For the updated report accompanying this review, click here.

Rating action

Scope Ratings GmbH (Scope) has today affirmed Hungary’s long-term local- and foreign-currency issuer and senior unsecured debt ratings at BBB+. Scope has also affirmed the short-term issuer ratings at S-2 in local and foreign currency. All Outlooks are Stable.

Summary and Outlook

The affirmation of Hungary’s BBB+ rating reflects the country’s: i) robust growth performance supported by strong investment; and ii) increased resilience against external shocks. The rating is constrained by: i) high public debt and growing budgetary pressures; ii) long-term risks to competitiveness; and iii) a polarised political environment and political headwinds with the EU.

The Stable Outlook reflects Scope’s view that risks to the ratings are balanced over the next 12 to 18 months.

The rating/Outlook could be downgraded, if individually or collectively: i) protracted fiscal deterioration or a fading commitment to fiscal consolidation would result in weakened debt sustainability; and/or ii) there is a strong decline in foreign investment and/or significant delay in the availability of EU funds, lowering Hungary’s growth potential.

Conversely, the rating/Outlook could be upgraded if, individually or collectively: i) medium-term growth potential increases, supported by high EU inflows ii) public finances improve, resulting in a significant public debt reduction; and/or iii) external debt is materially reduced, strengthening Hungary’s reserve adequacy.

Rating rationale

The first rating driver to affirm Hungary’s BBB+ ratings reflects the economy’s strong record of robust growth and high investment – driven by inflows of foreign direct investment and projects co-financed with EU funds – creating high value-added jobs and supporting growth potential, as well as Scope’s expectation of a robust economic recovery from 2021 onwards.

Hungary benefits from a competitive economy and has recorded very robust economic growth and greater macroeconomic stability in recent years, with average real growth rates of 4.1% over 2014-19, among the highest in Europe. Growth has been underpinned by improvements in employment rates and solid wage growth and structural improvements in the economic diversification and increasing production capacity. Hungary’s economy has largely maintained price competitiveness relative to euro area economies, with unit labour costs in relative terms increasing moderately by about 10% since 2015. Another critical development contributing to Hungary’s economic strength is rising services exports, reflecting the country’s improving competitiveness in commercial services and the rise of the services sector across economies globally. The growth of the services sector’s output has led to strong employment growth.

Following a pandemic-related substantial decline in output of 4.7% in 2020, Hungary’s economy has rebounded strongly on the back of ongoing fiscal stimulus via tax relief, increased transfers and social spending programmes, with GDP recovering to the pre-pandemic level in the second quarter of 2021. Partly owing to support measures, the unemployment rate rose only modestly to 4.1 percent, remaining the lowest in the region. Scope forecasts annual GDP to grow by 7.5% in 2021 and 5.4% in 2022, supported by government support measures, income gains and increases in exports. Going forward, Scope expects growth to slow to a solid 4.0% in 2023 as output returns closer to its potential and policy support is gradually withdrawn.

Hungary benefits from a strong and rising investment share, at 28.2% of GDP in 2021. Subject to the disbursement of EU funds to be allocated to Hungary over 2021-2027, which is currently on hold, Scope expects investment to grow markedly from 2021 levels. The improving economic outlook is supported by significant policy support through grants via the Multiannual Financial Framework (EUR 10bn), EU transfers from the Recovery and Resilience Facility (EUR 30bn or 20% of GDP in 2021) and favourable financing conditions.

The second rating driver to affirm Hungary’s BBB+ rating relates to Hungary’s increasing resilience to external shocks, with an increasing share of domestic financing of government debt, small share of foreign-currency-denominated debt, balanced external accounts and improvements in the net international investment position. These factors support Hungary’s macroeconomic stability in the long term.

Hungary's foreign-currency-denominated central government debt was reduced to 19.9% of total debt end of 2020 from 31.3% end of 2015 while non-residents’ holdings of central government debt have declined to about 31% from more than 50% a few years ago. Although the government reentered external bond markets for the first time since 2018, debt continues to be held predominantly by domestic financial institutions and households. The share of foreign currency denominated debt within the total debt increased from 19.9% to 21.0% in 2021, reflecting recent issuances of 10-year and 30-year foreign currency bonds (totalling USD 4.25bn) as well as the EUR 1bn 7-year foreign currency bond issued in September, with a record low coupon by Hungary during euro bond issues. The government’s debt agency is pursuing a strategy of broadening the domestic investor base. To increase the proportion of government debt held by domestic retail investors, Hungary funds large part of the deficit via retail financing. The domestic banking sector's exposure to the government has also risen, to around 20% of its total assets. The decreasing debt ratio and the increasing domestic financing enable Hungary to maintain a low share of foreign currency debt within the total debt.

