Hungary for diversity? Hungarian Government bonds that are Baa1/BBB rated and mature in Feb. 2014 are currently yielding about 6.15%. Hungary’s local-currency bonds, the world’s best performing debt this year, have slumped in the past month on concern that Europe’s credit crisis will spread. However, it is our opinion here at Durig Capital that fundamentals still support the Hungarian forint and we view this as a good opportunity for adding exposure to the forint while attaining higher yields as we continue to diversify our clients away from US dollar based assets. You can find other international recommendations in our Foreign and World Bond Reviews.
Not only are fixed income investors in the United States struggling to obtain yield, there is an increasing concern about the loss of buying power and a weakening of the US dollar relative to other world currencies. There appear to be no real or comprehensible solutions to the 14.3 trillion US debt problems that will not affect the viability of the US dollar remaining as the word’s reserve currency. While the US Federal Reserve has moved to keep interest rates at historic lows during its attempt to stimulate growth in the US economy, all the quantitative easing of efforts 1 and 2 have failed to accomplish their mission. With investor concerns now growing in the face of a weakening US economy, there is more reason than ever for Fed chief “helicopter Ben” Bernanke to initiate money drop number 3. How or where this trend will end is unknown. What is clear is that prudence has directed us to diversify our clients away from the US dollar, many of whom already overweight with fixed business and real estate assets in our country.
Current Direction to Free Markets
On the political front, Viktor Orban won the election in a landslide last year, and his party received 2/3 super majority in the parliament. This will mark 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.
Hungary’s Economic Background
Hungary emerged from 40 years of Communist in 1990, and has successfully transformed itself from a centrally planned to a market economy. In 2004 it joined the European Union. However, the ruling coalition of the Hungarian Socialist Party and the liberal Alliance of Free Democrats collapsed in April 2008 when the country was seriously hurt by the global financial crisis. The global downturn, declining exports, low domestic consumption and fixed asset accumulation dampened by government austerity measures resulted in an economic contraction of 6.3% in 2009. However, Hungarian bonds rallied and default swaps have fallen the most in the world this year. Furthermore, the government pledged spending cuts are designed to help shrink its fiscal deficit below the European Union’s limit of 3 percent of GDP.
Hungary has implemented critical reforms in all facets of its economy, with the private sector now accounting for about 80 percent of its approximately $US185 billion GDP. Currently there is an estimated 10 million people living in Hungary, with a jobless rate at about 11.4% and an inflation rate that has declined to 4.7%. Hungary’s financial sector is dominated by banking. However, the government has largely withdrawn from banking, and over two-thirds of the sector is foreign-owned. Foreign capital receives domestic legal treatment, and foreign companies account for a large share of manufacturing, telecommunications, and energy. The government allows 100 percent foreign ownership with the exception of some defense-related industries. There are no restrictions or controls on current transfers or repatriation of profits and no restrictions on sales of capital market instruments aside from some reporting requirements.
The government’s austerity measures, imposed since late 2006, have reduced the budget deficit from over 9% of GDP in 2006 to 3.2% in 2010. In 2010 the new government cut business and personal income taxes, but imposed “crisis taxes” on financial institutions, energy and telecom companies and retailers. Other taxes include a value-added tax (VAT), a property tax, and a gift tax. Overall tax revenue as a percentage of GDP in 2010 was 40.5 percent. The economy rebounded with a big boost in exports, especially to Germany, and growth of more than 2.5% is expected in 2011. In 2011, Hungary changes from tiered to a 16% flat tax on personal income and is raising its top corporate rate from 16% to 19%. Investor confidence that the country will contain its debt without a bailout has risen significantly.
Hungary’s Political Considertion
The Heritage Foundation publishes an annual index ranking nations on merits of Economic Freedoms. This indexed is based on variables such as easy of doing business, personal monetary freedoms, and 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.
The most obvious risk is that of default. The Hungarian Government has obtained a Baa1/BBB- rating for their sovereign debt, and is shown to be improving rather than declining. Therefore, we believe the greater risk resides with its currency, the forint, and the exposure it gives investors to the Hungarian economy.
Although Hungary does not use euros as its main currency, the euro and the forint do have some correlation. With recent the troubles stemming from, but not isolated in, Greece, FX currency markets have been and may continue to be quite volatile. While Hungary’s location in the heart of Europe precludes escaping sever or major economic eruptions happening around it, we believe that the sovereign forint does offer some degree of insulation to possibly a more systemic weakening of the euro.
Hungary’s economy is slowly recovering from the effects of the global financial crisis, which hurt economic growth and increased public debt. However, fiscal consolidation and better management of public finance are needed, and the high level of government spending is holding back private-sector growth.
How to Purchase Foreign Denominated Securities
At Durig Capital, we have developed a process to review, select, purchase and monitor securities denominated in foreign currencies on an ongoing basis. While many of the debentures we review are financially the most sensible only when purchased only in large institutional sized lots, we are able to offer through syndication a much more viable size and cost for the average retail investor’s entry. Chances are good that we may already have a working relationship with your existing custodian. Please contact one of our investment advisor representatives for more details.
With so many uncertainties lingering in the US and global economies, we believe a securities portfolio that includes issues denominated in foreign and world currencies could potentially be beneficial both in the higher yields they offer as well as protecting principle through diversification. We believe that an exposure to the Hungarian economy should be considered as a minor position in a well diversified portfolio to assist our clients in protecting against a possible loss in buying power of the US dollar. Both its higher short term yield and the potential appreciation of the forint give us ample reason to recommend the addition of this BBB rated Hungarian government bond as part of our fixed income portfolio.
Disclosure: Durig Capital clients may already own Hungarian Government bond positions in their fixed income portfolios.
To know more about this Hungarian Government bond call our fixed income specialist at 971-327-8847