Scope Ratings AG has today upgraded the Republic of Hungary's long-term local-currency rating to BBB from BB+, following the release of its revised sovereign rating methodology, and has converted its status from subscription to public. The agency has also assigned a long-term foreign-currency issuer rating of BBB, along with a short-term issuer rating of S-2 in both local and foreign currency. The sovereign’s senior unsecured debt in local and foreign currency was also rated at BBB. All Outlooks are Stable.

Rating drivers

Hungary's BBB rating balances the country’s European Union (EU) membership and high absorption of EU structural funds, robust economic performance and sustained fiscal consolidation against high public debt levels and weakening institutional credibility leading to a less predictable policy environment. The rating upgrade is driven by strong improvements in Scope’s assessment of Hungary’s ‘domestic economic risk’, ‘public finance risk’ and ‘external economic risk’ analysis categories and reflects: i) the improving macroeconomic performance and outlook; ii) progress in fiscal consolidation and prudent debt management; and iii) reduction in external imbalances.

Scope’s upgrade of Hungary’s rating is underpinned by the country’s robust economic performance and outlook, along with an expected pick-up in the absorption of EU structural funds. Annual real GDP growth has averaged 2.8% since 2013, primarily driven by private consumption, attesting to an efficient and improving labour market. Over the coming years, Scope expects robust economic growth to continue on the back of rising private consumption supported by several social reforms and investments, including recently announced business developments in the automotive sector. Public consumption is also expected to increase steadily in the short and medium term, stimulated by the 2018 parliamentary elections as well as a higher absorption of EU structural funds after the transition to the new 2014-2020 EU multiannual framework. In fact, Hungary is the third-largest recipient of EU funds in absolute terms and the first in terms of GDP, with EUR 22bn in EU structural and cohesion funds allocated over the 2014-2020 time period.

The ratings are further supported by Hungary’s continued fiscal consolidation, as well as improvements in the government’s debt structure and funding sources. The sovereign successfully exited the EU’s Excessive Deficit Procedure in June 2013 and has reduced its budget deficit to below the Maastricht threshold of 3% of GDP since 2012. Going forward, Scope expects the government to continue to commit to European fiscal rules despite higher expenditures and lower tax rates, following recent tax reforms. Long-term budgetary pressures remain moderate in view of an ageing population with long-term health and pensions expenditures projected to increase only gradually to 2060, and to remain below the EU average.

In addition, the debt structure has improved significantly over the past few years, reflecting the debt management office’s prudent debt funding strategy. Public debt exposure to exchange rate risk has fallen sharply in line with efforts to limit the share of foreign-currency-denominated debt within a 15-25% share of total debt. At the same time, debt held by non-residents has decreased markedly from a share of above 60% in 2011 to around 40% in 2017. It is Scope’s opinion that these structural changes in the composition of Hungary’s debt, combined with a solid cash buffer of approx. 5% of GDP alongside continued investor demand, significantly reduce the sovereign’s refinancing risk.

Scope has a positive view on the clear progress made in reducing external imbalances, driven by sustained current account surpluses since 2010, deleveraging in the banking sector, redemption of loans granted under the Balance of Payments assistance in 2010-2012, and the government substituting its external debt for domestic issues, supported by the Hungarian central bank’s self-financing programme. Hungary’s external debt declined from 185% of GDP in Q2 2009 to 115% of GDP in Q1 2017. In addition, the improved composition of external debt has also reduced Hungary’s external vulnerabilities. The country’s share of short-term external liabilities declined to around 10% in 2016 (down from 16% back in 2010) while at the same time, 70% of foreign liabilities are related to direct investments, limiting the potential impact of any possible reversal of capital inflows resulting from a normalisation of US and euro-area monetary policies. Moreover, the high reserves-to-short-term-external-debt ratio of around 170% provides Hungary with an additional buffer against external shocks.

However, Hungary’s credit strengths remain constrained by its high public-debt level, relatively poor non-price competitiveness as well as weakening institutional credibility contributing to a deterioration in the country’s business climate. Despite a continued downward trajectory since 2011, Hungary’s public debt of 74% of GDP in 2016 remains relatively high compared to peers and well above the Maastricht threshold of 60%. Scope’s public-debt sustainability analysis (DSA) foresees only a gradual decrease in the debt-to-GDP ratio to around 70% over the medium term. In addition, while Scope’s stressed DSA scenario highlights the recently attained resilience of debt dynamics to exchange rate risk, it also identifies slower growth as the key risk to Hungary’s debt sustainability.

Finally, relatively weak non-price competitiveness, reflected in subdued productivity growth and a deterioration in the business climate, represents an important credit weakness in Hungary’s long-term economic growth prospects. Recent political developments in Hungary, especially growing government disregard for EU institutions and foreign companies, and the resulting unpredictability of the regulatory system, have affected the sovereign’s creditworthiness by altering the perceived credibility of its institutions, and the associated ability to conduct business in a free, transparent and predictable environment. This state of affairs is documented by a continued worsening in the World Bank’s indicators for Hungary’s rule of law, government effectiveness and control of corruption.

Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative “BBB” (“bbb”) rating range for the Republic of Hungary. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis. For the Republic of Hungary, debt sustainability has been identified as a relative credit strength. Relative credit weaknesses are: i) vulnerability to short-term shocks; ii) recent events and policy decisions; and iii) financial sector oversight and governance. The combined relative credit strengths and weaknesses indicate a sovereign rating of BBB for Hungary. A rating committee has discussed and confirmed these results.

For further details, please see Appendix 2 of the rating report.

Outlook and rating-change drivers

The confirmation of the Stable Outlook reflects Scope’s view that risks to the ratings remain broadly balanced. The rating could be upgraded if: i) the sovereign meets its fiscal targets and achieves a sustained debt reduction; ii) gains in non-price competitiveness, including transparency in government policymaking, lead to improvements in the business climate and increase growth potential. Conversely, the rating could be downgraded if: i) public finances deteriorate due to a reversal of fiscal consolidation; ii) there is a rise of external and foreign-currency debt; iii) a further deterioration in the business climate reduces investments; iv) the absorption of EU funds is lower than expected.

For the detailed research report, please click HERE.

Rating committee

The main points discussed by the rating committee were: i) Hungary’s growth potential, ii) macroeconomic stability and imbalances, iii) current account vulnerabilities, iv) vulnerability to shocks, v) coherence and credibility of monetary policy, vi) fiscal performance, vii) public debt sustainability, viii) external debt sustainability, ix) recent events and policy decisions and x) peers.

Methodology

The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available at www.scoperatings.com.The historical default rates used by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/governance-and-policies/regulatory/esma-registration. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies at www.scoperatings.com. The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is, however, not automatically ensured.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings AG.

Rating prepared by Rudolf Alvise Lennkh, Lead Analyst
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director

The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The subscription ratings/outlooks were last updated on 05.05.2017. The senior unsecured debt ratings as well as the short-term issuer ratings were assigned by Scope for the first time. As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on Republic of Hungary are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2017" published on 21.07.2017 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the deviation was due to the recent revision of Scope’s Sovereign Rating Methodology and the subsequent placement of the ratings under review, in order to conclude the review and disclose ratings in a timely manner, as required by Article 10(1) of the CRA Regulation.

Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.

The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: the Ministry of Finance of the Republic of Hungary, Central Bank of Hungary, BIS, European Commission, European Central Bank (ECB), Statistical Office of the European Communities (Eurostat), IMF, OECD, and Haver Analytics.

Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Conditions of use / exclusion of liability
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