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Fitch disappoints with continued ‘junk’ rating

Hungary’s reduction of external debt was not enough to earn an upgrade. Political stability, business environment and indebtedness remain the drags, according to the rating agency.

Mónika Kiss, senior analyst with Equilor Befektetési Zrt.

To the disappointment of many, Fitch Ratings left Hungary’s sovereign debt rating in the BB+ category – just one notch below investment grade – on November 20, while keeping the country’s outlook positive.

“Hungary’s long-term sovereign debt has remained in the junk bond category in 2015, the noticeable reduction in external debt not enough to support an upgrade,” Mónika Kiss, senior analyst with Equilor Befektetési Zrt told the Budapest Business Journal.

She said the key rating drivers are the strong economic growth performance in 2014-2015 and high current account surpluses since 2011, supporting external debt reduction. The key economic policy objective from the government and the National Bank of Hungary is to promote commercial lending, and the “Self-Financing Program”, which increases domestic ownership of government debt. “All agencies would like to see the implementation of the memorandum of understanding agreed between Hungary and the European Bank for Reconstruction and Development (EBRD) and further proof of current trends,” Kiss said.

Fitch expects that Hungary’s GDP will grow 2.9% in 2015 after 3.7% in 2014, driven by an acceleration of European Union (EU) fund disbursements in 2014-2015. High job creation (the unemployment rate was 6.4% in September, whereas it had been above 10% in 2010-2012), low inflation, and relief to household finances following the foreign currency mortgage conversion in early 2015 all support household consumption.

Fitch forecasts that growth will slow from 2016 to 2.3%, as EU disbursement falls markedly, and to remain at about 2% in the medium-term as private sector investment gradually recovers. The ratings agency expects the government deficit to be 2.3% of GDP in 2015, down from 2.5% in 2014, supported by higher tax revenues linked to fast GDP growth. A decline in interest payments (expected to be 3.5% of GDP in 2015 from 4% in 2014 and 4.5% in 2013) linked to very low interest rates domestically and externally, is helping to contain current expenditures.

The agency expects the headline deficit to be 2.1% in 2016 and to remain close to 2% in the medium-term as improving economic conditions offset expected tax cuts. The structural deficit is likely to remain stable in the medium-term at 2.5%.

Debt expected to decline

Commenting on government debt, Fitch analysts project a gradual decline from 76.1% last year to 72% by the year 2017 and further to 61% in the year 2022. In order to stay on track with that forecast, Hungary needs to reach approximately 5% nominal economic growth and to curb the budget deficit at 2%.

The current account surplus will increase to 4.3% of GDP in 2015 and remain high over the forecast horizon, reflecting higher exports, low commodity prices, low domestic demand relative to the pre-crisis era and lower external interest payments, the report noted.

According to Fitch, the desired upgrade from junk status to investment grade requires three elements: Greater political stability and an improved business environment; continued reductions in external indebtedness, supported by current account surpluses; and a reduction in the government debt ratio.

“We expect the first upgrade during the spring of 2016. Greater policy stability, further reductions in the government debt ratio, and continued lowering of external indebtedness are a must currently. In our view, Fitch might break the ice first, followed by Moody’s,” Kiss from Equilor said.

The list of upgrade requirements does not come as a surprise, as these factors have been repeatedly mentioned over the past few years by all three major ratings agencies. Fitch, Moody’s and S&P are expected to release their 2016 schedules in December. 

What about the base rate?

Interest rate expectations in Hungary are not directly linked to the sovereign debt rating, but are rather derived from the inflation forecast, output gap conditions (a measure of unused capacity in the economy) and a complex valuation of the local and international macroeconomic environment, according to Mónika Kiss, senior analyst with Equilor Befektetési Zrt.

So the Hungarian National Bank (MNB) instead focuses on European Central Bank (ECB) communications, suggesting that it would adopt a looser monetary policy stance looking forward, continued uncertainty about an interest rate increase from the Fed, and concerns over growth prospects in emerging economies.

During the summer the MNB declared that the interest rate cut cycle was finished, but the easing cycle would be continued with non-conventional tools. The central bank aims to flatten the yield curve of Hungarian government bonds and to bring the entire yield curve lower, and also plans steps to boost lending to small firms, Márton Nagy, deputy governor disclosed on November 4. Equilor expects the interest rate to remain at 1.35% until the end of 2016, while non-conventional tools might be introduced after the ECB’s meeting in December or early January.