Hungary Faces Tougher Public Finance Challenges in the Era of Covid-19

Scope Ratings says improvements in Hungary’s debt structure and the expected timely return of the economy to pre-Trisis growth mitigate an increased vulnerability of the country’s public finances to future shocks.

“An important absorption measure would be the further extension of public debt maturities,” says Giulia Branz, analyst at Scope. “Doing so could reinforce Hungary’s fiscal resilience by reducing high gross annual financing needs, although a critical issue remains the capacity of domestic investors to absorb higher volumes of government bonds issued by the Hungarian State Treasury – especially at longer durations.”

Scope draws five main conclusions from its latest analysis of Hungary, illustrated by five charts in a new report, available here.

Upward revisions to public deficit and debt, but significant improvements in debt profile

“We have made an upward revision in our deficit forecast to 10% of GDP in 2020 after higher spending in response to the pandemic, expected further extension of fiscal support, and a deep recession,” says Branz.

Nevertheless, a robust recovery in nominal output is foreseen in the years ahead, which should ensure the gradual decrease of debt back toward 75% of GDP by 2024.

A significant improvement in Hungary’s debt profile over the past decade, including a substantially lowered share of foreign-currency denominated debt, has reduced external sector risks and helped to advance Hungary’s domestic capital market liquidity, especially via the issuance of retail bonds.

Constraints from low average debt maturity and domestic sector’s limited debt absorption capacity

At the same time, Hungary still faces a relatively low average public debt maturity – only 4.4 years for HUF-denominated debt – resulting in high yearly gross financing needs relative to other countries’ in Central and Eastern Europe.

“The fact that domestic debt holders have a limited capacity to absorb longer-dated government bond issuance compared to the tolerance of international investors may pose a constraint on the government’s objective of extending debt maturities,” says Branz.

The benefits of fairly benign market conditions

Hungary benefits from fairly stable market conditions over recent months, with current 10-year yields around 70bps above pre-crisis levels. Hungary’s international capital market access was also successfully tested through the placement of a EUR 500m bond denominated in Japanese Yen (Samurai Bond) this month.

“The mix of lower interest rates and the quantitative easing of the Magyar Nemzeti Bank (MNB) have provided robust support for Hungary’s debt management agency, ÁKK, to complete a large share of its funding needs for 2020, including 100% of the planned foreign-currency debt issuance,” she says.

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Giulia Branz is Associate Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Demographics Squeeze Advanced Economies’ Long-Term Growth Potential; Big Test for Italy & Japan

Scope Ratings has examined the impact of demographic trends on long-term economic growth in major economies, assuming productivity growth and employment rates remain constant.

“We show that GDP growth rates are likely to decrease in all countries in the coming decades, but large differences exist between advanced economies. Comparing the best and worst performers – the US on the one side and Italy and Japan on the other – over time highlights the magnitude of the problem: by 2050, US GDP could be significantly higher compared to its 2020 level in real terms, while, in the absence of significant productivity and employment gains, Japan and Italy would likely have lower real GDP levels than potential GDP today,” says Giulia Branz, analyst at Scope Ratings.

At the same time, countries can enhance productivity to maintain positive long-term growth and implement policies to address adverse demographic trends and employment trends – two key variables that are captured in the ESG-risk pillar in Scope’s forthcoming update to its sovereign rating methodology.

Demographics explain a large part of structural downward trends in growth

Demographic factors explain a large part of the downward trend in advanced economies’ recent economic growth rates and are likely to remain important over the coming decades according to Scope’s study of the 1960-2050 period, focusing on working-age populations, productivity, and employment rates.

“Our model holds productivity and employment rates constant at 2014-19 levels – which we recognize is a bold assumption as these can change significantly as a result of government policies – but this allows us to estimate a country’s growth prospects based only on its demographic trends that are less likely to fluctuate as significantly,” says Branz.

Significant differences in growth prospects between countries

Growth prospects are structurally declining in all advanced economies, but significant differences exist across selected countries:

  • The US, UK, and France are likely to continue to grow over the long term thanks to relatively favorable demographic trends.
  • Germany and Spain are likely to see GDP stagnate over the coming decades. Adverse demographic trends are likely to offset some of the expected gains in productivity and employment (assuming the latter are sustained over the coming period).
  • Japan and especially Italy would likely experience a marked decline in GDP levels over the next decades based only on adverse demographic trends were such trends not offset with productivity and employment gains that have been distinctly lacking over recent years.

