Scope affirms Hungary’s credit rating of BBB, changes Outlook to Positive

Robust economic performance, reduced external imbalances, fiscal consolidation and an improving debt structure underpin the Positive Outlook; high public debt, poor non-price competitiveness and weakening institutional credibility remain constraints.

Scope Ratings GmbH has changed the Outlook to Positive from Stable on Hungary’s BBB sovereign rating. At the same time Scope has affirmed Hungary’s BBB long-term and senior unsecured local- and foreign-currency ratings, along with the short-term issuer rating of S-2 in both local and foreign currency. The Outlook on the long-term issuer and senior unsecured debt ratings has been set to Positive. The Outlook on the short-term issuer rating is Stable.

Rating drivers

The drivers for today’s rating action reflect: i) the sovereign’s robust economic outlook, along with an on-going pick-up in the absorption of European Union structural funds; ii) the significant progress achieved in reducing external imbalances, driven by sustained current-account surpluses and the deleveraging in the private sector; iii) the consolidation of public finances accompanied by a marked improvement in public-debt structure and funding sources; and iv) the stabilising and strengthening financial sector.

The Positive Outlook indicates Scope’s assessment that the upside potential from better-than-expected economic and fiscal outcomes outweighs the challenges stemming from a still-high public-debt burden, the country’s low non-price competitiveness and labour shortages, as well as weakening institutional credibility and economic policy predictability.

The first driver underpinning Scope’s decision to change Hungary’s Outlook to Positive is the country’s robust economic performance – annual real GDP growth has averaged 3.1% since 2013 – and outlook, along with an ongoing pick-up in the absorption of EU structural funds. Over the coming years, Scope expects robust economic growth to continue on the back of rising private expenditure supported by several social reforms and corporate investments in the form of foreign direct investments. Public consumption is also expected to increase steadily in the short and medium term, stimulated by a higher absorption of EU structural funds after the transition to the new 2014-2020 EU multiannual framework. In fact, Hungary is the sixth-largest recipient of EU funds in absolute terms and the first in terms of GDP, with EUR 22bn in EU structural and cohesion funds allocated over the 2014-2020 period.

The second driver of the Outlook change is the progress made in reducing external imbalances, driven by sustained current-account surpluses since 2010, deleveraging in the banking sector, the redemption of loans granted under the EU Balance of Payments assistance programme in 2010-2012, and the government substituting its external debt for domestic issues, supported by the Hungarian National Bank’s (MNB) self-financing programme. Based on MNB data, Hungary’s external debt declined from 156% of GDP in Q2 2010 to 89% of GDP in Q3 2017. In addition, the improved composition of external debt has also reduced Hungary’s external vulnerabilities. The country’s share of short-term external liabilities declined to around 12% in Q3 2017 (down from 17% in 2010) while, at the same time, 53% of foreign liabilities are related to direct investments, limiting the potential impact of any possible reversal of capital inflows resulting from the normalisation of US and euro-area monetary policies. Moreover, the high ratio of reserves to short-term external debt, at around 170%, provides Hungary with an additional buffer against external shocks and is in line with that of CEE peers.

The third driver supporting the outlook change is Hungary’s continued fiscal consolidation, as well as improvements in the government’s debt structure and funding sources.

The sovereign successfully exited the EU’s Excessive Deficit Procedure in June 2013 and has reduced its budget deficit to below the Maastricht threshold of 3% of GDP since 2012. Going forward, Scope expects the government to continue to adhere to European fiscal rules despite higher expenditure and lower tax rates, following recent tax reforms. Scope assesses that any breach of the Maastricht deficit criteria, which would (re)open an intrusive excessive deficit procedure, stands in stark contrast to the current government’s ambition of reducing the EU’s spheres of competence. In addition, the debt management office’s prudent debt-funding strategy has reduced the public-debt exposure to exchange rate risk, limiting the share of foreign-currency-denominated debt to 15-25% of total debt. At the same time, debt held by non-residents has decreased markedly from a share of above 60% in 2011 to around 40% in 2017. It is Scope’s opinion that these structural changes in Hungary’s debt, combined with a solid cash buffer of 5% of GDP alongside continued investor demand, significantly reduce the sovereign’s refinancing risk.