Home Ratings and Research Currently valid ACRA Europe affirms unsolicited credit ratings of BBB to Hungary, revises outlook to Negative
ACRA Europe affirms unsolicited credit ratings of BBB to Hungary, revises outlook to Negative
Friday, 22 May 2020

Hungary (or the country) has been assigned the following ratings:

  • Long-term foreign currency credit rating at BBB and local currency credit rating  at BBB;
  • Short-term foreign currency credit rating at S2 and local currency credit rating at S2.

The outlook on the long-term foreign currency credit rating has been revised to Negative and local currency credit rating to Negative.

The Negative outlook assumes that the rating will most likely be downgraded within the 12 to 18-month horizon.

The COVID-19 crisis will cause a deep recession and place a heavy burden on the country’s public finances. ACRA Europe recognizes that the vulnerability of the economy declined markedly in the past decade, mainly on the back of internalization of government debt and a sustained decline in the FX share of the public and private debt. Nevertheless, the extent of the COVID-19 shock will challenge the resilience of the economy which, in the Agency’s view, is constrained by a relatively high public debt load, high gross public sector financing needs, moderate FX exposure, and relatively limited international reserves. These risks are reflected in the downgrade of the rating outlook.

Credit rating rationale

Positive rating assessment factors

  • Robust and job-rich pre-COVID-19 economic growth.
  • External deleveraging of both the public and private sectors.
  • Declining FX exposure of both the public and private sectors.
  • Substantial pre-COVID-19 decline in debt servicing costs.

Negative rating assessment factors

  • COVID-19 shock negatively impacting a wide range of macroeconomic indicators.
  • High public debt load.
  • Pro-cyclical fiscal policy.
  • Relatively low innovative capacity of the economy.
  • Relatively high risks for long-term fiscal sustainability.

Potential rating upgrade factors

  • Substantial decline in government debt load after the fading of the COVID-19 crisis.
  • Increase in reserve coverage ratios.
  • Further progress in external deleveraging of the public and private sectors.
  • Material increase in governance indicators.

Potential rating downgrade factors

  • Long-lasting impact of the COVID-19 crisis on the country’s growth potential and public finances.
  • Substantial weakening of the Hungarian forint.
  • Severe financial shock resulting in a costly bailout of the banking system.
  • Further weakening of the institutional quality.

Sovereign model results  

Block

Indicative credit rating for the block

Modifier

Score

Modifier corrections to the indicative credit rating

Final credit rating for the block

Macroeconomic position

AA-

Potential economic growth

-2

-2

A

Sustainability of economic growth

-1

Efficiency of structural, economic and monetary policies

0

Public finance

BB+

Contingent liabilities and risk of them materializing on the sovereign balance sheet

0

-2

BB-

Fiscal policy framework and fiscal flexibility

-2

Market access and sources of funding

-1

Debt sustainability

-1

External position

A

Balance of payments vulnerabilities

-1

-1

A-

External debt sustainability

-1

Stability of currency regime

0

Institutional framework

BBB+

Willingness to pay

0

0

BBB+

Default history

0

Political instability and recent political decisions

0

Involvement in geopolitical conflicts, exposure to geopolitical risks

0


Assigned credit rating

Indicative credit rating

A-

Modifier corrections to the indicative credit rating

-2

Final credit rating

BBB

Assigned credit rating

BBB

MACROECONOMIC SITUATION AND ECONOMIC POTENTIAL

Trade openness, a high share of manufacturing and relatively low diversification makes the economy more susceptible to global fluctuations.

Hungary is an upper middle-income economy with a GDP per capita PPP of more than 34,000 international dollars (IMF, 2019). It is a member of the European Union, OECD, Schengen Area, and NATO. As a relatively small and very open economy (exports contribute 83% of GDP) with a high share of manufacturing in total output (gross value added in manufacturing accounts for 18.2% of GDP), it is more susceptible to the global economic cycle. The structure of exports is skewed towards motor vehicles (18.5% in 2018) in terms of products and Germany in terms of partners (27.7% in 2019), making the country’s exports susceptible to the country and sector specific shocks of the EU countries.

