Economy
S&P revises outlook on Hungary to positive from stable
Rating action
On 25 August 2017, S&P Global Ratings revised its outlook on Hungary to positive from stable. At the same time, it affirmed its 'BBB-/A-3' long- and short-term foreign and local currency sovereign credit ratings. S&P also revised its outlook on the National Bank of Hungary (MNB) to positive from stable and affirmed its 'BBB-' long-term issuer credit rating.Outlook
The outlook revision reflects our expectation that Hungary's improving economic and external metrics might support ongoing improvements in the financial sector and thus strengthen the monetary transmission channel.
After five years of creditless economic recovery, the rating agency expects loan growth to resume and nonperforming loans (NPL; domestic loans more than 90 days overdue as defined by S&P Global Ratings) to stabilize at about 10%--much lower compared to historical peak levels.“This is driven by a gradual recovery in demand for new loans, the recent recovery in real estate prices, and measures by MNB to stimulate lending as well as its prudent regulatory efforts. In 2016, the banking sector returned to profitability, in part due a gradual reduction in the bank levy," S&P added.
S&P said it could raise the ratings
- if these financial sector developments proved sustainable and improved the relatively low effectiveness of Hungary's monetary transmission channels, enhancing the authorities' ability to influence domestic monetary conditions.
- This would be triggered by further reductions in the banking sector's NPLs (for example, via a more concerted reduction in legacy NPLs in the commercial real estate sector) and
- a sustainable recovery of bank lending,
- in parallel with continued economic recovery accompanied by current accounts surpluses and contained fiscal deficits.
- This upside scenario also assumes that the real exchange rate remains in line with underlining fundamentals.
S&P could revise the outlook back to stable
- if lending growth remained subdued and
- the downward trend in the stock of NPLs halted.
- if Hungary's public finances weakened;
- external vulnerabilities built up again, contrary to S&P’s current expectations;
- exchange rate policy became more interventionist; or
- S&P observed further institutional weakening, especially if it anticipated an eventual fiscal risk associated with such developments.
Rationale
“Hungary's strong external profile and its track record of fiscal restraint support the sovereign ratings. Moderate long-term growth prospects, high public debt, and a so far impaired monetary transmission mechanism are key constraints to the ratings."
As regards Hungary’s institutional and economic profile, S&P highlighted the following factors:- Cyclical recovery amidst weaker institutional settings;
- Cyclical recovery aided by external environment and government stimulus;
- Structural challenges will contain longer-term growth;
- Constrained predictability of policy-making due to weaker check and balances.
Negatives
“More recent restrictive actions toward independent mass media, as well as the clamp down on nongovernmental organizations, have resulted in further political centralization, which undermines Hungary's institutional effectiveness and the predictability of its policy making," S&P said.It added that several ongoing infringement procedures against Hungary pose a risk of destabilizing relations between Hungary and the EU, potentially derailing EU investment projects and undermining private investor confidence.
S&P’s base-case scenario assumes that “the suboptimal policy settings will continue to constrain Hungary's ability to conduct structural reforms as well as effectively address periods of economic distress."
Key estimates
S&P thinks that real GDP growth for 2017 will approach 3.5% due to the following factors:- booming consumption triggered by fiscal stimulus and minimum wage hikes;
- substantial recovery in EU fund absorption;
- gradual reduction in the banking levy;
- rising expenditure on housing subsidies;
- real wage and employment gains; and
- stronger private sector balance sheets.
Strong first quarter results (GDP expanded by 4.2% year-on-year) have increased the possibility of higher economic growth this year and next.
However, over the medium term, S&P expects Hungary's structural growth challenges to slow the pace of average GDP growth to just under 2.5% per year between 2018 and 2020. These challenges are:- poor demographics;
- worsened by net emigration,
- a large and encroaching public sector,
- weaknesses in the business environment,
- low productivity, and
- an overheating labor market.
Moreover, given the prominence of EU funds in public investments, post-2020, “Hungary's growth outlook will be exposed to risks of potential changes to the EU's structural funds allocation framework as well as the very likely reduction in the total size of funds."
Whereas S&P noted that some unconventional policies employed under PM Orbán, aided by a favorable external environment, “have been instrumental in reducing external vulnerabilities and securing macroeconomic stability", and it also acknowledges the cabinet’s ambitious reform agenda aimed at boosting competitiveness and productivity, the rating agency highlighted that “institutional changes implemented since the early 2010s, which re-codified legal frameworks for Hungary's key institutions (for example, MNB and the Constitutional court) have weakened the checks and balances between branches of government."
“The consequent concentration of power has resulted, in particular, in expanding the influence and size of the public sector at the expense of governance, in our view."
Despite the government's intentions to continue its fiscal stimulus via tax cuts and higher spending in the 2017 budget, in our base case, we assume that, going forward, fiscal slippage will be negligible, resulting in general government deficits of 2.3% of GDP on average in 2017-2020. This is despite a potentially wider fiscal deficit in 2017 ahead of the 2018 parliamentary elections compared to the 1.8% of GDP general government deficit in 2016, which was supported by asset sales and strong consumption tax receipts.
The 2018 budget already passed by the parliament, targets a deficit of 2.4% of GDP--similar to 2017.S&P forecasts that general government debt, net of liquid assets, will reduce gradually to about 66% of GDP in 2020 from 70.4% in 2016.
