Tim Gosling in Prague -

Hungary has dismissed proposals from the country's banks to address the issue of foreign currency loans, and the government will now impose its own plan, Economy Minister Mihaly Varga said on October 28. The move will leave the financial sector on tenterhooks in the coming weeks.

The Hungarian Banking Association announced on October 26 that it had submitted a proposal to the government the previous day, beating a November 1 deadline to come up with a solution to the problem of the huge volume of Hungarian mortgages that had been taken out in Swiss franc and euro. However, it has taken the government just one weekend to reject the plan out of hand.

Varga told MTI that the banks' proposal fails to address the gravest problems of troubled forex debtors, who have seen their installments skyrocket due to the drop in the value of the forint since the loans were issued ahead of start of the crisis in 2008.

The official said the government had received the proposal in time, but claimed that the banks should have been already talking with clients and started acting. He also claimed the proposal does not satisfy the government's aims of phasing out forex loans entirely, nor preventing borrowers with forint loans from ending up worse off than those with loans in other currencies.

"There was no word about modifications to contracts; the banks did not apply decisions taken by the Kuria [supreme court] to the contracts, even though there would have been no legal barrier to prevent this," Varga said. "Because the banking association's proposals do not solve these problems, the government will submit its proposals to parliament early in November," he said.

While the banks have been eyeing losses from the government's latest push on forex loans for some time, the imposition of a government package will have them sweating on the details, including the level of losses incurred when converting the debt back into forint, how much of that burden they will be forced to shoulder, and the pace at which the conversions will take place. Hungary's biggest bank OTP, whose CEO has emerged as a staunch government critic in recent months over the plan, dropped 2.77% on the Budapest Stock Exchange while the index fell 0.7%.

Crunch time

The head of Hungary's ruling Fidesz parliamentary faction Antal Rogan announced the November 1 deadline on September 5, insisting that the banks had a moral responsibility for the problems and should modify loan contracts in favour of borrowers. That followed the government's rejection of an earlier proposal from the banking association.

The issue provides Prime Minister Viktor Orban with a double benefit. On the one hand, it is now in full swing preparing the ground for parliamentary elections set to be held by next spring. A hit to the mostly foreign-owned lenders in favour of households will clearly offer a populist boost. At the same time, the huge volume of forex debt is one of the last brakes on the government's unorthodox economic policymaking, as any move that lowers the value of the forint, such as interest rate cuts, hits households hard.

The government has spent the last three years dismissing criticism of its erratic and unorthodox policymaking from the likes of Brussels, Washington and international financial institutions, and in the summer made the surprise announcement that it intends to wipe out forex debt one way or the other.

In a bid to soothe market nerves, it quickly promised to negotiate a settlement with the country's battered lenders, but they are clearly set for significant losses whatever the outcome. The banks shouldered huge costs in a three-month scheme to allow early repayments from borrowers in late 2011. On top of high taxes that have been piled on the sector since Orban came to power in 2010, that has seen the banks pull in lending.

Attempts have been made to placate investors and the markets in recent weeks. Varga has said care must be taken to prevent the banking system from "collapsing at the end of the story," adding the government understands the banks cannot handle losses on the same scale as they incurred during the last scheme. However, they will fear rough treatment once more when it comes to the crunch.

Varga said on October 25 that the economy ministry is in the process of drafting a plan that would see the monthly payments on forex mortgages drop by 15-20% from the start of 2014, with the costs to be split between the banks, the state and - to a lesser degree - borrowers themselves. Loans denominated in currencies other than the forint should phased out within 3-5 years, he added, rejecting a suggestion by Hungarian Banking Association head Mihaly Patai that the banks need at least 10-15 years to achieve that. "We don't have that much time," the economy minister stated.