In recent years, Hungary’s economic performance has been robust with an average annual GDP growth of 4.1% since 2015. The main driving factors have been fixed investments and household consumption (with an average five-year annual growth of 9.1% and 4.7%, respectively). Investments have been driven by strong absorption of EU funds (net transfers from the EU accounted for 4% of gross national income in 2014–2018). At the same time, household consumption has been supported by strong wage growth in light of rapid absorption of spare labor force along with a robust increase in public sector wages.

The European Commission expects the economy to contract by 7% in 2020.

The economic prospects are grim for 2020 due to the COVID-19 pandemic. Hungary’s economy will suffer amid the coronavirus-induced shutdown of a significant portion of the economy and a poor external environment. After growing 4.9% in 2019, the economy is expected to contract significantly in 2020. The depth of the recession is likely to be amplified by a limited fiscal response compared to the majority of other EU countries. The European Commission (EC) expects a contraction of 7% in 2020 followed by a recovery to 6% growth in 2021.

The final GDP figure is subject to significant uncertainty related to both the domestic and external development of the pandemic. Nevertheless, ACRA Europe sees a potential upside risk to the EC’s baseline scenario due to the following two considerations: firstly, according to preliminary data, GDP has contracted by only 0.4% on a quarter-on-quarter basis in the first quarter, well below the 3.3% decline for the whole EU. Secondly, with a declining number of daily identified COVID-19 cases, Hungary is gradually lifting its economic restrictions, and thereby providing some economic relief to the business sector.

Long-term growth perspectives are constrained by low innovative capacity and weak competitiveness relative to peers and poor demographics.

From a long-term perspective, the growth potential is constrained by a relatively weak innovative capacity compared to peers and negative demographics. Hungary’s R&D expenditures (1.35% of GDP in 2016–2018) are well below the EU average. Moreover, Hungary lags behind in competitiveness: the country scored fifth-worst among the EU 27 in the 2019 Global Competitiveness Report. Both these factors will make it more difficult for the Hungary to sustain higher growth rates. Looking at the demographic trends, the working-age population is expected to decline by 9% by 2040 under Eurostat’s baseline scenario, thus constraining the capacity of the economy to grow on the basis of labor input.

PUBLIC FINANCE

To counter the negative impact of the COVID-19 pandemic, the government has adopted several fiscal and liquidity measures:

  • Alleviating the financial burden for the business sector by lowering or cancelling certain payments of taxes, social contributions and other payments to the general government (costs are estimated between 0.2 and 0.4% of 2019 GDP).
  • Creation of three funds:
  • Pandemic defense fund (HUF 634 bln; 1.4% of 2019 GDP) dedicated to purchasing medical equipment and financial support for healthcare workers.
  • Economic defense fund (HUF 1.35 tln; 2.9% of 2019) dedicated to job protection, job creation, supporting priority sectors and business financing.
  • Fund to handle EU anti-pandemic resources — the EU has allowed its members to reallocate unabsorbed cohesion funds for the current budgeting period into crisis-related measures. For Hungary, such financing might reach up to EUR 5.6 bln (3.9% of 2019 GDP). On top of that, the EU is providing its members with the opportunity to tap into its EUR 100 bln SURE loan facility (aimed at funding short-time working schemes) and liquidity facilities to help hard-hit small and medium-sized enterprises.
  • Liquidity support in the form of loans and guarantees through state-owned Eximbank and Hungarian Development Bank, along with direct government purchases of bank bonds (altogether estimated at approximately at HUF 2 tln; over 4% of 2019 GDP).

The anti-COVID-19 package relies mainly on a reshuffling of government expenditures.

The government claims that most of these measures will be covered through reallocation of budget expenditures from lower priority areas, dissolution of budget reserves, and a new tax on credit institutions and multinational retail chains. The EC expects the general government deficit to increase from 2% in 2019 to 5.2% in 2020. If the fiscal response to the recession remains muted, this deficit would be the third-lowest in the EU according to the EC’s spring forecast. In this scenario, the debt to GDP ratio would increase from 66.3% in 2019 to around 75% this year.

