Hungary: Risk Assessment

Country Rating¹

Rating: B

Business Climate Rating¹

Rating: A2

Risk Assessment²

A laborious recovery
Hungary was profoundly affected by the financial crisis as evidenced by the severe recession suffered in 2009. The recovery that developed in 2010 was very modest and largely due to the upturn of exports. In 2011, economic growth is expected to be driven once again by demand from European trading partners, particularly Germany, which provides a market for nearly 30% of sales abroad.  This will spur growth in corporate investment, but only in modest proportions and, with European demand remaining sluggish. Household consumption will likely recover after four years of contraction thanks to a few tax credits and the expected growth in real income. On balance, economic growth will remain disappointing with foreign trade ultimately making a negative contribution due to the expected rebound in imports. Nor will fiscal policy make a positive contribution to economic activity. The improvement in the payment behavior of Hungarian companies in 2010 reflected in Coface monitoring records is expected to stabilize in 2011. In view of the softness of the recovery, however, the risk will remain relatively high compared to the rest of Central Europe. Companies will continue to experience difficulties in the construction, metallurgy, and retail sectors. Conversely, the situation is getting brighter in telecommunications and financial services. A rebound in foreign direct investment inflows to the automotive sector will constitute a positive factor for Hungarian industry: Audi and General Motors have announced extensions of their production capacity. The country thus remains an attractive platform for the production and sale of manufactured products intended for European markets.

Persistence of considerable financial weakness
Hit hard by the financial crisis, Hungary had to request assistance, particularly from the IMF, late 2008, which enabled it to improve its foreign currency liquidity position and stabilize its foreign-exchange reserves. But that only resulted in a shaky improvement in public-sector finances. The fiscal deficit will remain large while public-sector debt - 80% of GDP expected in 2011 according to forecasts - is one of the highest in emerging Europe. The government has announced short-term fiscal measures, particularly the taxation of particular sectors including banking. But the budget proposal does not include the vast and necessary structural reforms involving public transportation, subsidized prices, and local finances in particular. Fiscal policy is thus relatively opaque. In this context, marked volatility can be expected in the Hungarian forint. And private sector debt in foreign currencies remains substantial with a high proportion in Swiss francs. A new episode of decline in the exchange rate could result in repayment difficulties for households but also for companies.

Economic policy options remain uncertain
In April 2010, the legislative elections resulted in a sweeping victory by the center-right party Fidesz, which emerged with a two thirds majority and thus all the necessary leeway to take up the challenge of consolidating public finances. But a fiscal adjustment does not appear to be the priority, with the government preoccupied with keeping the support of a public weary of a seemingly interminable crisis. But a new IMF agreement could be essential (the previous agreement expired in October 2010) if current policy fails to significantly resolve the macroeconomic imbalances, which could lead to new crises of investor confidence.

Strengths

• Among the most advanced Central European countries on reforms
• Quality infrastructure, labor force, regulatory framework, and banking system
• Diversified economyContinued progress on the prudential oversight of the banks
• Large stock of foreign direct investment

Weaknesses

• Low savings rate and dependence on foreign capital
• Low workforce participation
• Erosion of the economic growth potential
• Substantial exposure of borrowers to exchange rate risk due to the high proportion of loans denominated in foreign currency
• High public-sector debt
• Deteriorated social climate as a result of austerity policy