Bonds

In the history of securities market 1990 was a very important year. The first law on securities was approved and the Budapest Stock Exchange (BSE) was reopened. The Hungarian bond market is in effect a government securities market, because both the volume of issues as well as the majority of transactions are related to the government itself.

Government bonds

According to the 1993 plan, central budget deficit financing was based on issues of government securities. At the beginning of 1993 government bonds were issued at a very low yield. Interest rates had decreased by 15% in 1992 and by the middle of the year it had become clear that the macroeconomic situation had diverged from forecast and the balance of payments current account had deteriorated substantially. Due to uncertain economic prospects, inflation and higher interest rate expectations, government securities issues were again dominated by short-term discounted T-bill auctions.

In 1994, in order to increase the demand for longer-term bonds, the government introduced a tax allowance system for individuals who bought government papers with maturities over three years. The tax allowance made banks’ savings schemes less competitive, so savings shifted away from the banking sector.

Devaluation, increases in interest rates by the national bank and a rise in interest-rate-expectations characterized the period from the middle of 1993 to the first quarter of 1995. During this time interest rates increased by approximately 20%.

In 1995, a new, stringent stabilization policy was introduced. The most notable feature of monetary policy was the introduction of the crawling peg devaluation system. Due to this devaluation system, the yield from investment in the forint was attractive because the aggregate rate of devaluation and the interest rate on foreign deposits was lower than the yield on T-bills. The tax allowance on purchases of government papers by individuals was abolished.

In 1996, improvement in the external and internal equilibrium, falling inflation and an increase in savings characterized the Hungarian economy. The savings structure changed and retail foreign exchange deposits declined, reflecting a growing confidence in the Hungarian currency.

The downward trend of interest rates resulted in an improvement in the maturity profile. The issue of bonds with seven-year maturities and a CPI-linked interest rate, listed in October, was a remarkable success.

Commercial paper and medium-term notes

The commercial paper markets were expanded during 1993 and 1994, because the interest rate structure was favourable. The yield on T-bills was much lower than on loans, but in the structure of issues there was a special shift towards private offerings. This was because the administration of issues was less complicated and selling was easier (special guarantee, special price ).

The main issuers with large volumes were subsidiaries of good international companies with parent company guarantees. The yield on these papers was very close to the yield on T-bills.

Other issuers’ paper – banks, local governments, along with some Hungarian companies – without guarantees earned high yields, although some were considered risky investments. Some investors asked for collateral behind the paper – especially banks – so they were constructed in a manner similar to loans. The main investors were banks, insurance companies and other financial institutions.

From the end of 1994 market activity decreased. On the one hand, banks had a limit for investment. Medium-term notes fell into this category, meaning that banks’ demand fell. On the other hand, owing to tax allowances and the high yield in government paper, it was impossible to sell bonds to individuals.

Secondary market

Government bonds, discount T-bills with residual maturities of three, six or 12-months, interest bearing T-bills with one year expiration and some corporate bonds are traded on the stock exchange. Between 1993 and 1996 the T-bills market was very active, with the turnover of government bonds increasing from Ft73 billion to Ft416 billion from 1993 to 1996. The largest part of the turnover of government papers was on the over-the-counter (OTC) market. The central clearing house and depository (KELER), formed in 1993, acts not only as a clearing house for cash and futures transactions for the two exchanges (stock and commodities), but also operates an as an OTC government securities settlement system and provides central securities depository services.

Macroeconomic factors

In 1997 there have been further improvements in the external and internal equilibrium. Inflation has continued to fall and savings to increase. The country’s credit rating has improved and Hungary has been given investment grades by many credit rating institutions (BBB by Ibca, BBB- by Standard and Poor’s and Baa3 by Moody’s Investors Service).

At the end of 1996 the new law on securities was approved, introducing regulations for market that has entered its maturity phase. The Hungarian securities market has attracted investors’ interest in the first half of this year, resulting in dynamic growth in the stock market .

Types of bonds

Government bonds

The two main objectives of government’s financial strategy are: a lengthening in maturity periods for government securities and a decrease in yields, in accordance with declining inflation rates. According to plans, two and three-year fixed interest rate government bonds, complemented by a seven-year floating rate government bond and a five-year fixed interest rate bond will be issued. The role of T-bills is declining. Government bonds to the value of Ft160.3 billion were sold through public placement during the first three months of 1997. This volume represents a 55% increase compared with the previous quarter.

Commercial paper

Commercial paper has a less significant role in the bond market than government paper. In 1996 there were only 40 issues and their total value was Ft10 billion. There were issues on a small scale this year, but the purpose of these was to replace loans with bonds. The main issuers were subsidiaries of international companies, while some small Hungarian companies organized private offerings.

Only a few company bonds are listed on the stock exchange. The largest one is Pannon GSM, which has three different bonds. The total volume of the issues was Ft25 billion. This company was first among GSM suppliers to issue bonds.

Investors

The main investors on the Hungarian bond market are financial institutions and institutional investors. During the past two years financial institutions’ share of outstanding stock and deficit-financing government securities has increased from 27% to 40%. The role of institutional investors – investment funds and insurance companies – has also increased, and their share is now equal to that of financial institutions.

According to Government Decree No. 161 of 1995 paragraph 8/C, residents are entitled to transfer government securities to non-residents without the permission of the foreign exchange authorities only if the tenor of the security is equal to or longer than 365 days.

Investor confidence is reflected by the fact that Ft79.58 billion Hungarian government securities are held by foreign investors, constituting a 5.2% share of outstanding stock in 1997.

Yields

Yields on government securities, especially yields on three-month T-bills are very important indicators for the Hungarian loan market.

In the first half of 1997, yields on the government securities market showed a declining trend and the slope of the yield curve became increasingly negative. This was particularly striking in the case of securities with maturities of over one year. The reasons for this were that a) the monthly rate of inflation, year on year, was lower for the first months of 1997 than in the preceding two years, and, according to expectations, average inflation in 1997 will reach 18%, and b) in the first half of 1997 the money market was characterized by excess liquidity.

While interest rates should be low enough to satisfy government budget interest expenses and economic growth considerations, the national bank’s monetary policy goal to maintain an interest rate differential favouring the forint against foreign currencies is also influential.This is intended to guarantee the inflow of foreign capital, to prevent negative real interest rates and to maintain the dynamic of growth of household savings. The national bank influences interest rates through repo rates. Decreases in the monthly devaluation rate were officially announced twice this year, first in March and then in July. From August 15 the forint exchange rate will be devalued by 1% per month.This announcement has influenced short-term rates more than long-term rates.

Secondary market

Major institutional changes took place in the government securities market in 1996. The primary dealer system was implemented in order to ease investors’ access to securities issued by the government. The system consists of 22 dealers who receive commissions from the government on the purchase of bonds and T-bills. Exclusively primary dealers may purchase government bonds, while auctions of discount T-bills are open to banks and other brokerage firms. The members of the primary dealer system have been obliged to quote ask and bid prices on the stock exchange and the OTC market for discount T-bills, government bonds and interest-bearing T-bills issued after January 1 1996, as long as the remaining term of maturity on these securities is at least three months.

Outlook

Economic activity is expected to rise over the next two years, generating increased demand for funds. As a result, the downward inflationary spiral will continue in 1997. In 1998, however, according to our projections inflation-rate-decline will be slower than anticipated by the government, and in 1998 we expect 15.3% average yearly inflation. Repo rate cuts are expected to follow declining inflationary expectations, but will not be higher than the further devaluation of the forint allows. The result of a more significant decline would undermine the foreign trade balance considerably. The yield curve will remain inverse, but less steep, with further flattening expected during 1998.