Central Bank of Hungary digs into reserves to supply banks with foreign currency

The Central Bank of Hungary (CBH) said this week it will use reserves to help banks meet liabilities in foreign currency that it believes pose a risk to the country's exchange rate.

The programme, which will be launched in October, is intended to cover a looming currency mismatch on banks' balance sheets that will result from a government plan to convert forex-denominated consumer loans into Hungarian forint.

Loans denominated in euros and Swiss francs were popular in Hungary ahead of the financial crisis due to cheap rates. A subsequent weakening of the forint, however, has left many households unable to pay them back.

The government is looking to reduce the debt overhang by allowing households to repay loans in forints. That would force banks stripped of forex assets to cover their own liabilities by turning to the market – something the central bank fears would quickly sap the forint of value.

"The aim of the [central bank's] programme is to ensure that the phasing-out of household foreign currency loans is carried out in a rapid and well-organised manner, safeguarding the stability of the financial system and without significantly affecting the exchange rate of the Hungarian forint," it said in a statement on September 23.

"The supply of foreign currency will be covered by the [central bank's] foreign exchange reserves," the CBH said, but stressed the "adequacy" of reserves would be "continuously maintained".

"The [central bank's] programme will not jeopardise the adequacy of foreign exchange reserves: the stock of foreign exchange reserves will remain above the level expected by international financial institutions and investors," it said.

Hungary's reserves fell to €35.2 billion ($44.8 billion) in July from €36 billion ($45.8 billion) in June. The forint currently stands at 311 against the euro, compared to 228 in the summer of 2008, a depreciation of almost 27%.

Gergely Tardos, head of research at OTP Bank in Budapest, described the measures as "good" because they "counterbalance a sudden and huge demand for forex and would prevent an undesirable volatility in the market" for forint.

"The less forex liabilities you have, the less you are bound by forex reserve adequacy, as you can have a more flexible exchange rate regime," he argued. But Tardos also said the wider government effort was "not a good idea" and amounted to "political bullying".

The CBH will allocate a total of €3 billion for covering forint conversion by banks from October 13, €2 billion of which will be "set aside for spot euro sales conditional on the reduction in short-term external debt". The programme will run "at least until the end of March," the bank said.

It added it stands "ready to raise, to the extent necessary, the amounts allocated" to the programme "in view of the details of the regulation on the forint conversion of households' foreign currency loans".