in spades.

Bloomberg reports Hungary Hit by Second Debt Downgrade to Junk on Orban’s Policies

Hungary lost its investment-grade rating at Standard & Poor’s, the second such downgrade in a month, increasing pressure on Premier Viktor Orban to obtain an International Monetary Fund backstop and reverse policies.

The country’s long- and short-term foreign- and local- currency sovereign credit ratings were cut one step to BB+ from BBB-, the company said yesterday in a statement.

The IMF and the European Union suspended talks over an aid package to Hungary, citing concerns about the government’s plans for a central bank law they say may curb monetary-policy independence. Hungary will have the highest debt level and slowest economic growth among the EU’s eastern members next year, the European Commission forecast on Nov. 10. IMF backing would bolster policy credibility, S&P; said.

The forint weakened to 307.01 per euro as of 11:21 p.m. in Budapest yesterday from 300.74 on Dec. 20. It has lost 13 percent since June 30, the worst performance among more than 170 currencies tracked by Bloomberg.

Hungary’s five-year credit-default swaps, which measure the cost of insuring government debt against non-payment, traded at 572 basis points yesterday, the ninth-highest in the world, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers.

The central bank raised its benchmark interest rate to 7 percent on Dec. 20 from 6.5 percent, which was already the EU’s highest. Policy makers said they may boost borrowing costs further if risk perception and the inflation outlook deteriorate “substantially.”

Orban shunned IMF aid after taking office to protect what his government called “unorthodox” measures from oversight, including the effective nationalization of $13 billion of private pension-fund assets and extraordinary industry taxes to control the budget, which had a deficit of 182 percent of the Cabinet’s full-year target at the end of November.

Hungarian Forint vs. the Swiss Franc and the Euro

Please consider the following chart of the Hungarian Forint vs. the Swiss Franc and the Euro.

click on chart for sharper image

Forint Falls After Downgrades

The Wall Street Journal reports Hungarian Forint Falls After S&P; Downgrades Rating To Junk

The Hungarian forint tumbled sharply against the euro, dollar and Swiss franc Wednesday after Standard & Poor’s cut Hungary’s rating into junk territory.

Hungary’s currency slid to a one-week low against the euro, though in very thin trading, following the announcement. The euro rose to HUF306.42, from the HUF303 area before the ratings downgrade, according to CQG. The euro later steadied itself around the HUF305.50 level. The dollar, meanwhile, jumped 1.8% on the day against the forint, and the Swiss franc advanced 1.4%.

Investors have largely avoided Hungary’s currency, as the country grapples with high levels of foreign currency debt, and has yet to obtain financial assistance from the European Union and International Monetary Fund. The IMF and EU halted preliminary talks on back-up financing to Hungary last week, after a new central bank bill raised concerns about the central bank’s independence.

The Hungarian government recently proposed the central bank bill, which would merge the central bank with Hungary’s financial markets regulator, and would also designate a third deputy governor and raise the number of members in the Monetary Policy Council.

Expect Defaults on Public Debt

A junk rating on public debt by the S&P; does not come easily. You have to really try to get it. Moreover, you have to really try hard to get the IMF to walk away from debt deals.

Bear in mind it is most always correct to refuse money from the IMF. Iceland is a classic example. However, the policies of Hungary are extremely questionable to say the least.

Hungary had plans to join the Euro in 2007 or 2008. The target date is now 2020. Will the Euro even be in existence then?

Expect Defaults on Private Debt

Given massive amounts of private loans, primarily mortgage loans, I see little hope for those loans to be paid back, except for the small percent capable of refinancing on agreed upon discounts, right here right now.

Who would be dumb enough to take out loans in Swiss Francs on Hungarian properties? Good question. The answer, amusingly enough includes economics professors, based on their models.

Please consider “Decision was rational. I put it into a model” says Hungarian Economics Professor who took Mortgage in Swiss Francs, then Clobbered on 40% Currency Move

Mike “Mish” Shedlock
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