A chain under stress usually breaks at its weakest link. For the global financial system, the pressure point could well prove to be Hungary.
Although not in the single currency, Hungary’s depressed economy is entirely dependent on credit from banks that are in the eurozone, particularly those located in neighbouring Austria and Italy.
Those credit lines have dried up as a result as the drift to a full-scale banking crisis in Europe takes its toll on lending, leaving Hungary vulnerable to a sudden withdrawal of funds.
Banks everywhere, including the UK, are now reluctant to lend to anyone, including other financial institutions, for fear they won’t get their money back. And their scope for lending has been further reduced by a requirement to increase their asset base (which led to a run on Italian bank Unicredit’s shares yesterday).
Hungary’s beleaguered autocratic government led by the populist Viktor Orban yesterday had to pay interest of 10% to borrow some short-term money. A debt-swap auction was cancelled for lack of interest.
Hungary needs to roll over nearly €5bn of external debt this year and in February is due to start repaying a loan from the International Monetary Fund that saved the country from collapse in 2008.
The country is now asking for more help from the IMF. This won’t be straightforward as the IMF is demanding political and economic policy changes first. The danger of a Hungarian sovereign debt default remains high, which would have a contagion impact throughout Europe.
Orban’s nationalist posturing is adding to the risk, as does a growing political crisis which last weekend saw tens of thousands of people rally in Hungary against a new constitution that gives the state draconian new powers over its citizens (as well as the central bank, much to the angst of the EU and IMF who are not particularly bothered about the rest). A declaration on the “decline of democracy and the rise of dictatorship” in Hungary was circulated by a number of former political dissidents.
Other so-called periphery countries, like Rumania and Poland, are equally vulnerable to a credit crunch. Austrian, French, German, Greek and Italian banks are heavily committed to loans to these countries.
There are no “solutions” in sight, as billionaire investor George Soros acknowledged in relation to the eurozone crisis. Soros was only stating the obvious when he warned that a collapse of the single currency would be “catastrophic not only for Europe but also for the global financial system".
The stresses are showing up throughout the system. A survey by the Bank of England reveals that Britain's banks are more worried now about a credit crunch than at any time since the first one brought down Northern Rock in late 2007. Inter-bank lending rates have risen as a result of the eurozone crisis and these have been passed on to companies in the form of higher interest charges.
The survey also showed the first increase in default rates on loans by bigger business in two years. "For large and medium-sized corporates, default rates were reported to have picked up for the first time in two years and a further pick-up was expected," the survey said.
The central bank's quarterly Credit Conditions Survey also showed that small businesses' demand for credit had fallen sharply, and that banks expected demand for credit to drop in the coming months. The survey confirms that the UK economy is on a knife edge, heading from recession to outright slump.