Junk-Rated Hungary Trades as Rising Star in Default Swaps Market

  • Ratings reviews start next week for central European nation
  • Upgrade would reverse 2011 decision to strip investment-grade

Derivatives traders have already promoted Hungary out of junk.

Less than two weeks before global ratings companies begin reassessing the eastern European nation’s debt, credit-default swaps imply an investment-class ranking of Baa3 at Moody’s Investors Service. The country has been rated Ba1, one level below the high-grade status, since November 2011.

“Hungary is the only country below investment grade in the central European space and that’s not fair,” said Nicolaie Alexandru Chidesciuc, an analyst at JP Morgan Chase & Co. “Both Fitch and Moody’s will likely upgrade this year.” JPMorgan has an overweight recommendation for Hungary’s external debt and sees potential upside in the event of a rating increase.

Prime Minister Viktor Orban has lowered the European Union’s highest bank tax, narrowed the budget deficit and cut government debt. A boost would also vindicate Gyorgy Matolcsy, who as central bank chief has helped insulate Hungary from the past year’s turbulence in emerging markets by converting foreign-currency mortgages and lifting domestic ownership of government debt. As economy minister he was blamed for policies that contributed to the loss of the investment position and drove up bond yields.

"Authorities are now focusing more on public debt reduction in view of the rating agencies’ reluctance to upgrade Hungary to investment grade," said Mai Doan, an analyst at Bank of America Corp., who like peers at Erste Group Bank AG and JPMorgan, expects an upgrade this year.

Moody’s is set to review Hungary’s rating on March 4, followed by Standard & Poor’s on March 18 and Fitch Ratings on May 20. A move up by Moody’s would be the first in the region since it raised Lithuania’s credit score in May and Ukraine’s restructuring triggered a new rating in November. S&P on Jan. 15 unexpectedly cut Poland’s investment-grade ranking, citing concern the government in Warsaw is eroding the independence of key institutions.

It costs 165 basis points to buy default insurance against Hungary’s debt for five years. That’s the least among junk-rated countries worldwide, data compiled by Bloomberg show. Protection for Croatia, which has a higher assessment from S&P and the same level at Moody’s, is 293 basis points.

Danube Revival

The implied rating shows the market is betting that Moody’s or Fitch will follow through on their positive outlooks for the central European country on the banks of the Danube, bringing it closer in line with peers such as Poland and the Czech Republic. S&P has a stable outlook on the sovereign.

Hungary’s five-year credit-default swaps have stayed largely unchanged compared with the start of this year, versus a 20 basis-point surge for Poland to 94 and a four basis-point increase for Romania to 135. Romania is held one step higher at the lowest investment tier while Poland is five steps higher.

The yield on Hungary’s dollar-denominated bond maturing 2024 has fallen 20 basis points this year to 3.81 percent. That’s 84 basis above similar-maturity Polish debt and compares with a spread of as much as 160 basis points in 2014.

Sustained Trends

Moody’s lifted the country’s outlook to positive in November, citing a sustained downward trend in government debt and prudent fiscal policy. It was the first to strip Hungary of its investment grade in 2011 after Orban effectively nationalized private pension funds and levied industry-specific taxes to avoid an international bailout. Those steps, while drawing criticism from rating companies, helped lower the budget deficit below 3 percent of gross domestic product.

Public debt fell to 75.5 percent of GDP at the end of last year from 76.2 percent a year earlier, according to central bank data. The government’s net financing need was 1.8 percent of economic output in 2015, compared with 2.4 percent in 2014.

“We expect Hungary to return to investment grade this year, after the huge rebalancing of its external position and improvement of deficit and debt ratios,” said Juraj Kotian, the head of central and eastern Europe macro and fixed-income research at Erste in Vienna.

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