Home Ratings and Research Currently valid ACRA Europe affirms unsolicited credit ratings of BBB to Hungary, outlook Negative
ACRA Europe affirms unsolicited credit ratings of BBB to Hungary, outlook Negative
Friday, 20 November 2020
There are no translations available.

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 is Negative and local currency credit rating is Negative.

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

The COVID-19 crisis caused 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 the internalization of government debt and a sustained decline in the FX share of the public and private debt. Nevertheless, the resilience of the economy amid the uncertain global outlook is constrained by a relatively high public debt load, moderate FX exposure, and relatively limited international reserves. These risks are reflected in the negative 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 (based on 2020 baseline scenario)


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

-1

-1

AA

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

B+

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 around 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 82% of GDP) with a high share of manufacturing in total output (gross value added in manufacturing accounts for 17.7% of GDP), it is more susceptible to the global economic cycle. The structure of exports is skewed towards motor vehicles (18% in 2019) in terms of products and Germany in terms of partners (28% in 2019), making the country’s exports susceptible to the country and sector specific shocks of the EU countries.

Prior to the COVID-19 shock, Hungary’s economic performance was robust with an average annual GDP growth of 4% between 2015 and 2019. The main driving factors were fixed investments and household consumption. Investments were driven by strong absorption of EU funds (net transfers from the EU accounted for 3.6% of gross national income in 2015–2019). At the same time, household consumption was supported by strong wage growth in light of the rapid absorption of spare labor force along with a robust increase in public sector wages.

The V-shaped recovery was halted by the second wave of the pandemic.


In the first half of 2020, the economy contracted by 5.8% year-on-year. The contraction was markedly lower than in the EU as a whole (-8.3%) as the economy was less affected by the pandemic in the first quarter. However, at the height of the COVID-19 crisis, Hungary experienced one of the biggest year-on-year contractions in manufacturing in the EU (-38% in April and -29% in May) due to an EU-wide collapse in the manufacture of motor vehicles. Although car production and manufacturing have recovered significantly since then, this slump highlighted the vulnerability of the economy not only to global, but also sector-specific risks.

Prior the second-wave restrictions (closure of restaurants, limited opening hours for retailers…), most of the high-frequency indicators pointed to a V-shaped recovery. However, with a new wave of mobility restriction both domestically and in the EU, economic activity is expected to cool down in the final quarter of 2020. ACRA Europe expects the economy to contract between 6% and 7% in 2020 prior growing between 4% and 5% in 2021. However, the outlook is subject to significant uncertainty related development of the pandemic and the timing of the phasing out of government support measures, both domestically and externally.

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 Hungary to maintain 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. And last but not least, support for growth stemming from sizable net EU transfers is very likely to decline after the EU recovery package expires.

PUBLIC FINANCE

The debt to GDP ratio is set to increase above 75%.

The recession-induced revenue shortfall along with increased healthcare expenditure and measures to support the economy have significantly worsened the shape of Hungary’s public finances. The government’s 2020 target for the cash deficit has been increased to HUF 3.6 tln (7.6% of 2019 GDP). The European Commission expects the 2020 ESA deficit to reach 8.4% of GDP before declining to 5.4% in 2021. The 2021 figure is much higher than the authorities’ optimistic target of 2.9%. As a result, the debt to GDP ratio is expected to increase from 65.4% to 75–80% GDP in 2020.

Despite the massive increase of net issuance, so far Hungary has managed to keep the share of FX debt in the total central government debt below 20% (it rose from 17.3% in 2019 to 18.7% in Q3 2020) and the ratio of government external debt to GDP below 30%, well below the figures seen at the beginning of the previous decade. Yet, given the relatively high debt load, the ratio of central government FX debt to GDP remains moderate at around 13%.

Maturity of the debt is short and the rollover ratio is high.

The increase in the debt servicing cost is contained as well, with interest expenditures expected to increase from 2.2% in 2019 to 2.5% of 2020 GDP. Nevertheless, this ratio will remain the highest among the EU-CEE countries. Moreover, interest expenditures are compressed by the short maturity of the government debt, which makes the debt servicing costs more sensitive to changes in the interest rates. In Q3 2020, the average residual maturity stood at 4.6 years, the third shortest in the EU. As a result, Hungary’s debt service in the next 12 months amounts to 10.4% of GDP, the second highest among the EU-CEE countries.

