TEXT-S&P cuts Hungary's rating to 'BB', outlook stable

Fri Nov 23, 2012 12:21pm EST

Overview
     -- In our view, the predictability of Hungary's policy framework 
continues to weaken, which could affect the country's medium-term growth 
prospects.
     -- We are therefore lowering our long-term foreign and local currency 
sovereign credit ratings on Hungary to 'BB' from 'BB+' and our long-term 
counterparty credit rating on the National Bank of Hungary (the central bank) 
to 'BB' from 'BB+'.
     -- The stable outlook balances our assessment of Hungary's still-high 
fiscal and external liabilities and recurrent use of unorthodox, and possibly 
unsustainable, economic policies against its success in reducing fiscal 
deficits to less than 3% of GDP and containing external liquidity pressures by 
achieving current account surpluses.

Rating Action
On Nov. 23, 2012, Standard & Poor's Ratings Services lowered its long-term 
foreign and local currency sovereign credit ratings on the Republic of Hungary 
to 'BB' from 'BB+'. We affirmed the foreign and local currency short-term 
ratings at 'B'. The outlook is stable. We have assigned a recovery rating of 
'3'. The transfer and convertibility assessment remains 'BBB'.

We have also lowered the long-term counterparty credit rating on the National 
Bank of Hungary (the central bank) to 'BB' from 'BB+'.
    
Rationale
The downgrade reflects our opinion that the government's unorthodox policies, 
including exceptional measures applied to the financial sector, could erode 
the country's medium-term growth potential. This could eventually undermine 
the government's efforts to sustainably reduce general government debt. 
Although we expect the government's fiscal targets to be met in the short 
term, we believe that this could become increasingly difficult if, as we 
expect, economic growth remains muted.

In our opinion, measures taken in recent months--which continue to place the 
burden of fiscal adjustment on some key services sectors, particularly the 
financial sector--could weigh on Hungary's medium-term growth prospects by 
reducing further banks' willingness to lend and companies' propensity to 
invest. In particular, the imposition of tax hikes and levies on various 
services--including the telecoms, energy, and financial sectors--may depress 
private investment and job creation, although we note that the authorities 
have introduced several schemes aimed at supporting small businesses and that 
the manufacturing sector has not been affected by fiscal adjustment measures.

Bank sector deleveraging in Hungary has been more pronounced than in other 
countries in the region, although we note that the sector has benefited from 
capital injections from foreign parent banks, most recently in 2012. As a 
result, we expect that credit supply to the economy, a crucial driver of 
growth, will remain stagnant in the medium term.

Like much of Europe, the Hungarian economy is currently experiencing a 
contraction; we expect it to fall by 1.2% in real per capita terms in 2012. 
Real GDP remains about 5.0% below its 2008 peak. Continued fiscal 
rationalization, an unpredictable tax environment, and tight credit conditions 
will likely weigh on the economy in the short term, and we anticipate a muted 
recovery in 2013, with real GDP per capita growth of 0.8%. After 2013, we 
forecast real per capita growth to strengthen to about 1.7% on average in the 
medium term. Our projections are based on the government's current fiscal 
consolidation plans, an assessment of measures designed to support the labor 
market, and our assumption of no growth in the eurozone in 2013 and 1.2% 
growth in 2014. 

We anticipate that the government will meet its objective of keeping fiscal 
deficits below 3% of GDP over 2013-2014, using the accruals-based European 
(ESA 95) accounting standard, but we believe that from 2014 the authorities 
will face increasing difficulties in keeping the general government deficit in 
line with its projections, given the low-growth environment. That said, we 
acknowledge that our forecasts are subject to revisions in either direction, 
as economic growth prospects--and therefore the outlook for public 
finances--depend on domestic credit conditions, the policy environment, and 
external developments. The Hungarian economy, which we consider to be very 
open, is dependent on trade with the eurozone, particularly to Germany.

We expect net general government debt to ease to 73% of GDP at end-2012, but 
then to stagnate at about 71% if there is no increase in economic growth. Our 
calculation of net general government debt is more restrictive than national 
measures, as it deducts from the general government debt only the most liquid 
assets, such as currency and deposits held at the central bank. Roughly 40% of 
commercial general government local-currency debt is held by nonresidents. 
While we view this as a positive factor in terms of diversified funding, the 
financial crisis in late 2008 illustrated the rapidity with which local 
currency bonds held by nonresidents can be sold if investor confidence 
falters. This increases pressure on the balance of payments, the exchange 
rate, and, therefore, debt servicing capacity. Although the foreign currency 
component of general government debt has fallen, it remains high at an 
estimated 42% of the total, which makes the debt burden highly sensitive to 
exchange rate fluctuations.

Hungary's current account has been in surplus since 2010, and there has been a 
sharp correction in the country's net external liability position. External 
debt net of liquid assets is estimated to be 55% of current account receipts 
in 2012, down from a peak of just over 80% in 2009. Although we view the 
stronger external performance positively, we see that Hungary still faces 
substantial refinancing needs, particularly in the short term as the 
government amortizes its debt to the IMF and EU.

The ratings are supported by what we view as Hungary's comparatively advanced 
economy, highly skilled labor force, and relatively well-diversified economic 
and export structures.

The recovery rating on Hungary's foreign currency debt is '3', indicating our 
view that post-default recovery would likely be about 50%-70%. The recovery 
analysis assumes a default stemming from a sharp adjustment in the country's 
exchange rate. Under this hypothetical scenario, the recovery rating is 
supported by our view of the country's flexible and open economy.

Outlook
The stable outlook balances our assessment of Hungary's still-high fiscal and 
external liabilities and recurrent use of unorthodox, and in our view possibly 
unsustainable, policies against the government's success in reducing fiscal 
deficits to less than 3% of GDP and the benefits afforded by current account 
surpluses.

We could raise the ratings if we saw that the government were to use its 
strong majority in parliament to establish policies that encourage investment, 
while implementing its structural reform program. Similarly, we could consider 
an upgrade if we saw a sustained reduction in external debt net of liquid 
assets, even as economic growth strengthens.

Conversely, we could lower the ratings if Hungary's economic recovery weakens 
significantly more than we currently expect, if banks accelerate their 
withdrawal of credit, or if we saw external or public finances weaken 
materially.

Related Criteria And Research
     -- Sovereign Government Rating Methodology And Assumptions, June 30, 2011
     -- Criteria For Determining Transfer And Convertibility Assessments, May 
19, 2009
     -- Introduction Of Sovereign Recovery Ratings, June 14, 2007
Ratings List

Downgraded; CreditWatch/Outlook Action/Affirmed
                                        To                 From

Hungary
 Sovereign Credit Rating                BB/Stable/B        BB+/Negative/B
 Senior Unsecured                       BB                 BB+
 Recovery Rating (Foreign Currency)     3
 Transfer & Convertibility Assessment   BBB                
 Short-Term Debt                        B                  

Hungary (National Bank of)
 Issuer Credit Rating                   BB/Stable/--       BB+/Negative/--
 Senior Unsecured                       BB                 BB+


Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.
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