Reduction of External Vulnerability with Monetary Policy Tools

 focus: New central bank policies 

Pál Péter Kolozsi – Mihály Hoffmann Reduction of External Vulnerability with Monetary Policy Tools

Renewal of the monetary policy instruments of the National Bank of Hungary (2014–2016)

Summary: The outbreak of the economic crisis in 2007–2008 changed the views about economic policy worldwide, in particular, the role, tasks and responsibility of monetary policy. Hungary was hit by the crisis in a particularly vulnerable state; therefore the aim of reducing external vulnerability was a central element of the transformation of economic policy. The Self-Financing Programme announced in 2014 by the National Bank of Hungary (MNB) served this particular objective by facilitating the reform of the central bank toolkit – in accordance with the authorisation received and the provisions set out in the MNB Act – the strengthening of financial stability and the reduction of external vulnerability. This study presents the transformation of the central bank toolkit and the benefits of the different measures, using the Mandl–Dierx–Ilzkovitz conceptual model. The conclusion drawn from the analysis is that the programme proved efficient in the technical and operative sense: indeed, starting from the spring of 2014, the debt management agency refinanced foreign currency debts borrowed from the market with forint issues, while banks’ portfolio of collateral securities increased and the central bank’s sterilisation portfolio diminished. The programme achieved its macroeconomic goals as well, as the foreign currency ratio of external funding and public debt has decreased and monetary conditions have eased, while the monetary transmission remained intact. In accordance with the announced actions of the MNB and the effective financing plan, self-financing will continue in 2016 as well.

Keywords: monetary policy, monetary policy instruments, external vulnerability

JEL codes: E52, E58, H63, G21

The purpose of the monetary policy instru- the key policy rate. Financial markets operat- ments used by central banks is to ensure the ed adequately with sufficient liquidity, which efficiency and effectiveness of monetary policy meant that the monetary policy toolkit essen- decisions. In the period preceding the out- tially performed a technical function.1 break of the economic crisis in 2007‒2008 The crisis and the management of the cri- this meant that monetary policy implementa- sis, however, shed new light both on monetary Ttion primarily focused on ensuring the trans- policy as a whole and on monetary implemen- mission of monetary policy, i.e. that money tation.2 The crisis overrode the previous con- market yields are adjusted to and aligned with sensus of monetary policy.3 It demonstrated that price stability and financial stability are E-mail address: [email protected] not synonymous, that flexible inflation target-

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ing does not necessarily create a solid mone- the theoretical foundations outlined above – tary framework, that zero lower bound (ZLB) primarily by the objectives laid down in the can be an important monetary policy prob- MNB Act; accordingly, the main contours of lem, and that monetary and fiscal policy need the monetary policy toolkit of the MNB are to be managed in a coordinated manner even determined by the Hungarian legal environ- in the short and medium term. Apart from the ment6. Although the objectives set out in the prevention of excessive risk taking and ensur- MNB Act are stable, economic and institu- ing transparency, it is also in the interest of tional features may change; hence the mon- the national economy – and at the same time, etary policy toolkit also needs to be continu- a public duty – to ensure that the banking sys- ously adapted to the changing environment. tem fulfils its fundamental social role, i.e. it The global financial crisis opened a new era transfers savings to investors and manages the in this regard as well, as central banks should risks arising, while keeping transaction costs increasingly focus on various other objectives low. As a result, central bank strategies after without jeopardising the price stability target, the crisis often broke away from the “one ob- and due to the deteriorating efficiency of the jective – one instrument” approach, and rec- previously applied transmission channels they ommend the application of a variety of poten- should do all – or at least a part – of this with tial tools in a complementary manner or even non-conventional (or non-traditional) central jointly.4 bank instruments. As regards central bank implementation, The Self-Financing Programme announced it was an important recognition that the re- by the MNB in 2014 – which constitutes lationship between the operative goal and the the focus of this study – is also adjusted to different money market yields that determine this framework. Concentrating on one of the monetary conditions and the relevant financial major structural weaknesses of the Hungar- volumes is not stable, which logically led to ian economy, the programme is intended to the dismissal of the previous “monetary mac- eliminate the reliance of the Hungarian econ- roeconomy versus monetary policy implemen- omy on external resources and to improve the tation” dichotomy.5 As markets are inefficient structure of the economy in general and the with opportunities for arbitrage and trans- financing structure of public debt in particu- mission is ineffective, while markets tend to lar, thereby contributing to maintaining and face persistent liquidity problems, short-term strengthening the stability of the financial in- yields – influenced by monetary policy primar- termediary system, while achieving and main- ily through classic tools – are not necessarily taining price stability remain the primary ob- reflected in other market segments. All this jective of the central bank. means that the operation of monetary policy This study discusses the MNB’s Self-Fi- instruments is no longer a technical task, as the nancing Programme and the transformation efficiency and effectiveness of monetary policy of central bank instruments in the context as a whole are determined by the tools applied of the programme.7 The declared objective of by the central bank to achieve the pre-defined this article is to examine the macroeconomic objectives. According to Bindseil (2014), in effects of the programme, specifically, its effect such turbulent periods monetary policy imple- on financial stability and monetary policy and mentation becomes an “art”. therefore, it is not intended to present the po- The design and application of central bank tential effects of the instruments adopted on instruments are determined – apart from the central bank’s result or the relevant risks.

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As the effects are diverse and complex and when the share of foreign investors persis- they may materialise separated in time, and tently dominates the funding structure of the the expenses and benefits may not necessarily economy, and reliance on external liabilities affect the same economic agent or the same becomes excessive. It is the main drawback of macroeconomic sector, any in-depth analysis external exposure that in times of crisis it pos- and evaluation of potential costs and risks es a severe rollover risk, and – as external debt would exceed the limits of this study. These is often denominated in currencies other than issues may constitute the subject of separate the national currency – the reliance of the research.8 This study accepts the conclusions economy on foreign currency liquidity may of Nagy (2015), according to which the risk- increase significantly. Reliance on external benefit analysis of the different steps should savings and foreign exchange markets inten- be carried out in a complex manner, taking sifies the volatility of exchange rates and in- into account their contribution to the pro- terest rate spreads, which may undermine the gramme as a whole, and that the benefits of opportunities of the economy to raise funds the Self-Financing Programme prevail at the when a crisis materialises. macroeconomic level and exceed the quantifi- In crisis periods with severe market turbu- able costs incurred by the central bank, while lences, the risks arising from the reliance on the risks showing at the central bank level are foreign markets may exacerbate as a result of also offset by the contraction of the MNB’s adverse changes in exchange rates and interest balance sheet. rate spreads, or even due to the deterioration The structure of the study is as follows. of market perception. As regards indebtedness Chapter 1 describes why the reduction of to foreign markets, short-term liabilities carry external vulnerability is a relevant economic special risks, as in periods of crisis the refi- policy goal, and how this is adjusted to the nancing of such debt poses the first difficulty. central bank’s mandate and the possibilities Economies with capital shortfall often expe- offered by the central bank toolkit. Chapter rience a natural need to raise foreign funds 2 describes the decisions related to the reform when domestic savings are insufficient, espe- of central bank instruments in the period of cially when they can be obtained on more fa- 2014–2016. Chapter 3 summarises the effects vourable terms than domestic funds denomi- of the programme using the Mandl–Dierx– nated in the national currency. Cheaper funds, Ilzkovitz conceptual model. Finally, conclu- however, entail a greater potential outflow of sions are drawn. revenues which, when coupled with extreme exchange rate fluctuations and volatile interest rate spreads, may lead to a downturn in Central bank instruments economic performance. and external vulnerability There is no one single indicator of external vulnerability in the literature: it is typically The significance of external vulnerability9 measured by the different indebtedness ratios relative to GDP or to the foreign exchange re- External vulnerability (external exposure) serves, by index numbers showing the curren- may be defined as excessive reliance on sav- cy structure of debt, by the size of export reve- ings denominated in currencies other than nues serving as the source of the repayment of the national currency, which poses a real and the debt, by the trade balance, or by indicators relevant economic policy problem primarily calculated from foreign direct investment in-

