Rating Action Commentary
ֳ Upgrades Hungary to 'BBB'; Outlook Stable
Fri 22 Feb, 2019 - 4:02 PM ET
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Hungary - Rating Action Report
ֳ - Frankfurt am Main - 22 Feb 2019: ֳ has upgraded Hungary's Long-Term Foreign- and Local-Currency Issuer Default Ratings to 'BBB' from 'BBB-. A full list of rating actions is at the end of this rating action commentary.
Key Rating Drivers
The upgrade of Hungary's IDRs reflects the following key rating drivers and their relative weights:
HIGH
Hungary has undergone rapid external deleveraging. Net external debt, as calculated by ֳ, has fallen from an average of 34.4% of GDP in 2013-17 to an estimated 10.2% in 2018, compared with a current peer median of 7.8%. The fall in net external debt has been due to consistent (albeit declining) current account surpluses, stable net FDI inflows, and capital transfers from the EU. The high level of inter-company lending - around 40% of gross external debt as per ֳ estimates - also mitigates risks from the external position. The external liquidity ratio has improved significantly - to an estimated 138% in 2018 from an average of 95% in 2012-17 - but remains below the peer median of 153.5%.
The current account remained in surplus, at an estimated 1.1% of GDP in 2018, despite strong domestic demand, reflecting competitiveness gains, particularly in the services sector. ֳ expects the current account surplus to narrow to 0.8% of GDP in 2019, owing to weaker external demand, before recovering to 1.1% in 2020. Nevertheless, Hungary compares favourably with 'BBB'-rated peers (current median: -1.3% of GDP). ֳ expects current account balance+net FDI inflows to average of 2.4% of GDP in 2019-20, above the current peer median of 1.7%. This will support a reduction in net external debt to 3.6% of GDP at end-2020 (current peer median 6.2%).
MEDIUM
General government debt/GDP ratio remains on a downward trend and is forecast to fall from an average of 75.2% of GDP in 2012-17 to an estimated 71% in 2018, 68% in 2019 and 66% in 2020. The decline will be supported by continuing primary surpluses. While Hungary's GGD/GDP compares unfavourably with the current peer median of 38.5%, ֳ assesses that the sovereign's relatively strong fiscal financing flexibility (low proportion of FX-denominated debt, declining non-resident share of central government debt) partially mitigates risks. Debt service is lower than the 'BBB' median.
Hungary's general government deficit was little changed at 2.1% of GDP in 2018 (government target 2.4%; 2017 outturn: 2.2%), balancing election-related spending and other expenditures with robust revenue growth. ֳ forecasts the fiscal deficit to remain largely unchanged (2019F: 2%, 2020F: 1.9%) given the expected strong contribution of EU funds and the cushion available from contingency fiscal reserves, despite slowing economic growth (our deficit forecasts are more conservative than the government's 1.8% and 1.5% of GDP for 2019 and 2020, respectively).
Hungary's 'BBB' Long-Term IDRs also reflect the following key rating drivers:
Hungary outperforms its 'BBB' rated peers on the World Bank governance indicators as well as ease of doing business. However, concerns about the independence of the judiciary are increasing. Legislation passed in December 2018 paves the way for establishment of special administrative courts to begin adjudicating certain politically sensitive cases from 2020. ֳ does not expect the ongoing Article 7 disciplinary proceedings by the EU against Hungary to make much headway in 2019, given backing for Hungary from Poland and Romania. From 2021, proposed reductions in EU structural funds could be compounded by potential rifts in relations with the EU (over issues such as rule of law), with an adverse effect on GDP growth.
Real GDP growth reached 4.8% in 2018 (preliminary estimate) (2017: 4.1%), which likely represents a cyclical peak, well above the current peer median of 3.5%. Investment and household consumption will remain robust contributors to growth over the forecast horizon. The latter received a strong boost from double-digit growth in wages and minimum wages in 2018 (and will continue due to planned increases to public sector and minimum wages in 2019).
ֳ expects the contribution of net exports to GDP growth to remain subdued in 2019-20, given the decline in growth prospects we expect in the eurozone (the main destination for Hungarian exports) and Germany in particular (the recipient of about 25% of Hungarian exports). Risks to growth are predominantly on the downside. Hungary is an open economy and vulnerable to a sharp slowdown in external demand, particularly in Germany and other key EU export markets.
The banking sector is stable and characterised by ample capital (total capital ratio of 21.2% as of 3Q18) and declining NPL ratios (around 5.6% as of 3Q18). Loan growth remains strong: corporate credit grew by 14.8% while mortgage growth amounted to 10% in 2018. Credit growth will remain robust, boosted by the Funding for Growth scheme and the state-guaranteed interest-free loans for young married couples announced by the government in February 2019.
Macroprudential regulation will continue to focus on reducing the proportion of variable rate mortgages. This is a key priority for the central bank (MNB) given expectations of interest rate normalisation over 2H19-2020, which would potentially raise debt servicing costs for holders of variable mortgages. The proportion of fixed-rate new mortgages rose from 63% at end-2017 to 95% in 2018.
The labour market remains extremely tight, putting upward pressure on wages. Unemployment is among the lowest in the EU, at 3.7% in 2018 (2017: 4.2%), well below the current peer median of 5.4%. Further reductions in the unemployment rate will be marginal over the forecast period, given unfavourable demographics and a reluctance to permit non-EU labour immigration. Average monthly gross wages rose by 10.2% yoy in 2018 (2016-17: average of 9.1%), reflecting in part the increases in public sector wages and the minimum wage.
Seasonally adjusted core inflation rose from 2.5% on average in 2018 to 3.2% in January 2019, above the midpoint of the MNB's inflation target (3% + 1%). Over the forecast horizon, risks to the inflation outlook remain broadly balanced. ֳ expects a tapering of unconventional monetary policy tools in 1H19, followed by gradual rate hikes by the MNB in 2H.
Derivation Summary
ֳ's proprietary SRM assigns Hungary a score equivalent to a rating of 'BBB+' on the Long-Term Foreign-Currency (LT FC) IDR scale.
ֳ's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- Macro: -1 notch, to reflect policy credibility that is assessed to be weaker than peers in view of a track record of unorthodox, unpredictable and pro-cyclical policy moves; and moderate growth potential relative to peers.
ֳ's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. ֳ's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
Key Assumptions
ֳ assumes that under severe financial stress, support from Hungarian subsidiary banks would come first and foremost from their foreign parent banks.
ֳ assumes that the eurozone will grow by 1% in 2019 and 1.5% in 2020.
RATING SENSITIVITIES
The main factors that could, individually or collectively, lead to positive rating action, are:
- Sustained decline in general government debt/GDP
- Increased confidence in the economic policy framework and improved business environment that would support stronger GDP growth potential without the emergence of macroeconomic imbalances
The main factors that could, individually or collectively, lead to negative rating action, are:
- Deterioration in the policy framework that could pose risks to macroeconomic stability
- Worsening of fiscal metrics that could lead to adverse debt dynamics
- Weakening of the institutional framework
Additional information is available on
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.