UPDATE - Fitch downgrades Hungary rating outlook to negative

Fitch Ratings on Friday said it revised the outlooks on Hungary’s long-term foreign and local currency Issuer Default Ratings (IDR) to Negative from Stable and affirmed the ratings at ‘BBB-’ and ‘BBB’, respectively.

Fitch also affirmed Hungary’s Short-term IDR at ‘F3’ and Country Ceiling at ‘A-’.

"The revision in Hungary’s Outlook to Negative reflects a sharp deterioration in the external growth and financing environment facing Hungary’s small, open and relatively heavily indebted economy," said Matteo Napolitano, Director in Fitch’s Sovereign Group. "Moreover, various fiscal policy measures and the scheme to allow the repayment of household foreign currency mortgages at below market exchange rates have dented foreign investor confidence, on which medium-term growth prospects depend," he added.

Hungary is particularly exposed to any deterioration in the economic and financial conditions in the eurozone, because of its open economy, mainly Western European-owned banking sector, relatively high levels of public and external debt and financing ratios, sizeable stock of portfolio investment and Swiss franc-denominated mortgage debt, Fitch said.

Fitch said it expects Hungary’s economy to grow just 0.5% in 2012, down sharply from its projection of 3.2% growth made in June 2011.

Hungary’s government "appears committed to fiscal consolidation", Fitch said. The agency projects a general government surplus of around 3.5% of GDP in 2011, helped by big one-off factors, such as the transfer of private pension fund assets to the state, but it projects a general government deficit of 3.3% of GDP for 2012, noting that the government’s 2.5% deficit target for that year is "challenging" because of "the weak growth outlook, the uncertain costing and implementation of some measures and potential reform fatigue".

Fitch projects Hungary’s state debt as a percentage of GDP will fall to around 76% at the end of 2011 from 80% at the end of 2010.

Fitch said a government scheme allowing early repayment of foreign currency-denominated mortgages at discounted exchange rates "may turn out to be fairly ineffective and have negative consequences". Although Fitch estimates only 20-25% of borrowers will be able to avail of the scheme, the ratings agency said it would still place further pressure on the forint and on the banking sector’s balance sheet. A number of banks are already making losses and will require re-capitalization, which is likely to be forthcoming from foreign parents, Ftich said. But foreign parent banks are likely to continue to cut their exposure to Hungary and the supply of credit is likely to continue to contract, weighing on GDP growth, it added.

Fitch said some of Hungary’s fundamental rating strengths remain in place, such as "a rich and diverse economy, and underlying political stability", and it acknowledged the country’s big current account surplus.

"A significantly worse than currently anticipated slowdown, evidence of private sector capital outflows or problems in the banking sector, a rise in the risk premium or fiscal financing pressure could lead to a downgrade. A material weakening in the government’s commitment to fiscal consolidation could also lead to a downgrade," Fitch said. "Conversely, the government meeting its budget deficit targets and a return to healthy growth, particularly in the context of significant structural reforms and declining external debt ratios, could lead to positive rating action," it added.