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flows (IMF, 2012; Supriyadi, 2014). There are (2) Without prejudice to its primary objec- three important factors identified in the litera- tive, the MNB shall support the maintenance of ture as safeguards against external vulnerabil- the stability of the system of financial interme- ity: the export-led economic growth potential diation, the enhancement of its resilience, its sus- inherent in the private economy, the size and tainable contribution to economic growth; fur- liquidity of the domestic bond markets, and thermore, the MNB shall support the economic the foreign exchange reserves (Dyson, 2014). policy of the government using the instruments Of these factors, the central banks relevant at its disposal. for this study are traditionally able to directly In accordance with the central bank man- influence the size of the foreign exchange re- date and the inflation targeting system ap- serves, but indirectly they may exert influence plied by the MNB, the primary objective of over bond markets as well, partly by determin- the MNB is to achieve the inflation target ing the range of eligible securities required as embodying price stability. This, however, is collateral in the case of traditional credit ten- supplemented by additional objectives. These ders, partly and potentially by participating additional objectives are also statutory obli- directly or indirectly as a player in these mar- gations, which means that the central bank kets, or by applying other non-conventional should also bear these objectives in mind and instruments.10 use the instruments at its disposal to facilitate As in most countries, the management of their achievement, provided that they are not international reserves is a central bank task, contrary to the primary objective. and the primary safeguard for central banks As regards the other objectives laid down in against external economic shocks is the ad- the MNB Act, specifically, financial stability, equacy of the foreign exchange reserves back- and the support of the economic policy of the ing short-term external debts. One can meas- Government, upon the announcement of the ure this using the Guidotti–Greenspan ratio, Self-Financing Programme in April 2014, the which relates short-term external debt to the National Bank of Hungary defined the reduc- size of the foreign exchange reserves, and re- tion of external vulnerability as the objective gards the reserves as adequate if the ratio to be achieved (MNB, 2014). Accordingly, reaches the 100 per cent level (Palotai, 2014; below we examine: Csávás, 2015). In accordance with interna- • (a) whether the reduction of external vul- tional trends, the foreign exchange reserve nerability defined as the objective of the strategy of the National Bank of Hungary also programme promotes financial stability, features the Guidotti–Greenspan ratio as the • (b) whether such an objective is consist- primary indicator (Nagy and Palotai, 2014). ent with the economic policy goals of the Government, • (c) whether external vulnerability may be External vulnerability and the central bank reduced by central bank instruments, and mandate • (d) how all this relates to the primary objective of the central bank. Act CXXXIX of 2013 on the Magyar Nemzeti Bank provides that: Relevance of the external vulnerability Article 3 (1) The primary objective of the problem for Hungary MNB shall be to achieve and maintain price Relatively developed countries have signifi- stability. cant net and gross external debt in interna-

10 Public Finance Quarterly  2016/1  focus: New central bank policies  tional comparison, and there is a particularly –, both its net and gross external debt exceeded sharp boundary in Europe as well between the corresponding values of most countries in new (or prospective) and the old EU Mem- the region, and took similar values than those ber States in this regard. The gross external recorded in explicitly high-risk Southern Euro- debt-to-GDP ratio of old EU Member States pean countries (see Figure 1). Prior to the com- is typically 100–400 per cent, whereas that of mencement of the Self-Financing Programme, the emerging economies of the CEE region is i.e. the renewal of central bank instruments, around 100 per cent. Nevertheless, this does Hungary was counted among vulnerable coun- not mean that risks are distributed according- tries in terms of external vulnerability even by ly; in the case of stable states holding reserve international standards11. currencies (for example euro area Member In Hungary, the significant growth of in- States, the United Kingdom) the high value debtedness to foreign countries was partly does not imply a substantial risk, while in the driven – beside the proliferation of foreign case of small and open emerging (developing) currency lending to households12 – by sover- economies even a lower value impairs market eign borrowing starting from the mid–2000s. perception. While less than 50 per cent of gross public The CEE region is of primary relevance for debt was financed by foreign creditors at the Hungary, and in the years following the cri- beginning of 2008, by 2012 this value rose to sis, Hungary found itself in a worse situation almost 70 per cent. It also indicates substan- than most of its peers: in 2013 – before the an- tial external vulnerability that, according to nouncement of the Self-Financing Programme Moody’s (2015)13, in 2014 only Peru and Indo-

Figure 1 Net and gross external debt in European Union Member States (2013) Gross external debt (2013 Q3, in percentages)

Net external debt (2013 Q3, in percentages)

Source: European Central Bank

Public Finance Quarterly  2016/1 11  focus: New central bank policies 

nesia recorded a higher share of non-residents identified high exposure to foreign investors in total debt than Hungary. as a key risk and a problem to be addressed.14 The funding structure was also unhealthy External vulnerability became an acute eco- from the aspect that the Hungarian economy nomic policy problem of Hungary after the excessively relied on foreign currency funds. In crisis, the reduction of which was regarded as 2013, the last year before the Self-Financing a relevant economic policy objective. Programme, the ratio of foreign currency debt High external vulnerability poses a risk per to total Hungarian public debt exceeded 40 per definitionem to financial stability; therefore, cent, whereas in the European Union only four its reduction is consistent with this central countries recorded higher corresponding val- bank mandate. The reduction of vulnerabil- ues. Importantly, of these four countries Bul- ity is a justifiable economic policy objective of garia maintains a currency board system, which the Government also because Hungary’s con- means that, for practical purposes, it does not vergence programme for 2013 declares that face any exchange rate risk, and Lithuania’s the reduction of high external debt – which subsequent accession to the euro area practical- was one of the major factors behind the finan- ly eliminated its exposure to exchange rate risk. cial vulnerability of Hungary – is one of the The relevance of the problem is demon- four key economic policy objectives.15 strated by the fact that numerous investor The question may arise, however, how all analyses and country reports on Hungary this suits the primary objective of the central

