Economy 29 April 2020, 8:50am

S&P lowers outlook on Hungary's rating

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Standard & Poor's Global Ratings has revised its outlook on Hungary to stable from positive. At the same time, it affirmed its 'BBB/A-2' long- and short-term foreign and local currency sovereign credit ratings on the country. The rating agency said it expects the Hungarian economy will contract by 4% in 2020 due to the adverse effects of the COVID-19 pandemic. S&P also noted that the invocation of the emergency law has further eroded checks and balances between branches of power.

Overview

S&P expects the Hungarian economy will contract by 4% in 2020 due to the adverse effects of the COVID-19 pandemic.
Strong macroeconomic fundamentals and ongoing policy stimulus should allow the country to absorb the shock, and S&P expects growth to recover in 2021.
However, there is high uncertainty over the pandemic's duration and the resulting economic and fiscal fallout.
S&P has therefore revised its outlook on Hungary to stable from positive, and affirmed its 'BBB/A-2' sovereign credit ratings on the country.

A stable outlook is not a drama in itself. This does not imply a risk of a credit rating downgrade. S&P only sent a message that Hungary should forget about an upgrade in 2020. The surprise lies in the timing, as it suggests that the rating agency wanted to send Hungary a message immediately rather than wait for the scheduled review in August.

Outlook

S&P believes that the negative repercussions of the public health emergency have moved risks to Hungary's sovereign credit quality over the next 24 months into balance.

The stable outlook reflects our view that downside macroeconomic risks stemming from the COVID-19 pandemic will be mitigated by the country's strong policy response and projected economic rebound in Hungary's key trading partners in 2021.

The outlook also reflects S&P's expectation that fiscal deficits will remain contained after the one-off expansion in 2020.

Downside scenario

Pressures could build on the rating should the economic downturn result in a more permanent weakening of public finances, setting public debt on a firm upward path; or put pressure on Hungary's balance of payments performance with external liquidity deteriorating significantly beyond the rating agency's expectations.

Upside scenario

S&P said it could consider a positive rating action if, following the temporary shock, Hungary's economic performance were to return to its previous strong trajectory, boosting its income levels without creating external or fiscal imbalances.

Rationale

The outlook revision follows a significant deterioration of the growth outlook for the Hungarian, European, and global economies in 2020, mainly related to the COVID-19 pandemic. The key question pertains to the timing and speed of economic recovery following the lifting of measures to contain the pandemic. This will determine the ultimate impact of fiscal and monetary stimulus on the Hungarian economy's medium-term growth trajectory.

"In line with our growth outlook for the global and European economy, our rating scenario for Hungary considers a recovery starting in the second half of 2020. In such an event, the expected weakening of the government's fiscal position and a resulting spike in public debt would prove temporary.

A later and more gradual recovery path, however, could require recurring policy stimulus. This could have a more detrimental effect on the government's fiscal and monetary policy position.

S&P said there are no signs of external releveraging, and foreign currency funding of the private sector has been contained in recent years. While headline fiscal deficits have remained limited, general government debt remains at the highest level among regional peers and weighs in the sovereign rating.

Additional rating constraints pertain to weak checks and balances between government branches and moderate wealth levels.

Key estimates

Driven by the global slowdown, S&P expects the small and open Hungarian economy (exports represent 85% of GDP) will contract by 4.0% in real terms in 2020 before rebounding to 4.8% growth in 2021. It expects all expenditure components of GDP will contract except for government consumption.

S&P forecasts the tourism and transportation sector, estimated at 5% and 6%, respectively, in 2019, will be hit particularly strongly, while manufacturing, at about 22%, will be somewhat less severely affected.

Unemployment will also rise because of this year's contraction, potentially doubling to above 7.0% from 3.4% in 2019, which had been one of the lowest levels in the EU.

S&P estimates the fiscal measures will widen the budget deficit to about 5% of GDP in 2020, pushing net general government debt to just below 70% of GDP. It also believes that the current account deficits should remain contained and overfunded by nondebt inflows.

Effectiveness of responses to the pandemic depend on timing and speed of recovery

In response to the pandemic and to cushion its economic effects, the central bank and government have been quick to announce monetary and fiscal stimulus measures, which could reach about 20% of GDP. These are aimed at supporting households, corporates, and the financial system and primarily include:

An extensive repayment moratorium on private sector loans (principal and interest)
Further extension of loans to the private sector through the central bank
Provision of increased liquidity to the banking system through various swap options, lending facilities, and temporary waiving of reserve
The installment of a quantitative easing (QE) program by the central bank
Tax reliefs, such as for heavily affected economic sectors and corporations and waivers of employees social and health care contributions
The creation of the Anti-Epidemic Protection Fund and Economy Protection Fund
Additional health care spending of about 0.6% of GDP
Additional export support measures, covering additional grants, working capital loans, and guarantees for exporters through Magyar Export-Import Bank as well as additional loan, guarantee and capital programs by the Hungarian Development Bank (MFB)

Despite these measures, the pandemic's effects will be severe and its overall effect will primarily depend on the timing and speed of the recovery, which we currently expect to start in the second half of 2020.

However, S&P does not believe that the country will revert to growth rates of the past two years by 2021. In 2018 and 2019, growth exceeded 5%, aided by exceptionally strong labor market trends and real wage growth, very high absorption of EU funds, and buoyant services export growth, which seem challenging even after the pandemic's economic effects fade.

S&P warned that even if Hungary's potential growth rate exceeds the rating agency's expectations (reflecting, for example, faster productivity gains in the dynamic services sector), it believes that

absent decisive policy measures, the country's long-term growth performance will continue to be constrained by structural challenges, namely poor demographics--exacerbated by the political reluctance to accept labor migrants--a large public sector, low productivity (especially among small and midsize enterprises [SMEs]), and a chronic skills shortage.

Checks and balances remain limited

Against the pandemic, the government has passed an "Emergency Law", allowing Prime Minister Viktor Orban to rule by decree without requiring parliamentary approval. The law includes no specific sunset clause and will be active as long as the governing coalition in parliament assesses the pandemic is having a strong effect.

Although the parliament retains the right to revoke this law, this measure reinforces our view that checks and balances between different public institutions remain limited and could make future policy responses less predictable.

"Some previous unconventional measures from the current administration have helped reduce the open economy's external vulnerabilities but were also aided by a favorable external environment. Other measures could, however, be detrimental to long-term growth performance by reducing competition in the country's product markets, including via the introduction of sectoral taxes that have disproportionately fallen upon foreign investors," S&P added.

At the same time, it noted that these restrictive actions do not appear to have made Hungary less attractive to foreign investors in manufacturing (including car-making) and S&P previously did not observe that these measures had resulted in weaker net foreign direct investment (FDI) inflows. The rating agency believes FDI will fall in 2020 but resume after the pandemic fades.

In this respect, at a quarter of German levels, Hungarian wages remain considerably below those of Western Europe. This means that once the European economy recovers, key export sectors, such as the auto sector, could stream even more FDI into the country. Indeed, the pipeline of new FDI before the pandemic was one of the strongest in Central and Eastern Europe.

While the measures can effectively cushion some effects of the downturn, S&P believes that they will result in a significant fiscal deficit of about 5% of GDP, including a decline in revenue due to the economic contraction. This will push the net general government debt stock-–the highest public debt stock in the region--to just below 70% of GDP at the end of 2020. S&P projects net general government debt to decline to about 66% of GDP toward the end of its forecast horizon.

Cover photo: Getty Images