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Monday, October 27, 2008

Ukraine and Hungary To Receive IMF Loans, While Belarus Joins the Line

by Edward Hugh: Barcelona

Hungary announced on Sunday that it had reached agreement with both the International Monetary Fund and the European Union on a broad economic rescue package, which will include substantial financing, in a bid to stabilize a Hungarian economy which has been both shaken by the global financial crisis and faces long term macro economic and structural problems which make any easy solution to the situation hard to expect.

"A substantial financing package in support of these strong policies will be announced when the program is finalized in the next few days," IMF Managing Director Dominique Strauss-Kahn said in a statement that did not indicate the size of the package.

Hungary announced the loan at more or less the same time as Ukraine received a USD16.5bn loan from the IMF. Under normal circumstances both these moves would be good news for Central and East European equity markets assets. This was not the case on this occassion, however, and Hungary's stock markets fell more than 10% on opening yesterday, suggesting that either investors are not convinced the packages will be sufficient, or that they fear there is more to come.

Hungary (which is a member of the European Union but not the Eurozone), had been in talks with the IMF since early October trying to sort out some kind of package which would restore confidence in the country's falling equity and struggling bond markets. The Hungarian government and the central bank had taken a series of measures to shore up the currency and financial markets, and the central bank hiked interest rates by 300 basis points only last Wednesday (to 11.5 percent), in addition to offering support to local residents who wanted to transfer their debt obligations from Swiss francs to Forint.

Ukraine Loan Agreed

The International Monetary Fund also reached agreement with Ukraine on a $16.5 billion loan to help the country confront the ongoing financial and economic crisis. IMF managing director Dominique Strauss-Kahn said on Sunday that agreement had been reached between the IMF staff mission to Ukraine and the government, although the agreement still needs to be formally ratified by the IMF board, while some members of the Ukraine government itself scarely seem to be convinced of the urgent need to adopt the package (and here).

An aide to Ukraine's president accused Prime Minister Yulia Tymoshenko on Monday of putting a big IMF credit at risk by linking quick approval of financial legislation with the country's long-running political upheaval......Tymoshenko and her supporters last week blocked discussion of the financial package for four days in order to prevent inclusion in it of any funding for disputed early elections, called by Yushchenko for next month.

Ukraine's prime minister and the head of the IMF called on parliament to pass legislation quickly to underpin a loan deal and described political stability as a key part of the process, the government said on Tuesday. The government issued the statement ahead of a scheduled sitting of parliament, blockaded for a week by protesting deputies, to consider a package of financial measures.

Consultations to forge a package were proceeding in parliament, which has a long history of fractious behaviour. It was uncertain debate would go ahead as scheduled. Ukraine remained gripped by its latest bout of political turmoil after President Viktor Yushchenko dissolved parliament last month and called a snap election. Tymoshenko opposes the election and her supporters disrupted debate last week to prevent any bid to finance the poll.

Even in the Ukraine case investors seemed pretty unphased, and the hryvnia sank to a record low yesterday, forcing the central bank to abandon the "corridor" (or band if you prefer) it had previously maintained in an attempt to control its movements. Ukraine's stock market plunged a further four percent and credit default swaps, an indication of risk that Ukraine could default on debts, rose to 2,600 basis points, up from 300 in August.

The 24-month stand-by loan will be conditional on parliamentary approval of legislation to support the country's banks. Ukraine will also need to balance its budget and address the current-account deficit problem, according to a separate statement from the Ukrainecentral bank. Obviously we all hope that the loan will provide a framework within which it will be possible for the country to increase financial stability and rebuild confidence among investors, although there does seem to be a long hard road to go down here.

Really there is a very severe credit-crunch-type (sudden stop) crisis raging in Ukraine (and across Eastern Europe more generally by the look of it) at the present time, and the macroeconomic consequences are hard to forsee, although quite a serious recession does seem imminent in the Ukraine case.

