Economy
S&P upgrades Hungary's credit rating
The upgrade is not a huge surprise, given that the outlook on Hungary’s credit rating at S&P has been positive since August 2017, and such an outlook theoretically warrants an upgrade within two years. The current outlook is stable therefore no further upgrade should be expected in the near future.
The rating agency said it could take a negative rating action over the coming 24 months
“The Hungarian forint floats, and there is no longer any significant foreign currency funding to the private sector without a natural hedge," it noted.
Hungary's external position remains strong, with net external debt shrinking to below 10% of GDP in 2018 from 55% in 2010 during an extended credit crunch, S&P said.
“Although Hungary's current account surpluses have started to narrow, we believe that the floating exchange rate and still-low labor costs should support Hungary's external competitiveness at least in the medium term."
S&P also highlighted that the current acceleration of credit growth is, in net terms, domestically funded, though it also noted that in gross terms, non-resident wholesale funding to Hungary's domestic banks has been recovering.
“Hungarian banks appear to be well capitalized and profitable."
It anticipates a decline in annual EU structural and cohesion fund transfers by 1%-2% of GDP as soon as 2021 under the next EU budget.
“This reflects a bias toward conservative external assumptions, rather than a judgement on the outcome of the next round of EU budgetary negotiations," S&P added.
Taking this into account, the rating agency continues to project that Hungary's capital account will remain in surpluses over 1% of GDP through 2022.
S&P said the ratings are supported by
The key constraints on the ratings are
Hungary's economy is set to post another year of strong growth, with real GDP expanding by at least 3.3% in 2019, as accelerating domestic demand, on the back of real wage and employment gains, has propelled expansion, S&P noted.
S&P highlighted that Hungary's economy remains one of the most open in the region, with exports accounting for approximately 85% of GDP, of which over 16% comes from the automotive sector.
Given the prominence of EU funds in public investments, Hungary's growth in the longer term (i.e., beyond S&P’s current forecast horizon through 2022) is likely to suffer from potential post-Brexit cuts in the total size of EU funds, alongside likely changes to their allocation criteria, S&P warns.
The rating agency also noted that some government measures could be detrimental to long-term growth performance, “by reducing competition in Hungary's product markets, including via the introduction of sectoral taxes that have disproportionately fallen upon foreign investors."
Checks and balances between branches of government are more limited than in the past, it added, but noted that “these restrictive actions do not appear to have made Hungary less attractive to foreign investors in manufacturing (including car making), or the more outward facing parts of Hungary's booming services sector, which is currently operating an external surplus of over 5% of GDP."
With regard to competitiveness, S&P highlighted that, at a quarter of German levels, Hungarian wages remain considerably below those of Western Europe.
At the same time, it also believes that sizable financial sanctions or cuts in the structural funds to Hungary for EU policy noncompliance are unlikely before 2020, when the current EU multiannual financial framework ends. It also noted that reductions after 2020 are more likely but they would still require unanimity among EU member states.
Highlights
S&P highlighted that 2018 marked the sixth consecutive year in which Hungary has reported solid balanced GDP growth. While private debt increased during 2018, both public and overall external debt have continued to decline as a percentage of Hungary's GDP. Unlike previous episodes of strong growth, the Hungarian economy is now less leveraged, the currency floats, and both the government and the private sector finance themselves mainly in local currency.Outlook
“The stable outlook balances risks to Hungary's competitiveness from an overheating labor market against prospects of further economic convergence with wealthier trading partners."
S&P said it could raise the ratings in the next 24 months if- Hungary's economic performance continues to be stronger and more balanced than peers'.
- Potential for ratings upside could also build should Hungary's net public and external debt decline faster than S&P currently expects,
- for example, if the government were to run budgetary surpluses.
The rating agency said it could take a negative rating action over the coming 24 months
- in the event of a significant external shock to Hungary's open economy or
- an unexpected deterioration in external financing,
- including a suspension of EU transfers, or
- recurring weakness in Hungary's public finances that fueled public debt.
Rationale
While S&P expects growth to slow toward 2% by 2021, it thinks Hungary's small open economy will be able to weather a period of weaker external demand, as well as the expected decline in EU funding.“The Hungarian forint floats, and there is no longer any significant foreign currency funding to the private sector without a natural hedge," it noted.
Hungary's external position remains strong, with net external debt shrinking to below 10% of GDP in 2018 from 55% in 2010 during an extended credit crunch, S&P said.
“Although Hungary's current account surpluses have started to narrow, we believe that the floating exchange rate and still-low labor costs should support Hungary's external competitiveness at least in the medium term."
S&P also highlighted that the current acceleration of credit growth is, in net terms, domestically funded, though it also noted that in gross terms, non-resident wholesale funding to Hungary's domestic banks has been recovering.
“Hungarian banks appear to be well capitalized and profitable."
We consider banks' renewed appetite to lend and stronger financial performance as a sign that the monetary and credit transmission mechanism to the real economy is largely restored, a development that would also support authorities in the event of a more difficult trading environment in Europe and globally over the next couple of years.
