By Zoltan Simon
Oct. 22 (Bloomberg) -- Hungary raised its benchmark interest rate by 3 percentage points, the biggest increase in five years, and pledged measures to shore up the economy after steps to halt the flight of investors failed.
``The forint remains under extremely strong speculative pressure,'' Prime Minister Gyurcsany told reporters in Budapest today. ``The government will intervene if that becomes necessary to protect the Hungarian economy.''
The Magyar Nemzeti Bank lifted the two-week deposit rate to 11.5 percent today, the highest since 2004, in an emergency move. The forint, which fell to near a record earlier today, rose as much as 2.5 percent against the euro.
Stocks, bonds and the forint plunged in the past two weeks on concern that the country will face difficulties in financing its current account and budget deficits with global credit drying up. Lining up help from the European Central Bank and the International Monetary fund, along with moves to increase liquidity, failed to stem the slide.
``This is a desperate, brutal decision,'' said Daniel Bebesy, an economist at Budapest Investment Management. ``The size is fine, but what we got here is the evaporation of global liquidity, so it's uncertain if the rate increase will rev up demand for the forint.''
Forint, Stocks
The forint, which fell to 283.35 per euro earlier today, close to its record low, traded at 274.20 2:52 p.m. in Budapest, erasing gains after the rate decision. It has lost 13 percent of its value this month. The benchmark BUX stock index was down 3.6 percent extending its October plunge to 37 percent.
In Hungary, where foreign currency loans made up 62 percent of all household debt at the end of the second quarter, up from 33 percent three years earlier, consumers were threatened by the currency's slide.
The government has agreed with the country's banks to allow customers to convert foreign-currency loans to forint, to extend the duration of their debt or to suspend payments in extraordinary circumstances, Gyurcsany said.
Local Worry
``Local people have also started to worry about the currency's level,'' analysts at KBC Groep NV wrote in a note to clients today. ``The major risk in any currency crisis is to have local players convert their deposits into foreign currencies.''
History shows that attempts to save currencies from plunges by raising interest rates are prone to failure. The U.K. on Sept. 16, 1992, boosted its benchmark rate by 5 percentage points in two moves to 15 percent in a doomed effort to keep the pound in a European exchange-rate system. Britain gave up the attempt the same day and canceled the second rate rise; the pound lost 22 percent against the dollar in the final two months of the year.
During the 1997-98 Asian financial crisis, the International Monetary Fund advocated high rates to help restore confidence in sliding currencies. Central banks from Indonesia and Thailand to South Korea and Singapore lifted borrowing costs. South Korea took its main rate to 30 percent in December 1997.
The strategy failed to prevent exchange-rate collapses across the region. South Korea's won lost 47 percent against the dollar in 1997, the Thai baht fell 45 percent and Indonesia's rupiah plummeted 56 percent.
Hungary Scrambling
Hungary is scrambling to shield its markets from being engulfed by the global financial crisis that erased more than $25 billion from equities in 2008. Central banks from London and Frankfurt to Washington and Hong Kong two weeks ago reduced interest rates after yearlong credit-market seizure stoked concern banks will run short of money.
Gyurcsany today urged ``significantly increasing'' next year's budget reserves from the proposed 300 billion forint ($1.4 billion) to improve its ability to respond to the financial crisis.
The central bank two days ago kept the interest rate unchanged at its regular rate-setting meeting, discarding earlier calls for a rate cut because of slowing inflation. The bank then said the credit crisis warranted a ``strict'' monetary policy.
The increase is an ``extreme decision'' that may backfire and further damage prospects for economic growth, said Bartosz Pawlowski, an economist at Toronto Dominion Bank in London. He said emerging market currencies were weakening today across the board and may not be linked to interest rate levels.
``Today every emerging market currency except the Romanian leu was losing ground. If the forint stays weak or continues to weaken and credit dries up, we could be looking at a horrible situation in the real economy,'' he said in a phone interview.
Slower Growth
Hungary's government has postponed tax cuts aimed at boosting growth from a 14-year low of 1.1 percent last year to focus on reducing reliance on external financing as investors shun riskier assets. The government expects growth of 1.8 percent this year and 1.2 percent next year, instead of earlier estimated of 2.4 percent his year and 3 percent next year.
The government plans to narrow the budget gap to 3.4 percent of gross domestic product this year and 2.9 percent in 2009 from last year's 5 percent. The earlier goals were 3.8 percent for this year and 3.2 percent for next year.
Bond Sales
To ease external financing pressure, the government cut bond sales by 200 billion forint ($937 million) this year, pledged to cut the budget deficit faster than previously planned, while the central bank is buying back state debt and is offering new loan facilities to provide liquidity to a stalled bond market.
Hungary today scrapped an auction of bonds due in 2012 and the central bank allocated 44 million euros in a foreign exchange swap tender.
The ECB agreed to lend Hungary as much as 5 billion euros ($6.7 billion) to help unfreeze the credit market, while the IMF said it was ``ready'' to discuss financial assistance. The funds were a ``last resort,'' Andras Simor, the president of the central bank, said after the rate decision on Oct. 20. Negotiations with the IMF are continuing, Gyurcsany said today.
To contact the reporter on this story: Balazs Penz in Budapest at bpenz@bloomberg.net.
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