The IMF's Ukraine package is actually pretty large if we take into account that IMF’s total funds available for global distribution at the present time only run to about USD220bn - and there are undoubtedly going to be more customers. The package is similar in size to the one Turkey got in 2002 after the collapse of the Turkish economic and financial system. This would seem to be a clear indication that the IMF sees the risks in the Ukraine as extremely high. Furthermore, the fact that the IMF has acted so rapidly (relative to the time it took with Turkey in 2001/02) offers a clear indication that they fear a domino effect across central and eastern Europe wherby a collapse in one country “automatically” leads to a collapse in another one. Unfortunately, it is just such a process that we seem to be seeing right now.

A further factor to worry about is that the IMF will now effectively have to take over responsibility for economic policy in the Ukraine, especially given the size of the loan. But given the level of political uncertainty and instability which exists in the country there is a serious risk that the IMF will be unable to implement the desired reforms, and even more to the point, given the deep structural nature of Ukraine's longer term demographic demise, there are reasonable doubts that even were they able to introduced these reforms they would have the desired effect. In which case the IMF is in above its head, and the resulting damage to its credibility may impede subsequent rescue efforts, in countries with similar problems, further on down the line. Since a key component in the IMFs ability to see off financial trouble in a given instance depends on its credibility, it is important that this is carefully guarded, and maybe the Ukraine is not the best place to put all that carefully built confidence back at risk again.

Bottom line, this is not a pretty picture, nor is there an especially pleasant outlook.

Belarus Negotiating Loan

Belarus also made public last week that they have requested a loan from the IMF. The amount of the loan has yet to be determined, but Interfax reported they had applied for a $2 billion loan and may also seek funds from central banks and commercial banks in other countries.

``The Belarusian economy and its access to external finance,'' have been hurt by the credit squeeze, IMF Managing Director Dominique Strauss-Kahn said in its Belarus statement. ``At the same time, changing conditions in trade have negatively affected the country's balance of payments. A Fund mission will begin discussions with the authorities in the next few days.''

Russia has also pledged to lend Belarus $2 billion, granting half the loan this year and half in 2009, according to a statement from Finance Minister Alexei Kudrin. Belarus's foreign currency and gold reserves fell 12 percent to $4.94 billion in September, according to the National Statistics Committee.

Belarus is likely to face a growing budget deficit because of decreasing prices for its oil-product exports to Europe, at the same time as it will be much more difficult to raise funds from selling state assets, and slowing demand in Russia for Belarusian consumer goods will crimp exports. EU countries also account for more than half of Belarus exports, so the rising recession threat across the EU won't help either.

Belarus' current-account deficit widened to $986 million in the second quarter from $424 million in the first three months of the year, according to the National Bank of the Republic of Belarus, while the economy expanded 10.4 percent in the first half of the year, the second fastest rate in the CIS, after Azerbaijan.

Belarus has a Ba2 rating from Moody's Investors Service, two levels below investment grade, while the Belarus ruble has declined 1.8 percent against the dollar in the past year.

Hard To Say What Happens Next In Hungary

Hungary's most immediate and pressing problem is that it relies heavily on foreign investors buying its bonds while its banks face difficulty in securing foreign currency financing as liquidity dries up in international and local money markets. The crisis has caused credit markets generally to malfunction so severely that many emerging market economies are having real difficulty accessing the capital they so badly need.

While we still lack details on theHungarian package, we are being assured by Hungarian government sources that it will be "of convincing size and force."

"The agreement contains standby access to resources, which will significantly reduce Hungary's exposure to foreign market financing," according to one anonymous source.

With Hungary's commitment to strengthened economic policies, Strauss-Kahn said he expected Hungarian banks and other financial institutions would be able to start lending. "The policies Hungary envisages justify an exceptional level of access to fund resources," Strauss-Kahn added.
We also learned yestreday that the IMF had agreed in principle to a $16.5 billion standby loan deal with Ukraine and that on Friday it agreed to a $2.1 billion deal with Iceland.

Portfolio Hungary points to the following sentence in the IMF statement - "The policies Hungary envisages justify an exceptional level of access to Fund resources" - and read it as suggesting that the IMF financial support to Hungary could be several times the value of the country's IMF quota. This see this assumption as backed up by the fact that the USD 16.5 bn facility to Ukraine is eight times as large as Ukraine's quota.

