S&P Global Ratings downgraded Hungary's sovereign rating to 'BBB-' from  'BBB' at a scheduled review on January 29, one notch over the investment grade threshold.

The move is another blow for Viktor Orban's semi-authoritarian regime, which is struggling to stabilise the economy after pumping up spending before last year's general election. The last time Hungary was downgraded by one of the three major rating agencies was in November 2012. Fitch has a 'BBB' rating and Moody's 'Baa2', the equivalent of 'BBB'.

However, S&P also revised its outlook to "stable" from "negative" on expectations that Hungary's economy will avoid a substantial economic downturn in the next two years and weather the indirect effects of the war in Ukraine.

The rating agency noted that the downgrade follows"a series of economic shocks" to Hungary in the context of the pandemic and the war in Ukraine, which have "impaired the policy flexibility of fiscal and monetary authorities".

S&P expects that fiscal consolidation will be difficult given still-elevated energy costs, a rising interest bill, and a challenging economic outlook

It pointed to the timely availability of European Union funds, which remain suspended under the EU's rule of law conditionality mechanism, as a specific economic risk.

In the baseline scenario, Hungary will reach an agreement without losing a “substantial part" of the funding, but a significant delay or shortfall in EU funding would significantly affect forecasts for economic growth, fiscal balances, and external metrics over the next four years.

S&P acknowledged that risks to Hungary's energy supply have abated since autumn because of lower demand and a mild winter, but said another deterioration of European energy markets in 2023 could be more strongly felt in Hungary given its high dependence on Russian energy.

The rating agency expects Hungary to barely avoid falling into recession with a mild 0.3% growth boosted by exports, which have increased in manufacturing, including EV production. It sees growth to converge close to 3% after 2023 supported by a "resilient" labour market, with high employment and strong wage growth.

S&P acknowledged that some "unconventional measures" by the government have helped reduce Hungary's vulnerabilities, but said others "could hurt long-term growth performance".

Inflation is set to fall sharply from the second half and could average at 18.5%, above the government’s 15% forecast. Headline CPI is set to fall into the MNB 2-4% tolerance band at the end of 2024.

S&P said central bank measures, such as the introduction of short-term FX swaps and deposit facilities, an increased reserve requirement threshold for lenders, and providing FX liquidity to energy importers, have helped stabilise financial markets, and contributed to improved monetary transmission and to a stronger currency.

S&P puts the general government deficit at 4.2% of GDP in 2023. It sees state debt, relative to GDP, falling to 64.9%.

A significant cut of Hungary's EU funding or energy supply constraints could put downward pressure on the sovereign rating. The rating could be upgraded if the fiscal and current-account deficits narrow more quickly than expected or the economy posts a stronger and earlier recovery, S&P said.

Economic Development Minister Marton Nagy highlighted the positive notes from the S&P  report, adding that the current revision could be shortly followed by a period of credit rating upgrades given positive economic trends. The government's main goal is for Hungary to avoid recession in 2023 and achieve economic growth of 1.5%.

The downgrade will not have a significant impact on the country's ability to finance itself, he added. The recent FX bond issues confirms that investors’ confidence in Hungary remains strong, he added.