Italy, Portugal and Hungary share sizeable credit challenges

Weak government balance sheets and banking system event risks are among the key credit weaknesses of Italy, Portugal and Hungary, three countries that now share broadly similar credit profiles, according to a leading rating agency. 

In a recent note to clients, Moody’s said reform efforts have increased the resilience of Portugal and Hungary's economic and fiscal profiles in recent years. Although Italy benefits from its diversification and wealth, the new government has slowed reform momentum needed to restore competitiveness and bring public debt onto a downward trend.

"Italy, Portugal and Hungary still face sizeable credit challenges in 2019," said Evan Wohlmann, Senior Analyst at Moody’s. "In all three countries, the emergence or lack of effective policy responses will drive our assessment of creditworthiness."

Since the financial crisis, the economies of Portugal (Rated - Baa3 stable) and Hungary (Baa3 stable) have become more resilient, Moody’s noted.

The Portuguese economy recovered to its pre-crisis peak in real terms in the second quarter of 2018, a milestone that Hungary reached four years ago. Conversely, Italy's (Baa3 stable) economic output remains around 5% below its 2008 peak, reflecting a sustained loss of international competitiveness since the start of monetary union, which has only recently been halted but not reversed.

In contrast to Italy which never accumulated large net external liabilities, Hungary and Portugal entered the crisis with sizeable external imbalances, although reforms have led to a marked turnaround in current account balances for both countries.

That said, Italy's much larger economic scale provides solid buffers against future shocks which, together with a near balanced international investment position and high wealth levels, differentiates Italy from most Baa-rated sovereigns, Moody’s noted. 

In the context of a more challenging global growth environment in the coming years, Moody's forecasts real economic growth between 2018 and 2020 averaging 1.8% in Portugal and 3.6% in Hungary, compared with a more modest 1.2% in Italy.

All three countries share lingering structural challenges that will constrain long-term growth and upside credit potential if left unaddressed.

These challenges include poor demographics, weak overall productivity growth relative to other euro area peers, and limited fiscal space. In common with most of the EU, all three countries will be "super-aged" by 2030 at the latest, with more than 20% of the population aged 65 years or over.

The three countries carry sizeable public debt burdens, which increased markedly during the crisis and remain well above those of similarly rated peers and the Baa-rated median of 48% of GDP in 2017.

Still sizeable banking sectors, together with high levels of nonperforming loans and weak profitability, heighten risks for Portugal and Italy, although some contingent liability risks have already crystallised.

The Hungarian banking system is more moderately sized, but the government's drive towards greater domestic ownership heightens the contingent liability risks compared to the pre-crisis period.

“We expect the pace of reform will remain slow and timid in Italy, while Hungary's policy responses will be tested by more challenging external conditions in the coming years. In contrast, we consider Portugal's high institutional indicators and its more stable political environment to be more conducive to maintaining its reform momentum,” the rating agency concluded.