Hungary policy blunders spook rating agencies


Matthew Turner
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As forint falls, fears over sovereign creditworthiness grow, with the jury out on the pace and composition of fiscal adjustment.

ECR overview Investors have received an early warning of the increased risks associated with the Hungarian economy from analysts participating in Euromoney’s Country Risk (ECR) survey – a real-live measure of risk sentiment across 186 markets. ECR economists participating in the survey downgraded Hungary’s overall risk assessment score by 4.8 points yr/yr and 0.9 points Q/Q. This score decline leaves the sovereign among the 10 worst performers in 2012, after Argentina and Zimbabwe. And investors appear to have reacted, with gross investment as a percentage of GDP dropping by 5.5% in 2011, from an average of about 25% between 2000 to 2005, according to a report by Standard and Poor’s (S&P). However, with a global rank of 68 in the ECR rankings, Hungary, lead by Prime Minister Viktor Orbán, now languishes at the bottom of tier three and could soon exchange places with the Philippines and slip into tier four if unorthodox economic policies, initiated by the government, persist.
Hungary, lead by Prime Minister Viktor Orbán, has seen its credit rating score deteriorate in 2012
The sovereign’s position in the rankings roughly equates with a BB+ credit rating – one notch below investment grade. This means Hungary’s ERR score and global rank is on a par with Fitch’s BB+ and Moody’s Ba1 credit rating. Countries in tier four score between 36 and 49.9, and are usually equated with a junk credit rating, ranging from B- to BB+, whereas countries in tier three score between 50 and 64.9, and can be equated with a credit rating of BB+ to A-. Credit rating actions The deterioration in Hungary’s overall ECR score corresponds closely with the decision by the three main credit rating agencies, which either downgraded the country’s credit rating or assigned it with a negative outlook in 2012. Moody’s downgraded Hungary’s government bond rating to Ba1 with a negative outlook in November 2011. The decision has remained unaltered, but fears are growing that the country could face a further downgrade in 2013 if current economic conditions persist and if the policy environment becomes more unpredictable. Moody’s cited “high susceptibility to event risk stemming from the government’s high debt burden, high refinancing needs and heavy reliance on external investors as the country is exposed to heightened external market volatility” as key reasons for assigning Hungary with a Ba1 credit rating. In January 2012, Fitch followed suit, after the rating agency downgraded Hungary’s rating to BB+ from BBB- with a negative outlook. However, the country’s outlook has since been revised upwards to stable in December 2012, after the government announced fiscal consolidation measures that would commit the incumbent administration to narrowing the budget deficit to below 3% of GDP, in line with EU standards. S&P is more bearish on the government’s economic course, after the agency lowered the country’s credit rating to BB from BB+ in November 2012. This leaves the country’s credit rating two steps below investment grade. The agency cited “Hungary’s still-high fiscal and external liabilities and recurrent use of unorthodox, and possibly unsustainable, economic policies against its success in reducing fiscal deficits to less than 3% of GDP”. Unorthodox policies exacerbate debt burdenHungary’s credit outlook is therefore threatened by a volatile and unpredictable policy environment, according to analysts, which has cast a dark shadow on the government’s ability to effectively contain the country’s spiralling debt burden and spur economic growth. Leila Butt, a credit analyst at S&P, acknowledges that “some of the polices the government has implemented over the past few years have the potential to damage economic growth”. She adds: “While the government does have a strong indemonstrable commitment to reducing the country’s deficit, the quality of the adjustment could have been much better.” A credit analysis report, published by Moody’s Investors Service, recognises that Hungary’s growth prospects are “constrained by a number of economic policies, which have negatively affected investor confidence”. Similarly, Fitch points towards the “government’s track record of unorthodox policies, with respect to the banking sector” and “fiscal and external financing risks” as key factors that continue to undermine the country’s credit portfolio. While S&P cites Hungary’s continued “fiscal rationalization, an unpredictable tax environment and tight credit conditions” as factors that continue to weigh heavily on the country’s growth prospects. Hungary’s public debt is estimated at around 78% of GDP in 2012 – a level that compares unfavourably to the BB median of 40%. The impact of the government’s harsh austerity measures and crisis taxes have been felt in almost all sectors of the economy. However, the measures inflicted on the banking sector is a credit negative. As Butt says: “The measures imposed in the banking sector resulted in muted or stagnant credit growth over the next few years. The level of deleveraging in the banks has been much more pronounced in Hungary than other Eastern European countries. The financial services sector has been heavily burdened by the fiscal adjustment policies.” Credit outlook in 2013 Restoring investor confidence will therefore hinge on the formation of a more predictable policy environment, with the government needing to ease the pace and extent of adjustment measures – a move that would require creating conditions that support sustainable and inclusive growth. Indeed, Hungary’s low economic growth prospects have been a main drag on the country’s credit profile. The economy is expected to grow by only around 0.2% to 0.4% between 2011 and 2013, and growth rates of this could hinder the government’s ability to control the fiscal deficit. “The weak growth environment will make it more difficult to reduce the level of debt stock,” says Butt. Factors that are credit positive, however, include the strong performance of the manufacturing sector and the government’s institutionalization of structural reforms. These should stand the economy in good stead down the line. Also, the flexibility of the labour market should assist competiveness in the economy and could prompt investors to set up in Hungary. “The labour market is extremely flexible, much more so than in other EU states and structurally it is quite dynamic,” says Butt. However, forecasts for economic growth are largely based on what will happen in the eurozone – and Germany in particular – as there is a high correlation between German import demand and Hungarian exports. “A recovery in the eurozone would result in stronger overall economic growth in Hungary, although domestic demand would remain quite muted, given the effect of the austerity measures,” says Butt. This leads ECR to conclude that improved external conditions, followed by a commitment to restore debt sustainability by the government, is needed to improve Hungary’s credit profile and restore investor confidence. This will depend on the extent to which the government eases the pace of fiscal consolidation and the extent of austerity measures, by following a more predictable and sustainable policy path. Achieving this would help improve investor confidence and boost the economy’s competitiveness.

This article was originally published by Euromoney Country Risk