Upgrades not Timely, Just Yet

Hopes were high in August, when reviews for Hungary’s sovereign debt rating were scheduled at two of the three large international credit rating institutions. In slightly disappointing decisions, both Standard and Poor’s and Fitch Ratings affirmed the country’s status as is, meaning the Hungarian economy hasn’t received the much awaited – and, according to many officials, the much deserved – upgrade. 

On August 17, Standard & Poor’s Global Ratings affirmed Hungary’s “BBB-/A-3” long- and short-term foreign and local currency sovereign credit ratings. The outlook on the ratings remained “positive”. 

S&P admitted the achievements the Hungarian economy had recorded, but also highlighted some downsides. 

“Hungary’s strong external profile, its resilient export-driven economy, low private sector debt levels, and the flexible exchange rate regime support the sovereign ratings,” S&P said, explaining its rationale for affirming the ratings. “Relatively weak checks and balances between government branches, moderate wealth levels, and high public debt are key constraints on the ratings,” it added.

Signs of Overheating

The rating agency expects Hungary’s GDP growth to peak at 4% or slightly higher this year. Increasing domestic demand and growing wages are among the engine of the growth. However, S&P warns that the economy has started to show signs of overheating. According to the firm, the labor market is extremely tight, and unemployment reached a historical low at 3.6% in July.

“Labor shortages have been reported across almost all sectors, resulting in accelerated wage growth over the past few years. Coupled with continuous minimum wage hikes, this has led to fast growth of unit labor costs, which exceeded that in many neighboring countries. We note that so far this has been mitigated by cuts in social security contributions and corporate taxation. Yet, in the absence of a decisive policy response aimed at boosting productivity, prolonged overheating could weaken Hungary’s external competitiveness and balance of payments performance,” the agency writes in its rationale. 

S&P forecasts that the longer term GDP growth should moderate at around 2-2.5%. “This reflects Hungary’s structural growth challenges, namely poor demographics – exacerbated by net emigration resulting partly from the official reluctance to accept labor migrants – a large public sector, a challenging business environment, low productivity, and a chronic skills shortage,” it says. 

While the government rhetoric claims that Hungary’s economy growth is well-balanced and each sector contributes to the increase, S&P points out that Hungary’s economy remains one of the most open in the region, with exports accounting for some 90% of GDP, of which more than 16% comes from the automotive sector. The extent of Hungary’s export sector exposes the economy to external demand, in particular to swings in the German business cycle and the fortunes of the global car industry. Also, post-2020, growth outlook is likely to suffer from potential post-Brexit cuts in the total size of funds, alongside likely changes to their allocation criteria, the agency adds. 

“Despite Hungary’s highly pro-cyclical underlying fiscal stance, we assume that pronounced budgetary slippages similar to those reported in 2010-2011 are highly unlikely. At the same time, we believe the government’s plans to reduce general government deficits to 0.5% by 2022 might be challenging to implement,” the agency says.

A Surge in Prices?

“Inflation has remained subdued in recent years, due to stable administrative prices, tax cuts, and low inflation expectations,” the rating agency writes. In the mid-term, it believes tight labor markets, strong domestic demand, and rising energy costs could lead to a surge in prices, bringing the consumer price index slightly above 3% in 2018 followed by stabilization at around 3% in 2019-2020. “This will in particular result from the gradual removal of monetary stimulus, which we expect to start in 2019,” S&P concluded.

Shortly after the disappointing decision by S&P, another rating agency released a similarly dissatisfying report. The Hungarian authorities had again been hoping for an upgrade, which did not happen when Fitch announced on the last day of August that it had affirmed Hungary’s long-term foreign- and local-currency issuer default ratings (IDR) at “BBB-”, just over the investment grade threshold.

Prior to the review, the National Bank of Hungary (MNB) said Hungary was “fit for an upgrade now”, according to its own assessment. Afterwards, MNB reasoned: “The credit rating agency may wait for indicators to stabilize at favorable levels and for a consolidation in the global investor environment before an upgrade,” adding that it continues to expect an upgrade in future.

In a note, Fitch said that ”Hungary’s ratings balance strong structural indicators compared with ’BBB’ peers against higher public and net external debt, and risks from policy unpredictability and pro-cyclical fiscal policies. The positive outlook indicates the improving trend on net external and government debt,” it added.

But while international credit rating firms are not in a hurry to acknowledge Hungary’s economic performance, second quarter GDP data shows that the country is able to produce steady growth: the Hungarian economy continued to expand significantly in the second quarter of 2018. 

According to preliminary data released by KSH, the Central Statistical Office, GDP growth in Q2 was 4.6% year-on-year, accelerating from a 4.4% expansion in Q1. Most analysts agree that this year GDP growth might come to around 4.2-4.3% – the government’s expectation is 4.3% –, but the pace of the expansion will slow down from next year.

Numbers to watch in the coming weeks

KSH will release the consumer price index for August on September 11. Next day, a second estimate of the performance of the Hungarian industry in July will be published, to be followed by the agricultural producer prices for the same period a few days later. On September 14, construction sector data for July will come out.