Global Investing

A bond trader in London is still marvelling at the market’s willingness to snap up a Eurobond from Hungary, calling it a country with “a policy mix so unorthodox even Aunty Christine won’t lend to them”.  But Hungary’s probable glee at bypassing the IMF and “Aunty Christine”  with $3.25 billion in two bonds that were almost four times oversubscribed, is probably short-sighted.

Hungary needs to raise the equivalent of $23.4 billion this year to repay maturing debt. The bond placement will enable Hungary to easily meet the hard currency component of this, and it has been enormously successful in luring buyers to domestic debt markets.  Such has been the demand for Hungarian bonds in recent months that foreigners’ holdings of forint-denominated government debt are at a record high of over 45 percent.

The success does not necessarily represent a thumbs-up for Prime Minister Viktor Orban’s policies but is more likely due to the yield Hungary paid — well over 5 percent for five and 10-year cash. In dollar terms that is not to be sneezed at, especially at a time when liquidity is abundant and the yield on mainstream dollar assets is low. The same reason is behind the demand for forint bonds, where Hungary pays over 5 percent on one-year paper. An IMF loan would have been far cheaper. (The rate for a standby loan of the kind Hungary had is tied to the IMF’s Special Drawing Rights (SDR) interest rate. Very large loans carry a surcharge of 200 basis points)

The dollar bond sale is forcing Budapest to pay lenders roughly double what it would have paid for an IMF standby loan, says William Jackson at Capital Economics:

Of the Hungarian government’s 5.1 billion euro of maturing hard currency debt this year, 3.6 billion euro consists of IMF loan repayments, which carry a much lower interest rate than the Eurobonds. By rolling over these repayments with Eurobonds, debt servicing costs will rise. Note too that the new dollar bonds add to Hungary’s underlying FX debt problem.  Around half of government debt is hard currency-denominated (c. 36% of GDP). And Hungary’s economy has contracted in  dollar (and euro) terms over the past five years – increasing the burden of dollar (and euro) debt in local currency terms.

Hungary says it might borrow money from global bond markets before it lands a long-awaited aid deal with the International Monetary Fund. That pretty much seems to suggest Budapest has given up hope of getting the IMF cash any time soon. Given the fund has already said it won’t visit Hungary in April, that view would seem correct.

There is some logic to the plan.

Hungary desperately needs the cash — it must  find over 4 billion euros just to repay external debt this year.

It is also an attractive time to sell debt.  Appetite for emerging market debt remains strong. Emerging bond yield premiums over U.S. Treasuries have contracted sharply this year and stand near seven-month lows. Moreover, U.S. Treasury yields may rise, potentially making debt issuance more costly in coming months.

Now that markets appear to have decided that a $1 trillion stabilisation package from the European Union is enough to soothe global nerves and ward off a sovereign debt crisis, emerging market sovereigns and corporates may start to issue bonds again.

Emerging market debt issuance was heading for a bumper year — at more than $100 billion issued so far — before investors started to fear an imminent default by Greece and markets froze up.  

But a return this week in emerging sovereign debt spreads below the psychologically key threshold of 300 basis points over U.S. Treasuries is likely to encourage issuers back again.