Figure 2 Ratio of foreign currency debt to total public debt in European Union Member States (2013) Italy Spain Latvia France Poland Austria Croatia Cyprus Finland Estonia Sweden Bulgaria Belgium Slovakia Slovenia Portugal Hungary Romania Germany Denmark Lithuania Netherlands Luxembourg

Ratio of foreign currency debt to total public Czech Republic debt in European Union Member States (2013)

Source: EUROSTAT, Government finance and EDP statistics database

12 Public Finance Quarterly  2016/1  focus: New central bank policies  bank. As there is no logical connection offer- tive amid the subdued inflation environment. ing itself automatically here, the specific pe- As will be shown later, the Self-Financing Pro- riod and programme need to be evaluated. gramme in the centre of this study may be re- It is an important circumstance that in the garded as such a step (see Figure 3). years of crisis management – following 2010, but particularly after 2013 – the Hungarian Correlations between external vulnerability central bank faced a persistently low infla- and monetary policy instruments tion environment (see Figure 2), as a result Among the aforementioned indicators of ex- of which, and with a view for achieving its ternal vulnerability, external debt ratios have inflation target, it commenced a policy of key importance for Hungary. External ex- monetary easing. This materialised primarily posure is best captured by net external debt; in the central bank’s easing cycles (compared however, its changes depend on the country’s to 7 per cent in mid–2012, by end–2015 the current account and capital account;18 in oth- central bank base rate fell to 1.35 per cent),16 er words, they arise from macroeconomic de- but non-traditional central bank instruments velopments, and thus they can only be shaped also had a pronounced role in the easing of at substantial real economy costs. Lowering monetary conditions.17 Accordingly, any non- the gross elements of net external debt, how- conventional steps that implied a reduction ever, may also reduce external vulnerability, as of yields, i.e. monetary easing, also supported the rollover risk stemming from gross debt is the achievement of the price stability objec- lower, whereas due to the fact that the level of

Figure 3 Inflation and inflation target in Hungary

tolerance band percentage points

Core inflation excluding indirect taxes Non-core inflation excluding indirect taxes Indirect tax effect Inflation (per cent) Inflation target

Source: MNB, Inflation Report, December 2015

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net debt remains the same, there is no need Although the Self-Financing Programme – to expect real economy adjustment or costs. launched by the MNB with a view to facili- As regards a government economic policy pro- tating the success of self-financing – is closely gramme, in terms of gross external debt it is connected to the self-financing concept in changes in gross external public debt that have that it assumes cooperation between banks, special significance, given that a government the manager of public debt and the central programme can exert the greatest and most bank, it is separated from it at a conceptual direct impact on this factor. level. The central bank’s programme is an in- This is the reason why, according to the tegral part of the concept, and is based on the “self-financing concept”, external vulnerabil- assumption that the above-described goals of ity should be mitigated by the reduction of self-financing may be achieved if the condi- gross external debt,19 which should be carried tions of central bank instruments are modi- out by moving in the direction of government fied. This assumes the existence of a relation- forint financing. The reduction of gross exter- ship between central bank instruments and nal debt will result from the funding of pub- external vulnerability (see Figure 4). lic debt from internal resources – which can The diagram below shows the logical con- be achieved by restraining foreign currency nections through which the terms and con- issuance by the state, refinancing maturing ditions of deposit and credit transactions be- foreign currency debt with forint issues, and tween the central bank and commercial banks by shifting toward the issuance of forint-de- (central bank counterparties) influence banks’ nominated government securities (negative liquidity management and ultimately, indebt- net foreign currency issuance). Although self- edness and external vulnerability in economies financing does not directly influence external characterised by structural liquidity surplus, debt, as the majority of foreign currency debt such as Hungary20. is owed to foreign investors, the reduction of In accordance with the schematic and sim- foreign currency financing eventually lowers plified correlations of Figure 4, banks may external debt. Shifting toward HUF financ- manage their liquidity in two ways: using ei- ing will improve the currency composition ther the central bank’s deposit facility or cen- of public debt and reduce the sensitivity of tral bank loans backed by liquid securities. The debt to foreign exchange rate changes, which relative features of the central bank’s deposit means, as an added benefit, that the exchange and credit products will determine the extent rate fluctuations of the forint will be reflected to which the banks will choose one or the other in debt ratios to a lesser degree. option. Assuming that the yield on the cen-

Figure 4 Central bank instruments and external vulnerability

Funding of public Parameters of Banks’ liquidity Banks’ demand debt External exposure, central bank management for liquid (non-resident vs. external instruments (central bank deposits securities resident investors, vulnerability (liquidity, yield, risk) vs. liquid securities) denomination)

Source: authors’ own editing

14 Public Finance Quarterly  2016/1  focus: New central bank policies  tral bank’s main sterilisation instrument is the could reasonably expect to achieve the objec- base rate – which is reflected in money market tive of increasing – from a bank and liquid- yields – and that central bank deposits in the ity management perspective – the appeal of national currency practically imply risk-free eligible non-central-bank securities by mak- investment, liquidity remains the only variable ing central bank instruments less attractive.22 that influences the banks’ decisions. Therefore, The Self-Financing Programme of the MNB to simplify matters, if the central bank’s de- is built on the following impact mechanism posit facilities are of high liquidity, banks will (see Figure 5). consider them preferable to liquid securities; uThe modification (impairment) of the in other words, banks will keep their liquidity liquidity profile of central bank instruments surplus in central bank deposits. This is consist- prompts banks to shift toward liquid securi- ent with foreign investors having a dominant ties that are more favourable from the aspect role in the financing of the public debt (rela- of liquidity. As due to the peculiarities of tive to a situation where the liquidity of central the Hungarian securities market Hungarian bank instruments is worse), and this may raise government securities dominate the range of the level of the foreign currency ratio. Thus, liquid securities eligible as collateral for the overall, central bank deposit products with fa- purposes of central bank operations, the re- vourable liquidity features might distort banks’ structuring primarily affects the government liquidity management with insufficient reliance securities market (see Figure 5: a rise in HUF on liquid securities21, and ceteris paribus may, bonds generates a decline in MNB deposits on albeit implicitly, increase external vulnerability. the asset side of the balance sheet of the bank- It is also important to note that if exposure to ing system, a decline in the MNB deposits foreign investors entails increased foreign cur- comprising the sterilisation portfolio on the rency issuance, the balance sheet of the central liability side of the central bank23, and an in- bank may also expand which, due to the costs crease in the Single Treasury Account [STA]). of central bank sterilisation, would also imply vTaking advantage of the surplus demand costs at the level of the national economy. generated by the impact mechanism described above, the Hungarian state will refinance maturing foreign currency debt in forint, i.e. Transformation of the MNB’s it will issue additional forint-denominated monetary policy instruments bonds in a quantity corresponding to the in 2014–2016 maturing debt (which generates an increase in bonds on the liability side of the balance Based on the above we may conclude that ex- sheet of public finances, and a simultaneous ternal vulnerability posed a relevant economic increase in the balance of the Single Treasury policy challenge at the beginning of the decade Account on the asset side). in Hungary; its reduction was consistent with wUpon the maturity of foreign currency the central bank’s mandate and the MNB Act assets, the government will convert the addi- and, due to the correlations between central tional forint issue of the central bank into for- bank instruments and external vulnerability, eign currency, then repay the foreign currency the central bank indeed was in the position to to non-resident investors (with the conversion facilitate the reduction of external exposure. generating a decline in STA and the foreign Consequently, through the transformation exchange reserves on the central bank’s bal- of its monetary policy instruments the MNB ance sheet, the repayment generating a decline

Public Finance Quarterly  2016/1 15  focus: New central bank policies 

Figure 5 Impact mechanism of the Self-Financing Programme

Public finances Central bank

A (assets) L (liabilities) A (assets) L (liabilities)

STA 1. HUF bonds 2. STA  (resident)   MNB deposits  1.