External liabilities mostly consist of foreign direct investment and equity rather than debt-creating flows, mitigating risks associated to the country’s external debt burden of 80.4% of GDP in 2020. Scope expects Hungary’s external debt burden to gradually decline to 65% of GDP by 2026, supported by continuation of successive external surpluses and a shift from external debt issuance by the government to domestic borrowings. In addition, the country’s net international investment position improved from -90% of GDP in 2013 to -43% in 2020, supported in part by private-sector deleveraging, increase in Hungarian companies’ assets abroad and stable current account receipts with a manufacturing sector highly integrated in global supply chains. Adequate international reserves making up 120% of short-term external debt (with maturity up to 2022) further provide a comfortable cushion and protect the country against adverse economic shocks. A repurchase agreement (repo) line between the Hungarian National Bank and the ECB provides the central bank with further policy space to react to external shocks, if required.

Despite these credit-positive developments, Hungary’s ratings remain constrained by: i) high public debt and growing budgetary pressures; ii) long-term risks to competitiveness; and iii) a polarised political environment and political headwinds with the EU, limiting long-term policy predictability.

First, compared to that of middle-income country peers, Hungary’s public debt is high, at an estimated 77% of GDP in 2021. Furthermore, previous periods of fiscal consolidation were mainly being achieved through high economic growth, while the structural balance has remained in deficit (-3.5% of potential GDP in 2019), reflecting the pro-cyclical budgets of the past. Scope expects the debt-to-GDP to gradually decline to 67% in 2025, supported by a low interest-payment burden, a resilient debt structure and a favourable interest rate environment allowing the refinancing of previously issued securities at cheaper rates. In addition to financing options from the local banking sector, the government runs a sizable retail bond programme to finance itself domestically. Despite the favourable projection of the interest rate-growth differential and declining primary deficits, the gross financing needs continue to remain elevated and are largely affected by the average maturity of public debt (about 4.5 years) and the size of maturities falling due on existing debt.

Hungary’s budgetary discretionary measures implemented during the pandemic materially weigh on the government’s fiscal position. In the context of the delayed release of the EU’s Covid recovery fund, the Hungarian government modified its 2021 financing plan to establish the possibility for the issuance of benchmark-sized international foreign currency denominated bonds to raise up to EUR 4.5bn. This allows Hungary to finance discretionary government expenditure in 2021 and pre-finance some 2022 budgetary expenditures, should there be further delays in transfers from the EU’s Recovery and Resilience Facility. Despite a strong economic rebound in 2021, Scope forecasts the general government deficit to remain high at 7.1% of GDP. Expenditure is set to remain high with implementation of social programmes, support for home ownership and renovation and a subsidised loan programme for SMEs. For 2022, Scope expects a deficit of 5.3% of GDP supported by strong revenue growth, a gradual reduction in discretionary spending and phasing out of pandemic-related measures including a temporary reduction in the local business tax.

Another constraint to Hungary’s ratings is the economy’s long-term risks to competitiveness, a result of structural employment gaps, high wage increases in the non-traded services sectors and the public sector's predominance in many economic sectors.

While productivity and wages move in parallel with high-skilled and exporting manufacturing sectors, smaller non-exporting corporates, small and midsize enterprises and the public sector have raised salaries despite low or stagnating productivity growth. As a result, while terms of trade for manufactured goods have remained stable over 2015-19, they worsened by around 3% for other traded goods such as food and beverages or crude materials. The government has partly compensated for this through tax cuts and reductions in employers’ contributions to secure the profit margins of less competitive firms while raising the minimum wage to prevent worker emigration. Thus, it remains important for Hungary’s economic convergence process to raise SME productivity towards the levels of larger exporting firms.

While the general labour market situation has been improving in Hungary in recent years, Hungary’s long-term competitiveness is eroding due to adverse demographic trends and structural employment gaps. These remain wide in EU comparison, including employment gaps between skills groups, with the unemployment rate of the low-skilled at 9.5% against 1.3% among the tertiary graduates in 2019. Going forward, a rapidly ageing and declining working age population will exacerbate the country’s skills shortage. As is the case with all CEE countries, Hungary’s share of the working age population (20-64 years) in the total population is projected to continue declining across over the next five years which intensifies challenges to labour supply. Timely implementation of reforms within strengthened labour markets is key to putting the economy post crisis on a more sustainable path.

