Hungary for Income?
Hungarian Government Debt rated Baa1/BBB- with multiple maturities yielding 5.5% for one year
Investors should consider International Bonds for the following reasons
- In this low rate environment, people are often seeking higher interest rates with shorter maturities.
- It’s current wisdom that through proper diversification one can reduce risk.
- Many believe the US Dollar currency could decline in value due to large deficit government spending.
Fixed income investors in the United States are struggling to obtain yield in the shorter term. The US government spending habits have been called out of control by many. This leaves the long term “real” value of the US dollar at risk. The US Federal Reserve has moved and kept interest rates historic lows attempting to stimulate growth in the US economy. It was announced last week that the Federal Reserve will pursue a second round of easing by purchasing bonds in the secondary market thus possibly further diluting the value of the US Dollar. The additional spending by the Fed has investors wondering what next if this doesn’t work. Pundits have predicted that the newest move by Mr. Bernake’s may be adding too much fuel to the fire and could cause a bubble in the financial markets. With many uncertainties lingering, we believe a diversifying portfolio includes foreign and world currencies could potentially be beneficial both in increase income as well as protecting principle.
At Durig Capital, we have developed a process to review, select, purchase and monitor bonds on an ongoing basis. One country that we are adding to our foreign bond holdings is Hungary. Enclosed is our review, along with supporting documents, showing why we believe Hungarian Government bonds makes sense in clients’ portfolios. We reviewed thousands of separate bond listings to find what, we believe, is currently the best fixed income instrument for investors.
Hungary is a land locked country nestled in the middle of Europe with a rich history. Origins of the current Hungary can be dated as far back as 1000 A.D. Currently there are an estimated 10 million people living in Hungary with a land area of over 35,000 square miles or about the size of Maine. 17% of Hungarians live in the economic and political epicenter of Budapest.
Economically Hungary has had issues but data could be pointing to a turnaround. Gross Domestic Product (GDP) was almost $200 billion US Dollars in 2009. The size of government has been the largest issue as it debt load represents over 75% of GDP while government spending is around 40% of Hungary’s annual GDP. Steps are being taken to reduce both the size and scope of government in Hungary.
In late 2008, Hungary was in a precarious position due to the pressures of financing government debt. The Forint lost 20% of it value in less than a month. The International Monetary Fund, European Union, and World Bank made a $25 billion US Dollar line of credit available to Hungary. “The Hungarian authorities have developed a comprehensive policy package that will bolster the economy’s near-term stability and improve its long-term growth potential,” IMF Managing Director Dominique Strauss-Kahn said in a statement.
In October of 2010, the Hungarian officials were offer again IMF support but claimed it would not need to extend this temporary line of credit. “Many people have said there is no life without the IMF. There is,” Economy Minister Gyorgy Matolcsy told parliament. “We do not need a new loan agreement, we can finance ourselves, because we committed to (fiscal) balance.” These quotes illustrate Hungary is coming out of it’s financial miseries. It appears they are becoming a self reliant country and dealing with it at a much faster pace then the US currently is.
On a good note, Hungary has know established a trade surplus. Exports and imports for September 2010 both increase 21.6% and 19.3% respectively. On an annual basis, it is estimated for 2010 that Hungary will export $4.75 billion US Dollars and import $4.36 billion US Dollars. This trade surplus is a positive step that could lead to an export-led economic recovery.
On the political front, this past summer a new Prime Minister was elected in Hungary. Viktor Orban won the election in a landslide and his party received 2/3 super majority in the parliament. This marks the first time since the communist era ended that Hungarian government will be run without a political coalition. Mr. Orban ran with the promise to cut taxes, curb tax evasion, create jobs and reduce state bureaucracy. Since taking office, Hungary has announced a 10% reduction in government employment and reductions in the governments funding of pension funds. These larger austerity measures could aid Hungary return to fiscal health, plus the return to free markets often precludes a stronger currency.
The Heritage Foundation publishes a annual index ranking nations on merits of Economic Freedoms. This indexed is based on variables such as easy of doing business, personal monetary freedoms, labor and property rights. Hungary ranks 51st out of the 179 countries that are rated. One item that we seek is the continual improvement in the freedoms of a country. Indications are that as business and personal freedoms improve, the greater the probability that currency, business and job markets could follow suit. Hungary’s freedom index level has improved since the mid 1990’s and is now above the global average. With the recently elected administration’s programs being implemented, this could accelerate this transformation.
One of the more newsworthy headline regarding the Hungarian economy should be mentioned about there new tax policy. They have cut the corporate tax rate for companies earning 500 million Forint and less (about $2.5 million) from 19% to 10%. This rate reduction will allow more cash flow for small companies to hire and expand. Although this reduction does not help large corporations, the more people that are employed the higher the added income tax base it creates a larger income base for the government. This could be a step in the right direction for Hungary.
In addition to the above mentioned tax reduction, the Hungarian government in general is trying to simplify the taxing system. The have let luxury taxation on items like boats, planes, and expensive cars expire. A flat tax has been established on income of 16% for everyone. Often simplifying a process reduces excess waste and makes the whole operation run smoother. With the measures the government is taking, we believe that the Hungarian governments tax revenues could be more dependable and greater transparency is better governance and more desirable.
One of the greatest risks associated with investing in Hungarian bonds is the currency risks associated with owning assets denominated in Hungarian Forint. In the early part of 2010, the so called P.I.I.G.S. of Europe (Portugal, Ireland, Italy, Greece, and Spain) spooked the global investor to sell due to speculation of government collapse. Global currencies, including the US Dollar, were very volatile during this period. Hungary is located in the heart of Europe and although it currently does not use Euros as it main currency, the Euro and Forint are closely correlated to each other.
Below one can see the difference between the yields of Hungary and the United States government bonds. One should note that these bonds have different ratings from the ratings agencies and inflation forecasts are different which could effect overall returns.
Hungary should be considered as a position in a well diversified portfolio. We are recommending the addition of Hungarian government debt as part of a fixed income portfolio. The Hungarian Government has obtained a Baa1/BBB- rating for their sovereign debt. Hungarian debt could add value to a portfolio by adding a higher short term yield with the potential for appreciation in the Forint.
At Durig Capital, we have been able to place many foreign government and corporate bonds, like the Hungarian, Brazil, Australia, and New Zealand, for clients with as little as $10,000 US Dollars. This allows clients to enjoying often much higher yield, plus the additional strength of these underlying currencies, while reducing our client exposure to our US Dollar.
Dislcosure: Durig Capital is currently recommending clients allocate a portion of their fixed income portfolios in Hungarian Debt.
Disclosure: Durig Capital currently does not have a position in Hungarian bonds.
To know more about this Hungarian bond call our fixed income specialist at 971-327-8847
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