Rizikové faktory a výhľad

After a slippage of the activity in 2012, the Hungarian economy found its way back to growth as from last year, largely supported by higher public spending in the build-up to the April 2014 elections and by an export rebound. Activity is expected to consolidate this year with the help of an accommodative monetary policy, while a more favourable euro- area environment should continue to support external demand. In spite of the improved economic and monetary conditions, credit to corporates and households has continued to decrease in the first months of this year, reflecting the ongoing deleveraging process of the private sector. The banking sector remains fragile, affected by a heavy tax burden and non-performing loans. Those elements explain the mitigated commercial risk appreciation.

The current account surplus and the comfortable level of foreign exchange reserves (covering about 4 months of imports) associated to it indicate a fairly good liquidity position on the back of a reasonable short-term debt level. Combined with the European Union (EU) membership and its corollary freedom of goods and capital movement, those factors account for the short-term transfer risk being deemed low (2 out of 7).

While the financial markets’ confidence in Hungary has been maintained somehow, recently, several factors continue to undermine the Hungarian MLT political risk. The heavy burden of external and public debt – the highest levels in Central and Eastern European countries when related to GDP – constitutes a threat that could materialise in case of a general withdrawal of foreign investors from emerging markets or in the event of a sudden loss of confidence in the country.
Also, a large part of the private and public debt is denominated in foreign currency, and therefore subject to the exchange rate risk. Even if their share in total loans stock is declining, those foreign exchange liabilities would increase the pressure on foreign exchange reserves in case of a weakening currency. Finally, the uncertain business climate and the implementation of unorthodox policy measures deter domestic and foreign investors and weigh on potential growth. In spite of the country’s EU membership, its vulnerabilities raise the MLT political risk to category 3 (out of 7).

Fakty & Čísla

Pozitíva

  • Current account in surplus allows reasonable foreign exchange reserves level
  • Strong commitment to fiscal discipline
  • Good integration in the German supply- chain

Negatíva

  • High external and public debts
  • Non-orthodox and unpredictable policies
  • High forex risk of private domestic debt
  • Erosion of democratic principles and authoritarian drift of head of government

Main export products

  • Machinery and transport equipment (42% of current account receipts), other manufactured goods (24%), investment income (9%)

Income group

  • Upper middle income

Per capita Income

  • USD 12,380

Population

  • 9.9 M

Description of electoral system

  • Presidential election: 5-year term; next election: May 2017
  • Parliamentary election: 4-year term; next election: 2018

Head of Government

  • Victor Orban

Head of State

  • Janos Ader

Hodnotenie rizikovosti krajiny

A maverick way of governing

PM Orban first came to power in 2010 after defeating the Socialist Party, which was blamed for the economic disarray Hungary endured in the preceding years. His centre-right party Fidesz, in alliance with the Christian Democratic People’s (KDNP) junior party, enjoyed a two-third majority in parliament, which ensured the power to pass any legislation it proposed. Orban has therefore availed himself of that support to bring changes to the constitution and, thereby, modify the electoral system and attempt to enlarge his control over public institutions (central bank, judiciary system, state audit office). Viewed as threatening the independence of the judiciary, freedom of religion, freedom of the press and other democratic values, those constitutional amendments were repeatedly criticised by European institutions and human rights associations, and the Hungarian parliament reconsidered some of the most controversial amendments for fear of EU sanctions. On the economic and fiscal plan, Orban’s policy has proved volatile and unorthodox as well. Bank levies, ‘crisis’ taxes mostly in foreign- invested sectors (energy, telecoms and retail) and the nationalisation of private pension funds are examples of such measures, which weigh on the investment climate and its predictability.

The parliamentary elections which took place in April this year, brought a new overwhelming victory for the incumbent PM Orban’s party (in alliance with KDNP), which, again, means a two-third majority of the parliamentary seats. The adoption of populist measures, such as energy price cuts for households, prior to the vote contributed to this victory. The continuity of the Fidesz ruling should bring another four-year period of uncertainty and unpredictable economic and fiscal policies, without any opposition forces able to threaten it. Measures disadvantaging some foreign-invested sectors are likely to remain in place or to be strengthened and to weigh on the business climate. The emergence of the far-right Jobbik as the third party with 20% of the votes, whose strength was confirmed at the European elections cast, is also likely to give additional support to Fidesz for adopting more nationalistic and Eurosceptic positions.