Finally, Hungary faces several institutional challenges related to rule of law issues, reflected by recent deteriorations captured in governance metrics including the rule of law, political polarisation and political headwinds with the EU.

The political environment in Hungary continues to be dominated by the conservative Fidesz Party, despite the results in the latest municipal elections, which brought the liberal opposition to power in major cities including Budapest. General elections are scheduled for spring 2022 and current polls show support for the United Opposition close to support for Orban’s party Fidesz, respectively at 45% and 50%. Political polarisation remains high under Prime Minister Viktor Orbán, especially on migration and social policies.

In Hungary, the government’s strong presence in the corporate and financial sectors, its increasing intervention in the judiciary and the media as well as its asylum policies have led to ongoing legal disputes with the European Commission. In Scope’s view, the polarised political environment in Hungary and political headwinds with the EU limit long-term policy predictability, which could weigh on future foreign investment inflows and on macroeconomic sustainability given Hungary’s high reliance on foreign funding and external demand.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative rating of ‘a-’ for Hungary. This indicative rating can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses against a peer group of countries.

For Hungary, the following relative credit strengths have been identified: i) external debt structure. Relative credit weaknesses are: i) vulnerability to short-term shocks; ii) social risks; and iii) institutional and political risks.

The combined relative credit strengths and weaknesses indicate a sovereign rating of BBB+ for Hungary.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope explicitly factors in ESG sustainability issues during its rating process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 20% weighting under the quantitative model (CVS) as well as in the qualitative overlay (QS).

With respect to environmental risks, Hungary receives high CVS scores for having low natural disaster risk and a high biocapacity surplus. Scope assesses Hungary’s QS adjustment for ‘environmental risks’ as ‘neutral’. Hungary’s economy is energy intensive, with energy consumption levels above the EU average. This is largely due to the high household energy consumption per capita, which remains 12% higher than the EU average despite considerably lower income levels. The transformation of the country’s coal region, which produces up to 15% of electric power, and the energy-intensive industries represent transition risks in Hungary. Electricity consumption is expected to increase over the next decade, in parallel with the electrification of the economy. By 2030 up to 90% of Hungary's electricity generation might come from low carbon technologies (nuclear and renewables together), with a low share of renewables in 2030. Hungary is among the lowest emitters of greenhouse gases per person in the EU. Hungary remains an overachiever on its greenhouse gas emissions 2020 target. By 2018, emissions compared to 2005 fell by 10% altogether and the 2020 target is expected to be met with a wide margin. However, Hungary faces several environmental challenges, including weak water quality and air pollution reflected by persistent breaches of water and air quality standards and weak energy efficiency in the residential sector, resulting in environmental repercussions.

Regarding social risks, Hungary scores low in the CVS for old-age dependency. Scope assesses Hungary’s QS adjustment for ‘environmental risks’ as ‘weak’. While the general labour market situation has been improving in Hungary in recent years, Scope notes persistent employment gaps, which remain wide in EU comparison. Income inequality has increased over the past decade and inequalities in access to public services remain high. A significant share of the population lives in inadequate housing. The shortage of affordable rental housing hinders mobility. The adequacy of the social safety net weakened over the past decade. The duration of unemployment benefits remains one of the shortest in the EU, at a maximum of 3 months, which is significantly shorter than the average duration of unemployment of 1 year in 2018. Educational outcomes are below the EU average and large differences remain. By the age of 15, basic skills are significantly below the EU and regional averages and have decreased over the last decade.

With respect to governance risks, Hungary receives low CVS scores. Scope assesses Hungary’s QS adjustment for ‘governance risks’ as ‘weak’. This assessment reflects i) weaknesses via below-average checks and balances between public institutions and government branches, weighing on policy predictability; and ii) tense relations with the EU, given fundamental disagreements over the rule of law issues.

Rating Committee
The main points discussed by the rating committee were: i) economic and fiscal performance; ii) impact of Covid-19; iii) growth potential, external environment, financial stability and macro-economic sustainability; and iv) institutional developments and reform progress.

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Rating Methodology: Sovereign Ratings, 8 October 2021), is available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party participation     NO
With access to internal documents                                   NO
With access to management                                            NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Jakob Suwalski, Director
Person responsible for approval of the Credit Ratings: Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 18 Deecember 2019.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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