Strategy Note /

Hungary promises reform again as EU funding imperiled

  • EU is finally getting closer to restricting funding: at risk are funds equivalent to 3.8% of Hungary's 2022 GDP

  • Reliance on Russian gas reduces Hungary's leverage in EU dealings now Russia is losing ground in Ukraine

  • Fiscal deficit of 4% in 2022 also puts pressure on PM Orban to deliver on his justice minister's latest reform promises

Hungary promises reform again as EU funding imperiled
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
20 September 2022
Published byTellimer Research

Hungary signalled its willingness, via comments from Justice Minister Varga on 19 September, to address EU concerns on corruption and democratic deficiencies (more than its infringement on human rights).

The day before, the European Commission had proposed restricting a portion of EU funding for Hungary, specifically US$7.5bn or 3.8% of 2022 GDP, under the "conditionality mechanism" that is invoked in cases where the principle of rule of law is breached.

The government of Prime Minister Viktor Orban, who has led the elected right-wing Fidesz-KDNP parliamentary supermajority since 2010, historically has managed to cultivate sufficient diplomatic support elsewhere in the EU and make sufficient promises to reform in order to evade this scenario in the past.

However, this is the first time the EC has proposed a restriction on funding. It follows the European Parliament's vote to label Hungary an "electoral autocracy" on 15 September, with a 74% majority of members.

The European Council has up to three months to approve the restriction recommended by the European Commission. To do so requires a qualified majority – ie at least 15 out 27 countries, and countries representing at least 65% of the total EU population.

Hungary among the most corrupt EU members

PM Orban's leverage this time round

PM Orban's leverage in dealing with the EU is grounded in two factors:

  • Russia: Hungary is more reliant on Russian gas imports than any other EU member, except for Italy, and the EU has struggled to establish an agreement on sanctions on Russian oil and gas (requiring exemptions for Hungary in the process).

  • EU unity: Brexit has heightened the sensitivity of the EU, particularly France and Germany, to risks of another exit by Hungary as well as to any alliance between Hungary and illiberal politicians from other governments (eg Poland) or oppositions (eg France, Italy).

Hungary more reliant on Russian gas than European peers

However, currently, this leverage is compromised by two factors:

  • Fiscal deficit has spiked post-Covid from an average of 2.1% of GDP in the years 2015-19 to an average of almost 6.8% in 2019-22 and a forecast of almost 4% in 2023 (according to IMF forecasts).

  • Russia's territorial setbacks in Ukraine and challenges to its influence elsewhere in its periphery (eg Armenia) also may reduce the willingness of other EU members to compromise with Hungary over matters related to the enforcement of Russian oil and gas sanctions.

Hungary's high fiscal deficits post-Covid

Cheap equities but government policy headwind

Hungary equities, measured by the Budapest Stock Index, are down 35% year to date in total US$ terms.

Spillover from the Russia-Ukraine conflict, weakness in the euro, and the introduction of windfall taxes on the largest listed companies (36% weight OTP Bank, 27% weight MOL Oil & Gas, 4% weight MagyarTel) are the main reasons.

In European EM, this performance is similar to Poland (down 38%) but substantially worse than Greece, Iceland, and Romania (all down in the range of 13-16%).

  • The FX rate is down 19% ytd, compared to down 14% in Poland.

  • Trailing Price/Book of 0.7x (for 16% ROE) is at a 40% discount to the 5-year median, compared to a 25% discount in Poland.

  • Forward consensus dividend yield is 5.1%, compared to 3.5% in Poland.

Hungary equities cheaper vs history than EM Europe peers

Related reading

Hungary: Windfall tax in Orban's state of emergency de-rates equities further, May 2022