Relations with Russia are being reinforced, as illustrated by the loan (EUR 10 billion or 10% of Hungarian GDP) provided in January this year by Moscow to expand the unique nuclear power plant in Hungary, or as recently shown by Orban opposing to EU sanctions on Russian officials.

Activity rebound supported by expansionary policies

After two years of positive growth, the Hungarian economy slipped into recession again in 2012. It was hurt by the difficult international environment, by the increased fiscal drag since exiting the EU Excessive Deficit Procedure (EDP) had been one of the authorities’ priorities, and by the deleveraging process in which the private sector was embarked, the latter two elements curbing domestic demand.

The economy found its way back to growth (+1.1% of real GDP growth) in 2013, largely supported by higher public spending in the build-up to the elections and by an export rebound driven by improved external conditions and an increase of the production capacity of the fast-growing automotive industry. The persistence of the accommodative monetary policy should further boost investment and private consumption this year, while a more favourable euro-area environment should continue to support external demand. Resulting growth is expected to be of 2% in 2014 and 1.7% in 2015, according to the IMF forecast.

The risk related to the events affecting Russia and Ukraine is considered as moderate, at least where direct trade is concerned, as direct exports to those two countries are modest (they represent about 3% and 2% of total goods exports respectively, while exports to Germany account for about 25%). However, indirect exports of automobiles via the German supply chain could be impacted in case of an important Russian slowdown. Energy dependency on those two countries is also large, mainly on Russia, which provides a significant part of imported gas. The risk is lessened by Hungary having ample gas reserves. But the links with Russia are more important on the financial side, as exposure of the Hungarian OTP bank to Russian economy via its local subsidiaries accounts for 9% of the group’s total assets.

The important fiscal adjustment completed in 2012 allowed the country indeed to exit the EDP in June 2013. In spite of the recent easing of public expenditures, the public deficit is still expected to remain, for this year and the following ones, under the 3% of GDP threshold. On the one hand it will reflect the quite ambitious programme of the authorities in terms of health and education expenditures and infrastructure projects cofinanced by the EU  and on the other hand, the heavy interests charge paid on the elevated public debt (79% of GDP in 2013).This controlled deficit, combined with weak GDP growth, should stabilise the public debt ratio at a high 79% of GDP in the next few years, well above the Maastricht criteria.

The external debt stock and the large open forex position of the economy are sources of vulnerability…

Besides the high level of public debt, the external debt (reaching 119% of GDP in 2013) is another source of fragility. External debt was accumulated mainly by the private sector in the years prior to the global economic and financial crisis and by the public sector during 2008 and 2009, when the IMF and the EU granted the country a financial package equivalent to 16% of GDP amid financial market tensions. Nonetheless, the external debt ratio is declining and, last year, the Hungarian government and central bank repaid ahead of schedule all remaining obligations (about $ 2.85 billion) vis-à-vis the IMF, originally due later in 2013 and in 2014. That transaction was financed thanks to a previous external bonds issuance for which a large demand was registered.

Hungary_Graph1EN

… but current account surplus remains the best protection against investors’ sentiment reversal

The risk implied by the high level of the external debt compared to GDP is mitigated by several factors. First of all, sizable non-official foreign assets considerably reduce the gross external debt (the net external debt reached  a low 60.1% of GDP in 2013). Also, the external debt consists mainly in medium- to long-term liabilities, softening the risk of a sudden reversal of capital flows. What is more, public external debt is largely held by a few institutional investors (mainly from the US) expected to keep sovereign bonds to maturity. This argument has been confirmed during the two recent episodes mid-2013 and early 2014 of capital outflows in emerging markets that followed the announcement by the Fed of a strengthening of its monetary policy. In comparison to what happened in other emerging markets, confidence in Hungary remained globally resilient, although a depreciation of 3.4% of the forint with respect to the euro was registered during the first quarter of 2014. A large current account surplus and a reasonable level of foreign exchange reserves (covering about 4 months of imports) contributed to this.

A rapid adjustment of the current account balance has indeed taken place since the outset of the financial crisis. While the balance was still negative in 2008 (deficit reached 7.6% of GDP), it has become positive as from 2010 and reached 2.9% of GDP last year. Between 2008 and 2010, the adjustment was due mainly to imports of goods and (non-financial) services falling more than the exports due to the plunge in domestic demand, while a stronger growth of exports than imports has helped to maintain the positive adjustment since then. Service receipts have also significantly contributed to the improvement of the current account.

