Hungary’s dangerous dependence on eurozone banks
The financial crisis in Hungary is a warning of why the eurozone's debt crisis is the world's debt crisis. Hungary is not a member of the eurozone, but economic woes partly of its own making have been seriously exacerbated by the weakness of the eurozone's banks and the anxieties of eurozone investors.
The big point is that as an economy, Hungary is very dependent on credit from abroad, especially credit provided by eurozone banks. According to the latest figures from the Bank for International Settlements (which are always several months out of date by time of publication) European banks have provided $120bn of credit to Hungary's public sector and private sector, out of total international lending to Hungary of around $140bn.
To put that into context, overseas lending to Hungary represents around 100% of GDP.
So, unsurprisingly, a recent analysis by the BIS showed that Hungary is one of the emerging economies more vulnerable than most to what it calls "sudden capital withdrawals through the banking system" - because foreign banks supply four fifths of credit in the country and around half of this was delivered from outside the country rather than being funded locally by the foreign-owned banks.
Austrian banks had the biggest Hungarian exposure, with $42bn, followed by Italy with $24bn. So the supply of vital credit in this struggling economy was not helped by a stipulation last year that any new loans by Austrian banks to European countries classified like Hungary as "emerging economies" had to be matched by increases in local deposits - which effectively froze lending across the border.
But the more fundamental point is that all eurozone banks have been ordered by their regulators to strengthen their balance sheets by boosting the ratio of their capital to assets. Which has forced them to raise additional capital where they can.
The collapse in the share price of the huge Italian bank Unicredit over the past two days shows how difficult it is for banks to persuade investors to provide them with additional capital resources. So of course banks are resorting to lending less and disposing of assets as another way of boosting that ratio of residual capital to assets.
Most vulnerable to this so-called deleveraging process (the fancy banking name for banks lending less and shrinking) are the emerging economies, especially the emerging European economies - and not just Hungary - because eurozone banks, especially Austrian, French, German, Greek and Italian banks, are responsible for 80% of these loans to the European periphery.
Romania and Poland are both for example very dependent on credit supplied by overseas banks.
Now many would argue that Hungary's problems stem from economic mismanagement by its own governments over a number of years. Certainly the confidence of international investors hasn't been helped by the unothordox steps taken by the current government to reduce its deficit and to reduce the autonomy of the central bank.
But the retreat into possible recession of the eurozone economy naturally weakens the economies of all adjacent and semi-dependent economies. And inevitably it's harder for a financially stretched government like Hungary to borrow, when governments of much bigger and stronger economies, like Italy's, are facing serious funding challenges.
For most of us the important point is the contagion one. Hungary is signalling it needs a bailout from the International Monetary Fund. It has been tipped over the edge by the crisis in the eurozone - that's been part trigger and part of the underlying cause.
If further austerity is forced on Hungary, that could make it harder for Hungarians to repay their debts - which could weaken eurozone banks even more, and simply reinforce the vicious cycle of financial disintegration in the currency union.
Or to put it another way, what is happening in Hungary isn't a big deal in itself - except of course for Hungarians, for whom it is the biggest deal of all right now. But it shows that failure to find a comprehensive, once-and-for-all solution for the eurozone will cause all sorts of serious accidents all over the world (including in the UK).