Foreign cur- Foreign rency bonds 3. STA exchange re- STA 3. (REPHUN) serves (Bund)  (non-resident)   

Banking sector Non-residents

A (assets) L (liabilities) A (assets) L (liabilities)

Foreign currency bonds 3. 1. HUF bonds  (REPHUN)  Foreign cur- 1. MNB deposits rency bonds 3.  issued abroad  (Bund)

Source: authors’ own editing

in STA and the foreign currency bond debt of Steps of the Self-Financing Programme public finances, and as regards non-residents, Hungarian foreign currency bonds will be re- The Self-Financing Programme may be divid- placed by foreign currency instruments issued ed into three phases. Commenced in the sum- by non-residents). mer of 2014, in the first phase26 of the pro- Through the effect mechanisms described gramme the two-week MNB bill (main policy above, the changes implemented under the instrument) was replaced by a deposit, and the Self-Financing Programme contributed to MNB announced the introduction of an in- the mitigation of external vulnerability as the terest rate swap instrument (IRS). The second modification of the liquidity profile of central phase of the programme was announced by bank deposit instruments ultimately lead to the MNB on 2 June 2015, when the maturity the reduction of foreign currency debt and ex- of the main policy instrument was extended ternal debt24,25. to September 2015 and the available volume

16 Public Finance Quarterly  2016/1  focus: New central bank policies  of the two-week deposit instrument was grad- EFFECT OF THE SELF-FINANCING ually reduced.27 Subsequently, the conditions PROGRAMME of the central bank’s interest rate swaps were made more flexible, and the terms applicable Integrating the steps of the Self-Financing to the interest rate corridor and collateralised Programme into the conceptual model of credit instruments were modified. It is also Mandl–Dierx–Ilzkovitz (2008), the following related indirectly to the Self-Financing Pro- structure will arise (see Figure 6). gramme that in the context of the European The model distinguishes between effects that Union harmonisation, the MNB brought the are more technical in nature and materialise in minimum reserve system more in line with the the short term (output), and effects manifested practice of the European Central Bank, which in the longer term that can be also interpreted had an impact on banks’ liquidity manage- at the macroeconomic level (outcome). Based ment, the appeal of central bank instruments on the conceptual pattern outlined above, it is and hence, the demand for non-central bank possible to evaluate the operative and technical issued, eligible collateral, including, in par- efficiency, as well as the benefits achieved by the ticular, government securities. The third and changes implemented in the central bank’s in- closing phase of the programme involves the struments in the context of the Self-Financing complete phase-out of the two-week deposit Programme, ultimately facilitating the achieve- product, which is to be implemented in April ment of price stability, the stability of the finan- 2016 (seeTable 1). cial system and sustainable economic growth.38 Table 1 Steps of the renewal of central bank instruments in relation to the Self-Financing Programme

Affected Change Link to the Self-Financing Programme instrument

Main policy Two-week bill is replaced by In August 2014, the two-week bills issued by the MNB were replaced instrument28 three-month deposit by a two-week deposit facility,29 and as of September 2015, the maturity of the main policy instrument was extended to three months.30 The transformations were intended to reduce the appeal of the main central bank sterilisation instrument, which increases the demand for non- central bank, eligible securities. Interest rate Symmetric corridor is The previous ±100 bps interest rate corridor around the base rate was corridor31 replaced by asymmetric rendered asymmetric by the MNB in September 2015. As a result, the corridor interest rate on the overnight (O/N) deposit facility deviates by –125 bps, while the interest rate on the overnight (O/N) collateralised loan deviates by +75 bps from the central bank base rate. The purpose of the measure was to reduce the appeal of the O/N deposit instrument.32 Minimum reserve Optional ratios replaced by a As of December 2015, the minimum reserve ratio in Hungary is fixed standardised reserve ratio33 at 2 per cent. Previously credit institutions were free to choose their own reserve ratio within a range of 2 to 5 per cent. By prescribing a fixed reserve ratio, the MNB prevented banks from adjusting to the transforming liquidity environment via the reserve system.34

Public Finance Quarterly  2016/1 17  focus: New central bank policies 

Affected Change Link to the Self-Financing Programme instrument

Collateralised loans Two-week and six-month Starting from September 2015, two-week loans were replaced by one- maturities replaced by week loans, whose interest rate fell from base rate +50 bps to base rate one-week and three-month +25 bps. The MNB replaced six-month loans with three-month loans, maturities continued to be sold at floating rate tenders. The changes have made collateralised credit instruments more attractive for banks. Supplementary Introduction of restricted In parallel with the modification of the main policy instrument, between instrument for the two-week deposits September 2015 and April 2016 the MNB also maintained the two-week management of deposit product as a tool to assist banks’ liquidity management, subject forint liquidity to a quantity limit of HUF 1,000 billion. In the scope of the third phase of the Self-Financing Programme, in April 2016 the MNB is set to phase out the two-week deposit instrument altogether. Instrument for the Introduction of the The MNB has held IRS tenders conditional upon securities purchases management of conditional interest rate since June 2014.35 If a bank shifts its funds from two-week and three- interest rate risk swap instrument month central bank deposits into securities with maturities of 2 years or longer, its interest rate risk will increase due to the longer maturity. In order to prevent this from impeding banks’ adjustment, the MNB added interest rate swaps suitable for the management of interest rate risks36 to its set of instruments. In summer 2015, the MNB supplemented the initial 3- and 5-year maturities with a 10-year maturity, and in September 2015 it allowed banks to choose between 2014 Q1 and the period of March to May 2015 in respect of the base portfolio against which adequacy is to be checked.37

Based on a quantitative and qualitative lateral holdings and contracting the balance analysis, below we examine the realisation of sheet of the central bank. Ultimately, this the assumed output and outcome effects of the leads back to two basic questions: schematic model depicting the Self-Financing uDid the ÁKK succeed in refinancing ma- Programme framework. turing foreign currency debt by raising forint funds through self-financing? vDid the renewal of central bank instru- Operative efficiency of the Self-Financing ments prove to be efficient in driving out a Programme (output effects) part of banks’ funds from central bank instruments and channelling the same funds into Inputs of the Self-Financing Programme de- the market of liquid securities, in particular, note changes in the central bank instruments. government securities? For the purposes of this exercise, first-round, operative and technical efficiency indicates Refinancing foreign currency debt with whether the steps concerned were capable of forint issues establishing the conditions indispensable for In respect of the refinancing effect of the self- the intended social impact, i.e. in this case of financing concept, it is reasonable to start from restructuring the banks’ funds, increasing col- the net foreign currency issuance of the Gov-

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Figure 6 The Self-Financing Programme framework

Environmental factors (high external vulnerability, the resulting negative international perception, substantial surplus reserve, significant foreign currency debt and foreign currency maturities, significant structural liquidity surplus, etc.)