In ACRA Europe’s view, the risks for the deficit and the debt outcome are tilted to the upside, also given the high reliance of Hungary’s budget on consumption taxes, whose collection might take a bigger hit compared to the EC’s baseline scenario. In 2018, their share in total general government revenue stood at 42.6%, the fourth-highest in the EU.

Figure 1. Share of consumption taxes in the total tax revenue in the EU countries

f1


Source: EC, 2018

2020 financing needs are high.

On top of the expected deficit, Hungary has to refinance a quite significant portion of its maturing debt (in April, debt maturing in the next 12 months stood at 11.7% of 2019 GDP; 13.5% including interest payments). ACRA Europe does not expect any significant issues for Hungary in meeting its funding needs in the short term due to following considerations:

  • Central government debt maturing until the end of 2020 is almost exclusively HUF-denominated (more than 95%).
  • The demand for HUF-denominated government debt remains solid. There has been neither a significant increase in the average accepted yield in the auctions, nor a significant decline in bid-to-cover ratios since the start of the pandemic.
  • The Magyar Nemzeti Bank (MNB, Hungary’s central bank) has launched a government bond purchase program of fixed rate government securities on the secondary market. The facility is focused on (but not limited to) purchasing government securities with at least 3-year maturities, and the MNB can acquire up to 33% of the stock of the eligible securities outstanding. In the first two weeks following the program’s launch (as of May 17), the MNB purchased government securities worth 119 bln HUF (0.4% of consolidated general government debt).
  • The situation in the CDS market signals solid confidence in Hungary’s bonds given the current circumstances.

Hungary has the shortest average maturity of outstanding public debt in the EU.

Nevertheless, in the longer term, the Agency assesses the risk profile of Hungary’s public finances as moderate. This assessment is based on the relatively high debt load, moderate debt servicing costs (the EC expects interest expenditure to increase slightly from 2.3% to 2.5% of GDP in 2020, the highest among the EU-CEE countries), and a short average residual maturity of government debt (4.3 years in April 2020, the shortest in the EU). A sharp tightening of global financial conditions, which is can by no means be ruled out during the COVID-19 crisis, might lead to an increase in debt service costs and austerity measures slowing the economic growth. A mitigating factor is the sustained decline in the share of external debt (from nearly two-thirds in 2012 to 39% in 2019 on the balance of payment basis) and FX debt (from over 50% of the central government debt in 2011 to 16% in Q1 2020) in the total debt.

In ACRA Europe’s view, the risks related to contingent liabilities are lower compared to the EU average. In 2018, contingent liabilities by the EU definition stood at 17.5% GDP (of which 6.2% GDP was attributable to liabilities of financial institutions). Even when considering the recent measures, which might increase contingent liabilities by up to around 4% of 2019 GDP, Hungary’s contingent liabilities remain well below the EU average.

Household debt is the second-lowest in the EU.

The risk of large-scale assistance to the banking sector is mitigated by a low indebtedness of households. In Q4 2019, household debt to GDP stood at 18.6%, the second lowest in the EU. In contrast, banks’ exposure to the corporate sector is more risky, especially in the event of a strong depreciation of the forint. Credit to the corporate sector stood at 64.4% of GDP in 2019 (lower than the unweighted EU average of 102.5%), with more than 40% of the total loans to the non-financial sector being FX denominated.

In order to temporarily relieve households and the corporate sector from their debt servicing burden, the government has introduced a moratorium on all existing payments (with a voluntarily opt-out) until the end of the year. Banks can, in turn, replace the shortfall of payment inflows via several liquidity facilities introduced by the MNB. Nevertheless, the longer the COVID-19 crisis continues, the more borrowers will face solvency pressures after the end of the moratorium. Thus, the banking system’s capitalization is expected to come under pressure in 2021.

Over 50% of credit institutions’ assets are owned domestically, the highest share among EU-CEE countries.

