Hungary’s EU Budget Veto May Prove Risky Gamble

The Hungarian and Polish governments’ veto blocking the approval of the EU's long-term budget and coronavirus rescue package may have dire economic consequences, international credit rating agencies warned. If the standoff with Brussels drags on, it could have a negative effect on Hungary’s credit rating.

Hungary and Poland followed through on their threat to block spending plans through to 2027 by vetoing the bloc’s budget and the EUR 750-billion (USD 888 billion) rescue package designed to combat the economic fallout caused by the coronavirus pandemic. Budapest and Warsaw are opposed to a rule-of-law mechanism that the EU set as a precondition for disbursing subsidies to member states. EU leaders decided in July that access to EU funds should be tied to a government’s respect for the rule of law, a decision that was clarified in negotiations between EU governments in November, triggering protests from Poland and Hungary.
The EU needs a unanimous vote from all 27 members in order to pass the budget and the economic recovery fund. The EU’s seven-year budget cycle begins on January 1, 2021. Hungarian Prime Minister Viktor Orbán said that the rule of law proposal was designed “to punish governments” that do not support immigration. The Hungarian government is standing firmly by its opinion, with Orbán’s chief of staff declaring on Thursday that Hungary cannot accept the EU’s budget in its present form, underlining the right of each EU member state to use its veto. Gergely Gulyás added that Hungary was open to further negotiations but noted that “there will not be an agreement” if the rule of law mechanism is maintained.

Possible consequences
While political leaders in Brussels and other western European capitals are scrambling to find a solution to the impasse, Hungary may also see considerable risks arising from the veto. Major international credit rating agencies are confident, for the time being, that the EU and the two countries will reach agreement on a new EU budget and a recovery fund, according to a poll by news website portfolio.hu. None of the three big companies (Standard&Poor’s, Fitch Ratings and Moody’s) threatens to downgrade Hungary because of the veto, but if the debate drags on, the situation would undoubtedly be a negative factor for the country’s credit rating assessment.
At the moment, the chances of a compromise seem slim, as western European member states and the European Parliament remain intent on including the rule of law proposal into the budget proposal. Experts believe that eventually one or both sides will make a concession, as it is in everyone's interest to reach an agreement. Some member states in the EU are in dire need of financial assistance and Hungary may lose funds permanently if the new budget were to be permanently delayed.

Rating agencies on standby
The three major credit rating agencies are in standby mode for now, waiting for a possible solution to emerge. Analysts at S&P are confident that an agreement will be reached, as the stakes are high for both sides. They added that Hungary and Poland would eventually have to agree to some pre-conditions for the disbursement of EU funds. In their latest analysis, S&P economists highlighted weaker-than-expected growth and growing fiscal pressures as the primary risk factors for Hungary. A failure to reach an agreement would jeopardize Hungary’s economic recovery in 2021-22 and the euro area would also post a weaker performance, which could put further pressure on the Hungarian economy, according to S&P.
Fitch analysts echoed the same opinion in that Budapest and Warsaw will at one point agree to the rule of law mechanism, but maybe not in its current form. Fitch's experts project that Hungary's and Poland's relations with the EU will remain frosty in the coming years.
Moody’s has long emphasized that Hungary’s troubled relationship with the EU poses a risk in terms of the country’s credit rating, but for the time being the agency sees no sign that the current debate has weakened investor sentiment or the business environment. If the Hungarian government's commitment to disciplined fiscal policy declines after the epidemic, that may pose a negative risk to the country’s credit rating at Moody’s. An additional risk would be government measures that impair growth prospects and put the debt ratio on a sustained upward path.