INPUT OUTPUT OUTCOME Transformation and I) Foreign currency A) reducing external supplementation debt refinanced financing of monetary policy from HUF B) l owering the FX instruments II) Increasing col- ratio of public debt lateral security C) looser monetary holdings conditions III) Contracting sterilisation portfolio Technical and opera- Social tive efficiency benefits

Price stability, financial stability, economic growth

Source: authors’ own editing, based on Mandl–Dierx–Ilzkovitz (2008) ernment Debt Management Agency (ÁKK) (see Increasing collateral security holdings Figure 7), as this item captures the amount by The refinancing of maturing foreign cur- which foreign currency issuance in the given rency public debt with forint issues can only year exceeded maturing foreign currency debt. be linked clearly to the Self-Financing Pro- In 2014 and 2015 net foreign currency issuance gramme if the necessary demand for forint- amounted to HUF –766 billion39 and HUF denominated government securities was pro- –1,186 billion, respectively.40 The total refinanc- vided by the banks. This may be confirmed if ing effect in 2014–2015 is estimated to be HUF the liquidity management of banks is trans- 1,952 billion, which means that the Hungar- formed, i.e. if the banks have shifted their li- ian Government repaid foreign currency debts quidity to the government securities market in equivalent to this forint value from the forint line with the volume of net foreign currency funds converted at the MNB (gross foreign cur- issuance. Figure 8 confirms this, as it clearly rency issuance was not zero even after the spring shows that between the summer of 2014 and of 2014 because the Self-Financing Programme February 2016 most of the surplus liquidity did not affect the issue of foreign currency secu- flowing into the banking system landed in the rities for households, i.e. those definitely pur- market of collateral securities, particularly, chased by resident income earners). in the government securities market. Since

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Figure 7 Changes in the foreign currency issuance of ÁKK

2,500

2,000

1,500

1,000

500

–500 HUF billions –1,000

–1,500

–2,000

–2,500

Gross foreign currency Foreign currency Net foreign currency issuance redemption issuance

Source: MNB

Figure 8 The liquidity of banks held in central bank instruments and collateral securities

7,000

6,000

5,000

4,000

3,000 HUF billions 2,000

1,000

Government Mortgage Other Central bank securities bonds bonds instruments

Source: MNB

20 Public Finance Quarterly  2016/1  focus: New central bank policies  the impact mechanism of the Self-Financing bank’s interest rate swap instrument (the Pear- Programme specifically points in this direc- son correlation coefficient is 0.9752, which is tion, actual data reconfirm that banks have also outstandingly high). The slope of the lin- restructured their liquidity management in- ear function between the two variables in the struments. case of a positive axis intercept is 1.756, which It also shows the impact of the instruments means that one unit of IRS allocation gener- of the Self-Financing Programme that the rise ated more than a 1.5 times increase in banks’ in the central bank’s IRS portfolio and the government securities holdings. rise in banks’ government securities holdings show close co-movement (see Figure 9). It is Contracting sterilisation portfolio particularly striking that after the announce- If the ÁKK refinances maturing foreign curren- ment of the launch of the second phase of the cy debt with forints issues, the central bank’s programme both IRS use and the government balance sheet will contract by definition. As the securities portfolio reversed dynamics. The central bank’s cost of funds is higher than the correlation coefficient between the increment rate of return achieved on the foreign exchange of the IRS portfolio and the increment of the reserves, the contraction of the central bank’s government securities portfolio of credit in- balance sheet means interest saving for the stitutions is 0.9875, which means that the in- MNB. Due to its very nature, the self-financing crease in the government securities portfolio is concept points in the direction of the contrac- almost fully explained by the use of the central tion of the central bank’s balance sheet; howev-

Figure 9 Changes in the IRS and government securities portfolios of the banking system

2,400 2,200 2,000 1,800 Announcement of continuation of 1,600 the Self-Financing Programme 1,400 1,200 1,000

HUF billions 800 600 400 200 0

3-year IRS portfolio 5-year IRS portfolio 10-year IRS portfolio Increase in banks’ government securities (right axis)

Source: MNB

Public Finance Quarterly  2016/1 21  focus: New central bank policies 

er, since there are numerous factors influencing Self-Financing Programme) fell from over 53 the balance sheet of the MNB,41 self-financing per cent in 2014 Q2 to around 43 per cent by alone will not be able to actually contract its 2015 Q3 (see Figure 10). In addition to the balance sheet. Therefore, the balance sheet con- negative net foreign currency issuance, it may traction is measured in this case in terms of the be regarded as a kind of indirect effect of the extent to which the ÁKK has redeemed matur- Self-Financing Programme that the intensify- ing foreign currency debt from forint liabilities; ing demand of banks for government securi- thus, ceteris paribus – based on the processes ties might have motivated foreign investors to shown of Figure 7 – as a result of self-financing, close their government securities positions, at the beginning of 2016 the banking portfolio and if the government securities were taken on which the MNB pays sterilisation costs de- over by domestic sectors (the banking sector), creased by almost HUF 2,000 billion.42 this also generated a decline in external debt. Taken together, we may conclude that the Apart from this, other factors might also have steps affecting the central bank instruments influenced the gross external debt of public fi- resulted in operative consequences that are nances (e.g. the movement of cross rates), but consistent with the impact mechanism of the the Self-Financing Programme – due to the Self-Financing Programme. impact mechanism described above – was certainly one of the main causes of the decrease.

Macroeconomic effect of the Self- Lowering the FX ratio of public debt Financing Programme (outcome effects) According to the impact mechanism of the self-financing concept and programme, as a The declared purpose of the Self-Financing result of the programme, the ratio of foreign Programme is to reduce the external vulner- currency debt to total public debt should fall ability of the national economy; therefore, the significantly, as self-financing means, first and success (benefits) of the programme primarily foremost, that foreign currency debt typically depends on whether the objective described held by foreign investors is replaced by forint- above is achieved or not. denominated debt held by residents (domestic banks). Changes in the foreign currency ratio Reducing external financing of public debt confirm the preliminary assump- As it has been mentioned earlier, the Self-Fi- tion, as the FX ratio has decreased substantially nancing Programme can only influence gross since the announcement of the Self-Financing external debt, as net debt arises from savings Programme. The foreign currency ratio in 2013 developments in the different domestic sec- was over 40 per cent, and by end–2015 it fell tors. Therefore, the benefits of the programme below 33 per cent (see Figure 11). do not primarily mean that net external debt The foreign currency ratio of public debt has decreased further since 2014, but that all had fallen significantly during a short period this has taken place in parallel with a sustain- (2012) even before the announcement of the able reduction of gross external debt with a Self-Financing Programme in 2014. Accord- recently unprecedented intensity (the reducing to Figure 7 that depicts changes in the tion of net debt should be regarded as a conse- foreign currency issuance of the ÁKK, 2012 quence of the current account surplus). saw an outstanding volume of negative net As regards public finances, gross external foreign currency issuance (over HUF 1,000 debt relative to GDP (a key indicator for the billion). This means that the ÁKK financed a

