Hungary eyes second investment grade in the autumn

Hungary eyes second investment grade in the autumn
Viktor Orban's erratic policymaking has held the country back from regaining investment grade.
By Blanka Zoldi in Budapest July 22, 2016

With two rating agencies’ reviews scheduled for this autumn, Hungary is hoping for a second investment grade that could convince cautious investors to return to the country.

After Standard & Poor's suggested that it is unlikely to follow Fitch in upgrading Hungary in its scheduled review in September, the focus has turned to Moody’s. The rating agency left Budapest on tenterhooks at its last review in the wake of Brexit, but the market expects Moody’s to upgrade the country’s sovereign in November.

Budapest has been pushing for a return to investment grade since it lost the rating at all three major agencies in 2011/12, stressing the economies improving fundamentals. In May, Fitch became the first agency to offer the country an escape after close to five years in 'junk'.

At the same time, bond yields show that many investors had already been convinced before Fitch’s decision. “Since mid-2015, the market had already been one notch ahead of the rating agencies,” Gintaras Shlizhyus, researcher of Raiffeisen Bank International tells bne IntelliNews. RBI also noted that spreads on Hungarian Eurobonds are already tight compared to the average rating spread on comparable peers.

"It was a disappointment that there was no return to investment last year,” Shlizhyus claimed, adding that this year both S&P and Moody’s should offer an upgrade.

At the same time, in spite of improvements in the economy, the agencies remain wary of erratic policymaking and the independence of institutions, the central bank in particular. This seems to undermine hopes for two additional upgrades this autumn.

S&P already suggested in June that it is unlikely to offer an upgrade at its next scheduled review on September 16. S&P has been highly conservative towards Central Europe’s Visegrad countries in recent years, and has put greater emphasis on political issues recently. It offered a particularly stern review in March as it held the country one notch below investment grade at BB+. The Hungarian government’s recent spats with the EU and scandals over the spending of central bank foundations will not help to change S&P's stance.

Since many large institutional investors demand investment grade status with at least two of the major agencies before they can buy assets, only one additional investment grade is needed to help boost investment in Hungary. All eyes are on Moody’s next review scheduled for November 4.

The timing would fit the standard mode of operations, as Moody's moved its outlook on Hungary to positive in November 2015. After years of pain for lenders, the Hungarian government has recently sealed a peace deal it agreed with the bank sector early last year. Moody's, which traditionally puts more weight than its peers on the banking sector, changed its outlook on Hungary’s banking sector to positive, raising hopes for offering a sovereign upgrade already on July 8.

In the wake of Brexit, however, Moody’s confirmed Hungary’s sovereign rating at “Ba1”, one notch below investment grade. As the UK’s decision to leave the EU has left many uncertainties about the future direction of European economies, the rating agency’s careful attitude did not come as a surprise. 

Funding challenges

In a note published ahead of Moody’s latest review, analysts at RBI had awarded a 40% probability for the upgrade in July, compared to 70% in November. “The market had been expecting that Moody’s would be more cautious after Brexit,” Shlizhyus tells bne IntelliNews, adding that post-Brexit uncertainty will present additional funding challenges for Hungary due to very high refinancing needs.

Moody’s also pointed out last November that debt is the major issue holding back an upgrade. “The Hungarian government has very large borrowing requirements, exposing it to higher refinancing risks than many higher rated peers,” the analysts wrote.

Hungary has been struggling to quash high state debt. Progress has been slow but steady, but went into reverse in the first quarter of 2016 as it rose by 1.6pp on a quarterly basis to 76.9% of GDP.

The increase in state debt, together with the recent U-turn of Hungarian fiscal policy towards loosening suggest that eyes of the ruling Fidesz government are more on the 2018 elections than on the reviews of rating agencies.

The 2017 budget – earmarking a 0.4pp rise in the deficit to 2.4%, and increased spending this year – has been a “disappointment”, according to Shlizhyus, while Otilia Dhand from Teneo Intelligence noted to bne IntelliNews that “fiscal loosening in 2017 seems to be a one-off in the run-up to elections”.

Dhand argued that strong current account surplus, low budget deficit, and declining though still high debt point to an upgrade by Moody’s, while GDP growth development remains the only unknown factor that might influence Moody’s decision.

Numbers for the Q1 were very disappointing, but if there is a credible rebound in Q2, it would point to a likely rating upgrade. Provided there is no major negative event in Hungary or globally in the meantime,” Dhand told bne IntelliNews.

Preliminary Q2 data will be released in mid-August and final data in September. Alarmed by poor Q1 data, the government was reported to be preparing an economic stimulus package, should the numbers be disappointing again. “Presumably, it would be announced before the November Moody’s decision,” Dhand predicted.

Should Moody’s return Hungary’s sovereign grade, there is little volatility expected on the market. "The market will be significantly expecting an upgrade,” Shlizhyus said, adding that "there is only downside risk” as the market would be disappointed if Hungary did not receive a second upgrade this year.