“Our findings have important implications for public debt dynamics and, as a result, sovereign ratings,” says Branz. “Policies that improve countries’ productivity levels, demographic trends, and employment rates are critical to ensuring the long-term sustainability of public debt.”

Download the full report from Scope Ratings.

For a look at all of today’s economic events, check out our economic calendar.

Giulia Branz is Associate Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Euro Area’s Fiscal Plans Face Financing Challenges Following Covid-19

Understanding gross financing needs (GFNs) is essential to assessing the sustainability of sovereign borrowing by providing an aggregate figure of the maturing debt volume, primary fiscal deficits and interest payments in a fiscal or calendar year.

In 2020, Scope Ratings expects euro area gross financing needs of around 18% of it’s GDP, assuming an aggregate primary deficit of 6% of the GDP and interest payments of 1.8%. By comparison, in 2019, GFNs amounted to 12% of GDP.

“We expect for 2020 a similar overall size for euro area gross financing needs compared with that in 2009, at the peak of the Global Financial Crisis, but this time the focus around the composition will be different,” says Giulia Branz, an analyst at Scope and co-author of the Euro Area Gross Financing Needs in 2020:
rise mitigated by favourable composition . “Hefty fiscal stimulus is the main driver of the rise in GFNs in 2020 while interest payments and the amount of maturing debt remain lower than in 2009,” she says. “Governments are issuing debt to counter-cyclically address the crisis, rather than to service past borrowing. This may support faster economic recovery and thus strengthen debt sustainability over the medium term.”

The euro area’s total GFNs this year might remain comparable to those during the Global Financial Crisis in 2009 if the economic contraction from the Covid-19 remains close to Scope’s baseline estimate of around 6.5% of the GDP. At the same time, euro area governments have varying degrees of fiscal space, with projected GFNs in 2020 ranging from 8% in the case of Estonia to over 30% of GDP in Italy’s case.

The Italian exception

“Italy is among the few countries facing very similar amounts of amortisations and interest expenditures this year compared to 2009, despite recurrent primary surpluses in the aftermath of the financial crisis and the extraordinary interventions of the ECB,” says Branz.

Italy’s gross financing needs in 2020 nonetheless remain far below those projected for other reserve currency sovereigns such as the United States (38.5% of GDP) or Japan (45.6% of GDP). In addition, the European Central Bank’s enhanced role as a lender of last resort and will support fiscal sustainability despite the one-time surge in fiscal deficits. ECB support is expected to keep interest costs low to mitigate spreads in risk premia across countries and absorb part of the additional gross financing needs resulting from higher primary deficits.

An elevated 2020 euro area deficit but a more homogenous fiscal response

“In absolute terms, we currently estimate the euro area’s fiscal deficit for 2020 at around EUR 890bn. This compares with the ECB’s additional purchase programmes totalling around EUR 1trn, of which we can assume around 70% relate to euro area government securities purchases.”

Scope’s forecast of an aggregate euro area fiscal deficit of around 8% of GDP can be broken down into the pre-shock primary balance, shock-related discretionary spending, the cyclical component including higher unemployment benefits and lower tax revenues, in addition to interest payments. While the projection for the cyclical component deterioration is comparable to that seen in 2009, interest payments are significantly lower this time – thus creating the space for greater stimulus.

“We see greater use of fiscal spending in 2020 and more homogeneous fiscal responses across euro area countries, as the discrepancies in their fiscal balances, are set to be much lower than in 2009,” says Branz. Counter-cyclical and coordinated fiscal policy are what countries have to do to mitigate the impact of the economic shock. Still, this will inevitably translate into an increase in the stock of public debt.

A rise in regional debt, but via growth-enhancing spending rather than higher interest cost

“We project the euro area’s debt-to-GDP ratio will increase to a record high of around 98% in 2020, up from 84% in 2019. However, thanks to prudent fiscal policies over the past ten years, much of the increase in public debt results from higher primary spending rather than from higher interest payments.”

Euro-area governments have several ways to offset the impact of higher GFNs on future economic performance, including:

  1. Lengthening debt maturities to lower annual refinancing needs.
  2. Improving the euro area’s long-term fiscal capacity (such as creating a recovery fund, new forms of emergency lending, region-wide unemployment insurance).
  3. Monetary policy support during times of market volatility.
  4. Common endeavours to raise the euro area’s growth potential.

Download Scope’s full report

Giulia Branz is an Associate Analyst in Public Finance at Scope Ratings GmbH.