22 Public Finance Quarterly  2016/1  focus: New central bank policies 

Figure 10 Gross external debt of public finances (as a percentage of GDP)

Gross external assets (mainly Gross external debt Net external debt foreign exchange reserves)

Note: gross external debt adjusted with the margin debts deposited by foreign swap partners, and gross external assets adjusted with margin debt and margin claims. Source: MNB Figure 11 Changes in the foreign currency ratio of public debt

Foreign currency replaced Foreign currency replaced by non-resident forint by resident forint

Announcement of Self- Financing Programme

Ratio of foreign currency debt Source: MNB

Public Finance Quarterly  2016/1 23  focus: New central bank policies 

substantial amount of maturing foreign cur- one-third of the total decline was associated, rency debt with forint issues in 2012. Differ- in one some form, with the Self-Financing ences between the two periods can be detected Programme. based on changes in the gross external debt The qualitative analysis of the shifting of the of public finances and the foreign exchange yield curve, however, leads to the conclusion reserves (Figure 10): in 2012 gross external that the Self-Financing Programme reduced debt rose significantly, which means that the longer-term yields substantially (see Figure 13). stepped up forint issues were purchased by Between the summer of 2014 and early 2016, non-resident investors, i.e. foreign currency the entire Hungarian yield curve shifted down- debt decreased, but external vulnerability wards, by 100–125 bps in magnitude. Divid- declined only in part. On the other hand, in ing the programme into two parts reveals that 2014–2015 the foreign currency ratio of pub- in the first year (between June 2014 and June lic debt and the share of non-resident inves- 2015) the reduction of short-term yields was tors both decreased, which means that exter- more dynamic, but the longer end of the curve nal vulnerability declined from the aspect of fell to a lesser degree. During this period the both key parameters. As a result – in addition MNB’s easing cycle was in progress, which in to the increase seen in households’ holdings itself may account for 80 bps of the reduction since 2012 –, by end–2015 the Hungarian of short-term yields (the central bank base banking sector became the number one player rate fell from 2.30 per cent to 1.50 per cent in the market of forint-denominated govern- in this period). In the second phase, however ment securities, overtaking even non-resident – between end-June 2015, when the second investors that had been dominant since 2011 phase of the Self-Financing Programme was (see Figure 12). announced, and end-January 2016 – , the decline in yields was limited almost exclusively to Looser monetary conditions longer maturities, while the base rate fell by 15 Due to the low inflation environment, the bps only (from 1.50 per cent to 1.35 per cent). MNB has endeavoured to ease monetary con- This indicates that the second phase of the ditions over the past two years. As the Self-Fi- Self-Financing Programme, announced in June nancing Programme channels banks’ liquidity 2015, had a greater easing effect, which is also to liquid securities markets and the resulting supported by the fact that in this phase banks’ surplus demand exerts a downward pressure government securities purchases were far more on yields, the programme may be regarded as intense than in the first year (Figure 9). an example of monetary easing. Based on the It also shows the effect of domestic factors impact mechanism of the Self-Financing Pro- – including the Self-Financing Programme gramme, in all likelihood, the transformation in particular – that Polish yields (that may of central bank instruments and the result- be regarded as a kind of reference from the ing boom in banks’ demand for government Hungarian point of view) decreased much less securities affected not only the size of banks’ than Hungarian yields, despite interest rate government securities portfolio, but market cuts of a similar order of magnitude (100 bps yields as well. According to the regression esti- or 125 bps, respectively). As a result of the dif- mate disclosed by the MNB (2015a), between ference that can be seen in the dynamics of April 2014 and March 2015, the rate of re- yield changes, the yield difference of 100–125 turn on 3-year and 5-year maturities fell by bps existing between the two countries in the 230 bps and 214 bps, respectively; and about early spring of 2014 – i.e. immediately before

24 Public Finance Quarterly  2016/1  focus: New central bank policies 

Figure 12 Ratio of holder sectors to the total forint-denominated government securities portfolio

Credit institutions Non-residents Households *Until end-2013, the ratio of credit institutions to other monetary institutions is based on estimated values

Source: MNB Figure 13 Changes in the yield curve of government securities

Source: MNB

Public Finance Quarterly  2016/1 25  focus: New central bank policies 

the announcement of the Self-Financing Pro- as efficient when central bank instruments en- gramme – has practically vanished by early sure that primarily short-term money market 2016 in the 3–5-year segment (see Figure 14). yields adjust to the (also typically short-term) As regards monetary policy effects, the im- key policy rate.43 It is not obvious how this can pact of the transformation of central bank be measured, but since the movement of over- instruments on monetary policy transmis- night market interest rates is limited by the sion – one of the classic duties of central bank interest rate corridor between the central bank implementation and instruments – should O/N deposit and lending rates, the movement also be examined. The monetary transmission of these interest rates should certainly be ex- mechanism means the process whereby mon- amined. In our analysis we started from the etary policy influences the ultimate objective assumption (which is in fact a simplification, of monetary policy, inflation (or economic but capable of capturing processes) that in output). The first step of the transmission Hungary the movement of the overnight un- mechanism is the attainment of the opera- secured interest rate (HUFONIA) around the tive objective of monetary policy. The opera- base rate may be regarded as a good approxi- tive objective is attained when money market mation of monetary transmission. yields adequately reflect the level of the base In Hungary, monetary transmission is rate or the expectations concerning the base fundamentally determined by the structural rate. Monetary transmission may be regarded liquidity surplus characterising the banking

Figure 14 Changes in the yield curve of Hungarian and Polish government securities bps

Changes relative to March 2014 (Polish)* Changes relative to March 2014 (Hungarian)* Poland 31/03/2014 Poland 29/01/2016 Hungary 31/03/2014 Hungary 29/01/2016

*Polish interest rate cut –100 bps, Hungarian interest rate cut –125 bps in the period under review

