Hungary is on a hiding to nothing as it awaits a review from Fitch after the market closes on May 20.
An upgrade, which until recently was the overwhelming bet, would offer some recovery from recent pressure on yields and the forint as concern that another disappointment is on the way has mounted. However, for the most part, an escape from five years in ‘junk’ has been priced in for months.
On the other hand, with speculation building in recent weeks that Fitch is now unlikely to return Hungary to investment grade, yields and the currency are at risk of a jolt, suggest analysts.
After S&P and Moody’s disappointed in March, the market has been pricing in an upgrade from Fitch on May 20. However, Hungarian bond yields have been moving out in recent days, illustrating building suspicion that the rating agency is set to disappoint Budapest.
There are some that still believe an upgrade could come this year. Fitch moved its outlook on Hungary to positive a year ago, and it usually takes at least 12 months for a change in a rating to follow such a move.
“Fitch can still decide to wait with the upgrade, given that according to [the agency’s] general guidance, rating outlooks indicate the direction a rating is likely to move over a one- to two-year period,” points out Eszter Gargyan at Citibank to bne IntelliNews.
However, like most, the analyst is doubtful that the May 20 review, on which so much expectation has been piled over the past few months, will now offer a return to investment grade, which Hungary lost at all three major agencies in 2011/12.
“The recent dynamics in domestic policies, such as the fiscal stimulus planned for 2017, the transparency concerns related to spending of central bank foundations, and the disappointing Q1 growth, weaken the chances of a rating upgrade from Fitch [on May 20],” she sums up.
To a large extent, that’s a result of an apparent change of tack in Hungary’s own approach. After years of lusting after a return to investment grade, the government appears to have changed tack at the last moment ahead of the Fitch review.
The fundamentals of the economy and fiscal policy have been Hungary’s argument for a return to investment grade for some time, with the markets apparently in full agreement. Earlier this year, Hungary’s 10-year benchmark bond yield dropped below its Polish equivalent for the first time this century.
"Over the past year, expectations of an upgrade have persisted and this can partly be seen in the compression of yield spreads between Hungarian and Polish debt, despite a sizeable four-notch rating gap," UniCredit pointed out in a recent note.
Change of plan
However, with an eye on elections in 2018, the Fidesz government surprised earlier this month as it unveiled a 2017 budget earmarking a 0.4pp rise in the deficit to 2.4%, and increased spending this year. Other data from the start of the year also suggests an escape from junk is no longer the top priority in Budapest.
Hungary has been struggling to quash high state debt – another red flag for the ratings agencies - for years. 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 deterioration in fiscal consolidation will likely only train Fitch’s eye more keenly on slowing economic growth. Hungary recorded a 0.8% q/q contraction in GDP in the first three months of the year. The budget shortfall is based on a growth target of 3.1% for the year.
It’s already attracted the eye of Prime Minister Viktor Orban, according to the evidence. Approaching what it says is the end of an easing cycle that started in March, the Magyar Nemzeti Bank has guided that it will likely offer a final cut this month, to leave the benchmark at 0.9%.
Tightly connected to Orban, the rate setter’s retreat at this point suggests it will now hand the stimulus baton over to fiscal policy, in a bid to offer a bigger push, analysts point out. The need for an economic boost is clear, with the government also fighting falling support due to protests from teachers and taxi drivers.
On the other hand, it may be that Fidesz has simply decided to bow out of a fight it either knows, or senses, is already lost. In the midst of a rise in populism around the region – ratings agencies have noted recently the risks of loosened fiscal policy in Poland and Slovakia also – Fitch et al. have put ever greater focus on institutions; none more so than the central banks.
Graeme Hutchison, who runs the local office of the European Bank for Reconstruction and Development, reflected common expectation as he suggested to bne IntelliNews in April that an upgrade is likely “in 2016 if there are no more shocks”.
That was just days before the Magyar Nemzeti Bank blew things sky high. A scandal over the use of billions of euro worth of central bank funds saw the opposition demand the head of Governor Gyorgy Matolcsy, and the likes of the European Commission expressed concerns about the independence of the MNB.
Orban has nailed his colours to the mast of the central bank chief, who was previously his finance minister, and refused to probe the public funds he has been distributing. Instead, the government has been trying to pass legislation to pull the spending from public scrutiny.
“An upgrade is well priced in,” Bank of America Merrill Lynch – which is one of the few to continue to forecast confidently that Fitch will offer an upgrade this month - noted in mid-May. That means a return to investment grade “could prove to be neutral for Hungarian assets", the analysts suggest. However, “any disappointment could add to the recent bearish sentiment towards the local bond markets amid the central bank's attempt to weaken the currency".
“The market would be disappointed for sure if no upgrade comes this year,” Gintaras Slizhyus of Raiffeisen Bank International said earlier this year. “There is only downside risk.”
Unicredit suggests "the risks may be skewed towards a knee-jerk HUF sell-off if the agency decides to remain on hold, rather than a rally on an upgrade to investment grade".
There are others that say that while an upgrade may not spark any immediate gains for bonds or the currency, it could set up it up in the long run, by opening the way for more conservative institutional investors – whose internal criteria demand an investment grade - to return to the market.
However, Szilard Kondora at OTP Bank pointed out to bne IntelliNews earlier this year that there may be little change in net investment. As the institutional investors return, he suggests, those with a greater risk appetite may well move on.
Even if Fitch - one of two agencies that has Hungary currently one notch below investment grade - does come through on May 20, the return of the more cautious investor class would largely have to wait for a second upgrade. Moody’s, which moved to a positive outlook in November, is scheduled to review the sovereign on July 8; Standard & Poor’s, which has a stable outlook on a rating that keeps Hungary two notches into junk and offered a surprisingly stern view in March, will take another look in September.
Should Fitch fail to provide an escape from junk this month, then it will have another chance in November. Moody’s is also due to issue a report that month. But by that point, Hungary’s focus may have moved even further from its sovereign rating, as the 2018 election will be just over a year away.
"The government has realised [that the economy needs more fiscal stimulus] along with recent ratings agencies comments about the risks caused by MNB unorthodoxy (policy which the government backs),” Peter Attard Montalto at Nomura suggested in a recent note. “As such, we think the government has abandoned the upgrade target, and this has facilitated a loosening of fiscal policy. The end goal is to boost growth and maintain popularity."