S&P said the Hungarian governments' relations with its EU partners remain complicated.It anticipates a decline in annual EU structural and cohesion fund transfers by 1%-2% of GDP as soon as 2021 under the next EU budget.
“This reflects a bias toward conservative external assumptions, rather than a judgement on the outcome of the next round of EU budgetary negotiations," S&P added.
Taking this into account, the rating agency continues to project that Hungary's capital account will remain in surpluses over 1% of GDP through 2022.
S&P said the ratings are supported by
- Hungary's resilient export-driven economy,
- strong external profile,
- low private-sector debt, and
- the flexible exchange rate regime.
The key constraints on the ratings are
- relatively weak checks and balances between government branches,
- moderate wealth levels, and
- high public debt.
Institutional and economic profile
S&P believes Hungary’s economic expansion has already peaked, and structural challenges, amid signs of overheating, may curb longer-term growth. It also thinks that challenging relations with the EU are likely to continue.Hungary's economy is set to post another year of strong growth, with real GDP expanding by at least 3.3% in 2019, as accelerating domestic demand, on the back of real wage and employment gains, has propelled expansion, S&P noted.
“At the same time, the economy has started to face capacity constraints and exhibits signs of overheating, S&P warns.
Labor shortages have been reported across almost all sectors, resulting in double-digit wage growth over the past few years. S&P believes, however, that “immediate risks to external competitiveness remain limited."- “First, wage increases have been so far compensated by cuts in social security contributions and corporate taxation.
- “Second, the floating exchange rate regime will likely help mitigate a buildup of sustained wage pressures.
- “Lastly, despite recent accelerated wage growth, Hungary's labor costs remain below those of the other three countries of the Visegrád Four (Poland, Czech Republic, and Slovakia)."
S&P highlighted that Hungary's economy remains one of the most open in the region, with exports accounting for approximately 85% of GDP, of which over 16% comes from the automotive sector.
The extent of Hungary's export sector exposes the economy to external demand, in particular to swings in the German business cycle and technological fortunes of the global car industry.
“As such, any risk to Germany's auto sector coming from weak Chinese demand or the threat of U.S. tariffs on EU auto exports would quickly translate into lower labor demand in Hungary, softening the economy and weighing on public finances."Given the prominence of EU funds in public investments, Hungary's growth in the longer term (i.e., beyond S&P’s current forecast horizon through 2022) is likely to suffer from potential post-Brexit cuts in the total size of EU funds, alongside likely changes to their allocation criteria, S&P warns.
The rating agency also noted that some government measures could be detrimental to long-term growth performance, “by reducing competition in Hungary's product markets, including via the introduction of sectoral taxes that have disproportionately fallen upon foreign investors."
Checks and balances between branches of government are more limited than in the past, it added, but noted that “these restrictive actions do not appear to have made Hungary less attractive to foreign investors in manufacturing (including car making), or the more outward facing parts of Hungary's booming services sector, which is currently operating an external surplus of over 5% of GDP."
With regard to competitiveness, S&P highlighted that, at a quarter of German levels, Hungarian wages remain considerably below those of Western Europe.
This means that cost constraints on the auto sector could stream more, rather than less, FDI into Hungary due to global pressures.
Legal action against Hungary by the EU (such as the recent approval of the "Stop Soros" package of laws, among other several ongoing infringement procedures), “could destabilize relations between Hungary and the EU, potentially derailing EU investment projects and undermining private investor confidence," S&P warns.At the same time, it also believes that sizable financial sanctions or cuts in the structural funds to Hungary for EU policy noncompliance are unlikely before 2020, when the current EU multiannual financial framework ends. It also noted that reductions after 2020 are more likely but they would still require unanimity among EU member states.
As regards the budget, S&P does not see risks of a material overshooting of the 1.8% of GDP budget deficit target for 2019, “given that a portion of this year's expenditures (about 0.2% of GDP) was allocated in 2018, still enabling the government to post a narrower-than-expected fiscal deficit of 2%." At the same time, it regards the government's plans to reduce general government deficits to 0.5% by 2022 as optimistic.
“This is due to recent tax cuts and new spending proposals, which--absent a profound public administration and pension reform, and despite the automatic compensation mechanism envisaged by the six-year wage agreement--might put long-term pressure on government finances, especially if economic growth becomes weaker than the relatively ambitious government projections (on average 4% in 2019-2021)."As a result, we believe that the opportunity to put public debt on a sharp downward trend offered by the current cyclical upturn might be missed.
If this proves to be the case, public debt net of liquid assets is likely to stay elevated at above 60% of GDP through 2022, limiting the government's room for fiscal maneuver in case of stress. (This estimate also includes debt liabilities of Magyar Eximbank, which Eurostat has recently classified as part of the general government sector.)Fitch ratings is scheduled to review Hungary’s credit ratings this Friday. The rating agency has a positive outlook on Hungary’s ratings since 2017, so another upgrade is possible.
