"If we were to write a brief summary of what happened to the Hungarian currency in 2008, the job would be relatively easy: Early in the year, abandoning the trading band seemed to open the path for the exchange rate to become a powerful tool in fighting inflation. However, the swift gain of the forint vs. the euro (and the even more intense gain vs. the US dollar) quickly evaporated in the fall when a minor exchange rate crisis ensued, as the ever more massive waves of the global financial crisis hit Hungary's vulnerable national economy. The year 2008 saw the forint at its strongest and its weakest nominal exchange rates in a decade.
Our own fault
It is a widespread belief that the exchange rate of a country's national currency reflects the problems of the national economy, yet you will find just as many people who dispute this view. The fluctuation of the forint in 2008 does not support either theory, as there are two possible interpretations of the exchange rate crisis.
One explanation is that the weakening of the forint began in a delayed fashion, at a time when there was nothing to justify an exchange rate crisis any more. The budget has made strides toward a sustainable path, Hungary's government debt was just beginning to decline, when “wicked speculative investors" picked Hungary as the next weak candidate to share Iceland's fate.
The other interpretation is that in a financing environment completely reshaped by the global crisis, dramatic changes in lending policies led to the predictable demise of Hungary's debt-ridden, lacklustre economy, aggravated by a credibility gap in the government's economic policy. Driven by a financial crisis that originated in the US, investors made a mad rush to bring capital back to where they felt it was safest - to the United States. (Risk appetite is over - as long as it is a safe strategy to finance a world power swimming in debt at 0% interest!)
Painful as it is, the second interpretation is closer to the truth; or at least it explains better what happened to the Hungarian forint in the fall of 2008. From this viewpoint, the dramatic devaluation of the currency may be equally due to weak fundamentals (first generation exchange rate crisis), market expectations (second generation exchange rate crisis) or the viral effect (third generation exchange rate crisis).
The exchange rate of the Hungarian forint vs. the euro soared from 230 in late July to 286 by October 23. Volatility indices jumped to a higher magnitude, and it took a colossal international loan guarantee plus a 300-bp rate hike to keep Hungary out of big trouble. A case of a genuine exchange rate crisis, even if Hungary managed to control of the situation before the rate could slip out of a tolerable range. One could argue that Iceland or Ukraine would be happy to get away with this amount of trouble, yet it hurts to see Slovakia watch the turmoil in Hungary from a VIP seat, so to speak. This should dispel any further doubt: while the crisis was immediately triggered by factors outside of Hungary, it was certainly rooted in the government's ill-advised economic policy.
The lesson is there, but are we willing to learn?
Over the year, you probably heard several different interpretations, explanations and arguments in connection with the crisis. One such (true) cliché is that one may have to pay dearly for past mistakes later in the future. Early in the year, Hungary could not believe its luck that the global crisis did not hit sooner. And then it became obvious that it did come too soon even so.
Another truth manifested by Hungary's weakened stability was the real importance of the country on the international scene. “Hungary is too big to fail", Nouriel Roubini commented, and he was right. Immediate action by the IMF-EU-World Bank trio is a clear indication that Hungary is a factor in global economy that cannot be ignored, even if this is due to the country's position and importance rather than its actual economic weight.
Of course, the lessons that the crisis taught us may be lessons for the future, not for the present, as Hungary's financial stability is still a far cry from an acceptable level. At least the country has understood that there is no need for constant worry about exchange rate; we can refocus on the traditional aspects of the exchange rate such as meeting the inflation target or anti-cyclic regulation.
Still, it remains an open question whether Hungary's movers and shakers have learned their lessons. We have seen painful and responsible decisions, yet these were dictated by immediate necessity. The “profound" political messages that abound in Hungary do not bode well for the future.
Interestingly, the fluctuating exchange rate of the forint would have made it to the top stories of the year in Hungary whether or not there was a global crisis. Without the latter, we would applaud the elimination of the trading band in February on this page, a move that helped coordinate the goals that the National Bank of Hungary is set out to achieve with the tools it can utilize. And moreover, a move that brought Hungary closer to a dream of every small country in Europe: the stability of the common currency. Now that the economy is in trouble, we are anxiously looking around: Is the euro zone a very long way to go? The answer is, yes, Hungary is still too far to get away with just sitting around and doing nothing."
Source: Portfolio Online Financial Journal
05.01.2009