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Rating Action:

Moody's places Hungary's Baa1 sovereign rating under review for possible downgrade

Global Credit Research - 23 Jul 2010

National Bank of Hungary also placed on review for downgrade

Frankfurt, July 23, 2010 -- Moody's Investors Service has today placed Hungary's Baa1 local and foreign currency government bond ratings on review for possible downgrade.

Moody's decision to initiate this review was prompted by the increased uncertainty regarding Hungary's fiscal outlook and economic prospects. This uncertainty is the result of the recent breakdown of Hungary's talks with the IMF and EU (after a disagreement over the country's 2010-11 fiscal deficit targets), which in turn led to a suspension in the next disbursement from the IMF/EU EUR20 billion loan programme for Hungary.

In a related rating action, Moody's also placed Hungary's Baa1 foreign currency bank deposit ceiling on review for possible downgrade. This ceiling reflects the risk that the Hungarian government would freeze foreign currency deposits to conserve scarce foreign currency resources during a crisis. The outlook on Hungary's Aa2 country ceiling for foreign currency debt remains stable. This is generally the highest rating attainable by an issuer of foreign currency debt domiciled in the country.

Moody's also placed the Baa1 foreign currency government bond rating of the National Bank of Hungary (NBH) on review for possible downgrade.

RATIONALE FOR REVIEW

While Moody's acknowledges the Hungarian economy's macroeconomic and fiscal adjustments (as reflected in current account and primary budget surpluses in 2009), the rating agency believes that the country's economy remains vulnerable because of the high foreign-currency indebtedness of both its private and public sector. Consequently, market confidence in both the government's fiscal consolidation programme and the value of its currency are considered very important.

"The failed talks between the IMF/EU and Hungary's government about the country's loan programme -- which represents a crucial policy anchor for Hungary -- has increased uncertainty about the authorities' determination to restore fiscal sustainability in the near term," says Dietmar Hornung, a Moody's Vice President - Senior Credit Officer and lead analyst for Hungary. By espousing fiscal deficits above those recommended by the IMF and EU, Moody's believes that the Hungarian government has increased the uncertainty over whether its debt affordability will stabilize within the next two to three years.

Moody's also says that the suspension of talks with the IMF/EU is clouding Hungary's economic growth prospects by exerting downward pressure on its currency and upward pressure on funding costs. The rating agency believes that the NBH may be forced to raise policy interest rates out of concern over the impact of exchange rate depreciation on the foreign debt-servicing costs of both public and private sector borrowers. For the NBH, this issue would likely outweigh concerns that higher interest rates might restrain economic growth.

In addition, Moody's says that the government's planned bank levy represents a further potential drag on economic activity as it could negatively affect banks' credit provisioning and the country's investment climate. Such a levy could also prompt foreign banks to scale back their Hungarian operations.

FACTORS TO BE CONSIDERED IN THE REVIEW

The review of Hungary's sovereign ratings will focus on the ability and willingness of the Hungarian government to formulate a coherent reform agenda that could stabilize economic strength generally, and the government's financial strength specifically, in a difficult economic environment.

In this context, the progress and substance of an expected resumption of discussions between the Hungarian government and the IMF/EU will be a key consideration in Moody's ratings review. "Moody's expects the Hungarian government and the EU and IMF to come to an agreement following the local elections (scheduled for 3 October), as all sides are aware of the negative consequences of a complete breakdown in the programme," adds Mr. Hornung. "Moody's will examine the specifics of the fiscal aspects of the agreement in order to assess whether the government's debt affordability will indeed stabilize."

The rating agency is likely to confirm the country's current rating if there is a credible commitment to the IMF's previously proposed fiscal targets and if other macroeconomic indicators remain positive. However, if the new fiscal targets that emerge from the next round of talks imply a less rapid fiscal consolidation path, then a one-notch rating downgrade is likely. Although a multi-notch downgrade is unlikely, Moody's says that this could be prompted by a lengthy impasse in programme negotiations, which would likely have adverse exchange rate and interest rate consequences.

PREVIOUS RATING ACTION & METHODOLOGY

Moody's last rating action on Hungary was implemented on 31 March 2009, when the rating agency downgraded Hungary's local and foreign currency government bond ratings to Baa1 from A3 and maintained a negative outlook. The last rating action on Hungary prior to that was taken on 7 November 2008, when Moody's downgraded Hungary's local and foreign currency government bond ratings to A3 from A2 and assigned a negative outlook.

Moody's last rating action affecting National Bank of Hungary (NBH) was implemented on 1 July 2010, when the rating agency corrected the NBH's foreign currency bond rating to Baa1 from A1, aligning the rating with the government's foreign currency bond rating. The Republic of Hungary is legally responsible for the payments on the bonds that are currently outstanding.

The principal methodology used in rating the government of Hungary and the National Bank of Hungary is Moody's "Sovereign Bond Ratings", which was published in September 2008 and can be found at www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.

New York

Bart Oosterveld

Managing Director

Sovereign Risk Group

Moody's Investors Service

JOURNALISTS: 212-553-0376

SUBSCRIBERS: 212-553-1653

New York
Kristin Lindow
Senior Vice President
Sovereign Risk Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Frankfurt
Dietmar Hornung
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Deutschland GmbH
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's places Hungary's Baa1 sovereign rating under review for possible downgrade
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