Source: MNB

26 Public Finance Quarterly  2016/1  focus: New central bank policies  system, as a result of which interbank (mar- interbank yields from the base rate. The av- ket) interest rates typically hover around the erage difference of O/N unsecured interbank base rate and the central bank O/N deposit rates from the base rate was –0.67 per cent interest rate (see Figure 15). in 2012, –0.41 per cent in 2013, –0.65 per The Self-Financing Programme and the cen- cent in 2014 and –0.51 per cent in 2015. The tral bank’s FX liquidity providing instruments 2015 value corresponds to the average level of related to the phasing out of households’ for- the two years preceding the announcement eign currency loans significantly reduced the of the Self-Financing Programme. Based on central bank liquidity of the banking system MNB (2015a), the apparent increase in the in 2014 and 2015,44 which means that, in ad- difference in 2014 was due to the fact that in dition to the contraction of the stock of liquid the August-September period the supply of assets,45 the measures of the MNB ceteris pari- liquid instruments declined in the wake of bus lowered the level surplus liquidity (that the phase-out (transformation into deposits) structurally impairs monetary transmission), of the two-week bill, while demand for liquid and as they overstretched banks’ liquidity instruments increased in the banking system, management, they exacerbated the volatility which exerted a downward pressure on money of yields. market yields. The frictions, however, proved In Hungary the transformation of central temporary, which clearly demonstrates the bank instruments did not affect permanently improvement observed in monetary transmis- and substantially the departure of overnight sion in 2015. The increase in the volatility of

Figure 15 Changes in the O/N interbank rate within the central bank interest rate corridor

HUFONIA Central bank base rate Interest rate corridor

Source: MNB

Public Finance Quarterly  2016/1 27  focus: New central bank policies 

interest rates is also consistent with the reduc- portfolio) and with the relevant outcome ef- tion of liquidity and the transformation of the fects (reducing external financing, lowering instruments at the MNB’s disposal. the ratio of foreign currency debt to public debt, looser monetary conditions). In accordance with the original objectives of the pro- Conclusion gramme, the external vulnerability of Hun- gary substantially decreased,46 while monetary External vulnerability posed a relevant chal- transmission did not deteriorate. lenge to the Hungarian banking system after According to the Debt Management Out- Hungary was hit by the crisis, which provided look of the Government Debt Management justification for defining the reduction of ex- Agency,47 in 2016 the net issue of forint- posure as one of the key objectives of Hun- denominated government securities may be garian economic policy. To that end, and in around HUF 1,800 billion, a level compara- accordance with its mandate laid down in ble to previous years. In terms of magnitude, the MNB Act, the MNB launched the Self- net foreign currency issuance is expected to be Financing Programme which, through the re- similar to 2015, around HUF –1,000 billion. form of central bank instruments, encouraged If the issue plan of the ÁKK is implemented banks to transform their liquidity manage- and banks’ demand remains adequate, the ment, while routing banks’ funds at the cen- foreign currency ratio of public debt may de- tral bank towards liquid securities, primarily crease further, allowing for the further mod- to the government securities market. eration of external vulnerability. By the end of The Self-Financing Programme affected the 2016, the share of foreign currencies in public MNB’s entire set of monetary policy instru- debt – in case a large portion of maturing for- ments. The asset side of banks’ balance sheets eign currency debt is refinanced from forint has been transformed in line with the impact funds – may also drop to 27 per cent. This mechanism of the Self-Financing Programme. would mean that in a matter of five years the The actual processes were consistent both with 50 per cent ratio (a historic peak) would be al- the output effects arising on the basis of the most halved. The MNB supports this process Mandl–Dierx–Ilzkovitz model (refinancing with the phase-out of the two-week deposit, of foreign currency debt with forint, increas- as a conclusion of the reform of central bank ing the collateral securities portfolio on banks’ instruments under the Self-Financing Pro- balance sheets, contracting the sterilisation gramme.48

Notes

1 Bindseil (2014) 5 Bindseil (2014)

2 Kolozsi (2015) 6 Specifically, the Fundamental Law and Act CXXXIX of 2013 on the Magyar Nemzeti Bank 3 On this, see Blanchard et al. (2012) and Stiglitz (2012) 7 After the crisis hit Hungary, changes in the central bank toolkit did not only arise in the context of 4 For further details, see Akerlof et al. (2014) the Self-Financing Programme. Between 2008 and

28 Public Finance Quarterly  2016/1  focus: New central bank policies 

2012 numerous new tools were introduced by the 17 On non-conventional easing, see: MNB (2015b) MNB; in 2013 the Funding for Growth Scheme was announced, and starting from 2014, instruments re- 18 See Csávás and Koroknai (2014) lated to the phasing out of households’ foreign currency loans also appeared. 19 See MNB (2014)

8 In this regard, see MNB (2015a) and Nagy (2015) 20 “Structural liquidity surplus” means that the aggre- gate net balance of the banking sector’s deposit hold- 9 As regards the macroeconomic significance of exter- ings with the central bank is positive. nal vulnerability, see Kóczián et al. (2016) 21 It cannot be seen as a “healthy” state if – for no par- 10 The central bank may not assume the debt of the ticular liquidity management reason – the banking economy if the securities market of the private econ- sector keeps its funds in preferential central bank omy is not sufficiently developed; it has a limited instruments. ability to buy corporate securities; and its government securities market interventions are constrained 22 As regards banks’ adjustment, it is an important con- by the prohibition of monetary financing (see Arti- sideration that the enforcement of tighter liquidity cle 123 and Article 125 of the Maastricht Treaty). It requirements will reinforce this incentive. Indeed, has opportunities, however, to improve the liquidity after the introduction of the LCR ratio, credit insti- of the bond market using non-traditional central tutions may only consider items maturing within 30 bank instruments, and support economic policy in days as liquid assets; consequently, the three-month the channelling of internal savings. Through their main policy instrument will improve the LCR ratio credit stimulating instruments, central banks may only in one-third of its term on average. The 100 per indirectly encourage lending to the private econo- cent LCR compliance will enter into force in April my, e.g. by providing funds, or by partially assuming 2016, which may prompt credit institutions with credit risks or facilitating their management. liquidity constraints even more to invest in government securities or other marketable instruments in- 11 For details, see Matolcsy (2015) stead of the central bank deposit facilities. See Nagy – Palotai (2015) 12 See Lentner (2015) 23 Assuming bank adjustment through the purchase of 13 Moody’s (2015) government securities.

14 See for example, IMF (2014), European Commis- 24 Assuming that the bulk of foreign currency debt is sion (2014), Moody’s (2013) held by non-resident investors.

15 The three other objectives are: (1) stop and reverse 25 The deduction as well as Figure 5 clearly show that the ever increasing path of public debt, (2) attain a self-financing pre-supposes a partial utilisation of reversal in employment, and (3) reverse the trend of the central bank’s foreign exchange reserves. Before deteriorating competitiveness and that of the alarm- the announcement of the MNB’s Self-Financing ingly decelerating growth rate of potential output. Programme, at the end of March 2014 the foreign See: Government of Hungary (2013) exchange reserves amounted to EUR 36.2 billion, and by end–2014 they dropped to EUR 34.6 billion 16 On this, see Felcser, Soós and Váradi (2015) overall. Meanwhile, short-term external debt – the

Public Finance Quarterly  2016/1 29  focus: New central bank policies 

key indicator of reserve adequacy – fell from EUR of banking funds outside of the central bank. The 28.3 billion at end-March 2014 to EUR 21 billion asymmetry of the interest rate corridor appreciated by end–2014. In 2014, the level of central bank re- non-central-bank liquid securities. serves significantly exceeded the level of short-term external debt. As shown in MNB (2014) and in the 33 Integrated into the European Union harmonisation, analysis of Csávás and Teremi (2015), the volume of this step was made possible by the significantly in- reserves was adequate looking ahead as well; thus it creased liquidity in the banking system and the im- can be established that there was sufficient latitude proving liquidity position of money markets in the to implement the measures based on actual as well as recent years. projected data. 34 That is, by keeping their funds in central bank de- 26 See Kolozsi (2014), Hoffmann and Kolozsi (2014) posits instead of liquid securities.

