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Hungary fails to count calories in its Swiss roll

12:01AM BST 19 Sep 2006

Borrowers have rushed to take out loans in francs and other currencies, but murmurs
over the exchange risks are growing, reports Ambrose Evans-Pritchard in Budapest
From the hilltop battlements of Buda castle you can look down over the sizzling
post-communist resurgence of the Danube basin and behold the wonders of the Swiss
franc. The ubiquitous new Citroens and restored Habsburg-era apartments are mostly paid
for with loans from Switzerland, where interest rates are just 1.75pc though, ominously,
creeping up. The borrowing craze reached a peak in July, when three quarters of all new
mortgages in Hungary were taken out in Swiss francs, with a smattering of euros, and a small
fraction in forints.

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Over 60pc of total loans to businesses and households are now in foreign currencies, and
damn the exchange risk. Though Hungary is the region's pioneer with some $2bn a year in
Swiss franc loans, Poland, Croatia, Romania, and lately Turkey are catching up fast. This is
Europe's "carry trade", every bit as creative as the better-known yen trade that has juiced the
world's asset markets with liquidity at near zero interest rates from the Bank of Japan.
"It's a train wreck waiting to happen, especially when novices are at the controls," said Prof
Steve Hanke, a currency expert at John Hopkins University. These mom-and-pop borrowers
must service their Swiss franc debts with incomes in Hungarian forints, creating a dangerous
currency mismatch," he said.
The International Monetary Fund has begun muttering about the dangers, mostly sotto voce
so far. An internal IMF paper this summer warned that Europe's ex-Communist bloc is
starting to look as vulnerable as Thailand, Indonesia, Malaysia, and South Korea a year
before the Asian crisis in 1997 if not worse, by most criteria.
Entitled "Asia 1996 and Eastern Europe 2006 Dj vu all over again?", the report has yet to
be published. The lure of foreign loans, of course, is cut-price credit. Payments on Swiss
franc mortgages average 5.5pc, while forint loans cost 12.3pc at least until the game
changes, as it did abruptly in the worldwide rout of emerging markets this May.
The mortgages are adjusted monthly to reflect the exchange rate, so Hungarians were briefly
hit with an 8pc jump in payments as the forint plunged. Peter Racz, a soldier turned estate
agent, said he had a nasty shock when he opened his mortgage statement to discover that the
forint debt on his Buda apartment had ballooned since he bought it 15 months ago.
"That was quite scary. I'm behind even though I've been paying interest all this time. Still, I
think most of us know the risks, and we'll be joining the euro soon so we can withstand it,"
he said. Andras Zekany, a currency expert at ING, said Hungarians remained blithely
insouciant even after the mini-crisis.
"It didn't hurt enough. Nothing has changed and it won't change until people start looking
beyond the cheapest option and begin taking exchange risk seriously," he said.
"The banks play down the dangers because they make higher margins on foreign exchange,"
he said.
The main lenders are Austria's Erste Bank, Belgian's KBC, and Italy's Unicredito, mostly
through local brands. All have sales teams pushing the Swiss loans, bombarding the airwaves

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with enticements. Mr Zekany said the risk for Hungary was a triple whammy of rising rates
in Switzerland, a forint crash, and a recession as government austerity measures start to bite.
"If all three factors go wrong at the same time, this becomes serious," he said.
Hamezc Istvan, the director of Hungary's central bank, can only shake his head wearily as he
awaits the inevitable denouement of East Europe's carry bubble.
"There is nothing we can do to stop foreign exchange borrowing, and we don't even try. As
members of the European Union, we have to respect the free flow of capital," he said.
"We can only warn the banks about the underlying risk and try to minimise any shocks. So
far we haven't had any defaults," he said.
Mr Istvan said Hungary's government had made a royal mess of the economy, letting rip on
spending four years ago.
"They over-promised thinking they would never be elected and then had to deliver on 50pc
wage rises in the public sector when inflation was just 4pc. Isn't that the most stupid thing to
do?" he said.
The budget deficit will reach 10.1pc of GDP this year, while the current account is 8pc in the
red far worse than east Asia in 1996. The central bank warned in its Financial Stability
Report that Hungary was on an "unsustainable" path. "The primary source of risk is rapidly
rising foreign exchange borrowing. Due to short credit histories we do not have adequate
information on the credit-worthiness of new customers and their ability to resist shocks," it
said.
In Berne, the Swiss National Bank (SNB) is looking on in bemused silence. "We are starting
to see commentaries in the East European press hoping we won't raise interest rates," said a
spokesman.
"We can only point out that we will set monetary policy to meet the needs of our own
country. There may come a day when we have to change strategy and this could cause
foreign exchange to fluctuate widely," he said. The screw has already begun to turn. The
Swiss raised rates to 1.75pc last week, up from 0.75pc just a year ago when the country was
still struggling to shake off its Japanese-style malaise.
Watching in London, the rating agencies are starting to fret about Eastern Europe's
over-eager embrace of fast capitalism. Standard & Poor's said Hungary was at "high risk" of

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crisis, warning that recession could push borrowers over the edge. Hungarians are facing a
jump in VAT from 15pc to 20pc and a "solidarity tax of 4pc, part of an austerity package
expected to drain 15pc from disposable income.
Fitch says 15 countries across the region have allowed credit growth to get out of hand, with
breakneck acceleration of 49.7pc in Lithuania, 46.1pc in Kazakhstan, and 41.1pc in Ukraine
last year. Such rates of growth have been a precursor to systemic banking crises in the past.
Nobody can agree on the exact trigger for Asia's crisis a decade ago, though it began with a
speculative attack on the Thai baht in May 1997, spreading across the region as foreigners
and local banks yanked out some $200bn not all of it "hot money".
In the end, Russia was engulfed, Italian and Spanish bonds crashed, and the hedge fund Long
Term Capital Management was left holding $100bn of bad bets, prompting emergency rate
cuts by the US Federal Reserve.
Anybody who thinks the global financial system is once again skating on thin ice should keep
a very close eye on that Hungarian forint.
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