Prepared by Rachel van Elkan.
Another contributing factor has been the comparatively strong demand for currency, which boosts seignorage revenue.
As residual claimant on the NBH, the government is legally obliged to cover NBH losses from budgetary sources.
Historically, and continuing into the present, the NBH has been the primary sovereign borrower for Hungary. While no direct on-lending to the government of foreign loans has taken place in recent years, prior to 1988 the proceeds from foreign loans were used to finance forint-denominated lending to the government and state-owned banks.
Prior to February 1996, banks’ foreign currency deposits at the NBH were deducted from their mandatory reserve obligations. Since these deposits earned (foreign) market interest rates—while mandatory reserves against banks’ foreign currency liabilities (which are held in forint) were remunerated at below market rates—banks had an incentive to retain their foreign exchange at the NBH. This inducement was most pronounced prior to 1995 when interest arbitrage considerations favored foreign-currency denominated assets.
Between January 1, 1990 and December 31, 1994, the forint depreciated by more than 220 percent against the U.S. dollar.
Moreover, these valuation losses are not recorded in the government’s budget. As a result, the true fiscal balance is understated by the annual increase in these losses.
The securities issued to replace the valuation losses have an original maturity of between 10 and 30 years. Interest on these securities, which is paid twice yearly, is linked to yields on discount treasury bills.
The Ft 440 billion of valuation losses converted in 1996 is equal to the decline in 1995 in the net foreign exchange liabilities of the NBH measured at end-1995 exchange rates (Ft 570 billion), less the amount securitized in 1994 and 1995 (about Ft 130 billion).
Moreover, it was agreed in January 1996 that the NBH would receive 5 percent of regular bi-weekly issues of 6-month and 12-month discount Treasury Bills and issues of government bonds in exchange for non-interest bearing debt. During the first half of 1996, the amount securitized under this facility was about Ft 30 billion.
In addition, Ft 11 billion in market-interest bearing securitization bonds were also retired.
Under both proposals, valuation losses incurred by the government on the foreign-currency bonds issued to the NBH will be budgeted below the line, rather than as an expenditure item.
If the amount of foreign currency bonds issued to the NBH in exchange for valuation losses exceeds (falls short of) its stock of net foreign exchange liabilities, depreciation of the forint will result in valuation gains (losses) to the NBH on its existing foreign exchange obligations.