By Win Thin, Senior Currency Strategist, BBH
Harvard Professor (and former IMF official) Kenneth Rogoff expects some Eastern European countries to face sovereign crises over next 2-3 years. In a weekend interview, Rogoff predicted that not every country will be able to successfully consolidate their budgets, naming Ukraine, Romania, and Hungary as “potential wobblers.” Due to close ties with Eastern Europe, he warned that the situation will create a “real stress test” for Austria. While Rogoff is clearly talking about the sovereign picture, we note that private sector developments remain troubling as well and are likely to feed into sovereign jitters. Earlier this month, Hungary’s largest bank said it expects the ratio of non-performing loans to rise further and sees risks in the quality of its foreign currency-denominated (mostly CHF) mortgage portfolio. We note that CHF/HUF spiked to around 220 last week, higher than previous peaks around 218 in June 10 and 217 in March 09, and so bad loans are likely to continue rising. The bank reported that profit dropped sharply as provisions for bad loans soared to a record high, and that loans overdue 90 days or more made up 12.4% (and rising) of the bank’s credit portfolio at the end of Q2. The bank also warned that it would see deterioration in its loan books in Romania and Ukraine, which echo Rogoff’s remarks. Given developments in Ireland, markets may rightly become concerned about increased government aid being needed to support the banking sector in the weak Eastern European sovereigns.
The three countries named by Rogoff are all countries that have had to go to the IMF for aid programs. Just as the bond markets are signaling continued stresses in the euro zone periphery after a period of calm, so too do we expect a similar trend in the weaker Eastern European credits. Bond yields and CDS prices are for now well below the crisis highs for Hungary, but if the economic outlook deteriorates as we expect, then we look for a sharp reassessment of Hungary’s risk profile. The government certainly hasn’t given markets any reason to be confident in their capabilities, not when officials continue to flip-flop with regards to fiscal policy and the IMF program. We remain long EUR/HUF and look for a move back to the late June/July highs around 288 and then the July high around 292. Early June high around 290.50 is in between.
