MASS EMIGRATION AND POLITICAL INSTITUTIONS

Responsible researcher: Bruno Benevit

Original title: Household Debt Revaluation and the Real Economy: Evidence from a Foreign Currency Debt Crisis

Authors: Emil Verner and Győző Gyöngyösi

Intervention Location: Hungary

Sample Size: 2,538 municipalities

Sector: Financial Economy

Variable of Main Interest: Debt

Type of Intervention: Exposure to foreign debt

Methodology: OLS

Summary

During currency crises, household debt in foreign currency can intensify financial risks, increasing default rates and triggering a reduction in consumption. This can have significant adverse effects on domestic economic stability and household well-being. In this sense, this study examines the consequences of the increase in household foreign currency debt during the Hungarian currency crisis at the end of 2008. The results found demonstrated that the revaluation of debts caused an increase in high default rates and a drop in the consumption of durable goods, accelerating the local recession with negative effects on nearby credit borrowers and presenting more severe effects for debts concentrated in families.

1. Policy Problem

During periods of currency crisis, households and firms that borrow in foreign currency face additional uncertainty due to exchange rate volatility. This exposure can make borrowers more vulnerable, as any sudden appreciation of the local currency can substantially increase the cost of debt service in local terms. The resulting pressure on agents' budgets can lead not only to an increase in default rates, but also to drastically depreciate consumption capacity.

In this context, this scenario not only amplifies negative economic impacts at the domestic level, but can also generate a broader economic slowdown cycle. Rapid credit expansions are often followed by major recessions, resulting in adverse effects on gross domestic product (GDP) growth and employment (VERNER; GYÖNGYÖSI, 2020). Emerging Europe before the 2008 financial crisis, in particular the case of Hungary, highlights this phenomenon, where the rapid growth of household credit in foreign currency was followed by large debt revaluations and severe household financial difficulties. Therefore, understanding the consequences of exposure to foreign debt during periods of crisis becomes essential to mitigate possible systemic risks and induce greater economic resilience in the long term.

2. Policy Implementation Context

The foreign currency debt crisis in Hungary had its origins in the rapid expansion of foreign currency denominated household credit prior to the 2008 global financial crisis. Between 2000 and 2008 there was a significant increase in household debt to GDP, driven by subsidized loans in local currency for housing and unsubsidized loans in foreign currency, mainly in Swiss francs. In September 2008, around 69% of outstanding housing debt was denominated in foreign currency, which left household balance sheets directly exposed to the sharp depreciation of the Hungarian forint (HUF) during the crisis.

The stability of the forint's exchange rates against the euro and the Swiss franc until October 2008 fueled the belief among market participants that a major depreciation was unlikely. However, between September 2008 and March 2009, the forint depreciated by around 27.5% against the euro and 32.3% against the Swiss franc. This movement was triggered by a general flight into safe assets away from emerging markets, and intensified by investor concerns about the Hungarian government's significant external financing needs.

Later, between 2010 and 2011, the subsequent depreciation of the forint during the eurozone crisis further aggravated the situation. Foreign banks took advantage of the previous stability and offered foreign currency loans at lower interest rates than local currency loans. Thus, there was an aggressive expansion of credit in foreign currency to areas with lower subsidized debt. The lack of hedging against currency risks meant that most debtors were not protected against currency volatility, given that their income and assets were predominantly denominated in local currency. These factors resulted in a foreign currency debt crisis in Hungary, where many families faced severe financial difficulties due to the sudden increase in debt burdens relative to their ability to pay in devalued forints.

3. Assessment Details

To measure the foreign currency debt exposure of municipalities prior to the depreciation of the forint in 2008, the credit registry was reconstructed from 2000. An annuity model and detailed interest rate data were used to estimate monthly payments and debt outstanding before 2012 for all loans on the credit record. Hungarian Central Statistics database Office's T-Star , including the unemployment rate, household income, tax payments, population, and net migration. New car registration was used as an indicator of household durable expenditure and sub-regional house price indices (NUTS-4) were estimated from the Hungarian National Bank's house purchase transaction database for assess the evolution of housing prices.

Furthermore, company-level data was obtained from corporate tax returns to the Hungarian Tax Authority, covering employment, payroll, export sales and investments for all dual accounting companies in the country. The majority of companies included in the analysis had a single establishment, including the headquarters, and each company operated in approximately 1.66 municipalities on average. Based on this, the exposure of a company to local household debt in foreign currency by the municipality of its headquarters was defined.