The banking sector’s capital buffers are somewhat lower compared to the EU average; the system-wide CET 1 ratio stood at 15.1% in Q3 2019, while the unweighted EU average stood at 17.1%. Compared to its regional peers, Hungary has the highest share of banking sector assets held by domestic credit institutions (56%), which in the Agency’s view makes the government more susceptible to providing extraordinary support to the country’s banks in case of solvency issues.

ACRA Europe is currently not assigning a negative adjustment for the contingent liabilities stemming from the financial system. Nevertheless, the Agency will monitor closely the development of the solvency of the private sector and might change its assessment in case the risk of large-scale support for the banking sector increases, especially in the case of renewed selling pressure on the forint.

Figure 2. Share of domestic credit institutions in total banking sector assets in the EU-CEE countries

f2

Source: ECB, Q3 2019

EXTERNAL RISKS

The robust surplus in the balance of services is expected to deteriorate in 2020.


The impact of the COVID-19 crisis on the current account is uncertain at this stage. The balance of goods (-1.9% of GDP in 2019) is likely to improve on the back of constrained domestic demand. Similarly, the primary income deficit (3.6% of GDP in 2019) is expected to improve due to a decline in profitability of foreign investments. In contrast, the robust surplus in the balance of services (5.6% of GDP in 2019) attributable mainly to tourism and transport (predominately air transport) is expected to deteriorate sharply due to travel restrictions. Likewise, travel restrictions are likely to have a negative impact on workers’ remittances (2.7% of GDP in 2019). International institutions’ estimates of the current account balance dynamics vary significantly, with the IMF expecting only a slight improvement from -0.8% of GDP to -0.1%, while the EC expects a surplus of 1.3%. Nevertheless, in both cases, the current account balance is projected to remain at healthy levels.

The gross external debt in proportion to GDP retained its declining trend in 2019, when it fell from 100% to 89%, mainly on the back of a declining stock of intercompany lending. Although the external debt is still the highest among the non-eurozone EU-CEE countries, the refinancing risk is somewhat limited by its structure (only 30% of the external debt is attributable to sectors that are more susceptible to liquidity risk) and long maturity (the share of external debt maturing in 2020 excluding direct investments stood at 14%). Nevertheless, the refinancing risk is elevated in ACRA Europe’s view due to the COVID-19 crisis, given the approximately 75% FX share, especially in case of renewed selling pressure on the forint.

 

Year-to-date losses of the forint are similar to its peers.

So far, the COVID-19 crisis-inflicted depreciation of the forint has been in line with its regional floating peers. At the time of publishing this report, it had lost approximately 6% of its value year-to-date against the euro. However, compared to the aforementioned peers, Hungary has the weakest reserve buffers. In April, international reserves stood at EUR 29 bln, covering only 30% of FX external debt and three months of imports.

The immediate risk stemming from limited reserve buffers is low, given the over 160% reserve coverage of short-term external debt. However, in ACRA Europe’s view, the combination of MNB easing and limited buffers might put the HUF under pressure in case of renewed strong risk aversion in global markets.

INSTITUTIONAL FACTORS

Hungary’s Voice and Accountability score is the weakest among the EU countries. 

On a global scale, the governance indicators for Hungary are considered to be above average, but by EU standards they rank among the bottom countries. Moreover, they have been on the decline since the mid-2000s. The most significant decline has been recorded in the Voice and Accountability category (where Hungary scores the worst in the EU), resulting from measures undermining the freedom of the press and civil society. Looking at the score for all the governance indicators, Hungary scores the worst in the Control of Corruption category, which declined to its lowest level ever in 2018.

A poor relationship with the EU might lead to lower EU transfers.

The EU-Hungary relationship continues to deteriorate. The list of allegations, which already encompasses, among others, undermining the independence of the judiciary system and a crackdown on the freedom of the media and academic freedom, has been recently added to by the decision of the parliament to allow the government to rule by decree without a set time limit (however, the government has already announced its plan to renounce such powers shortly). A failure to resolve these issues might lead to a significant reduction of EU transfers to the country from the EU’s 2021–2027 budget which would thereby constrain the country’s growth.

