Fitch: Prospects of euro adoption in Hungary in foreseeable future remain remote

All else being equal, Fitch would likely upgrade a sovereign's Long-Term FC Issuer Default Ratings (IDRs) by two notches from the country's admission to the Exchange Rate Mechanism (ERM II) to joining the euro, the rating agency said in a report issued on Monday.

Fitch upgraded Hungary’s Hungary's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'BBB' with a Stable Outlook on 22 February this year, and it has affirmed both the rating and the outlook last Friday.

Fitch reminded that it had taken positive rating action in all three Baltic States before their euro area accession, upgrading their sovereign ratings by one or two notches.

Estonia adopted the euro in 2011, Latvia in 2014 and Lithuania also in 2014, but Fitch had upgraded sovereign ratings for Estonia (by two notches) already in 2010, and had done the same for Latvia in 2012 and 2013 and for Lithuania in 2013 and 2014.

Fitch said Eurozone membership has various implications in Fitch's Sovereign Rating Model (SRM), which is its starting point for assessing sovereign ratings. Access to the eurozone's reserve currency status and a likely reduction of the share of public sector debt denominated in foreign currency (FC) would have a direct positive impact on the output of our SRM.

In Fitch's view, the main euro benefits include:

• access to reserve currency status that eliminates the risk of self-fulfilling currency crises, supports foreign demand for domestic financial assets and adds to fiscal and external financing flexibility;
• the reduction of FC-related credit risk for "euroised" economies;
• access to the ECB's credible monetary policy framework and liquidity facilities for banks;
• lower transaction costs and increased trade and capital flows with the rest of the eurozone;
• and additional external funding options for countries in distress.

The main costs of joining the euro include:

• loss of monetary and exchange rate policy flexibility;
• macro and financial risks from excessive capital inflows (including a potential surge in credit and asset prices);
• potential for severe deflationary pressures in situations where excessive current account surpluses are being unwound;
• and the potential obligation to contribute financial support to other member states in the event of bail-out programmes.

Fitch believes, in line with its longstanding approach, the greatest beneficiaries of euro adoption are countries with weak external finances that would benefit from reserve currency status; countries with high levels of loans in euros to the private and public sectors ("euroisation"); and countries with pegged exchange rates (as their loss of independent monetary policy would have a minimal impact).

Romania (BBB-/Stable) has expressed interest in joining ERM II but there is no formal timetable.

The prospects of euro adoption in Hungary (BBB/Stable), Poland (A-/Stable) and the Czech Republic (AA-/Stable) in the foreseeable future remain remote, with little political willingness and in some cases very low public support for euro membership

, concluded Fitch.

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