Fitch Ratings has today downgraded the Republic of Hungary's Long-term foreign currency rating to 'BBB+' with a Stable Outlook from 'A-' (A minus) with a Negative Outlook. At the same time, Fitch has downgraded the Long-term local currency rating to 'A-' (A minus) with a Stable Outlook from 'A' and the Country Ceiling to 'A' from 'A+', and has affirmed the Short-term rating at 'F2'.
"Fitch's downgrade of Hungary's sovereign ratings reflects the adverse impact of persistently large budget deficits, which have increased the public and external debt burdens," says Edward Parker, Senior Director in the Fitch sovereigns group. "Furthermore, fiscal ill discipline is likely to delay the adoption of the euro, has heightened vulnerabilities associated with the financing of the sizeable current account deficit and has put strains on monetary and exchange rate policy."
The foreign currency rating had been on a Negative Outlook since July 2003, as Fitch has consistently signalled the risks of the government overshooting its budget deficit targets and the deleterious effect of that on Hungary's public finances, macroeconomic balance and, ultimately, credit rating.
Budget deficits (general government, ESA basis, including pension reform costs) for 2003 and 2004 have been revised up substantially to 7.4% and 6.5% of GDP, respectively, compared with original budget targets of 4.5% and 3.8%. And the government now expects the 2005 deficit to be 7.4% of GDP, compared with an original target of 4.7%. Fitch and the European Commission now forecast the 2006 deficit at around 8% of GDP (9% if motorway spending is not counted off-budget), compared with the budget target of 6.1%. The persistent missing of budget targets and non-transparent changes in accounting practices have eroded the credibility of fiscal policy. The size of the underlying deficit is such that Fitch believes it is highly unlikely that the country will be able to meet its target of adopting the euro in 2010. Moreover, general government debt has climbed to 60.3% of GDP (not excluding private sector pension holdings) at end-2004 from 53.6% at end-2001. Fitch forecasts this to rise to around 68% by end-2007, compared with the 'A' range median of 37%.
Public borrowing is contributing to large current account deficits in the order of 8%-9% of GDP. As a result, Fitch forecasts Hungary's net external debt to rise to 56% of GDP at end-2006, up from 35% at end-2001, and compared with the 'A' range median of 12%. The vulnerability of external financing is heightened by the country's dependence on potentially volatile foreign portfolio and debt financing and its fairly weak external liquidity position. Nonetheless, the economy has proved remarkably resilient, with GDP growth forecast to surpass 4% this year and next, exports growing robustly and core inflation at a record low, underscoring some of Hungary's underlying economic and credit strengths. At some point, however, an economic slowdown seems necessary to put public and external debt back on to a sustainable path. Unless there is a substantial fiscal tightening after the 2006 elections, there is a risk of a hard landing for the economy involving a depreciation of the forint, which could increase inflation, further raise the external debt burden and adversely affect some private sector balance sheets, in view of recent rapid bank credit growth, particularly in foreign currency.
Hungary's sovereign ratings remain supported by its level of human development, income per capita, democratic institutions and EU membership. The economy is open, diverse, benefits from a large stock of foreign direct investment and is closely integrated with the wealthy EU market. Despite recent policy slippages, these deep credit fundamentals remain intact and Fitch believes that real convergence with wealthier EU countries will continue over the long term. However, the downgrade is warranted by the rise in public and external debt burdens and risks associated with macroeconomic imbalances.