Fitch cut Hungary's long term foreign currency credit rating by one notch to BBB- with a negative outlook on Thursday, warning that the lack of a coherent medium-term fiscal strategy undermined confidence in fiscal sustainability.
The downgrade came just as Hungarian lawmakers prepared to approve the 2011 budget that cuts the deficit with one-off revenues, leaving markets hoping more reforms due in February will finally put the country on a sustainable fiscal path.
The 2011 budget targets a deficit below 3 percent of gross domestic product for the first time since Hungary joined the European Union in 2004, making it a top performer in the 27-member bloc.
But to do so it will rake in temporary taxes, including heavy new levies on profitable foreign businesses, and tap up to $14 billion of private pension savings, putting it on a potential collision course with markets and voters.
"The new Fidesz government... has set out fiscal plans that go in the wrong direction for further fiscal consolidation. Conversely, these plans could worsen the underlying medium-term budget outlook by around 4pp of GDP over 2011-2012," Fitch said.
Fitch warned that a failure to implement credible medium-term fiscal consolidation measures that restore public finances to a sustainable course could lead to a downgrade.
"A significant rise in the risk premium or absence of sustained economic recovery would also have adverse consequences for debt dynamics and the rating," it added.
It said a return to robust GDP growth and implementation of proper fiscal consolidation steps could lead to "positive rating action."
The government's strong parliamentary majority makes Thursday's final budget vote all but a formality and the eyes of investors are now trained on what they hope will be a programme of more durable public sector reforms due to be announced at the end of February.
Analysts say pressure from credit rating agencies -- with Hungary now on the brink of "junk" debt status at all three big rating agencies and rising refinancing needs as of next year will put pressure on Budapest to come up with a meaningful longer-term package.
"Should the package disappoint and only include cosmetic changes instead of thorough reforms, a downgrade into junk category would be a definite possibility. There simply is no more time to beat around the bush, in our view," said Gyorgy Barta, analyst at CIB Bank.
Hungary's forint currency EURHUF= weakened by 0.7 percent to trade at 277.60 against the euro at 1210 GMT on Thursday following Fitch' ratings downgrade.
Hungary's government plans to issue foreign bonds worth 4 billion euros "as soon as possible" next year to refinance expiring debt and begin repaying parts of an IMF/EU loan that ushered it through the global financial crisis.
The central bank raised interest rates by 50 basis points to 5.75 percent NBHI over the past two months to fend off price pressures fuelled by recent tax changes.