Goldman Sachs has put together a very informative chart, as part of its European chart of the day series, which shows the discrepancy between household accumulation in domestic and foreign denominated debt. While HUF-denominated debt is a mere 12% of GDP, FX-denominated is at almost 50% of GDP. Most of this debt is CHF-based, and with the CHF hitting fresh record highs, the pain for debtors is becoming unsustainable due to the relative FX strength. And while, as Goldman points out, new FX debt accumulation has plunged, the legacy positions will be there for a long time. For this debt to clear out, the Balance of Payments for Hungary and other non-euro countries will enforce a very prudent deleveraging regime, and will require that the economies grow, not contract. The last is something that is very much in question for Hungary, which as we pointed out recently, has decided to go it alone with IMF assistance, and thus without a safety net backstop should things not work out as expected. Either way, the bottom line is that as European countries loaded up on EUR-, and especially CHF-, denominated debt when the currencies were cheap, the current violent swings with a rising bias, will make the pain for the peripheral countries all that much more pronounced.
Here is some further clarification from Goldman:
The crisis has highlighted the dangers of the private sector accumulating substantial foreign debt. Central Europe, in particular Hungary, suffers from a no less dangerous variation of this problem - namely households borrowing (from domestic banks) in foreign currency, mostly Swiss Frank and the Euro. After the crisis hit Hungary in the autumn of 2008, the National Bank and MPC started an educational campaign to highlight the dangers of this practice to households, and FX lending regulations were tightened. As a result, new lending in foreign currencies almost ceased, however, households continued to pay the instalments on their FX mortgages, car, and consumer loans - which were now higher in domestic currency terms after the Forint weakened in late 2008 and early 2009. But the problem persists in stock terms.
Today, the MPC meets for the first time since the Hungarian President signed a law to ban FX mortgages altogether. We’ll be listening to the press conference for possible comments on the problem, including recent FX moves and the government’s reluctance to address its part of the imbalance.
Today’s European Chart of the Day illustrates how debt repayments and the debt stock have evolved since late-2008. After a long period of rapid growth, the start of 2009 brought a dramatic turnaround in accumulation of new FX debt. In net terms, and corrected for exchange rate changes, households have been repaying their FX debt at an increasing pace, with 2010Q2 marking the highest net repayment of about 0.7% GDP. However, with the Forint weakening against the Euro and the Swiss Franc (the latter being reinforced by the flight away from the Euro) household FX debt rose back to 40% of GDP, the same as in the beginning of 2009.
This underscores the vulnerable balance sheet position of Hungary (and other countries where household FX debt increased considerably), and the extent of the large balance of payments adjustment needed to reduce FX exposure. While capital continues to flow out through the banking channel, these countries will have to generate sustained trade balances and reduce public sector borrowing needs to allow for an orderly deleveraging process in the household balance sheets. This will be a long and complicated process.