Monetary policy turnaround and targeted measures in Hungary

Budgetary stabilisation and the independent monetary policy paved the way for a monetary policy turnaround in Hungary after 2013, which was based on the significant reduction of the policy rate and targeted measures.

The lower policy rate reduced the interest burden in all sectors of the economy while also supporting investments and consumption. Low inflation and the improving risk perception of the economy after the fiscal consolidation provided ample room for manoeuvre for the Magyar Nemzeti Bank to create steadily favourable monetary conditions actively supporting growth. The first and traditional tool for this was the prudent and gradual decrease of the central bank base rate from 7 per cent to the historic low of 0.9 per cent between 2012 (i.e. from the interest rate cuts launched with the support of the then new external members of the MNB Monetary Council) and 2016 (Figure 13). Government securities yields followed the development of the base rate in the context of low inflation, the favourable international money market environment and Hungary’s improving risk perception, which showed that investors also considered monetary policy sound and credible. The falling yields considerably reduced the government’s interest expenses. Total savings have amounted to 4.5 per cent of GDP since 2013 (HUF 1,600 billion).

The Funding for Growth Scheme and later the Growth Supporting Programme were targeted tools supporting the SME sector that helped avoid the risk of a creditless recovery. Similar to some foreign central banks, in addition to the general, traditional tools, the Magyar Nemzeti Bank used targeted, unconventional measures to effectively address the unprecedented money market and real economy crisis.

Such measures included the MNB’s Funding for Growth Scheme announced in the spring of 2013, which sought to alleviate commercial banks’ insufficient SME lending. This was necessary because there was a real danger of the credit market (which had contracted by around 6 per cent annually since mid-2009) freezing completely, which would have entailed a persistent growth sacrifice and also undermined potential growth. To address this issue, the MNB offered refinancing loans to the commercial bank sector at 0 per cent, which had to be lent to the SME sector with a premium of up to 2.5 per cent (for fixed capital formation, working capital acquisition, FX loan refinancing and prefinancing EU funds). Within the framework of the programme, around 40,000 SMEs obtained preferential loans amounting to HUF 2,800 billion (8 per cent of GDP) in total. Thanks to the success of the FGS and the Growth Supporting Programme (GSP) introduced in 2016, which aimed to gradually phase out the FGS and smoothly shift corporate lending to market financing, the contraction in credit was reversed, and by the end of 2016, SME lending had started increasing dynamically (Figure 14).

Figure 13

Central bank base rate in Hungary

0

Source: Edited based on Magyar Nemzeti Bank (2017) and current data

According to Magyar Nemzeti Bank (2016) estimates, the rate-cutting cycles and the central bank programmes fostering lending activity contributed to around half of the economic growth in recent years, directly and indirectly, and they also exerted a positive impact on potential growth.

The Magyar Nemzeti Bank’s Self-Financing Programme aimed to reduce the external vulnerability of the economy. The Self-Financing Programme was introduced by the central bank in mid-2014 and was then expanded in 2015 and 2016 in several stages. The primary goal of the programme was to reduce external vulnerability and improve the risk perception of the total economy, and to mitigate the central bank’s FX reserve requirements by lowering external financing and expanding the domestic investor base. Therefore, the MNB encouraged commercial banks to keep their liquid assets in securities rather than in the central bank's sterilisation instrument.

During the programme, the central bank policy instrument was transformed from a two-week bond into a three-month deposit, which considerably reduced its liquidity. Furthermore, the conditional central bank interest rate swap (IRS) was temporarily introduced to mitigate the interest rate risk of commercial banks arising from purchasing long-term, fixed-rate securities (Magyar Nemzeti Bank 2015).

Figure 14

Growth rate of loans outstanding of the whole corporate sector and the SME sector in Hungary

–10 –5 0 5 10 15 20 25

–10 –5 0 5 10 15 20

25 Per cent Per cent

Introduction of FGS

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Fact – SME sector

Fact – corporate sector Forecast – SME sector Forecast – corporate sector Note: Annual change on a transaction basis

Source: Edited based on MNB data

The programme contributed substantially to enhancing the financing structure of government debt as well as to lower exchange rate exposure via a significant reduction in the share of foreign ownership and the foreign currency ratio in debt.

After the extremely high figures at the end of 2011, both ratios are currently at historic lows (Figure 15).

The phase-out of households’ FX mortgages in cooperation with the Government and the banking sector saved the country from an economic and social catastrophe.

As a result of the widespread, large-scale FX-denominated lending from 2003, by the time the 2008 global crisis hit, a large portion of the private sector had become indebted in foreign currency, which entailed a huge systemic risk even by international standards, due to the significant exchange rate exposure (Figure 16).

This is because on account of the considerable weakening of the forint due to the crisis, the monthly payments of the debtors increased dramatically, making housing conditions uncertain for hundreds of thousands of people. In parallel with this, the rising payments also stymied aggregate demand, as they reduced the disposable income and consumption of debtors and drastically increased the ratio of non-performing loans (NPLs) (4–6-fold) in the banking sector, which jeopardised the

Figure 15

Foreign ownership and foreign currency ratio of the Hungarian central government debt

2005Q1 2005Q4 2006Q3 2007Q2 2008Q1 2008Q4 2009Q3 2010Q2 2011Q1 2011Q4 2012Q3 2013Q2 2014Q1 2014Q4 2015Q3 2016Q2 2017Q1 2017Q4

Share of FX-denominated debt in public debt Share of external debt in public debt Source: MNB, Government Debt Management Agency

stability of the financial system. Meanwhile, the widespread FX lending impaired the monetary policy transmission mechanism, as Hungarian monetary policy could not influence the interest rates on the loans denominated in foreign currency. It became crucial for society and for economic policymakers to phase out the FX-denominated loans as soon as possible, but only the Government that came to power in 2010 was determined to go that far.

Since 2013, the Magyar Nemzeti Bank has helped with all its available means in settling the matter of households' FX loans. Before the Supreme Court's (Curia) uniformity decision in mid-2014, the MNB played a proactive role in the negotiations between the Government and the Banking Association, and then contributed significantly to the successful forint conversion of household FX loans by providing the necessary liquidity (EUR 9 billion) to the banking sector (Kolozsi et al. 2015). To ensure the success of forint conversion and prevent money market speculation, the conversion rate had to be fixed in advance and without informing market actors, which required close cooperation from the three players, the Government, the Central Bank and the Banking Association (Nagy 2015). FX loans started to be converted in the autumn of 2014 with the announcement of the FX tenders linked to the phase-out of household mortgages, and they were followed by personal and car loans in 2015, therefore by the end of 2015 Hungarian households basically had no FX loans on their balance sheets. The average monthly instalments on the previously Swiss franc-denominated housing loans plummeted by 25 per cent.

Figure 16

Household sector housing loans borrowed from credit institutions in Hungary (as a percentage of GDP)

Households’ mortgage loans from credit institutions in foreign currency Households’ mortgage loans from credit institutions in local currency Dynamic spread of the

foreign currency loans

Government measures Phasing out of the

foreign currency loans

Exposure

Source: Edited based on MNB data

The importance of these measures was later underlined by the fact that all this was achieved before the Swiss National Bank discontinued the use of its exchange rate floor against the euro, after to which the appreciation of the Swiss franc would have had unpredictable consequences.

4.2. The European Central Bank’s crisis management was insufficient for the