For a more detailed assessment of the creditworthiness of Hungary, see our autumn report.

Appendix 1. Comparative analysis of Hungary and the sample group

Comparison of macroeconomic and institutional indicators

 

Hungary

Poland

Czech Rep.

Slovakia

Slovenia

Period

Macroeconomics

GDP per capita (1,000 USD, PPP)

34.4

33.9

38.8

36.4

38.3

2019

Real GDP growth (% y-o-y)

4.9

4.1

2.6

2.4

2.4

2019

HICP inflation (% y-o-y average)

3.4

2.1

2.6

2.8

1.7

2019

Openness of economy (% of GDP)

163

106

145

185

160

2019

Unemployment

3.4

3.0

2.0

5.6

4.1

Q4 2019

Public finance

Consolidated government debt (% of GDP)

66.3

46.0

30.8

48.0

66.1

2019

External consolidated government debt (% of GDP)*

25.3

19.4

12.3

30.8

45.1

2019

Consolidated government budget balance (% of GDP)

-2.0

-0.7

0.3

-1.3

0.5

2019

Interest payments (% of GDP)

2.3

1.4

0.7

1.2

1.7

2019

External position

Current account (% of GDP)

-0.8

0.5

-0.4

-2.9

6.6

2019

Net international investment position (% of GDP)

-47.9

-49.8

-20.7

-65.5

-19.3

2019

External debt position (% of GDP)

88.8

59.0

78.4

111.9

91.8

2019

Short-term external debt to total external debt (%) **

10.2

16.1

47.3

39.1

24.7

2019

Export diversification index ***

0.41

0.40

0.43

0.48

0.46

2018

Institutional framework ****

Political stability and absence of violence

0.76

0.55

1.04

0.75

0.91

2018

Government effectiveness

0.49

0.66

0.92

0.71

1.13

2018

Rule of law

0.56

0.43

1.05

0.53

1.06

2018

* On a balance of payments basis

** At original maturity, excluding direct investments.

*** Indicates the extent of differences between the country’s trade structure and the average world indicator and ranges approximately from 0 (weak differences) to 1 (strong differences).

**** Assessment of effectiveness ranges from approximately -2.5 (weak) to 2.5 (strong).

Sources:  Eurostat, ECB, IMF, UNCTAD, World Bank

Appendix 2. List of material data sources

International Monetary Fund

World Bank

Eurostat

The Bank for International Settlements

European Commission

Organisation for Economic Co-operation and Development

European Central Bank

Magyar Nemzeti Bank

Hungarian Central Statistical Office

Appendix 3. Key indicators

Balance of payments, EUR bln

 

2015

2016

2017

2018

2019

Balance of goods

4.1

4.0

1.9

-1.7

-2.7

Exports

78.5

78.6

85.6

88.7

93.0

Imports

74.4

74.6

83.7

90.4

95.6

Balance of services

4.9

6.1

7.2

7.7

8.0

Exports

20.3

21.9

23.9

25.4

26.9

Imports

15.4

15.8

16.6

17.7

18.9

Balance of income

-6.3

-4.8

-6.2

-6.0

-6.4

Income receivable

11.6

14.3

15.4

15.3

16.4

Income payable

17.9

19.2

21.6

21.2

22.9

Current account 

2.6

5.3

3.0

0.1

-1.1

Current account, % of GDP 

2.3

4.6

2.4

0

-0.8

International reserves at the end of the period

30.0

24.5

23.4

27.4

28.4

Sources: Eurostat, ECB

External position (assets and liabilities), EUR bln

 