ACRA Europe does not expect a swift return to sound fiscal policies. Prior to the COVID-19 shock, the government’s consolidation effort was low, considering robust nominal GDP growth rates. In 2015 to 2019, Hungary’s average structural deficit was the highest among the EU countries (3.3%). Our expectations are further underpinned by one of the weakest fiscal frameworks in terms of fiscal rules in the EU. Moreover, the country’s fiscal flexibility is constrained by high government revenue and expenditure compared to its EU-CEE peers. In 2019, general government expenditures stood at 45.6% of GDP, well above the EU-CEE average of 40.5%.

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 4.5% of 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 Q2 2020, household debt to GDP stood at 19.6%, 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 67.4% of GDP in Q2 2020 (significantly lower than the unweighted EU average of 108%), 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. This moratorium has been extended for a certain group of households and companies until mid-2021. 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 Q2 2020, while the unweighted EU average stood at 18.1%. Compared to its regional peers, Hungary has the highest share of banking sector assets held by domestic credit institutions (57%), 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 closely monitor 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.

EXTERNAL RISKS


The surplus in the services balance has reduced significantly as a result of the COVID-19 crisis.


The current account balance is set to worsen on the back of the COVID-19 shock but is expected to remain at healthy levels. The main driver is the declining surplus in services (transport and air travel), which has so far not been fully compensated by the improvement in the primary income resulting from deteriorating corporate profits. ACRA Europe expects the current account deficit to widen from -0.8% to between -1 and -1.5% of GDP in 2020.

External debt has increased significantly as intercompany lending has almost doubled between 2019 and Q2 2020. As a result, the gross external debt to GDP ratio has increased from 90% to 131%. Nevertheless, ACRA Europe considers intercompany lending to be low-risk external debt. Excluding intercompany lending, the external debt position has worsened only slightly, in proportion to GDP the external debt rose from 52% in 2019 to 54% in Q2 2020. On the negative side, 83% of external debt is denominated in foreign currencies, making it susceptible to forint depreciation.

Reserve coverage ratios remain low.


So far, the COVID-19 crisis-inflicted depreciation of the forint has been limited. At the time of publishing this report, it had lost approximately 8.5% of its value year-to-date against the euro, somewhat more than the regional peer currencies. However, compared to regional peers with floating currencies, Hungary has the weakest reserve buffers. In October, international reserves stood at EUR 30 bln, covering only 20% of FX external debt and 3.1 months of 2019 imports.

The immediate risk stemming from limited reserve buffers is low, given the approximately 150% reserve coverage of short-term external debt (by remaining maturity). However, in ACRA Europe’s view, the combination of MNB easing and limited buffers might put the forint 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 indicator (where Hungary scores the worst in the EU), resulting from measures undermining freedom of the press and civil society. Looking at the score for all the governance indicators, Hungary scores the worst in Control of Corruption, which declined to its lowest level ever in 2019.

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


The EU-Hungary relationship continues to deteriorate due to rule of law issues. Recently, Hungary and Poland have blocked the adoption of the next EU budget and the EU recovery package as they oppose the conditionality of EU funding on upholding rule-of-law standards. Failure to resolve these issues might lead to a significant reduction of EU transfers in the future, which would thereby constrain the country’s growth.

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)

34.0

34.5

42.7

34.2

40.7

2019

Real GDP growth (% y-o-y)

4.6

4.5

2.3

2.3

3.2

2019

HICP inflation (% y-o-y average)

3.4

2.1

2.6

2.8

1.7

2019

Openness of economy (% of GDP)

161

106

143

184

159

2019

Unemployment

4.6

3.1

2.3

6.6

5.2

Q2 2020

Public finance

Consolidated government debt (% of GDP)

65.4

45.7

30.2

48.5

65.6

2019

External consolidated government debt (% of GDP)

21.8

20.4

12.4

27.7

40.1

2019

Consolidated government budget balance (% of GDP)

