Hungary Moves Up to ‘BBB’, Where’s Croatia Heading?

Credit rating agencies S&P Global Ratings and Fitch lifted Hungarian credit rating to ‘BBB’, one notch above lowest investment grade due solid economic growth and external deleveraging. Meanwhile, its neighbor Croatia is still in the queue for the investment class and will have its first test in March, when S&P should maintain its review. In this article we are looking at the drivers for Hungarian uplift, similarities and differences with Croatia and seeing what market has to say on the matter.

On Friday, February 15^th, S&P decided to increase Hungarian credit rating to ‘BBB’ with a stable outlook while Fitch did it a week later. “The upgrade reflects Hungary’s sound growth prospects, supported by high private savings and real wage gains sustaining domestic demand, as well as the ongoing expansion of export capacity in the automotive and service sectors” it was stated by the agency. The decision did not surprise the market as GDP growth in 2018 of 4.8% YoY and strong external deleveraging are significant factors for credit houses. Namely, S&P stated that Hungarian economy reported solid balanced growth for six straight years, the external debt dropped to 10% GDP in 2018 down from 55% GDP in 2010, while double-digit wage growth did not derail its external competitiveness.

Nevertheless, there are some challenges that should be resolved before rising further on the investment grade scale. In particular, the economy has started to face capacity constraints as unemployment reached only 3.7% in 2018 with wages rising at double-digit pace. However, knowing Hungarian government’s stance on immigrants issue we see this challenge as an ongoing thing. Going further, exports make some 85% of Hungarian GDP and according to S&P some 16% comes from the automotive industry meaning that there are significant risks for the Hungarian economy in case of US-China-EU trade war. Hungarian politics is still under much scrutiny among EU officials and it looks probable that funds from the EU could decrease in the next program. Last but not least, Hungary is expected to run budget deficits of around 2% GDP in the coming years, with S&P saying that it finds government’s plans to reduce deficits to 0.5% GDP by 2022 too optimistic. Hence they “…believe that the opportunity to put the public debt on a sharp downward trend offered by the current cyclical upturn might be missed”, meaning that public debt should stay above 60% GDP handle for prolonged period of time. Talking about public debt, S&P states that Hungary significantly reduced its foreign currency denominated debt from 60% in 2010 to around 20% today.

Meanwhile, Croatia has not been in the investment class for six straight years now and there are many speculations that in this year the country might get back what it had lost in the latest double-dip recession. If you look at the bond market, Croatia seems to be investment grade for several months now, but let’s talk on that later. In its latest review in September 2018, S&P revised Croatian outlook to positive amid Croatia’s external and fiscal balance improvements, reduced risks on Agrokor issue and increased domestic demand and sound exports. Back then, they said that rating could be raised in case Croatia continues with reducing its public debt supported by control of expenditures and increasing revenues. Since then, the shipyard story emerged which still seems to be far from over while stories regarding Croatia entering ERM II became more frequent. Going on, Croatian economic development seems to be continued at the similar pace although tourist season did not accelerate further as some investors expected. As S&P’s analysts mentioned, Croatian external debt continued falling sharply while according to Eurostat public debt stood at 74.5% of GDP in Q3 2018, from above 84% only 4 years ago. Just to put things into perspective, Hungarian debt as a share of GDP stood at 72.4% while worth noting is that large share of Croatian bonds sits at domestic mandatory funds. All in all, with economic growth slightly decelerating towards 2.0% but still close to its peers, slight fiscal easing and unusually calm political situation we wouldn’t be surprised in case S&P decides to lift Croatia to the investment grade despite expectations on slowdown of global economy and stagnation of several main trading partners.

Looking at the market, as we said above, Croatia is already traded as it has investment grade although there are many funds that are not allowed to buy sub-investment papers, meaning that additional pressure could be expected in case S&P lifts Croatia on March 22^nd. On the chart submitted below you can see how Croatian EUR denominated Eurobond maturing 2027 trades much tighter compared to Romanian one but still has room for tightening versus Hungary while 5Y CDS, popular indicator in Croatian media shows that we are only 10bps away from Hungary, that now trades two notches above.