S&P Revises Hungary Outlook To Negative On IMF Talks Collapse
- We believe that key components of the government's plan to consolidate public finances could prove harmful to Hungary's medium-term growth prospects.
- We are therefore revising the outlook on Hungary to negative from stable.
- We are also affirming the 'BBB-/A-3' foreign and local currency sovereign credit ratings.
On July 23, 2010, Standard & Poor's Ratings Services revised its outlook on the Republic of Hungary to negative from stable. At the same time, we affirmed the long- and short-term 'BBB-/A-3' foreign and local currency sovereign credit ratings. The transfer and convertibility assessment on Hungary remains at 'A-'.
The ratings on the Republic of Hungary factor in our view of the positive effect that previous Hungarian governments' fiscal consolidation programs have had on their attempts to address the relative weakness in public finances and establish the foundations for more balanced economic growth. In this regard, we believe that the €20 billion funding package provided by the International Monetary Fund (IMF) and the European Union (EU) between November 2008 and October 2010 has proven a strong policy anchor and has helped improve access and reduced funding costs of the Hungarian government in the capital markets. This is notwithstanding the fact that Hungary has not drawn on the facility since September 2009.
Discussions with the IMF reportedly concluded July 17, 2010, without a subsequent donor package having been agreed. We understand that the IMF will return to reactivate discussions with the authorities in September 2010. In our view, the likelihood of a new program with the EU and IMF being agreed could be contingent on some amendments by the government of some aspects of specific policy measures such as the temporary financial institutions tax. We believe that without an EU/IMF program to anchor policy, Hungary is likely to face higher and more volatile funding costs, which in our view could weigh on financial sector balance sheets, the public finances, and economic growth.
In our view, the newly elected government is implementing measures that are likely to improve the sustainability of the public finances, such as those targeted at reducing wages in the public sector. We also expect the government to be close to its targeted general government deficit of 3.8% of GDP in 2010. Nevertheless, we estimate that the imposition of some of the government's other measures could have a potentially adverse impact on the medium-term macroeconomic outlook for Hungary.
Foremost among these policies, in our view, is the financial institutions tax. Under the government's current plans, this is expected to increase government revenues by as much as Hungarian Forint (HUF) 200 billion (0.8% of GDP) annually over the period 2010-2012. At the same time, we believe that a tax on financial system assets at the levels proposed could impede the functioning of the financial system over the medium term by impairing the banking sector's ability to raise capital and therefore its ability to lend. The six largest foreign bank subsidiaries account for around 60% of banking system loans in Hungary, and we believe the tax could reduce parents' commitment to the Hungarian financial system. Imposition of the tax as currently proposed could, in our view, lead to lower capital inflows and weaker economic growth
prospects, the second round effects of which would be to reduce government revenues adding to fiscal pressures.
In our view, there continues to be significant potential for the financial sector contingent liabilities to migrate to the government's balance sheet, particularly if there were further significant downward pressure on the forint. The forint has already depreciated by about 15% since the beginning of the year against the Swiss franc in which most Hungarian household mortgages are denominated. More than one-half of total domestic credit is denominated in foreign currency.
In our opinion, the newly-elected government faces significant challenges to raise the country's longer-term growth prospects, in terms of reducing the large size of the public sector and high employment taxes. The latter results in one of the highest "tax wedges"--between 40% and 50% depending on the demographic cohort under consideration--in Organization for Economic Cooperation and Development countries, and which in our view depresses private sector employment.
The negative outlook reflects our opinion that key components of the government's plan to consolidate public finances could prove harmful to Hungary's medium-term growth prospects, reducing the government's ability to put the public finances onto a more sustainable footing.
We could lower the rating if, over the next year, we conclude that government policies are unlikely to result in a meaningful decline in public debt as a percentage of GDP over the medium term or if the political commitment to pursue growth-supportive policies weakens.
Conversely, we could affirm the ratings if the government establishes clear medium-term fiscal objectives that, in our view, begin to address some of the longstanding impediments to economic growth and increase the prospects that the high public debt burden will begin to decline.