Rating agency Fitch cut the outlook on Hungary's credit rating to negative on Friday and warned that a sharp worsening of the country's growth prospects or fiscal pressures could prompt a ratings downgrade.

Hungary is the most heavily indebted country in eastern Europe and the change in outlook reflected concerns about its ability to push through ambitious fiscal reforms and its recent move to allow households to repay foreign currency mortgages at discounted exchange rates.

Fitch affirmed Hungary's long-term foreign and local currency issuer ratings at 'BBB-' and 'BBB', respectively -- both still investment grade but just above junk status. The ratings are in line with those of rival ratings agencies Standard & Poor's and Moody's who also have a negative outlook on Hungary.

Lingering fears that Standard & Poor's and Moody's could cut Hungary's rating have cemented a rise in risk premiums on Hungarian debt in recent weeks and weighed on the forint , which is trading near March 2009 all-time lows.

The forint briefly fell to 312.50 from 310 to the euro on the Fitch move, but quickly firmed back to 310.50.

The revision in Hungary's outlook to negative reflects a sharp deterioration in the external growth and financing environment facing Hungary's small, open and relatively heavily indebted economy, says Matteo Napolitano, director of Fitch's sovereign group.

Moreover, various fiscal policy measures and the scheme to allow the repayment of household foreign currency mortgages at below market exchange rates have dented foreign investor confidence, on which medium-term growth prospects depend.

The Hungarian government has failed to fully deliver on its ambitious fiscal reforms announced in March, while the economy -- hit by a slowdown in Europe and sluggish domestic demand -- faces a sharp slowdown next year.

The government's recent move to let households repay their foreign currency mortgages -- at discounted exchange rates, which is seen causing big losses to banks, has increased financial stability risks.

Fitch projected a budget deficit of 3.3 percent of GDP for next year, above the government target of 2.5 percent.

The deficit target is lower than a number of other European countries but Hungary's public debt stands at around 76 percent of GDP.

A significantly worse than currently anticipated slowdown, evidence of private sector capital outflows or problems in the banking sector, a rise in the risk premium or fiscal financing pressure could lead to a downgrade, it said.

It added that a material weakening in the government's commitment to fiscal consolidation could also lead to a downgrade.

Conversely, the government meeting its budget deficit targets and a return to healthy growth, particularly in the context of significant structural reforms and declining external debt ratios, could lead to positive rating action.

The Hungarian Economy Ministry said it did not agree with Fitch's assessment of the country's situation, adding that the government was committed to meeting its 2012 budget goal and cutting state debt further.

The government is convinced that early next year, when the final data on the 2011 budget balance and the repayment scheme will be available, Fitch will revise its current, overly pessimistic assessment ... and will modify its view in a positive way, the ministry said in a statement.

Hungary needs to tap international markets next year to finance expiring foreign currency debt worth close to 5 billion euros, including repayment of a loan from the International Monetary Fund, which saved the country from financial meltdown in 2008.

As this loan expired last year, Hungary does not have a backstop financing line from the IMF now.

With foreigners holding about 3.8 trillion forints worth of forint-denominated government bonds, the risks of a selloff on a potential downgrade are significant.

Some analysts said Fitch's move did not necessarily mean a downgrade was on the cards, but others were less optimistic.

I don't think this will definitely lead to a ratings downgrade, although Fitch has lined up with the other two agencies, Moody's and S&P, on the brink of junk, said Zoltan Arokszallasi at Erste Bank in Budapest.

The government continues to stick to its deficit targets, which are less in doubt than the growth outlook, whose engines appear to be sputtering out.