What awaits Hungary’s rollercoaster currency?

Hungary’s currency, the forint, has brokern numerous negative records against the euro and the dollar in recent weeks. The trend in currency markets is similar across Central and Eastern Europe (CEE) due to the war in Ukraine and the related sanctions, the forint has staged the steepest fall in the region. What could put a floor under the sliding Hungarian currency?

Rising inflation accompanied by currency depreciation are a common economic occurrence across many countries in the western world. The war in Ukraine and the resulting sanctions have triggered an staggering rise in energy prices. To make matters worse, the recovery from the Covid-induced economic malaise has led to massive shortages and a jump in demand for raw materials and products (such as microchips), which are also fueling inflation.

Flight to safety
Whenever a crisis situation emerges, international investors look for a safe bay and turn away from more risk-laden, typically emerging market assets. In the case of the Ukraine war, this is doubly true: in addition to the general risk averse attitude, investors are also tending to dump euros, and the national currencies of CEE countries closest to the war zone and most exposed to imported energy.
This is the international backdrop against which the forint has been performing over the past 6 or so months. The situation is made more delicate by Hungary-specific features, none of which are to the liking of international investors. Let’s just mention the country’s stand-off with Brussels and the resulting freeze in EU funds, the special corporate taxes slapped on various industries and Hungary’s reliance on Russian fossil fuels.

Forint divergence
The forint’s divergence from other CEE currencies began well before the war. Over the last decade, the forint has shed 23% of its value against the euro, as compared to the Czech koruna, which strengthened slightly against the euro over the same period. Data reveals the pandemic as a fault line – in 2020, the forint dropped 7% against the euro, while other CEE currencies got off more lightly. The difference between the maximum and minimum values of the forint over the last decade was 50%.
The forint has performed far worse against the US dollar than its regional peers over the last ten years, although all CEE currencies dropped considerably. While the Czech crown shed 18% against the greenback, compared to the Polish zloty (27%) and the Romanian leu (30%), the Hungarian forint weakened most, by 39%. The Hungarian government mostly blames the war and sanctions for the extreme depreciation of the forint, which finally broke through the psychological barrier of 400 to the euro in July. However, data show that the forint began its slow but inexorable slip against the euro back in 2016.

Central bank powerless
In spite of the most aggressive rate hike cycle in the EU delivered by the National Bank of Hungary, the forint’s slide seems unstoppable. The central bank has considerably increased its financial and gold reserves over recent years, reaching over EUR 38 billion in 2022. This means Hungary had easily met the so-called “Guidotti-Greenspan rule,” which states that a country’s reserves should equal short-term (of one-year or less maturity) external debt. Nevertheless, Hungary still has the smallest reserves in comparison to other countries in the region, and this explains why it has had to hike its interest rates, while Poland sold foreign currency on the market.
According to former central bank governor György Surányi, the forint did not weaken accidentally. Over the last decade, the forint underwent a slow but gradual – even purposeful –depreciation that was tolerated by Hungary’s central bank, with the latent consent of the government, Surányi said in a recent podcast. Economic policy makers expected the weak currency to boost foreign trade, FDI and GDP. By making exports cheaper, they sought to make Hungary more attractive than neighboring countries to investors, and thus foster economic prosperity. To keep the forint low, the MNB engaged in currency purchases and converted a considerable amount of Hungary’s EU funds into forints: EUR 3-5bn per year up to 2020, according to Surányi.

Change in dynamics
The weakening of the forint went ahead with the tacit support of the central bank and the government until the spring of 2020, Surányi said. Since then, however, the forint’s slide has no longer been purposeful, and investors no longer believe that the central bank and the government are committed to exchange rate stability. In the background is the dispute between the Hungarian government and the EU, which has led to the freezing of recovery funds for Hungary. This has significantly impacted the exchange rate, and if an agreement is reached, the forint would recover significantly. The results of the government’s recent austerity measures (delaying state investments, phasing out energy and food price caps) will start to show in official data soon, which should also increase investor confidence and help prop up the forint.
The final outcome, however is highly uncertain. Only time will tell whether the huge amount of foreign direct investments of recent years will help Hungary to recover from the current crisis, or whether the unstable currency, runaway inflation, high exposure to import energy and the war in Ukraine will deepen the crisis in Hungary even more than for its CEE neighbors.