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Currencies in central and eastern Europe are facing familiar demons.
Hungary’s forint has slumped to record lows while the Polish zloty has also stumbled sharply since the summer, in large part because of the manufacturing slowdown in the neighbouring eurozone. Analysts warn that more weakness lies ahead.
The pullback illustrates once again that when Germany sneezes, smaller nearby countries also catch a cold, but for Poland it also reflects the resurgence of an old foe: Swiss franc-denominated mortgages.
In the run-up to the financial crisis, households across central and eastern European households loaded up on Swiss franc loans, lured by an apparently attractive combination of a strong local currency, which promised to make repayments manageable, and low interest rates in Switzerland. But once the financial crisis pushed the franc to a record high and currencies like the forint and the zloty plummeted, the costs of borrowing rocketed for debtors, which by then included two-thirds of Hungarian households.
In 2011 the government in Budapest intervened, forcing mostly foreign lenders to convert some €9bn of mortgages from the Swiss franc to the forint at a fixed exchange rate significantly below the market value. Banks across Poland, which are still sitting on huge books of franc-denominated loans, are wondering if they could be next to swallow big losses.
On October 3, the European Court of Justice is due to rule on the status of 130bn zloty (€30bn) in outstanding Swiss franc-denominated loans, which borrowers have claimed were mis-sold. In an “extreme case,” a forced revaluation of these loans could cost Polish banks 60-80bn zloty, according to an estimate from ING. That could weaken the zloty significantly, although Petr Krpata, a currency analyst at ING in London, said the timing of the move lower is difficult to predict as legal wranglings could take years to resolve. While Hungary opted for a state-driven solution to the conversion problem, Polish borrowers will have to sue their banks individually if the ECJ sides with debtors.
The ECJ has indicated that it is likely to do this, which could eventually force banks to convert mortgages to the zloty at the exchange rate that prevailed at the time the loan was taken out. In 2008 the Swiss franc traded as low as 1.96 zloty; on Thursday it was worth 4.03.
Already, the zloty has dropped by over 3 per cent against the euro since July, with one euro now buying over 4.39 zloty. The ruling was originally scheduled for September.
Meanwhile, trade tensions between the US and China are increasingly filtering through to European manufacturing activity, despite a further easing of monetary policy from the European Central Bank. In response, investors are selling the currencies of smaller, open economies in Europe, which tend to be sensitive to investors’ general appetite for risk.
Weakness in currencies across the region should “persist, as weaker European and global growth continue to weigh on domestic demand,” said Nik Sgouropoulos, a currency strategist at Barclays in London.
David Petitcolin, an emerging markets currency strategist at Deutsche Bank, said an equally-weighted basket of the forint, zloty and the Czech koruna could weaken as much as 5 per cent in the short term against the Israeli shekel, another relatively small, open economy close to the region.
The outlook is darker still for the forint, which has fallen by about 4 per cent so far this year, and which sank to its weakest ever levels against the euro this week after manufacturing indicators for the eurozone slipped to a six-year low.
In the past, Hungary’s central bank at times reacted to economic slowdowns in the eurozone and a depreciation in the currency by raising interest rates, as the economy’s high dependence on foreign-currency debt meant a weaker forint posed a risk to financial stability. At its peak in 2009, the country’s foreign currency debt hit 90 per cent of gross domestic product
Gergely Tardos, the head of research at OTP Bank in Budapest, said Hungarian rate rises are unlikely this time, as the ratio of foreign-currency debt to GDP has fallen “dramatically” to 30 per cent. Instead, he said, policymakers will probably be comfortable with more weakness in the forint as long as inflation forecasts remain in line with the central bank’s target of 3 per cent.
“Instead of presenting a financial stability risk . . . a weaker forint will be good for boosting exports, household spending and overall economic activity,” Mr Tardos said. He expects the forint to trade around current levels for the rest of the year against the euro, unless global growth slows further, and to fade another 1.5 per cent or so over the next two years.
The Hungarian central bank sounded a dovish note at its policy meeting on Tuesday when it left its key interest rate unchanged at 0.9 per cent. Eszter Gargyan, Hungarian economist at Citigroup, said the central bank has scope to deploy more unconventional stimulus measures if growth remains weak but the bar for policy tightening remains high.
“The [central bank] has no concerns about the euro hitting new historical highs against the forint,” she said.
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