A Rating Upgrade in Late 2016?

HUNGARY - Forecast 18 Jan 2016 by Istvan Racz

Hungary had a successful year in 2015, with robust, though decelerating, GDP growth, zero inflation and a stable currency, combined with growing employment, improving fiscal balance and a massive external income surplus. Supporting external factors were low oil prices, robust growth of foreign demand for car industry products, and the availability of large amounts of development grants, due from the EU. In addition, key domestic factors were well-managed tax and spending policies, an efficient distribution of EU transfers and the central bank’s innovative easing policies.

In 2016, growth will depend greatly on how much fiscal and monetary policies will be able to provide compensation for the expected major shock from a large drop of incoming EU transfers. In this regard, the good news is that the underlying balance of the government budget was much stronger than expected in 2015, providing a strong basis for expansionary fiscal policy in the current year. In addition, the government is trying really hard to quickly mobilize the funds available to Hungary under the 2014-2020 EU budget. The lat-ter, and campaign spending ahead of the next election in 2018, will support growth in 2017-2018, but only moderately, due to fiscal constraints.

Inflation has been rising in recent months towards its underlying 1-2% annual rate on large base effects, but is likely to remain there, due to limited growth prospects, in 2016 and to rise further only very slowly in medium term. Increasingly tight labor market conditions will keep upward wage pressures significant, but these will be limited by weak private investment, as quality labor is scarcely available and the government continues to be unfriendly to foreign private investment in sectors other than manufacturing.

Even though the forint’s exchange rate is not defined as an explicit objective, it remains a key element of government / central bank policy. The EURHUF exchange rate has been and will likely remain managed to secure export and import price indices in HUF terms largely in line with domestic inflation. This implies regular but moderate forint depreciation vis-à-vis the euro.

The MNB is likely to hold its end-2015 base rate in 2016 and beyond, as long as it can, but continue monetary loosening through de-sterilization and cheap loans. The next steps in de-sterilization will be introduction of a 100% LCR for banks in April, the discontinuation of the 2-week deposit facility from May and further improvements in the MNB’s IRS facility to encourage banks to buy long-term government bonds. Given past failures, success with cheap MNB loans is less certain, but it will be helped this time by the authorities’ recent turn to more bank-friendly policies, including a sharp cut in the banking tax in 2016 and new incentives to banks that are active in lending to the economy.

Hungary is more likely than not to be upgraded to low investment grade by at least one major rating agency in 2016. This may be the top investment story for the country this year. The upgrade would be supported by improving fiscal indicators, rapidly declining external vulnerabilities and by an improving official attitude towards banks, but is likely to depend on the government’s ability to withstand the EU transfer shock.

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