Kester Eddy in Budapest -

Gyorgy Gemesi, mayor of Godollo, is a worried man. His university town just to the east of Budapest, with a population approaching 33,000, decided in 2007-08 to utilise EU funds in order to finance development projects - specifically a school, kindergarten, urban renewal and restoration of the town's former Habsburg Palace, which hosted many of the more fancy meetings during Hungary's tenure of the EU's presidency earlier this year. To raise its own share of the required capital, the town borrowed and issued bonds. Today, Godollo has total debt of around HUF3.8bn (€14m); at around €420 per man, woman and child, this might not seem excessive - except that the entire sum is denominated in Swiss francs.

When the loan was taken out, the city received around HUF160 in funding per franc, but with the inexorable rise of the Alpine currency, in early August the mayor was looking at a rate of HUF260 per franc to pay back the principal - a 62% increase in forint-based repayments. "We've had a brutal increase in costs due to exchange rate movements. We drew up our budget in February [when the exchange rate was around HUF210 to the franc], but now, in the middle of the year, we do not have the money for these repayments," Mr Gemesi tells bne.

Aware in July that many other municipalities were facing similar financial black holes - local councils in Hungary have some HUF1.2 trillion (€4.4bn) in debt, of which half is in Swiss franc-denominated bonds - the mayor consulted the Hungarian Association of Local Governments and in early August appealed to the prime minister to back a request for a one-year moratorium on principal repayments the banks.

The move - which the banks initially treated with scepticism though negotiations are continuing - raises the spectre of local councils unable to pay the bills for local services such as refuse collection and water supplies. However, it was downplayed by most economists in terms of the macro risks. "First of all, local government debt is included in the general government debt on an ESA basis, so it has no effect overall on the public debt level or the budget deficit figures. And it is not such a large sum, I calculate at around HUF30bn or so, even if the central government has to pay off this debt for one year. There are reserves to cover this," says Adam Keszeg of Raiffeisen Bank in Budapest.

Keszeg argues that the central government will automatically take over the debt burdens of any municipalities in default, thereby easing any concerns about the banks holding these municipal bonds, but others are less sure. "I don't think the state will automatically guarantee these loans," Janos Samu, economist with Concorde Securities, tells bne, adding that for banks more exposed to municipal bonds, such as OTP Bank, a string of defaults could be "more than significant money."

But whatever the concerns over municipal bonds, it makes up only a minor portion of the total foreign-currency debt in Hungary, and it is the household borrowing that remains of most concern, says David Nemeth, chief economist at ING Bank Hungary. "The Swiss franc loan debt in Hungary comes to just under 30% of GDP. Of this, households accounts for 15% of GDP, municipalities about 3%, and the rest is corporate and [small business]. So households is definitely the biggest problem," he says.

The situation with households is all the more worrying because industrial production, which has underpinned the economic recovery (and stemmed job losses) since late 2009, suffered a sharp and unexpected decrease over the summer, indicating household incomes will stagnate. "Industrial production in June [at just 1.0% year-on-year growth in June] was much worse than we expected, and this does not seem to be a temporary effect. I have always been pessimistic about domestic consumption, because of the Swiss franc problem; now I have changed my forecast for GDP growth due to the global slowdown, from 2.7% to 2.4% this year," Nemeth said.

Hand-up, hand-out

For the beleaguered homeowner struggling to pay the mortgage, some help is at hand - even if it is only of a temporary nature.

The government has designed a "fixed exchange rate" system to begin in Septembe, whereby homeowners may make repayments on mortgages based on a fixed exchange rate of HUF180 to the Swiss franc (with the unpaid excess totted up on a separate account for later payment).

In addition, OTP Bank has also begun offering a similar fixed-rate mortgage repayment package, but with the exchange rate set at a more realistic HUF200 to the franc, and lower fees than the government scheme.

At the same time, there has been some respite in the market as the Swiss currency fell from a peak of HUF273 in early August to around HUF240 by the middle of the month - a move anxious borrowers are hoping will not be so temporary.