If Hungary's economy deteriorates as Moody's expects it to, Austria is next. We expect an Austrian downgrade shortly. From Moody's on Austria's primary economic derivative.
Moody's Investors Service has today downgraded Hungary's foreign- and local-currency government bond ratings by two notches to Baa3 from Baa1.
The key drivers for the downgrades are:
1. Increased concerns about the country's medium- to long-term fiscal sustainability; and
2. Higher external vulnerabilities than most of Hungary's rated peers.
The outlook on the ratings of the government of Hungary remains negative. The negative outlook reflects the uncertainties regarding the government's financial strength, as the country's structural budget deficit is set to increase and external vulnerabilities make the country susceptible to event risk.
Moody's has today also downgraded Hungary's country ceiling for the foreign-currency debt by two notches to A1 from Aa2, and the country ceiling for foreign-currency bank deposits to Baa3 from Baa1. The local-currency ceilings for bonds and bank deposits have been downgraded by three notches to Aa3 from Aaa.
In a related rating action, Moody's has downgraded the National Bank of Hungary's (NBH) foreign-currency debt rating to Baa3 from Baa1 given that the Republic of Hungary is legally responsible for the payments on NBH's bonds.
RATIONALE FOR DOWNGRADE AND NEGATIVE OUTLOOK
"Today's downgrade is primarily driven by the Hungarian government's gradual but significant loss of financial strength, as the government's strategy largely relies on temporary measures rather than sustainable fiscal consolidation policies," says Dietmar Hornung, a Moody's Vice President -- Senior Credit Officer and lead analyst for Hungary. "As a consequence, the country's structural budget deficit is set to deteriorate."
These temporary measures consist of extra levies on financial institutions and other selected sectors. The government also intends to transfer to the public pension fund (until the end of 2011) the part of pension contributions that is normally transferred to the private pension pillar. This will result in a one-off revenue inflow in 2011 as well as a reduction in outstanding debt, as bonds currently held by the pension funds are cancelled. However, even if the near-term deficit targets are met by means of pension changes, the longer-term implications of the weakening of the private savings scheme are negative for public finances. This is because the government will assume responsibility for future pension liabilities in exchange for the inflow from ongoing contributions.
Today's rating action also reflects Hungary's high external vulnerability as the absence of more permanent fiscal consolidation poses heightened risks to medium- to long-term fiscal sustainability. In addition, the government, banking system and private sector each carry substantial external debt. Hungary's levels of external debt are high relative to those of its rated peers, especially non-European ones. The government also depends on purchases of its debt issuance by non-resident investors, implying that the maintenance of confidence among foreign investors is vital.
There are, however, certain key strengths of Hungary that merit attention. Hungary benefits from a significant level of economic and financial integration with Europe, which supports two-way trade and attracts foreign direct investment (FDI). Recently announced FDI projects reflect that Hungary remains well-positioned in the location-based competition for investment. Moreover, as an EU member, Hungary can rely on the availability of substantial external support -- as illustrated by the 2008 EU/IMF support package -- a feature that supports the credit. An additional strength of Hungary is the high share of foreign-owned banks within the banking system, adding to the resilience of the financial sector.
TRIGGERS FOR A POTENTIAL RATING DOWNGRADE
Moody's may again downgrade the ratings if the government fails to stabilise its financial strength. The stabilisation of the government's financial strength may be complicated by increased risk aversion from investors, reflected in exchange-rate pressures or rising financing costs.
TRIGGERS FOR A POTENTIAL RATING UPGRADE
The outlook on the government's Baa3 bond ratings could move to stable, and the ratings could eventually be upgraded, if the country embarks on a sustainable consolidation path -- possibly supported by a resumption of robust economic growth -- that stabilises government financial strength on a sustained basis.
h/t Mark Manfsield