Weekly Briefing, Vol. 64. No. 2 (HU) July 2023
Hungary’s country rating in 2023
Over the past twelve years, Hungary has successfully reduced the share of foreign funds in government debt and also the share of foreign-nominated bonds. At the same time, the development of Hungary’s sovereign debt rating is important for Hungary, as decisions on upgrades and downgrades guide foreign investors in public bonds, loans, and direct investments. The openness of the economy and the need for more capital and technology make it important to maintain a good rating for Hungary. Of course, the forint rate also reacts to the decisions, which affects refinancing options. For this reason, the briefing looks at the evolution of the economy’s country rating and the reasons behind the ratings agencies’ assessments. Since they rating agencies find the development of inflation crucial for the future economic growth prospects, the briefing also touches upon this issue.
Introduction
Standard and Poor’s affirmed Hungary’s rating (BBB-) with a stable outlook last Friday (June 7, 2023). Markets were eagerly awaiting this decision, as S&P had surprised investors in January by downgrading Hungary’s sovereign rating from BBB to BBB-. Several analysts explained the weakening of the forint’s last week by assuming a further downgrade of the Hungarian economy. In January, the negative assessment of the Hungarian economy’s outlook was explained by uncertainties of energy imports and EU transfers. In the new assessment, it was argued that the Hungarian economy could withstand last year’s economic shock and it stabilized which process was boosted by fiscal and monetary policy decisions. The analysis argued that decision makers in Hungary increasing preferred steps toward fiscal and monetary austerity and these steps will reduce public spending in 2023. The S&P made it clear that economic growth after 2023 is on stable foundation although it sees several problems in the scarcity of labor supply and the absence of positive decision on EU transfers for Hungary. At the same time, the government is committed to maintaining the course on fiscal consolidation which will reduce public debt in terms of GDP in the years to come.
In the analysis, S&P assumed that the volume of EU funds will not be significantly reduced but may be delayed. This assumption also means that Hungary’s rating would be downgraded if the EU funds did not arrive. The same applies to energy imports. If there were problems with the country’s energy supply, Standard and Poor’s rating agency would downgrade Hungary. The analysis argues that the two scenarios mentioned above would lead the government to provide financial support to companies and private households, which would ultimately lead to higher public spending and government debt. This would, of course, also have an impact on the forint exchange rate and the inflation trend. The rating agency expects the Hungarian economy to grow by 0.1 percent this year and by 3 percent in the coming years. The negative impact of slow growth on public spending and debt, the agency says, can be offset by lower domestic consumption, higher agricultural output, and greater net export volumes. The agency projects that inflation may remain at relatively high levels, and the agency appears to be less optimistic about inflation than the government. It projects annual inflation to remain at about 18 percent this year and to be about 5 percent in 2024. (1) We could see in this part that the development of external conditions is very important for the Hungarian economy, so we look at one of the key indicators, inflation.[1]
Inflation and government steps to curb price increases
According to the latest publication of the Hungarian Central Statistical Office, inflation in June was 21.4 percent compared to the corresponding months of 2022, a significant decrease compared to May, but inflation in Hungary is still the highest in the European Union. There are four main factors explaining the persistent inflation in Hungary:
- Hungary is geographically close to the war, which has a clear detrimental effect on regional supply chains and thus on the evolution of inflation. This factor is in the case of Central European countries.
- Hungary has its own currency, which on the one hand is less stable than the euro, but on the other hand it accelerates the adjustment to new business conditions. The Czech Republic, Poland and Romania also face this problem.
- The rise in energy prices had a profound impact on inflation in Hungary. Not only because fuel prices have soared significantly, but because energy prices also affect production costs in all sectors.
- Third, food retail supplies in Hungary are very much dominated by foreign companies, which is ironic since Hungary is a net exporter of unprocessed agricultural products but a net importer of processed food. For this reason, Hungary has set the ambitious goal to reduce the dominance of foreign retail chains in Hungary. But it is clear that this is a long-term project. Therefore, the government has taken steps to support the process of price deflation which can work in the short-run.
To effectively curb inflation, the Hungarian government has decided to introduce an online price comparison system. This system helps people find the cheapest products and puts pressure on retail chains. The system has been in operation since the first of July and allows the comparison of 60 items for the public. The retail chains are required to publish their prices for the 60 items on a daily basis. The reason for introducing the system is not only high inflation, but also pricing strategies, the government argues. It also adds that these strategies are not transparent.[2]
There is another pillar of government action to curb inflation. The government has introduced a system that makes discounts mandatory for retail chains. Chains must discount a basket of at least 20 products each week. This system applies to retail chains with annual sales of over HUF 1 billion. The 20 products must include 20 product categories. These product categories include poultry meat, milk, sour cream and substitute products, cheese, bread, pastries, dry pasta, rice and other cereal products, fresh fruit and fresh vegetables. A freely selected product from each specified product category must be sold in the relevant stores at a price that is at least 10 percent lower than the lowest price that was in effect during the mandatory promotion in the 30 days prior.[3]
Inflation according to analysts
MHB Bank economists are optimistic about inflation. They stressed that the recent decline in prices is in line with their expectations. With the exception of the prices of clothing, fuel and services, all product categories contributed to a relatively fair development of inflation. The bank’s analysts stressed that food prices declined in line with earlier expectations. Lower energy consumption also led to lower utility prices, and a stronger currency supported the trend toward deflation in consumer durables. They argued that deflationary pressures were also reflected in lower core inflation figures. They summarized the following factors accelerating the deflation trend:
- In the second half of the year, base effects will reduce price increases;
- The widening trend toward discounting will also have a positive impact on prices;
- The cost of international freight, raw materials and energy has fallen significantly; In most cases, prices have returned to pre-2022 levels in recent months.
As a result of these factors, the bank expects an annual inflation rate of 17.5 percent at the end of the year. Erste Bank analysts added low demand to the factors favoring the deflationary trend in Hungary. They expect the deflation trend to continue in 2024 and 2025. However, they believe that inflation will not rise to 3 percent again until 2025.
Summary
We saw in the briefing that the Hungarian economy weathered the 2022 economic shock relatively well. Although GDP growth will be slow and inflation is still high, prices started to slowly decline, which will contribute to lower interest rates and better investment figures. These positive trends were reflected in the latest rating by Standard and Poor’s, which affirmed Hungary’s rating (BBB-) with a stable outlook. The central bank has not lowered the key interest rate, which is still at 13 percent, but it has lowered the overnight rate in line with lower interest rates. If the trend continues, real interest rates could fall by the end of the year, as annual inflation is expected to fall to 7.5 percent by the end of the year, while the policy rate is likely to be cut to 11.5 percent by the end of the year. Real interest rates may be 4-4.5 percent by that time.
Stable labor market conditions, record inflows of foreign direct investment and countercyclical measures by the government have also contributed to the stability of economic development in Hungary. At the same time, however, it is clear that pressure on public budgets has steadily increased and the absence of EU funds has led to uncertainty about the future of the economy. This uncertainty is often reflected in a sudden weakening and appreciation of the currency, which makes the business environment for companies less predictable than in normal times.
[1] https://www.vg.hu/vilaggazdasag-magyar-gazdasag/2023/07/felesleges-volt-a-forint-aggodalma-megerositette-hazank-adosbesorolasat-a-standard-and-poors
[2] https://www.portfolio.hu/gazdasag/20230508/elesedik-a-kormany-arosszehasonlito-rendszere-613842
[3] https://24.hu/belfold/2023/06/01/elindult-a-kotelezo-akciozas-a-kormany-uj-csodafegyvere/