The enfant terrible of the EU, locked in a constant war of words with Brussels, while struggling to reduce the highest state debt burden in Central and Eastern Europe – the 2016 model Hungary looks little different on surface to the 2011-12 version, when the country lost its investment grade rating.
Yet analysts and investors are pretty confident this will be the year Hungary finally escapes “junk” status. That view garnered additional support in late January as Fitch Rating’s lead analyst for the country said there's “definitely hope” for an upgrade in 2016. So what has changed?
Budapest’s conviction has been constant over the past five years. Officials have variously blasted and cajoled Moody’s Investors Service, Standard & Poor’s and Fitch ever since the agencies downgraded the sovereign when the government finally gave up the pretence it was seeking a new stand-by loan agreement from the International Monetary Fund and EU.
The deal was meant to provide the international institutions with some leverage to rein in Prime Minister Viktor Orban’s erratic policymaking. Without it, the Fidesz government’s evident lust to extend its grip over the country’s political and economic life became one of two major risks for the sovereign credit rating. The other was the state debt’s stubborn refusal to stray far below 80% of GDP.
S&P’s “political downgrade” of Poland this January – triggered by policies from the new government in Warsaw seemingly taken straight from the Orban playbook to consolidate power – might suggest Hungary’s chances of an upgrade may have taken a step back. Moody’s and Fitch have both warned that they could follow suit on Poland.
Yet analysts say they expect the rating agencies to shift in the opposite direction in Hungary’s case, to focus instead on the country’s improving economic fundamentals. “It was a bit of a surprise that there was no return to investment grade last year,” Gintaras Slizhyus of Raiffeisen Bank International tells bne IntelliNews. “I think it’s almost a certainty this year – the rating agencies would have problems to explain it if they don’t act.”
“It’s a tough call,” says Charlie Robertson at Renaissance Capital somewhat more cautiously. While he still sees plenty of reasons why the rating agencies might be hesitant, mostly on the political side, he also notes that, “the Hungarian economy looks more creditworthy than it did”.
“Hungary’s significant current account surpluses, low interest rates and low inflation, and the delivery of faster economic growth can prompt at least one upgrade in 2016,” he predicts, adding that such a move “would still leave Hungary two notches below Poland”.
That’s too big a gap, most analysts agree. While Moody’s et al largely dismissed Hungary’s EU-leading growth of 3.7% in 2014 and the anticipated 3.0% of last year, they’re now likely to take more note of strong fundamentals, despite expectations that GDP expansion will drop to around 2.0% this year, suggests Szilard Kondora at OTP Bank.
Budapest’s continued efforts to rein in the deficit and, in particular, the debt burden are behind that belief. However, the government has struggled to gain much traction on headline state debt. In fact, without the strong economic growth seen over the past few years, the burden would likely have grown rather than falling to 76% or so of GDP by the end of 2015.
While Moody’s changed its outlook on the sovereign to ‘positive’ in November, it pointed out 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.
However, Hungary has made great strides in reducing its vulnerability to the rocky global markets by changing the structure of its debt, even though “headline debt is still high,” Kondora says.
The share of foreign currency debt and the volume held by foreign investors – always more flighty than domestic creditors – has been squeezed down by the authorities. Kondora points out that the level of forex debt in overall state debt fell to around 32% by late last year from 50% in 2011, and that domestic investors now hold close to 57% of the total compared with just 40% five years or so ago.
Back to business
The other negative issue persistently invoked by the rating agencies over the years has been Budapest’s erratic policymaking. More than anything, that was code for the government’s harsh treatment of the mostly foreign-owned banks.
Since Fidesz came to power in 2010, it has imposed a punishing tax on the sector, and forced them to compensate borrowers for what it insists were sharp practices during the boom years. That has seen lending to the economy nosedive.
However, while there are still details to be ironed out, Budapest signed a peace deal with the banks in February. Although clearly wary, the rating agencies made hopeful sounds at the time, and the government is unlikely to let the opportunity escape, reckon analysts.
Fitch’s Arnaud Louis was careful in January to note that, “the government’s attitude towards businesses has… started to improve and it began cutting its tax on banks this year”. He admitted that the agency has “wanted [over the past couple of years] to see more track record of the government keeping its line on improving the business environment”, suggesting it may now be convinced.
“The probability is very low that the government will in any way violate the agreement with the banks,” argues Kondora. “It is acutely aware that the economy needs to see a boost in lending.”
There’s an even more basic reason to believe the government will keep to its side of the deal: Hungary simply has no more major banking issues to deal with, notes Gintaras Slizhyus of Raiffeisen Bank International. “We don’t expect any more tough measures on the banks. In Poland, the action on forex loans is to come, but in Hungary it is done,” he says.
S&P’s downgrade of Poland came the same day that Warsaw introduced a bank tax of its own, and unveiled a draft bill to force conversion of foreign currency-denominated debt. Hungary began reducing its banking tax this year, and completed the conversion of such forex loans, mostly mortgages, in late 2014.
Add in the fact that the Hungarian state has renationalised a pair of large banks over the past couple of years and just about everyone agrees the bitter battle is genuinely over, despite one or two t’s that are yet to be crossed. “The banks’ balance sheets are improving,” Slizhyus notes. “We’ve passed the peak of de-leveraging, and the credit market is slowly coming back to life.”
Fitch’s optimistic comments in January helped rekindle hope in Budapest that a return to investment grade is in the offing. Economy Minister Mihaly Varga claims an upgrade before summer is a possibility. Although that’s not out of the question, he may have to remain patient and wait until Fitch’s scheduled review in May.
Moody’s, which kicks off the reviews on March 4 could prove wary still, suggests RBI’s Slizhyus. “Moody’s traditionally puts more weight on the banking sector, so may be more conservative due to any potential pending issues,” he notes.
S&P, which has been highly conservative toward Central Europe’s Visegrad countries in recent years, is also likely to disappoint in March. The agency upgraded Hungary to one notch below investment grade in March 2015, citing the improvements in debt and the continuing economic growth. Another move inside 12 months could be a stretch, given the progress since. A review in September kept the outlook stuck at ‘stable’.
“We [still] see plenty of reasons why the agencies may be hesitant,” says Robertson. “PM Victor Orban gets a lot of negative press internationally, even as other countries adopt his policies, from rolling back pension reform, to bank taxes, to building fences against refugees.”
That could yet cost Hungary. Many large institutional investors demand investment grade status with at least two of the major agencies before they can buy assets. Budapest is likely to have to wait until the autumn at least then, when S&P and Moody’s are scheduled to update their reviews once more.
No matter the specific timing, investors are already convinced. “The market has already made the decision if you look at bond yields,” says Kondora.
While that should offer comfort to Budapest in some ways, there is a catch. “The market would be disappointed for sure if no upgrade comes this year,” Slizhyus points out. “There is only downside risk.”
Indeed, Kondora suggests even a swift upgrade one-two may make little difference for Hungarian assets. The effect on net exposure may not change that much, he suggests. “While an upgrade will likely attract some more conservative investors back to the market, those with a greater risk appetite could see it as an opportunity to cash in.”