Era of "monetary unorthodoxy" Begins

György Matolcsy appointed Governor of NBH

• With the appointment of the new Central Bank governor all previously independent state agencies and institutions will be run by people with very close ties to the governing party and a quasi dependence from the Prime Minister himself. Regardless of the person of the new governor, the government will submit the Central Bank to its own economic policy objectives. This is made possible by a two-thirds parliamentary majority and has in fact been the case for some time through a “pro-government” majority within the Monetary Council. This resulted in a rate cutting cycle over the past six months, encouraged by a steadily improving global investor climate. Short of a radical negative shift in the international financial environment, the current rate cutting policy will continue.
• However, the monetary policy of the new leadership will be curtailed by the lack of economic growth and the political challenge it presents for the government. As things stand today, no new jobs are created and the declining curve of public debts cannot be sustained. The Central Bank’s latest report also called attention to this fact: while 2012 was the year of budget adjustments (and a drop in the budget deficit is an impressive result indeed) in the past three quarters the country's rate of indebtedness started to grow again. All this puts the government’s major promises in doubt and it is increasingly difficult to explain the failures with external factors when all regional countries are producing higher growth than Hungary. Instead of relaxing its fiscal policy, the government hopes to kick start the economy with the loosening of the monetary policy.
• While exercising great restraint and caution, various stimulation packages have already nibbled at the Central Bank’s EUR 37 billion reserve. Even as policy decisions involving part of the reserve are legally sanctioned, the utilization of Central Bank reserves for political/budgetary ends currently runs into serious legal obstacle, not to mention that the issue of the Central Bank reserve also falls under the competence of the ECB and Brussels and its use is controlled and restricted by international organizations and regulations. A further problem is that the unconventional tools that the new governor aims to implement (such as reducing the reserves) seem to be less applicable in Hungary due to the country’s vulnerability, high country risk premium and large foreign exchange exposure. These unconventional monetary policy measures are not likely to boost economic growth, but they may add to market concerns about fiscal sustainability, and result in exchange rate depreciation and flight of capital.
• The reserves can be used for the capitalization of some banks in Hungarian ownership.According to the most likely scenario, some of the reserves will be transferred to Hungarian banks – namely Takarékbank, Gránit Bank, Széchenyi Bank – and they, in turn, will convert foreign currency loans held by households and municipalities into forint facilities. The government expects the move to reduce the country's vulnerability, increase the power of Hungarian-owned and politically controlled “friendly” banks and boost exports through a significantly weaker forint. Since the 2010 election campaign Viktor Orbán has stated several times that the government would like to see 50% of the Hungarian banking system in Hungarian hands. Conceivably the government may transfer Central Bank funds to Hungarian-owned banks (owned by Fidesz-affiliated businessmen) that could then increase their market share at the expense of foreign-owned, especially Austrian competitors. The planned ‘Hungarianisation’ of the banking system also explains a series of hard-hitting government measures aimed at banks, such as the bank tax, its repeated extension, loan prepayments and the transaction levy. Aside from plugging holes in the budget, these measures also have the objective of destabilizing foreign businesses and artificially restructuring the market to benefit banks established by government cronies.

Background

• György Matolcsy, Minister for National Economy, will become the new Governor of the Hungarian Central Bank. In the Government he will be succeeded by Mihály Varga, who had led the Prime Minister’s Office before he became responsible for the negotiations with the IMF. The swing of HUF’s rate shows that market actors have not been surprised by the decision. However, market reactions will be determined in the upcoming months by the path of monetary and economic policy led by György Matolcsy and Mihály Varga.
• According to the most likely scenario, unconventional tools may find their way into the monetary policy of the Central Bank, while Mihály Varga will stand for a more calculable economic policy and a strict budgetary policy. However, regarding a stricter budgetary policy the new minister will face a serious barrier. Prime Minister Viktor Orbán will not be ready for a spectacular shift in the economic policy which would be equal to the confession that unorthodox economic policy has failed.
• Besides economic reasons, political considerations also play a role in the present personal changes. Recently, two of the most attacked and least popular officials have been withdrawn from the front lines by the Prime Minister. Rózsa Hoffman, State Secretary for Education lost her competence on the field of tertiary education, while György Matolcsy as new Governor of the Central Bank is likely to leave the front lines of daily politics. Due to these changes the unpopularity of Rózsa Hoffman and György Matolcsy may not overshadow the government’s work anymore.
• Following the change at the top, there will be new appointments at the deputy-governor level as well: the mandate of Ferenc Karvalits and Júlia Király terminates at the end of March and June respectively. Ádám Balog, former Deputy Minister of State for Taxation will be appointed as third deputy-governor. Large-scale replacement of professional administrators can be expected within the NBH following the arrival of the new governor.