ERA issues the following unsolicited credit rating for Hungary.

The unsolicited credit rating assigned to Hungary stems from a strong economy, sound private sector finances, and above average governance indicators. The rating is restricted by high government debt load, high structural deficits, and low foreign reserves indicators.

Rating components

Macroeconomic factors of rating assessment

The Hungarian economy is growing above its potential. Government debt is declining, but it still remains elevated. Weaker public finances together with low foreign reserves are constraining the capacity to tackle potential headwinds.

Highest growth since mid-2000s:

The Hungarian economy is currently experiencing a period of strong growth. As a small open and export-oriented economy, it has benefited from global recovery in recent years. With global recovery losing momentum this year, domestic factors took over. Record labor force shortages led to an increase in wage growth from 6.2% in 2017 to more than 8% this year, the third highest in the EU. ERA expects the wage growth to moderate in the coming years, but it should still remain at above average levels and, thus, support household consumption. Investment is also experiencing a boom, mainly as a result of strong EU-funds absorption.

As a result, real GDP increased by 4.1% in 2017. ERA expects the GDP growth to increase even further in 2018 to 4.3%, the most since 2005, in light of strong private consumption and investment, before moderating closer to the medium-term potential growth estimated at around 3% in the coming years. In the medium-term, potential GDP growth will be supported by a smooth transfer of capital and technology within the EU, which should result in faster growth rates compared to western EU-countries. In the long-term, potential GDP growth is expected to decline due to below average R&D expenditure and negative demographics. Hungary has been experiencing population decline since the eighties and ERA expects this trend to continue.

GDP growth in Hungary and EU-28 (%)

Source: Eurostat, ERA

Debt to GDP falls, but remains elevated:

The government debt to GDP ratio is declining. It fell from above 80% at the beginning of the decade to below 75% in 2017. ERA expects this trend to continue in the coming years with debt to GDP falling below 70% in 2020. However, for a country categorized as an emerging economy, it is still elevated. Among the countries in the emerging and developing part of Europe, Hungary had the second-highest debt to GDP ratio in 2017 (after Croatia). In case of headwinds from inside or outside the economy, the increase of the debt to less-sustainable levels cannot be ruled out.

Especially, when the current decline in the debt to GDP ratio is driven by nominal GDP growth and declining borrowing costs and not by fiscal consolidation. On the contrary, the general government is running deficits above 2% during the height of the economic cycle (the EU-28 deficit for 2018 is projected at 0.7% GDP). ERA expects a structural deficit slightly below 4% in 2018, the highest in the EU.

Deficits would be even higher without transfers from the EU-budget, which are expected to be lower in the new EU-budgeting period starting in 2021. Moreover, Hungary has the highest share of government revenue to GDP among the Visegrad Group countries (Hungary, Poland, the Czech Republic, Slovakia). In 2017, it reached almost 45%. Therefore, raising taxes, should it be necessary in the future, might prove to be more difficult.

Private sector indebtedness fell sharply:

Private sector finances are in sound shape. After increasing steadily for almost a decade, gross national savings stabilized at levels between 25% and 26% of GDP in recent years, which is well above the EU average (23,1%) as well as the Visegrad Group average (23,3%). After overcoming the issues related to mortgages denominated in Swiss francs in the aftermath of the financial crisis, household debt to GDP ratio experienced a very strong decline from its peak of 39.4% to 18.4% in Q2 2018, the second lowest level in the EU (after Romania). The indebtedness of private non-financial companies also fell sharply, from around 90% at the beginning of the decade, to 66.9% in Q2 2018, which is well below the EU average (96,1% in 2017). The NPL ratio was 4.2% in 2017, down from 7.4% in the previous year. In light of the declining indebtedness and NPL ratios of the private sector, ERA expects the banking sector to retain its solid profitability and capital adequacy in the medium-term.

Foreign reserves indicators are worsening:

Hungary has experienced a deterioration in foreign dependency indicators over the last several years. Foreign exchange reserves fell by more than a third since their all-time high in 2011. Currently, they account for less than 20% of GDP and cover only 23% of external debt and less than 2.5 months of imports. Aside from elevated levels of government debt, low reserves might also be a factor amplifying potential economic problems.

Foreign exchange reserves in months of imports and % of external debt

Source: Central Bank of Hungary, World Bank, ERA

Forward-looking factors of rating assessment

Governance indicators for Hungary are above average on the global scale, but the trend is negative.

Governance indicators are the worst in the region:

On the global scale, the governance indicators for Hungary are considered to be above average, but the trend is negative. They have been on the decline since the mid-2000s. The average of the five World Bank indicators monitored by ERA bottomed in 2016. Despite the slight increase in 2017, which can be attributed mainly to political stability/absence of violence and rule of law indicators, the composite indicator is still below the average of the Visegrad Group countries. Within its peer group, Hungary scored the worst in four of the five indicators. The control of corruption indicator was the lowest on record in 2017.

Average of World Governance Indicators (ERA score, 1-10):

Source: World Bank, ERA

Outlook: Stable

The outlook has been assigned based on expectations of a further gradual decline in the government debt to GDP ratio and macroeconomic stability in the EU.

The Stable outlook assumes that the rating will most likely stay unchanged within the 12-month horizon.

Key assumptions

• Debt to GDP ratio falling below 70% in the medium-term;

• Real GDP growth between 2.5% and 4% in the medium-term;

• Political stability in the EU.

Potential outlook or rating change factors

A positive rating action may be prompted by:

• Substantial decline in debt to GDP ratio below 60%;

• Substantial decline in structural deficit below 1.5% GDP;

• Substantial increase in foreign reserves;

• Material increase in governance indicators.

A negative rating action may be prompted by:

• Substantial increase in debt to GDP ratio above 90%;

• Substantial widening of fiscal deficit above 4% of GDP;

• Material decline in exports, above 10% year on year;

• Material decrease in governance indicators.

Appendix 1. Peer-analysis materials

General government debt/GDP (%)

Source: Eurostat

General government fiscal balance/GDP (%)

Source: Eurostat


Appendix 2. Major sovereign indicators

Appendix 3. List of material data sources

Regulatory disclosure

Download pdf

Hungary_Sovereign_Report.pdf

Approved by the Rating Committee:

Natalia Porokhova, Head of credit rating analysts

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