To construct a balanced panel, companies with less than three employees and those in the finance, real estate, public administration, education and health and social assistance sectors were excluded, resulting in a sample of 66,267 companies that were monitored from 2006 to 2012. Finally , loan-level data from the Credit Register of Hungarian Companies was combined to obtain information on corporate debt by currency and corporate defaults. On average, two thirds of the debts of families in the sample were in foreign currency, while for firms this portion was 11%.

4. Method

The objective of the analysis was to investigate the effects of exposure of families and firms to debt in foreign currency during the exchange rate crisis in Hungary from 2008 onwards. As outcome variables, the impact of debt revaluation on local economic variables was observed. The theoretical framework for household behavior considered three models: (i) a basic model, comparing the evolution of variables such as spending in municipalities with different levels of exposure to debt in foreign currency before and after 2008; (ii) a dynamic model, evaluating trends over time and the propagation of the debt revaluation shock; and (iii) a revaluation shock model focuses on the specific impact of the forint depreciation, isolating the exchange rate effects on the local economy.

The study's first analysis examined the effect of revaluing households' foreign currency debt on their credit default rate at the municipal level. Additionally, the effect of the revaluation of families' foreign currency debt on their consumption of durable goods was verified, measured based on the annual number of new car registrations. Both regressions estimated the coefficient of the share of debt in foreign currency of the family's municipality, controlling for covariates of fixed effects of municipalities, time and region, exposure to exports, and indicators of credit quality and employment by industry.

The study also presented estimates related to the impacts of debt revaluation in foreign currency on economic activity, observing the impact of the crisis on local unemployment. Furthermore, possible mechanisms for impacts on unemployment were analyzed through the level of local employment of firms (exporters and non-exporters), limitations in labor market adjustment and devaluation of the real estate market.

Finally, it was verified whether the revaluation of debt in foreign currency caused spillover effects on real estate loans in local currency and foreign currency. Analyzes were carried out for three samples: all credit borrowers, credit borrowers in local currency, and credit borrowers in foreign currency.

5. Main Results

The results indicated that the revaluation of household debt in foreign currency had significant impacts on both local default and consumption of durable goods. Regarding default, areas with greater exposure to foreign currency debt showed a default rate 9.30 percentage points (pp) higher after the depreciation of the forint. In relation to the consumption of durable goods, the debt revaluation resulted in a 41% reduction in car purchases in the most exposed regions, demonstrating a substantial drop in local spending on durable goods, influenced by the greater household debt burden.

Regarding impacts on economic activity, the revaluation of debt in foreign currency had significant and persistent negative impacts on employment and the local economy. Non-exporting firms, in particular, showed sharp drops in employment, while exporting firms did not suffer statistically significant impacts. This result indicates the persistence of high unemployment in more exposed areas and limited adaptation through the reallocation of labor to more resilient sectors. Furthermore, the devaluation in property prices further worsens the local recession, prolonging the negative effects on the job market and hindering the economic recovery of the affected areas.

Estimates regarding the impacts of exposure to debt in foreign currency on firm indicators revealed that companies with a higher fraction of debt in foreign currency reduce their investments after devaluation. However, these companies experience stronger growth in sales, value added and employment. According to the authors, this may occur because companies with exposure to debt in foreign currency are more productive and have better growth opportunities. Thus, they temporarily reduce investments, but keep employees waiting for stronger future growth.

6. Public Policy Lessons

This study investigated the effects of revaluing Hungarian households' foreign currency debt on several local economic indicators. Looking at panel data between 2006 and 2012, the paper examined how household exposure to foreign currency debt influenced Hungary's economic activity following the 2008 crisis.

The results indicated that the debt revaluation caused a significant increase in local defaults, reflecting a greater financial burden on debtors resulting from the fall in the forint exchange rate. As a consequence, there was a sharp drop in spending on durable goods in areas with high exposure to debt in foreign currency, depreciation in the Hungarian real estate market, and an increase in local unemployment associated with the drop in the level of employment in non-exporting companies. .

These results are relevant to understanding how financial shocks at the domestic level can propagate throughout the local economy, exacerbating problems in economic activity broadly. Such evidence emphasizes the need for macroprudential policies to limit leverage exposure to foreign currencies and promote economic stability in periods of exchange rate and market volatility.

References

VERNER, E.; GYÖNGYÖSI, G. Household Debt Revaluation and the Real Economy: Evidence from a Foreign Currency Debt Crisis. American Economic Review , vol. 110, no. 9, p. 2667–2702, 1 Sept. 2020.