Principal investigator: Bruno Benevit
Original title: Household Debt Revaluation and the Real Economy: Evidence from a Foreign Currency Debt Crisis
Authors: Emil Verner and Győző Gyöngyösi
Location of the Intervention: Hungary
Sample Size: 2.538 municipalities
Sector: Financial Economy
Primary Variable of Interest: Indebtedness
Type of Intervention: Exposure to foreign debt
Methodology: OLS
Summary
During currency crises, household borrowing 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 increased household foreign currency borrowing during the Hungarian currency crisis in late 2008. The results showed that debt revaluation led to high default rates and a drop in durable goods consumption, accelerating the local recession with negative effects on nearby borrowers and showing more severe effects for debt concentrated in households.
- 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 servicing the debt in local terms. The resulting pressure on agents' budgets can lead not only to an increase in default rates but also drastically depreciate their purchasing power.
In this context, this scenario not only amplifies the negative economic impacts at the domestic level, but can also generate a broader economic slowdown cycle. Rapid credit expansions are frequently followed by major recessions, implying adverse effects on gross domestic product (GDP) growth and employment (VERNER; GYÖNGYÖSI, 2020). Emerging Europe before the 2008 financial crisis, particularly the case of Hungary, exemplifies this phenomenon, where rapid growth in foreign currency household credit was followed by large debt revaluations and severe financial difficulties for families. Thus, understanding the consequences of exposure to foreign debt during periods of crisis becomes fundamental to mitigating potential systemic risks and inducing greater long-term economic resilience.
- Policy Implementation Context
Hungary's foreign currency debt crisis originated 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 relative to GDP, driven by subsidized local currency housing loans and unsubsidized foreign currency loans, primarily in Swiss francs. By September 2008, approximately 69% of outstanding housing debt was denominated in foreign currency, leaving 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 approximately 27,5% against the euro and 32,3% against the Swiss franc. This movement was triggered by a general flight to safe-haven assets away from emerging markets and intensified by investor concerns about the Hungarian government's significant external financing needs.
Subsequently, 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 loans in foreign currency at lower interest rates than loans in local currency. Thus, there was an aggressive expansion of foreign currency credit into areas with less subsidized debt. The lack of hedge The lack of currency risk protection meant that most debtors were not hedged against exchange rate 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 hardship due to the sudden increase in debt burdens relative to their ability to repay in devalued forints.
- Evaluation Details
To measure municipalities' exposure to foreign currency debt prior to the 2008 forint depreciation, the credit register was reconstructed from 2000. An annuity model and detailed interest rate data were used to estimate monthly payments and outstanding debt before 2012 for all loans in the credit register. These estimates were adjusted to match aggregated financial accounts by currency, resulting in a credit register covering 80,5% of aggregated housing debt as of September 2008. Key variables at the municipal level were extracted from the database. Hungarian Central Statistics Office's T-Starincluding the unemployment rate, household income, tax payments, population, and net migration. New car registrations were used as an indicator of household durable goods spending, and sub-regional property price indices (NUTS-4) were estimated from the Hungarian National Bank's property purchase transaction database to assess housing price trends.
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. Most 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, a company's exposure to local household debt in foreign currency was defined by the municipality of its headquarters.
To construct a balanced panel, companies with fewer than three employees and those in the finance, real estate, public administration, education, and health and social care sectors were excluded, resulting in a sample of 66.267 companies that were followed from 2006 to 2012. Finally, loan-level data from the Hungarian Business Credit Register were combined to obtain information on business debt by currency and business defaults. On average, two-thirds of household debt in the sample was in foreign currency, while for firms this share was 11%.
- Method
The objective of this analysis was to investigate the effects of household and firm exposure to foreign currency debt during the Hungarian currency crisis from 2008 onwards. The impact of debt revaluation on local economic variables was observed as outcome variables. 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 foreign currency debt 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 focusing on the specific impact of forint depreciation, isolating exchange rate effects on the local economy.
The first analysis of the study examined the effect of the revaluation of households' foreign currency debt on their credit default rate at the municipal level. Additionally, it examined the effect of the revaluation of households' foreign currency debt on their consumption of durable goods, measured from the number of annual new car registrations. Both regressions estimated the coefficient of the share of the household's municipality's foreign currency debt, controlling for fixed-effects covariates of municipality, time and region, export exposure, and indicators of credit quality and employment by industry.
The study also presented estimates related to the impacts of foreign currency debt revaluation on economic activity, observing the impact of the crisis on local unemployment. Furthermore, it analyzed possible mechanisms for the impacts on unemployment through the local employment level of firms (exporting and non-exporting), limitations in labor market adjustment, and devaluation of the real estate market.
Finally, it was verified whether the revaluation of foreign currency debt caused spillover effects on mortgage loans in local and foreign currency. Analyses were performed for three samples: all borrowers, borrowers in local currency, and borrowers in foreign currency.
- Main results
The results indicated that the revaluation of household debt in foreign currency had significant impacts on both local default rates and durable goods consumption. Regarding default rates, areas with greater exposure to foreign currency debt showed a default rate 9,30 percentage points (pp) higher after the forint depreciation. Concerning durable goods consumption, the debt revaluation resulted in a 41% reduction in car purchases in the most exposed regions, demonstrating a substantial drop in local spending on durables, influenced by the higher debt burden on households.
Regarding the impacts on economic activity, the revaluation of foreign currency debt exerted significant and persistent negative impacts on employment and the local economy. Non-exporting firms, in particular, experienced sharp declines in employment levels, while exporting firms did not suffer statistically significant impacts. This result indicates that the persistence of high unemployment in more exposed areas suggests limited adaptation through the reallocation of labor to more resilient sectors. Furthermore, the devaluation in property prices further exacerbates the local recession, prolonging the negative effects on the labor market and hindering the economic recovery of the affected areas.
Estimates regarding the impacts of foreign currency debt exposure on firm indicators revealed that companies with a higher proportion of foreign currency debt reduce their investments after devaluation. However, these companies experience stronger growth in sales, added value, and employment. According to the authors, this may occur because companies with foreign currency debt exposure are more productive and have better growth opportunities. Thus, they temporarily reduce investments but retain employees in anticipation of stronger future growth.
- Lessons in Public Policy
This study investigated the effects of the revaluation of Hungarian households' foreign currency debt on various local economic indicators. Looking at panel data between 2006 and 2012, the article examined how household exposure to foreign currency debt influenced Hungary's economic activity after the 2008 crisis.
The results indicated that the debt revaluation caused a significant increase in local defaults, reflecting a greater financial burden for debtors resulting from the forint's exchange rate decline. As a consequence, there was a sharp drop in spending on durable goods in areas with high exposure to foreign currency debt, depreciation in the Hungarian real estate market, and an increase in local unemployment associated with a decline in employment levels in non-exporting companies.
These results are relevant for understanding how domestic financial shocks can spread throughout the local economy, exacerbating problems in broader economic activity. Such evidence emphasizes the need for macroprudential policies to limit leverage exposure to foreign currencies and promote economic stability during 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, v. 110, no. 9, p. 2667–2702, 1 Sept. 2020.
