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.
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.
Scope also recognises the progress in strengthening the financial sector. After years of deleveraging, the banking sector is well capitalised, with a common equity tier 1 ratio of 15%; liquid, posting a liquid asset ratio of around 28%, similar to that of other Visegrád members; and profitable. Asset quality has also improved, with non-performing loans declining markedly to around 5% of gross loans, down from over 17% in 2013, supported by the MNB’s asset management company for commercial real estate. Credit flows to the private sector were again positive in 2017, indicating an end to the deleveraging cycle during which corporates and households had reduced outstanding debt by about 50 percentage points of GDP since 2010. In Scope’s view, private-sector debt levels do not constitute a significant source of risk to the sovereign and are again in line with peer levels.
However, Hungary’s credit strengths remain constrained by its high public-debt level, relatively poor non-price competitiveness and weakening institutional credibility. Despite a continued downward trajectory since 2011, Hungary’s public debt of 73% of GDP in 2017 remains relatively high compared to that of peers and well above the Maastricht threshold of 60%. Scope’s public-debt sustainability analysis foresees only a gradual decrease in the debt-to-GDP ratio to slightly below 70% over the medium term, significantly above that of peers. In addition, relatively weak non-price competitiveness, reflected in subdued productivity growth and labour shortages, represent an important credit weakness in Hungary’s long-term economic growth prospects. Finally, the current government’s conflictual relationship with EU institutions and its consolidation of political power at the expense of independent institutions, which especially affect the central bank and judiciary, have increased the unpredictability of economic policy, the regulatory system, and the ability to conduct business in a transparent and predictable environment. The Positive Outlook reflects Scope’s view that these developments may continue after the expected re-election of the current government on 8 April 2018, but not materially worsen the economic and fiscal outlook for Hungary.
Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative “BBB” (“bbb”) rating range for Hungary. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis. For Hungary, debt sustainability has been identified as a relative credit strength. Relative credit weaknesses are: i) vulnerability to short-term shocks; and ii) recent events and policy decisions. The combined relative credit strengths and weaknesses indicate a sovereign rating of BBB for Hungary. A rating committee has discussed and confirmed these results.