Hungary_Graph2EN

Source: IMF and IMF/IFS

Monetary authorities have started a monetary easing cycle since the summer of 2012, cutting the base rate 23 times between August 2012 (when the rate was 7%) and June 2014 (to a rate of 2.3%), as a tentative way of relaunching the activity. Some pause should now take place in the adjustment as weakening pressures of the lowering base rate on the exchange rate would hurt the service of the large foreign-denominated debt. What is more, such a low interest rate reduces the attractiveness of the Hungarian securities by diminishing the spread with more advanced economies. In addition to the easing of the policy rate, the central bank has proceeded to less conventional measures, including the implementation of the Funding for Growth Scheme (FGS) subsidising the lending interest rate for SMEs and facilitating the conversion of SMEs’ forex loans into forint at the same refinancing terms. This programme has encountered great interest from SMEs, allowing credit growth in local currency to turn positive as from September 2013.

A deceleration in inflation has been observed since early 2013 and this reached a record-low level of about 0% in annual terms in May 2014, with the activity remaining below its potential and thanks to energy prices being cut for end users prior to the elections. This low price increase is in contrast with the high rates encountered in the aftermath of the global economic and financial crisis, when episodes of the weakening exchange rate (increasing the price of imported products) and of tax rate increases explained inflation overshooting the 3% target of the authorities.
Hungary_Graph3EN

Source: Central Bank of Hungary

The banking sector is still suffering

The situation of the mostly foreign-owned banking system (about 90% of total assets belong to foreign banks) is currently negatively influenced by a special bank levy and a financial transaction duty and by the high and still rising level of the non-performing loans ratio. It is also affected by the losses stemming from the two successive foreign currency debt relief plans (in September 2011 and November 2013). Indeed, at the onset of the crisis, two thirds of the household debt was denominated in a foreign currency, particularly in Swiss francs and to a lesser extent in euros, which allowed for lower interest rates. Various measures were taken in the framework of those plans to alleviate the weight of the debt service for households, which had considerably risen following the forint depreciation that took place between 2009 and end-2011. Those plans mainly consisted of allowing households with forex-denominated mortgages to pay off their loans at a preferential exchange rate, the cost of which is supported by the banks and government. Today the banking system is still at risk of further losses since a bill was passed by the parliament early July requiring the sector to compensate borrowers for banks' unilateral increases in interest rates and fees on both foreign and local currency loans over the past 10 years. Moreover, a new relief package permitting the conversion of forex mortgages into forints is likely to be drawn up by the government by autumn, with banks bearing a significant part of the burden again.

While constituting a destabilising threat for the sector, those foreign currency loans relief plans for households have allowed a part of the large overall exchange rate risk stemming from the bulky forex exposure of overall debt to decline sensibly, yet remaining considerable.

Bank deleveraging has been impressive since 2009. Reduced bank financing needs because of the domestic credit demand contraction and the early repayment schemes of foreign currency mortgages have implied net repayments by domestic banks to their foreign parent banks. In spite of the accommodative stance of the monetary authorities, total credit to corporates and households is still decreasing, reflecting the deleveraging process of the private sector.

Unorthodox policies weigh on the investment climate and thereby on potential growth

Besides purely financial vulnerabilities, it is the policy missteps, the unpredictable character of the policies, the government’s interventionism and the weakened institutions that hurt the private (domestic and foreign) investment climate. This is illustrated by, among other things, the sectorial taxes targeting some of the mostly foreign-held sectors which were introduced as a way of dealing with public finance difficulties. While the ‘ease of doing business’ aggregated indicator of the World Bank ranks Hungary 54th (out of 189 countries), the country holds the 128th position regarding the peculiar ‘protecting investors’ indicator. However, the authorities try to attract FDI from export-oriented job-creating multinationals, in particular in the automotive, but also in the machinery and electronics sectors, allowing total FDI inflows to remain substantial (10.6% of GDP in 2012).

Combined with weaknesses of the labour market, the uncertain investment environment weighs on the potential growth of the country. As a consequence, convergence of income with Western Europe is expected to be rather slow.

Hungary_Graph4EN

Source: IMF WEO (April 2014)

Analayst: Florence Thiéry, f.thiery@credendogroup.com