-2.1

-0.7

0.3

-1.4

0.5

2019

Interest payments (% of GDP)

2.2

1.4

0.7

1.2

1.7

2019

External position

Current account (% of GDP)

-0.8

0.4

-0.4

-2.9

5.7

2019

Net international investment position (% of GDP)

-41.3

-45.5

-13.4

-67.9

-17.4

2020Q2

External debt position (% of GDP)

90

59

77

112

91

2019

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

10

16

47

39

24

2019

Export diversification index **

0.41

0.41

0.42

0.49

0.44

2019

Institutional framework ***

Political stability and absence of violence

0.73

0.52

0.95

0.78

0.82

2019

Government effectiveness

0.50

0.60

0.89

0.67

1.08

2019

Rule of law

0.49

0.45

1.05

0.56

1.12

2019

* 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

Hungarian Government Debt Management Agency


Appendix 3. Key indicators

Balance of payments, EUR bln

 

2015

2016

2017

2018

2019

Balance of goods

4.1

4.0

1.7

-1.7

-3.0

Exports

78.5

78.6

85.3

88.7

93.1

Imports

74.4

74.6

83.6

90.4

96.1

Balance of services

4.9

6.1

6.9

7.7

7.6

Exports

20.3

21.9

23.8

25.4

26.9

Imports

15.4

15.8

16.9

17.7

19.4

Balance of income

-6.3

-4.8

-6.2

-5.6

-4.9

Income receivable

11.6

14.3

15.4

15.4

15.5

Income payable

17.9

19.2

21.6

21.0

20.4

Current account 

2.6

5.3

2.5

0.5

-0.3

Current account, % of GDP 

2.3

4.5

2.0

0.3

-0.2

International reserves at the end of the period

30.3

24.4

23.4

27.4

28.4

Sources: Eurostat, ECB External position (assets and liabilities), EUR bln

External position (assets and liabilities), EUR bln

 

2015

2016

2017

2018

2019

Balance of goods

4.1

4.0

1.7

-1.7

-3.0

Exports

78.5

78.6

85.3

88.7

93.1

Imports

74.4

74.6

83.6

90.4

96.1

Balance of services

4.9

6.1

6.9

7.7

7.6

Exports

20.3

21.9

23.8

25.4

26.9

Imports

15.4

15.8

16.9

17.7

19.4

Balance of income

-6.3

-4.8

-6.2

-5.6

-4.9

Income receivable

11.6

14.3

15.4

15.4

15.5

Income payable

17.9

19.2

21.6

21.0

20.4

Current account 

2.6

5.3

2.5

0.5

-0.3

Current account, % of GDP 

2.3

4.5

2.0

0.3

-0.2

International reserves at the end of the period

30.3

24.4

23.4

27.4

28.4

* Excluding direct investment

Sources: ECB, Eurostat



Budget indicators, % of GDP


Consolidated government

2015

2016

2017

2018

2019

Income

48.4

45.0

44.1

43.8

43.5

Expenses

50.4

46.8

46.5

45.9

45.6

including debt servicing expenses

3.4

3.1

2.7

2.4

2.2

Primary budget balance

1.4

1.3

0.2

0.2

0.2

Overall budget balance

-2.0

-1.8

-2.4

-2.1

-2.1

Consolidated government debt

75.8

74.9

72.2

69.1

65.4

% of income

154

167

163

157

148

Central government

 

 

 

 

 

Income

33.1

30.9

31.4

30.8

30.8

Expenses

35.3

32.9

33.8

33.2

32.5

including debt servicing expenses

3.4

3.1

2.7

2.4

2.2

Primary budget balance

1.3

1.1

0.3

0

0.5

Overall budget balance

-2.2

-2.0

-2.4

-2.3

-1.7

Central government debt

75.7

75.5

73.3

71.0

66.9

% of income

225

245

233

229

213

Note: nominal GDP, EUR bln

113

116

127

136

146

Source: Eurostat

Rating history

The rating was first released for distribution on November 30, 2018, with the last review on May 22, 2020.

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 November 18, 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.

Dowload pdf