27 See Nagy and Palotai (2015) 35 As a condition for using interest rate swaps, banks participating in IRS tenders pledge to raise the value 28 The Hungarian banking system is characterised of their security holdings eligible as collateral in line by structural liquidity surplus; therefore, the main with the volume of the concluded interest rate swaps. policy instrument of the central bank is on the li- the volume of the concluded interest rate swaps. ability side. The absorption of the liquidity surplus is indispensable for financial stability and efficient 36 In the central bank’s IRS transactions banks may monetary transmission. The key policy rate is set by swap the typically fixed interest rates of securities the Monetary Council. (government securities) for floating rates.

29 Central bank deposits are less liquid than central 37 The last two changes provided a greater flexibility for bank bonds, as they may not be broken before ma- banks, increasing the probability of banks’ partici- turity, they are not accepted as collateral for central pation in the programme, hence the effectiveness of bank transactions, and they can be held only by the programme. counterparties of the central bank, excluding all other domestic and non-resident investors. 38 As regards the economic convergence potential, see Palotai and Virág (2016) 30 A longer term means a worse liquidity profile. 39 Government Debt Management Agency (2014) 31 With a view to reducing the volatility of interbank rates and absorbing liquidity shocks, the MNB of- 40 Government Debt Management Agency (2015) fers overnight standing facilities to commercial banks. The interest rate corridor is the gap between 41 Among balance-sheet-increasing factors, the inflow the O/N deposit rate and the O/N lending rate. of EU transfers and the Funding for Growth Scheme stand out, while the repayment of foreign currency 32 The reason for the transformation of the interest loans, the foreign currency expenditures of the gov- rate corridor was that by autumn 2015 the yield on ernment and foreign currency interest expenditures short-term government securities fell to the level of all point to the contraction of the balance sheet. central bank O/N deposit rates. In such yield environment the liquidity and yield profile of central 42 Assuming a balance sheet contraction of HUF 1,952 bank O/N deposits did not support the channelling billion, a Hungarian base rate of 1.35 per cent and

30 Public Finance Quarterly  2016/1  focus: New central bank policies 

a near-zero international yield environment, this ing composition of public debt, as well as the high amounts to almost HUF 26.3 billion per year. ratio of foreign currency funds and external finance, by end–2015 or early 2016 the tone of the assess- 43 See Introduction ments concerning Hungary changed fundamentally. This is aptly demonstrated by the example of the In- 44 See MNB (2015a) and Hoffmann, Kolozsi and ternational Monetary Fund (IMF). In 2014 the IMF Nagy (2014). emphasised that in Hungary “still-high public and external financing needs, heavy reliance on non-resident 45 As a result of the transformation of central bank in- funding, uncertainty regarding advanced economies’ struments, and in particular, the transformation of monetary policies, and re-emergence of financial the two-week MNB bill into a deposit, the portfolio stress in emerging markets pose risks”. Its assessment of liquid instruments available for banks substan- of February 2016, however, added that “the Hungar- tially decreased. ian economy is performing very well and its vulnerability to shocks has declined substantially”, and that 46 It may partly reflect the results of the Self-Financing “the self-financing programme contributed to a sig- Programme that international investor and analyst nificant reduction in the exposure of the economy to perceptions about the vulnerability of the Hungar- exchange rate risk”. See IMF (2014) and IMF (2016) ian economy changed considerably over the past 2–3 years. While at the end of 2013 or early in 2014 47 ÁKK (2016) country assessments repeatedly called attention to the key risk associated with the structure and the financ- 48 MNB (2016)

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32 Public Finance Quarterly  2016/1  focus: New central bank policies 

the Council and the Eurogroup. Results of in-depth February 15, 2016 http://www.imf.org/external/np/ reviews under Regulation (EU) No 1176/2011 on ms/2016/021616.htm the prevention and correction of macroeconomic imbalances. Brussels, 5.3.2014 COM(2014)http:// Magyar Nemzeti Bank (2014): Improving Hunga- ec.europa.eu/economy_finance/economic_govern- ry’s Debt Profile. Banks can Contribute to Hungary’s ance/documents/2014–03–05_in-depth_reviews_ Self-Financing through Government Security Purchas- communication_en.pdf es. Background material. 2014 https://www.mnb.hu/ letoltes/mnb-hatteranyag-az-orszag-adossagszerkezete- Government Debt Management Agency (2014): tovabb-javithato.pdf Government Debt Management Report. 2014 http:// akk.hu/uploads/qwGY2g7B.pdf Magyar Nemzeti Bank (2015a): The Magyar Nemzeti Bank’s Self-Financing Programme – April Government Debt Management Agency (2015): 2014 – March 2015. 2015 https://www.mnb.hu/letol- Government Securities Market. Monthly Report. De- tes/magyar-nemzeti-bank-onfinanszirozasi-program- cember 2015 http://akk.hu/uploads/lr4JmOn2.pdf ja–1.pdf

Government Debt Management Agency (2016): Magyar Nemzeti Bank (2015b): Press release on Debt Management Outlook. 2016 http://akk.hu/ the Monetary Council meeting of 15 December 2015 uploads/17bPO2wM.pdf https://www.mnb.hu/monetaris-politika/a-monetaris- tanacs/kozlemenyek/2015/kozlemeny-a-monetaris- Government of Hungary (2013): Convergence Pro- tanacs–2015-december–15-i-uleserol gramme of Hungary 2013–2016). http://ec.europa. eu/europe2020/pdf/nd/cp2013_hungary_hu.pdf Magyar Nemzeti Bank (2016): Termination of the two-week deposit to complete the reform of the IMF (2012): Pilot External Report. July 2, 2012 http:// MNB’s policy instruments. Press release. 12 Janu- www.imf.org/external/np/pp/eng/2012/070212.pdf ary 2016 https://www.mnb.hu/sajtoszoba/sajtokoz lemenyek/2016-evi-sajtokozlemenyek/a-kethetes-je- IMF (2014): Statement at the Conclusion of the gybanki-betet-megszuntetesevel-kiteljesedik-az-mnb- IMF’s 2014 Article IV Consultation Mission to Hun- eszkoztar-fordulata gary Press Release No. 14/115 March 20, 2014http:// www.imf.org/external/np/sec/pr/2014/pr14115.htm Moody’s (2015): TheE volution of Emerging Mar- ket Sovereign Debt: Dramatic Growth in Local Cur- IMF (2016) Hungary – 2016 Article IV Consul- rency Sovereign Debt Is Reducing Emerging Market tation Concluding Statement of the IMF Mission Financial Vulnerabilities, Report, 2015

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