• S&P downgraded Hungary by one notch to BB with a stable outlook on Friday
  • S&P said unorthodox policies may hurt long-term growth potential…
  • …but government deficit can be kept below 3% of GDP in 2013-14
  • While some negative reactions might come today, this might remain contained
  • We do not change our market forecasts, 25bp rate cut might come tomorrow

An agreement with the IMF could have prevented the downgrade

Friday evening, S&P cut the credit rating of Hungary by one notch to BB, with a stable outlook. Thus, the rating is now two notches below investment grade. A negative outlook was assigned to the rating since the late-2011 downgrade to junk, similarly to the other two major agencies (Fitch cut the credit rating to non-investment grade in January-2012). S&P told that the downgrade reflects their opinion that "the government's unorthodox policies, including exceptional measures applied to the financial sector, could erode the country's medium-term growth potential". Despite the downgrade, however, S&P expects that the government will be able to sustain the budget shortfall below 3% of GDP for 2013-14, and also forecast a modest recovery of real GDP for 2013 (+0.8%) and for 2014 (+1.7%). The relatively good growth figures may be the cause for keeping the outlook stable and not negative.

In our view, the debt-to-GDP ratio should be sustainable under S&P's assumptions in the absence of strong yield increases, and thus, while Fitch and Moody's may make similar steps in the upcoming weeks, we do not think that a strong negative market reaction will come in the days ahead if the external sentiment does not worsen too much. That said, the risks tied to the growth potential mentioned by S&P clearly exist, which is also reflected in our weaker growth assumptions for 2013 (-0.4%) and 2014 (+0.8%). In addition, this step from S&P would make it difficult (or at least more expensive) to issue Eurobonds in the upcoming time period. An agreement with the IMF (which we had anticipated some months ago to be reached by the end of this year, which is now very unlikely) could have prevented the downgrade.

Overall, we do not change our forecasts for the EUR/HUF (285 at end-2013 and at end-2013 as well) and 10Y yields (7.1% for end-2012 and 6.5% for end-2013). As for tomorrow's base rate decision, if there are no strong negative market reactions to S&P's move today, then the previously anticipated 25bp rate cut can take place tomorrow.