Hungary's woes could cost Indian companies

London:  Most of Europe has got over its New Year’s hangovers by now, but sadly Europe, and the rest of the world, must wait until it recovers from the hangover from the European, crisis. Notice, I said European, not Euro crisis. In 2012, we have a new worry: Hungary. It isn’t a member of the Eurozone, but it is the next teetering domino in our interconnected global economy. Hungary’s debt was downgraded to junk status on Friday, in part because the Hungarian government has imposed exchange rate losses on foreign banks. In a blog post by the BBC’s business editor Robert Peston titled “ Hungary’s dangerous dependence on eurozone banks ”, he writes, “The financial crisis in Hungary is a warning of why the eurozone’s debt crisis is the world’s debt crisis.” [caption id=“attachment_174853” align=“alignleft” width=“380” caption=“Hungary’s Prime Minister Viktor Orban. Reuters”] [/caption] Hungary’s economy hasn’t been the picture of health for a while, and the country turned to the IMF and European Union in 2008. The country’s prime minister, Viktor Orban, has said he wouldn’t be going hat in hand again to the IMF and EU, but now, he’s been forced to offer an olive branch to the IMF . With all of the triumphant talk about globalisation, the downside of our tightly interconnected global economy is that risks as well as rewards are quickly spread through the system. Why should Hungary worry the rest of the world, much less its European neighbours? First, Hungary’s problems are worrying European banks, especially in Austria, because they are so exposed to the country. Austrian banks might be holding $42billion in Hungarian debt, but number two on the list is even more worrying, Italian banks, such as UniCredit, have $24billion. That’s one of the things driving down the stock price of UniCredit, which had been hoping to raise money with a share offering. Only one Hungary’s seven largest banks is independent , according to Bloomberg. All of the rest have foreign partners. As the BBC’s Peston notes:

“According to the latest figures from the Bank for International Settlements (which are always several months out of date by time of publication) European banks have provided $120bn of credit to Hungary’s public sector and private sector, out of total international lending to Hungary of around $140billion. To put that into context, overseas lending to Hungary represents around 100 percent of GDP.”

One of the issues for Hungary has been the popularity of home loans denominated in Swiss francs rather than its own currency, the forint. Demand for franc-denominated loans rose in 2003, after the Hungarian government cut subsidies to forint-denominated loans. The mortgage rate for loans in Swiss francs could be half of what it was for loans in forints. It was an easy decision for many Hungarians. However, in 2008, after the collapse of Lehman Brothers helped trigger a global financial crisis and Hungary was forced to seek a bailout, the country’s currency the forint suffered. It has dropped another 40 percent since, dramatically pushing up the costs of repayment of the franc-denominated loans. Hungarian PM Orban forced foreign banks to accept currency losses by passing a law allowing his citizens to repay foreign denominated mortgages at about a quarter of the current exchange rate For two Austrian banks, Erste Group Bank and Raiffeisen Bank International, those losses could total $1.2billion. Now banks are offering to accept another $2.2 billion in currency costs but only if the Hungarian government agreed not to take any further action. If Orban doesn’t agree, the banks are threatening to quit Hungary. Another small country in Europe in trouble? Why does this matter? As John Stepak at MoneyWeek says, “Investors are finally waking up to the fact that Europe’s banks need a lot more money than any sane investor is prepared to give them. “ The European Banking Authority already estimated that European banks needed an additional €115 billion to shore up their balance sheets. Again as Stepak notes:

“The basic problem is simple. Banks don’t have enough capital to comfortably back the loans that they’ve written. If those loans go bad (say, oh I don’t know, a small European country goes bust), then they won’t have enough capital to absorb the losses.”

That’s why European banks are scared to lend to each other and are parking their money with the European Central Bank. That’s driving a new credit crisis and possibly another global crash, one that George Soros recently told an Indian audience could be worse than the one in 2008 . European banks don’t just loan to European countries and businesses. They also provide a lot of credit globally. Moody’s is already warning that this could raise borrowing costs for Indian companies . Cold winds are still blowing over Europe, and they continue to cause a chill to the rest of the world.