The sharp correlation between Hungary's electoral cycle and the deterioration of public finances was again in evidence in 2006, when the budget deficit widened to 9.2% of GDP (from 7.8% in 2005). Following the elections, the government announced its intention to narrow the deficit to 6.8% of GDP in 2007, 4.3% in 2008 and 3.2% in 2009. Although political pressure on the government to slow or reverse the consolidation programme remains, it appears on track to reduce the deficit to 6.3% of GDP this year, placing it in a good position to meet its 2008 target, which will be helped by the falling out of some lumpy expenditure items related to motorway investment, the purchase of military equipment and a capital injection to the railways.
The tightening of fiscal policy is having a significant dampening impact on the domestic economy: Fitch forecasts real GDP growth at just 2% in 2007 and 2.5% in 2008. Hungary will therefore continue to lag the economic growth performance of regional peers at least over the next few years. Lower domestic demand will however contribute to a rebalancing of the economy and a narrowing of the current account deficit, which Fitch forecasts at 4.7% of GDP in 2007 (compared with 6.5% in 2006) and 4.3% in 2008. A narrowing of the current account deficit should help to reduce Hungary's financing requirement and stem the sharp upward movement of the economy's external debt burden that has taken place over the past five years.
Hungary's ratings are supported by its high income level: at USD17,900 on a purchasing power parity basis, per capita incomes compare favourably with a 'BBB' peer group median of USD10,700 and - after Slovenia and the Czech Republic - Hungary is the richest country in Central and Eastern Europe. The economy is open and diverse, closely integrated with wealthy and stable EU markets and benefits from a large stock of foreign direct investment (FDI). Despite an at times turbulent domestic political scene, broader political stability is supported by robust institutions and EU membership. Hungary also has an untarnished modern debt service record.
With a high government debt burden (65% of GDP), large non-resident holdings of domestically-issued government debt, still large net external financing needs relative to peers, and over half of the domestic private sector's loan book denominated in foreign currency, Hungary will continue to be vulnerable to any sharp fall in market confidence. "Continued and sustained progress in reducing the budget deficit will be central to maintaining market confidence, contain the economy's external vulnerabilities, provide for the emergence of a downward trend in public debt ratios over the medium term and allow the government room to reduce Hungary's high tax and public spending ratios", says Heslam. "However, Fitch is less certain of the fiscal outlook from 2009, when spending pressures will rise following the end of a two-year public wage freeze and a potential waning of political will to continue to narrow the deficit with the approach of the 2010 general election". Given Hungary's already high government and external debt burdens, a loss of reform momentum and repeat of past election-related fiscal expansion would lead to renewed downward pressure on the sovereign IDRs.