2015

2016

2017

2018

2019

External debt

144.1

139.2

128.3

134.2

127.7

long-term *

67.2

65.5

63.1

62.4

63.0

short-term (up to 1 year) *

14.4

13.3

12.0

13.1

13.0

External liabilities

144.1

139.2

128.3

134.2

127.7

Sovereign issuer, including

47.3

44.1

39.0

38.6

38.2

monetary authorities

1.8

1.9

1.6

1.6

1.8

consolidated government

45.5

42.2

37.4

37.0

36.4

Banks

16.8

15.9

17.7

17.4

18.6

Other sectors

80.0

79.3

71.7

78.3

70.9

including intra-corporate loans

62.5

60.5

53.2

58.7

51.6

External assets, excluding shares

118.0

127.8

114.0

126.5

129.9

Sovereign issuer, including

32.9

25.5

23.6

26.6

27.5

monetary authorities

30.0

24.4

23.3

26.3

27.0

consolidated government

2.9

1.1

0.3

0.3

0.5

Banks

10.5

17.5

18.3

19.6

19.0

Other sectors

74.6

84.8

72.2

80.3

83.4

Net debt

26.1

11.4

14.3

7.7

-2.2

Sovereign issuer

14.4

18.5

15.4

12.0

10.7

Banks

6.3

-1.6

-0.5

-2.2

-0.4

Other sectors

5.4

-5.5

-0.5

-2.1

-12.5

International investment position (net),% of GDP

-67.9

-59.6

-55.1

-51.6

-47.9

External debt, % of GDP

128.4

120.8

102.2

100.3

88.8

* Excluding direct investment

Sources: ECB, Eurostat

Budget indicators, % of GDP

Consolidated government

2015

2016

2017

2018

2019

Income

48.6

45.4

44.5

44.5

44.0

Expenses

50.6

47.2

47.0

46.7

46.1

including debt servicing expenses

3.5

3.1

2.7

2.4

2.3

Primary budget balance

1.4

1.3

0.2

0.2

0.2

Overall budget balance

-2.0

-1.8

-2.5

-2.1

-2.0

Consolidated government debt

76.2

75.5

72.9

70.2

66.3

% of income

154

167

163

157

148

Central government

 

 

 

 

 

Income

33.2

31.1

31.7

31.3

31.2

Expenses

35.4

33.1

34.1

33.7

32.9

including debt servicing expenses

3.4

3.1

2.7

2.4

2.3

Primary budget balance

1.3

1.1

0.3

0

0.6

Overall budget balance

-2.2

-2.0

-2.4

-2.4

-1.7

Central government debt

76.1

76.0

74.0

72.2

67.8

% of income

225

245

233

229

214

Note: nominal GDP, EUR bln

112.2

115.3

125.6

133.8

143.8

Source: Eurostat

Rating history

The rating was first released for distribution on November 30, 2018, with the last review on November 22, 2019.

Regulatory disclosure

The sovereign credit ratings have been assigned to Hungary under the Methodology to assess Sovereign entities, applicable from October 4, 2019. An explanation of the importance of each rating category and a default definition is included on the ACRA Europe website. Information on the rate of historical failure is available at cerep.esma.europa.eu. The default rate means a percentage of ratings that were changed to default from the overall number of ratings, for each rating category and given period. The disclosure of the unsolicited rating and outlook was preceded by the approval of the Rating Committee. Since July 30, 2012, ACRA Europe has been a registered credit rating agency according to Regulation (EC) No 1060/2009 of the European Parliament and of the Council of September 16, 2009, on credit rating agencies.

The sovereign credit ratings and their outlook are expected to be revised within 6 months following the publication date of this press release as per the Calendar of planned sovereign credit rating revisions and publications.

The credit rating was issued as unsolicited. The rated entity did not participate in the credit rating assignment. ACRA Europe did not have access to the rated entity’s internal documents or management. ACRA Europe, in the context of routine care, verified all sources entering the rating process and considers the scope and quality of the information entering the analytical process to be sufficient to assign a credit rating. The rated entity was notified on May 20, 2020, and after the notification there were no changes or amendments in the rating.

ACRA Europe provided no additional services to the Hungarian government. No conflicts of interest were discovered in the course of the sovereign credit rating assignment.

Rating report

Research report

Minutes from the Rating Committee meeting