Moody’s Investors Service said late Thursday that it downgraded Hungary’s sovereign rating by one notch to Ba1 from Baa3, bringing it under "investor grade".
Moody’s said it is maintaining a negative outlook on the rating.
Moody’s cited the "rising uncertainty surrounding the country’s ability to meet its medium-term targets for fiscal consolidation and public sector debt reduction, particularly given Hungary’s increasingly constrained medium-term growth prospects" as well as "the increased susceptibility to event risk stemming from the government’s high debt burden, heavy reliance on external investors and large financing needs as the country enters a period of heightened external market volatility" as the reasons for the downgrade.
"Moody’s believes that the combined impact of these factors will adversely impact the government’s financial strength and erode its shock-absorption capacity," it added.
Moody’s explained its decision to maintain the negative outlook on the rating citing "the uncertainty surrounding the country’s ability to withstand potential event risks emanating from the European sovereign debt crisis".
The downgrade came hours after Standard and Poor’s postponed a ratings decision on Hungary from November until "likely before the end of February 2012", when more information is available on the likelihood of an agreement on financial assistance with the International Monetary Fund and the European Union.
Hungary’s government said a week earlier that it would seek the assistance from the IMF and the EU as a precautionary measure.
Moody’s acknowledged on Thursday Hungary’s "desire to negotiate a funding safety net without conditionality" and said an arrangement could "help to alleviate immediate funding challenges", but it added that "even with such an arrangement, the government’s debt structure will remain vulnerable to shocks in the medium term, which are inconsistent with a Baa3 rating".
Moody’s said the "first driver" of the downgrade was uncertainty surrounding the Hungarian government’s ability to meet its fiscal and public debt targets in light of higher funding costs and low economic growth.
"Although the government has committed to reduce general government debt to 50% of GDP by 2018, the government’s medium- term strategy to achieve this goal remains unclear and reliance on one-off measures to date, such as the liquidation of pension fund assets, will not improve debt sustainably in the long term," Moody’s said.
Moody’s also questioned the government’s fiscal deficit targets for 2012 and 2013 of 2.5% and 2.2% of GDP, respectively, because of the higher funding costs and low-growth environment.
Moody’s project Hungary’s economy will expand by 1.5% in 2011 and by 0.5% in 2012. Growth is likely to be constrained by weak domestic demand, slower growth in its biggest export markets, exchange and interest rates, and a banking system hampered by a rising stock of non-performing loans, government measures affecting profitability and the reduced ability of foreign parents to finance lending.
The "second driver" of the downgrade is Hungary’s vulnerability to external shocks stemming from its state debt structure, Moody’s said. About 64% of state debt is held by non-residents, and two-thirds of this is denominated in foreign currency, it explained.
Moody’s said it would consider a further downgrade of Hungary’s sovereign rating if "there is a significant decline in government financial strength due to a lack of progress on structural reforms and implementation of the medium-term plan".
"Conversely, Moody’s would consider stabilising the outlook on the government’s Ba1 bond ratings (potentially leading to an eventual ratings upgrade over the longer term) if the country were to embark on a sustainable consolidation path, involving a more consistent implementation of the medium-term plan and the Convergence Programme - possibly supported by a resumption of robust economic growth - which would stabilise government financial strength on a sustained basis," it added.
As a result of the rating action on Thursday, Moody’s said it also downgraded Hungary’s country ceiling for foreign-currency debt (to A3 from A1) and for foreign-currency bank deposits (to Ba2 from Baa3), as well as the country ceiling for local-currency debt and bank deposits (to A2 from Aa3).