Hungary faces downgrade risk, 2012 budget stretched

Hungary risks losing its investment-grade rating in coming weeks due to its weak growth and uncertainty over its policies, which would make it harder to refinance the country's expiring foreign currency debts next year. The Hungarian government has failed to fully deliver on its fiscal reforms announced in March, while the economy - hit by a slowdown in Europe and sickly domestic demand - risks stagnating in 2012.
That means Hungary may not be able to cut its debt further in 2012 after a one-off reduction this year due to the effective renationalisation of some $14 billion of pension fund assets. Prime Minister Viktor Orban's firm commitment to keep the budget deficit below 3 percent of gross domestic product (GDP) in 2012 may help avert a ratings downgrade for now, most economists asked by Reuters said.
But they said there is a still a risk that one of the three big rating agencies will pull the trigger. Fears that Standard & Poor's and Moody's - both of which rate Hungary one notch above "junk" with a negative outlook - could cut its rating have cemented a rise in risk premiums on Hungarian debt in recent weeks and weighed on the forint. The two agencies are due to review Hungary this month.
"How big a selloff a potential downgrade would trigger in forint-denominated bonds I'm not sure ... but it could affect the success of next year's issuance; it could make the issuance of a large stock of foreign currency bonds more difficult," said analyst Gabor Orban at Aegon Securities. "A downgrade could cement the CDS differential which we have compared to the region."
The cost of insuring Hungary's debt against default for five years in the credit default swaps market has climbed recently to 2-1/2-year highs of above 500 basis points. Hungary needs to tap international markets next year to finance expiring foreign currency debt worth 4.7 billion euros, including repayment of a loan from the International Monetary Fund, which saved the country from financial meltdown in 2008.
With foreigners holding close to 3.9 trillion forints ($18 billion) worth of government bonds - or about one-third of Hungary's forint-denominated debt - the risks of a selloff on a potential downgrade are significant. "The ratings are currently balanced by two opposing and cancelling forces ... on one hand you have lack of growth and the financial stability/fx mortgage issues all suggesting a downgrade to junk, but on other you have the fact that debt and the deficit are falling," said Peter Attard Montalto at Nomura.
"I think Hungary avoids a downgrade, but only just." Even if Hungary escapes a rating cut now, slowing growth will pose a challenge to its centre-right government which last year rejected signing a new backstop loan with the IMF.
BofA Merrill Lynch said on Monday that renewed co-operation with the IMF would have added credibility to Hungary's fiscal consolidation plans, and there was a "high risk" that S&P could downgrade Hungary in coming weeks, due to global risks and elevated uncertainty over the government's policy mix. Gyorgy Barta at CIB said he believed Hungary's fundamentals would not justify a downgrade. But he said it could not be ruled out completely after the government's move last month to let households repay foreign currency loans at discounted exchange rates, which is seen causing losses to banks, increasing financial stability risks.