A number of exchange restrictions may have been relaxed in the run-up to OECD membership in 1996, yet the Hungarian forint still falls short of full convertibility. According to current exchange regulations, residents may only enter forint-related spot contracts in connection with certain types of payments and they are prohibited from entering forward and options contracts with non-residents.
Mainly due to these restrictions, the depth and liquidity of the Hungarian interbank forex market is still limited. Daily average trading volume is in the region of $400 to $500 million (excluding spot transactions with the central bank – the National Bank of Hungary (NBH). Unlike the Czech koruna, however, the forint market is mainly driven by domestic participants – be they banks, funds, corporates or private individuals. Nevertheless, the impact of foreign investors buying Hungarian equities and government bonds cannot be totally ignored.
As a consequence of semi-convertibility, a London-based offshore forint market has developed parallel to the domestic market, trading non-deliverable forwards and some forint options, whilst settling the transactions at maturity on net base in convertible currencies.
Despite the lack of total convertibility, the Hungarian financial industry has made great progress since July 1992, when the domestic interbank foreign exchange market commenced operations. Compared with other central European emerging markets, the strength of the Hungarian foreign exchange market is its diversification in terms of participants and instruments. The industry is capable of delivering a wide range of forint-related forex products – from non-deliverable forwards to forex futures – whilst some banks have even started offering over-the-counter (OTC) traded plain vanilla options.
Undoubtedly the developments in the market were prompted and supported by the establishment of currency futures trading on the Budapest Commodity Exchange and Budapest Stock Exchange in 1993 and 1994 respectively. The financial stability since mid-1995, the import of know-how by major international banks entering the local market through privatization or through green field investment and improved regulation in the financial markets have added to these developments.
Based on this, an active OTC forward market – developed over the years – is now providing good liquidity for maturities of up to six months, and reliable liquidity can by now be found for up to 12 months in the futures market. This will further improve if the proposed merger of the two exchanges takes place.
The introduction of the financial stability package in March 1995 caused a change in attitude in the forex and money markets. Earlier speculation induced trading activity in anticipation of a forint devaluation. This was replaced by transactions linked to interest arbitrage and hedging considerations arising from buying currencies nine, six or even one month forward – especially prevalent from January 1996 when the decline in forint interest rates accelerated.
Thus, currency futures trading did not only promote forex trading but also provided an important impulse for developing interest risk management services. The first interbank forward deposit deals were concluded in February 1996, and some months later BUBOR (Budapest Interbank Offered Rate) – a daily interbank interest rate fixing mechanism (a precondition to trading forint FRAs and interest-rate-related currency futures) – was established.
Today a limited number of banks are actively quoting FRAs and the three-months BUBOR futures contract is attracting greater attention.
A further increase in market liquidity and the extension of maturities for trading and hedging instruments will largely depend upon the full convertibility of the forint, which is anticipated in the near future.