While Martin Blum, analyst at UniCredit in Vienna, say that - at least in terms of the information released so far - the package sounds positive in that the package is designed to ensure the external private sector remains on board and:

“The IMF/Hungary package could prove significant to the extent that it seems it will explicitly include EU and some EU govt funding. This is clearly positive for the rest of the EU27 including Romania and Bulgaria. Although big underlying problems remain, we'd remain flat EUR/HUF and Hu, Ro and Bg CDS into this weeks likely Hungary IMF financing announcement. In short, the big question now is the scale of EU/EU govt funding."

This all looks very interesting, although I am absolutely convinced that if Hungary is to continue to apply a rigourous fiscal policy in its own right, then some sort of external injection of demand (read cash) will be essential to keep the patient ticking over while it is on the life support system. I simply worry that with this problem now extending right across Eastern Europe, and the fiscal issues mounting at home for the foreign bank governments in the wake of their own massive "bailouts", then there may be a danger of overstretch here, and that we could see the fiscal positions (read treasuries) in some of the theoretically funding countries coming under attack next as they reveal the size of their own fiscal on-costs from all the "rescuing" that is going on. Remember, basically for ageing population commitment reasons, the EU countries had previously all agreed to try and balance their budgets before 2011 and this agreement is now most definitely about to get lost in the already overflowing rubbish bin of EU Stability and Growth Pact history.

Also, and since Martin Blum comes himself from the much troubled Italian bank Unicredit, maybe we also need to be including the Libyan government in any multilateral support system, since their government now seems to be the second largest shareholder in Unicredit, and the bank seems to be maintaining its Tier I capital ratio only thanks to Libyan support.

Difficulty Selling Bonds

News of the Hungarian and Ukraine loans does not seem to have done much to unblock liquidity in the affected countries at this point, since Hungary's Government Debt Management Agency (ÁKK) had to withdraw HUF 40 bn worth of discount T-bills (the auction was cancelled) which they offered for sale at a liquidity auction yesterday, after they received less than HUF 5.09 billion worth of bids. Last week they were forced to do the same with a 6-m T-bill and a 3-yr bond auction.

The National Bank of Hungary (NBH) similarly had to announce that it had bought HUF 50 billion worth of government bonds at auction yesterday, the full amount on offer. And the yields paid were extraordinarily high. The NBH purchased HUF 20 billion 2009/F bonds at an average yield of 14.05%, HUF 20 billion 2010/C bonds at 14.21% and HUF 10 billion 2011/C bonds at an average yield of 13.77%. At the last auction held on 17 October, the average yield on HUF 25 billion 2011/C bonds came in at 12.06%.

Christoph Rosenberg, Senior Regional Representative for Central Europe and the Baltics (who I respect as a really serious economist) was quoted by Reuters yesterday as saying “It's a really good policy package." We'd just better hope it is, since we have no details yet. And Chris, if you are listening out there somewhere, any package which has as its kernal a tight fiscal stance (and this alone) simply won't work due to the depth of the recession it will produce. The Hungarian government need to put their own books in order (to keep the investment community happy), so fiscal cutbacks at home are inevitable, but the Hungarian government will need support from the EU or elsewhere to be able to increase spending in some way or another, otherwise..... weak exports (external european environment), plunging domestic consumption (no forex loans) and cut-backs in public spending only add up to one thing: a substantial deflationary recession, and more financial crises as we move forward. Hungary needs the forint down and spending in some part of the economy UP - a mix of greenfield investment and public spending in support of this would perhaps be the best option, and a cheaper forint would make wages in the export sector more competitive at a stroke.

News like the following are what we need, and the investors are going to need incentives to put their money into this kind of investment in current recessionary environment:

Daimler has on Monday signed an agreement with Hungary's government to invest around EUR 800 million in a new plant in Hungary that will manufacture over 100,000 compact cars annually from 2012, and create up to 2,500 jobs. “Mercedes-Benz is building the plant in order to create additional production capacity in the compact car segment, where the model range will be expanded from two to four vehicles. The plant contributes to the profitability of the product portfolio extension," Daimler said in a statement.