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Fitch Ratings affirmed Hungary at 'BB+' on June 6, one notch below investment grade, and kept its outlook 'Stable'. The rating agency's refusal to offer a way back from "junk" will disappoint some.

There had been growing speculation - encouraged by the government - that Hungary would earn back investment grade status from at least one of the three agencies on June 6. Budapest has been boasting ever-louder of its success in reviving the economy, so it will particularly rankle that Fitch points out growth remains below other high yield peers on average. 

Officials from the central bank said in early June that it has been talking with one of the three major ratings agencies - which have all Hungary below investment grade for over two years - and that an upgrade is due by the end of the year. Analysts at Concorde followed that up by claiming this week that Fitch was set to deliver.

The frustration in Budapest has been palpable. Ferenc Kumin, international spokesman for Prime Minister Orban, railed against the country's high yield status on June 4, and claimed somewhat curiously that recent macroeconomic data "has many in the financial sector calling for an upgrade".

"An upgrade on Friday may be just a rumor," he admitted on his blog, "but it is becoming increasingly difficult for the credit rating agencies to ignore the brightening fundamentals of Hungary's economy. It is time to upgrade the rating."

The warnings on state debt, banking stability and government interference in the economy will do little to cheer the PM and his Fidesz government either. However, the hint that the recovery is yet to prove itself will likely do most to make blood boil in Budapest. The wider view of analysts is that while the recovery looks healthy in the short term, it will be shortlived without a return of investment - and Fidesz policy has scared much of that off for some time.

As Fitch notes, "the key growth driver has thus far been an increase in public sector activity (jobs schemes and stronger EU funds absorption), raising questions about the sustainability of the recovery."

While Fitch has disappointed however, Budapest will soon have another opportunity. Moody's Investors Service is due to review its rating on Hungary on July 4. S&P will next reassess its rating on September 19, after upgrading its outlook to 'Stable' from 'Negative' in late March.

The full press release from Fitch is below:

Fitch Affirms Hungary at 'BB+'; Outlook Stable 

Fitch Ratings has affirmed Hungary's Long-term foreign currency Issuer Default Rating (IDR) at 'BB+' and its local currency IDR at 'BBB-'. The Outlooks are Stable. The issue ratings on Hungary's senior unsecured foreign and local currency bonds have also been affirmed at 'BB+' and 'BBB-', respectively. The Country Ceiling has been affirmed at 'BBB' and the Short-term foreign currency IDR at 'B'. 

KEY RATING DRIVERS _
The affirmation of Hungary's sovereign ratings reflects the following key rating drivers: Gross general government debt (GGGD), at 79.2% of GDP in 2013, is around twice the 'BB' and 'BBB' medians and remains Hungary's key rating weakness. The public debt ratio has changed very little in recent years despite considerable fiscal consolidation and the return of private pension assets to the public sector. Fitch forecasts that the debt ratio will fall gradually in the medium term as deficits remain moderate and economic growth picks up, and that the share of foreign currency denominated debt (currently 41%) will gradually fall, reducing vulnerability to volatility in the HUF exchange rate. However, in the agency's baseline scenario, public debt will still be above 70% towards the end of the decade, generating large annual gross borrowing needs and rendering it vulnerable to economic or financial shocks. 

Average GDP growth in Hungary remains below that of its 'BB' and 'BBB' peers. Growth accelerated and unemployment fell sharply in 2013 and early 2014, leading Fitch to raise its growth forecast for 2014 to 2.7%. However, the key growth driver has thus far been an increase in public sector activity (jobs schemes and stronger EU funds absorption), raising questions about the sustainability of the recovery. Conventional and unconventional monetary policy measures, including a Funding for Growth Scheme are also helping to boost economic activity. Fitch deems evidence that private sector activity is strengthening is still tentative at this stage. 

The external balance sheet continues to improve owing to a substantial (3% of GDP in 2013) current account surplus (CAS) and ongoing deleveraging. Fitch expects the CAS to remain substantial in the medium term as export capacity is ramped up and net inflows of EU funds remain strong. This facilitates the ongoing process of external deleveraging. Fitch forecasts that net external debt will fall to 43% of GDP (on IFS methodology, which differs from national methodology) from 65% in 2013, although it will still be some way above the 'BB' (20%) and 'BBB' (11%) medians. A mitigating factor is that intercompany loans make up one-quarter of external debt. 

The banking sector is adequately capitalised in aggregate, although there is considerable disparity among individual banks. The sector enjoys solid HUF liquidity. Non-performing loan ratios remain high and rising, and banks' operating environment is unfavourable. Outstanding FX mortgages had fallen to 15% in 2013 from 27% of GDP in 2011, but remain sizeable and the risk of a solution that increases the burden on banks has not dissipated. 

The re-election of Fidesz in April 2014 with another two-thirds majority is likely to mean that the government will continue to mix fiscal discipline with economic policies aiming to increase the domestic footprint in sectors such as banking and energy. 

Hungary's GDP per capita is high, relative to 'BB' and 'BBB peers, reflecting its high level of economic development and integration with Western Europe. EU membership underpins domestic politics and institutions. 

RATING SENSITIVITIES 
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main risk factors that, individually or collectively, could trigger positive rating action are:_- A discernible reduction in the public debt ratio and further lowering of the foreign currency share. _- Continued, sustained reduction in external indebtedness._- Evidence of stronger growth prospects supported by an improved business environment and greater policy stability. 

The main risk factors that, individually or collectively, could trigger negative rating action are:_- Sustained fiscal slippage that endangers debt sustainability._- Policy missteps that pose risks to the inflation and currency outlook, which could in turn exacerbate macro-financial risks. _- A global macro-financial or geopolitical shock, leading to a severe recession or loss of financial market access. 

KEY ASSUMPTIONS

- Fitch assumes the Hungarian authorities will maintain fiscal discipline, broadly in line with the targets included in the Convergence Programme submitted to the EU in April 2014 - Fitch does not factor into its debt sustainability any impact from a EUR10bn bilateral credit line agreed with Russia in March 2014 for the construction of a new nuclear plant. Information regarding the drawdown and repayment schedules of the loan is scant at this juncture, although Fitch understands that these are spread over a period stretching beyond the horizon of the agency's debt sustainability analysis. 

- Fitch assumes that under severe financial stress, support for Hungarian subsidiary banks would come first and foremost from their parent banks - Fitch assumes the gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key economic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term.