Weaker Forint Means Higher Hungary Interest Rates, Futures Show

By Michael Patterson and Laura Cochrane

Feb. 24 (Bloomberg) -- Hungary will raise interest rates in the next three months, even as the economy shrinks, to boost the forint and keep foreign debt payments from escalating, prices in the futures market show.

Contracts used to bet on Hungary’s key rate three months from now signal the central bank will boost borrowing costs by a half-percentage point to 10 percent, compared with predictions two weeks ago for a cut to 9.25 percent, data compiled by Bloomberg show. The Czech Republic also is likely to raise borrowing costs to 2 percent from 1.75 percent, while traders trimmed bets for reductions in Poland, according to the so-called forward-rate agreements.

East European policy makers may be forced to sacrifice growth, adding to losses already suffered by stock investors, as plunging currencies increase costs of servicing international obligations, according to Citigroup Inc. Hungarian short-term foreign debt is about 105 percent of its currency reserves, data from New York-based Morgan Stanley show.

“The markets are assigning a probability that some of the central banks in the region at a minimum will have less room for rate cuts and may have to start rate hikes at some point if the currencies continue to be under pressure,” said Claudia Calich, a New York-based senior money manager specializing in emerging- market debt at Invesco, which oversees about $357 billion.

Tumbling Currencies

East European currencies led declines across emerging markets since New York-based Lehman Brothers Holdings Inc.’s collapse in September roiled credit markets worldwide. The Hungarian forint tumbled 19 percent against the euro, while the Polish zloty plunged 28 percent and the Czech koruna weakened 16 percent.

Hungary, led by Prime Minister Ferenc Gyurcsany, secured 20 billion euros ($25.4 billion) in emergency loans from the International Monetary Fund, the European Union and the World Bank last year as swelling foreign debt costs, falling export demand for the nation’s automobiles and a widening budget deficit raised concern the country would lose access to funding.

Hungary’s government, consumers and companies had $26 billion of foreign debt due within a year at the end of September, equivalent to 105 percent of the country’s foreign- exchange reserves, according to Morgan Stanley.

The region’s currencies and stocks tumbled last week after Moody’s Investors Service said reliance on overseas financing is making eastern Europe more vulnerable to the global crisis and may trigger credit-rating cuts at banks.

Sacrificing Growth

Hungary’s benchmark BUX Index declined 16 percent this year. Poland’s WIG 20 index is down 24 percent and the Prague PX Index has lost 25 percent. The MSCI Emerging Markets Index slid 10 percent.

Government bonds also have tumbled. Hungary’s 5.75 percent euro bonds due June 2018 fell to 85.65 cents on the euro yesterday from 86.92 at the end of last year. The yield has risen to 7.99 percent from 7.75 percent, according to Bloomberg data.

Poland’s 4.2 percent euro bond due April 2020 declined to 81.14 from 85.96, pushing the yield up to 6.65 percent from 5.9 percent. The Czech 5 percent euro bond due June 2018 has dropped to 95.73 from 101.38, increasing the yield to 5.6 percent from 4.8 percent, Bloomberg data show.

“They have to choose between defending the currency over maintaining growth,” said Viktor Broczko, a London-based investment manager at Progressive Developing Markets, which oversees about $500 million, including East European assets. Interest-rate increases are “not good for growth and not good for companies,” he said.

False Signal?

The forwards market may be sending a false signal for rate increases, said Gergely Papp, a bond trader at ING Groep NV’s Budapest unit. He doesn’t expect Hungary’s central bank to boost rates as the nation’s economy slides into a recession.

The government predicts the economy will shrink between 3 and 3.5 percent this year.

Hungary’s central bank supported the forint yesterday by keeping its lending rate unchanged at 9.5 percent, after four cuts since November. Central bank President Andras Simor said policy makers in the region have “similar” motives in acting against weaker currencies.

“You’re talking about potential interest-rate hikes in an environment that is pretty awful,” Andrew Howell, a European emerging-markets strategist at Citigroup in New York, said in an interview. “It’s very bleak for central and eastern Europe. We could see more downside.”

Hungary Futures

Three-month Hungary forward contracts were priced at 10.1 percent late yesterday, which is 60 basis points higher than the central bank rate and the Budapest interbank offered rate, or Bubor, that lenders charge each other for three-month loans, Bloomberg data show. The contract averaged 23 basis points below the central bank’s target interest rate during the past five years. A basis point is equal to 0.01 percentage point.

Czech central bank board member Pavel Rezabek said in an interview in Prague yesterday that he expects the koruna to erase its recent losses before the bank’s next interest rate-setting meeting on March 26. Vice Governor Miroslav Singer said last week that the bank may need to raise interest rates after the currency fell to a more than three-year low against the euro on Feb. 17.

Traders expect the Czech central bank to increase the benchmark lending rate from 1.75 percent, with three-month forward-rate agreements priced at 40 basis points above the Prague interbank offered rate, or Pribor, at 2.51 percent. The so-called FRAs settle to Pribor three months from now.

Czech foreign debt amounted to 78 percent of currency reserves, according to the Morgan Stanley figures.

Poland

Poland will lower its seven-day reference rate to 4 percent from 4.25 percent tomorrow, according to the median estimate of economists surveyed by Bloomberg. Three-month forward contracts are priced at 53 basis points below the Warsaw interbank offered rate at 4.15 percent, signaling the central bank will reduce its benchmark rate by at least 25 basis points in three months.

Polish central bank Governor Slawomir Skrzypek said yesterday that “an intensification of information exchange and coordination of action” would help regional central banks support their currencies.

Poland’s short-term external debt amounts to 87 percent of currency reserves, the Morgan Stanley data show.

Russian policy makers increased interest rates in November to help defend the weakening ruble, prompting a retreat in stocks. The benchmark RTS Index fell 7.7 percent in the month after the central bank announced the first of two increases Nov. 11 that pushed the benchmark interest rate to 13 percent. The nation’s bonds lost 8.75 percent, according to data compiled by Merrill Lynch & Co.

“The prospects for central banks to have to hike rates and defend their currencies is a trend you’re going to be hearing more,” Nick Chamie, the Toronto-based global head of emerging- markets research at RBC Capital Markets, said in an interview. “As the currency weakens it increases the burden of that foreign debt. You can get into a very vicious cycle, very quickly.”

To contact the reporter on this story: Michael Patterson in London at mpatterson10@bloomberg.net; Laura Cochrane in London at lcochrane3@bloomberg.net