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Weekly Financial Column No. 2, Budapest Week Newspaper

		Wednesday, 05 December 07 - 07:20 PM (GMT) By John Roberts in Portfolio: Finance/Investment

 

Weekly Financial Column No. 1, Budapest Week Newspaper

		Monday, 26 November 07 - 01:51 AM (GMT) By John Roberts in Portfolio: Finance/Investment

Research Report: Investment Risk in Hungary

		Tuesday, 20 November 07 - 07:23 PM (GMT) By John Roberts in Portfolio: Finance/Investment

DELTA LLOYD

investment research ltd

Mutual Funds Research and Management

Dózsa György út 108,               1068 Budapest, Hungary

E-Mail:                                        research@deltalloyd.hu

 

Research Report

By John Roberts

Managing Director

 

 INVESTMENT RISK IN HUNGARY

The Transition from Emerging to Converging Market

January 2001

       1.           Hungary is the least risky of the Central and Eastern European states.  It   nevertheless suffers from a variety of investment risk not normally seen in the EU which it expects to join in 2004.

 
2.           COUNTRY RISK. The overall country risk, as compared to other world emerging markets, is considered low. Although economic freedom has existed for only a decade, the relative maturity of the government and the relative lack of corruption and other problems seems excellent by comparison with countries which have had much longer to emerge from colonialism and dictatorship. The incentive to prepare for EU membership has been a major factor. We might also remember that Hungary was the financial center of the Habsburg Empire, it had achieved a level of equality with the Austrians, and it was later allowed greater economic and political freedom by the Russians after the 1956 revolution.

 
3.           EMERGING MARKET RISK. Hungary is still classed and treated as an emerging market, as was painfully seen when Russia defaulted and all emerging markets suffered. However, investors also know that Hungary has made greater progress than the other former communist states in such essential areas as transparency, law, institutions, economic freedom and the function of the free market. If only one state could join the EU first, it would be Hungary. However, the underlying problems of recently-communist economies and companies are likely to provide further negative surprises as compared to Western economies and countries that have been under development and experienced management for longer periods.

 
4.           LIQUIDITY RISK. Liquidity of Hungarian blue chips is good, but there can be a negative aspect to this, as was also seen in the Russia crisis of 1998. After crashing with emerging markets, Hungary then suffered further sharp decline because it offered the most liquidity to those who needed to sell stocks to cover losses elsewhere. In addition, the great majority of Hungarian secondary stocks are not liquid at the levels required by investment funds. This will improve, albeit slowly.

 
5.           DIVERSIFICATION RISK. The small number of quality stocks in the A category of the Budapest Stock Exchange, and the absence of some major sectors, makes it difficult to diversify with liquidity. Yet, the fund law requires that funds limit themselves to 5% maximum in any one stock. Thus, it is required to hold more stocks (17, plus 15% cash) than is prudent in terms of quality and liquidity. This is expected to improve to 10% with the new fund law in July, but the demand for diversification punishes investors by lowering quality and liquidity.

 
6.           POLITICAL RISK. While the previous government of former communists carried out reforms and managed the economy in a way that greatly encouraged foreign direct investment, the new government of the past two years has made a populist attack on free markets, fought the independence of the central bank and shown some lack of concern for development of other democratic institutions.  The media, for example, do not provide the level of scrutiny, penetration and investigative journalism seen in more mature democracies. There has been some recent improvement in lifting the heavy hand of profit-limiting regulation on the oil and pharmaceutical industries, while the movement of the Finance Minister to the central bank must be watched carefully. There does not appear to be a great danger of a serious retrogression to anti-investment policies.

 
7.           ECONOMIC RISK. The economy is in excellent condition thanks to the recent years of courage to reform, and the general acceptance of the pain of reform by the unions and lower elements of society. As a result, the gains of the upper elements are now trickling down to the lower, and economic growth is forecast to remain at a consistent and admirable 5% level for several years without serious inflation increase. FDI continues at strong levels, although foreign participation in the stock market has been subdued in the recent high risk and corrective phases of the US markets. World economic recovery without extreme valuations should cause increased investment in emerging markets, with Hungary leading the way.

 
8.           FORECAST. In general, investment risk in Hungary will continue to lessen, thanks largely to convergence reform and the fading of lingering fears of economic shocks such as the Asian, Russian and emerging market crises of the past few years. While various dangers will remain for the foreseeable future, Hungary will rapidly become more stable and less risky as it is enveloped by the EU. Now is probably the greatest time of opportunity as valuations remain extremely low, and the future economic environment looks increasingly bright. In the larger context, however, it must be noted that the leading American markets have been in an expansion phase for some years, and signs of an overbought, speculative market, especially in internet technology and the NSADAQ index, are giving technical warnings. Sharp declines in these markets would cause retrenchments in emerging markets because that is the first place that international investors raise cash and reduce risk when they experience losses in mature markets. Companies in emerging markets have less future earnings visibility and reliability.  JR

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