EU funds 5 May 2023, 2:36pm

Fitch sees downgrade risk for Hungary beyond dispute with EU

Portfolio

Hungary’s judicial reforms are a step towards unlocking some of the country’s suspended EU funding, but the timing and size of eventual disbursements remain uncertain, Fitch Ratings said on Friday. It continues to believe that disbursements of Recovery and Resilience Plan (RRP) funding are unlikely before the end of the third quarter this year. The credit rating agency warned that failure to address concerns about macroeconomic policy credibility and governance that could expose Hungary to renewed periods of market stress or worsen macroeconomic imbalances is a negative rating sensitivity.

The Hungarian parliament on 3 May passed a bill that aims to reduce the scope for political interference in Hungary’s courts. The government presented the bill last month after discussions with the European Commission. EU officials have said that its passage could help to unlock a big part of the suspended Cohesion Funds, but that additional reforms are still required for this to happen.

In particular, Hungary is still assessed as not being compliant with the specific enabling conditions due to provisions of the child-protection law (2% of the overall cohesion envelope) and threats to academic freedom and the right to asylum (9% of the overall cohesion envelope),

Fitch Ratings said.

Concerns about anti-corruption and the public procurement system were central to the EU’s decision to suspend 29% of allocated Cohesion Funds (cc. EUR 6.3 billion) related to three cohesion programmes from the 2021-2027 Multiannual Financial Framework (MFF) late last year. Disbursement of grants for Hungary’s EUR5.8 billion National RRP depends on meeting 27 ‘super-milestones’, many of which also relate to the rule of law.

As Portfolio reported yesterday, the €13 billion of cohesion funds not frozen by other procedures could ideally be drawn by the government only in the autumn. The judicial reform package adopted by parliament this week will only come into force on 1 June. Only then will the European Commission start assessing the legislation to see whether it meets EU requirements. And for the recovery fund, there are still more super-milestones to be met.

Risks in policy mix remain

Uncertainty persists over when and how Hungary will enact additional measures necessary to secure Cohesion Fund disbursements, Fitch said.

The government’s proposal to ask the OECD to assess its new policies and measures on public procurement and anti-corruption lowers the risk that differing interpretations by the EU and Hungarian authorities of whether the super-milestones have been met, as well as political considerations,

would further delay RRP disbursements (the Commission waived the 1Q23 deadline to fulfil the super-milestones).

Fitch added that further delays would be consistent with their assumptions when they previously reviewed Hungary’s sovereign rating in January 2023 (Outlook cut to Negative).

Any disbursement of Recovery and Resilience Facility grants before end-3Q23 seems unlikely,

but Hungary continues to receive agricultural funds under the current MFF and remaining funds under the 2014-2020 MFF, which need to be paid out by end-2023."

"While the impact of delayed disbursement on medium-term growth and public and external finances would be modest, EU funding remains a supportive and low-cost source of finance for Hungary, and

further delays would highlight questions over policy credibility.

Fitch reminded that vulnerabilities from a policy mix influenced by political considerations, in the face of tougher external conditions, were a key driver of their decision to revise the Outlook on Hungary’s ‘BBB’ rating to Negative at their January review.

Failure to address concerns about macroeconomic policy credibility and governance that could expose Hungary to renewed periods of market stress or worsen macroeconomic imbalances is a negative rating sensitivity,

Fitch warns.

It noted that several policy decisions that have contributed to this assessment are unrelated to the disputes over EU funding. For example, the introduction of price caps on basic foodstuffs has not stopped inflation exceeding 25%, while caps on mortgage rates have hampered monetary policy transmission.The next scheduled review of Hungary’s rating by Fitch is due on 23 June.