ECR Survey Results Q1 2014: Confidence in EMs nosedives as eurozone trust returns

The latest quarterly results from the ECR survey indicate that a majority of the world’s sovereign nations became riskier in Q1 2014.

Rising risk levels have continued among large emerging markets (EMs) – such as India, Indonesia, South Africa and Turkey – where investors worried about fiscal and/or external balances have been withdrawing capital in light of the tapering of the US Federal Reserve’s bond-purchase programme.

Russia and Ukraine, the two largest fallers in the survey during Q1, have seen their risk-scores plummet in the wake of the financial implications of the crisis becoming more apparent, which is now dragging in other countries in the region with close ties to Russia, notably Belarus and the Baltic states: Estonia, Latvia and Lithuania.

Bulgaria and Croatia have seen sharp falls in risk scores; Argentina and Venezuela, plagued by their political and economic problems, continue to suffer; while Thailand’s political crisis has also damaged its risk profile even further. It is one of several sovereigns across Asia, including the entire Indian sub-continent, to succumb to increased risk in Q1.

On the other hand, experts have ignored rising border tensions on the Korean peninsula to reward the strengthening economic situation in South Korea with a higher score, and some other EMs with stronger fundamentals, such as Mexico and Uruguay, continue to rise through the rankings.

Elsewhere, the entire G10, from the US and Canada, to large sections of western Europe, have also seen their country-risk scores bounce, with faith notably returning to Italy, Ireland, Portugal and Spain, as bailout programmes unwind and economic conditions gradually improve.

In total, 113 of the 186 countries surveyed saw their risk scores decline during Q1 2014, with three unchanged and 70 registering some improvement.

Bad quarter for EMs

Capital outflows spurred by the tapering of the Fed’s bond-purchase programme put riskier EMs – harbouring larger fiscal and external balances, and struggling to retain investor confidence – into a slide, with their currencies in a tailspin.

Scores for India, Indonesia, South Africa and Turkey all fell along with many other destinations, as experts questioned the safety of investing in Brics, Mints and other EM groupings.

China, bucking the trend, saw its score improve, with policy stimulus supporting its growth prospects. However, its score remains lower than in 2010, with the world’s most populous nation still failing to convince experts it can climb higher in the global rankings – it is still lodged in 37th place, within the third of ECR’s five tiered categories symbolizing medium risks commensurate with a BB+ to A- rating.

Alicia García-Herrero, chief economist for EMs at BBVA, attributes this to “growing indebtedness on the part of the corporates and the public sector, with the main immediate risk lying within a banking system saddled with bad debts and in need of a large recapitalization package”.

India’s travails are equally symbolic of a failure to fully admonish heightened risk perceptions. Its 0.7 point fall in Q1 continues a longer-term trend decline that has seen the country shed more than eight points since 2010 and remain close to the bottom of tier three.

The government has made some progress in ameliorating the fiscal and current-account deficits, which economist Madan Sabnavis at Credit Analysis & Research expects to continue, while also noting that “economic growth is low and investment declining”.

Moreover, India’s monetary policy will remain tight to quench inflation, which, as Sabnavis explains, “is more due to the extraneous forces of supply improving rather than any fundamental change in the structures”.

Elsewhere, Turkey’s political problems have begun to weigh more heavily on its risk profile, with the sovereign sliding three places to 51st. Indonesia has also slipped.

Russian crisis complicates matters

Political instabilities, civil strife and military conflict are still ravaging large parts of the Middle East, but they are also pinpointing new frailties in Russia’s backyard after the annexation of Crimea in the wake of Ukraine’s political crisis.

Russia (rated BBB/Baa1; negative by Fitch) has notably suffered from an unprecedented 4.1 point score decline this quarter, pushing down the sovereign eight places in the global rankings to 62nd and to near the bottom of tier three.

Ukraine, already a trend faller, has shed another 5.4 points, plummeting 24 places to 146th, with Kiev’s financing problems escalating against the backdrop of heightened tensions with Moscow as its eastern parts risk falling under ethnic-Russian control.

The impact of the crisis across Central and Eastern Europe (CEE) varies nevertheless. Whereas the Baltic states, Belarus, Kazakhstan and some of the other former Soviet satellite states have seen their risks rise in response to a weakening Russian economy inflicting pain on bilateral trade and financial transactions – accentuated by the fear of Russia extending its arc of authority to its former Soviet strongholds – some countries in the region have managed to avoid the risks altogether.

Bulgaria, Croatia and a handful of other CEE states, all with domestic problems of their own, have seen their scores slide. However, Poland and Romania, which have become integrated into the EU and have avoided notable domestic political upset, are riding out the region’s heightened tensions having seen their scores improve during Q1.

Eurozone staging a comeback

Many of the debt-distressed eurozone sovereigns, meanwhile, have a long uphill climb to regain the levels of safety prevailing before the global credit crunch in 2007/08.

Nevertheless, apart from the anxieties circling over the Baltic states – and Finland, too, which is still in a slump and vulnerable because of its trade links with Russia – only Cyprus among the euro participants saw its country-risk score continue to fall in Q1.

Scores for Ireland, Italy, Portugal and Spain remarkably staged a comeback in Q1, reflecting in part the brightening economic outlook, with GDP growth returning – or on the brink of returning – brightening the outlook for countries mired in recession for years.

A gradually improving political picture is also factored in. In Italy, for example, where despite the inherent difficulties involved, new prime minister Matteo Renzi is bent on reform to enact constitutional change to strengthen the electoral system and clear up the country’s fiscal mess.

Ireland’s exit from its troika bailout in December without ongoing programme support and a repeat act for Portugal this summer is bolstering their appeal, amid rising investor faith in structural reform programmes delivering more sustainable borrowing profiles for many eurozone participants.

However, although Greece has returned to the bond markets for the first time in more than four years, its risk-score remains very low, anchoring the bankrupt sovereign to the lowest of ECR’s categories containing the world’s highest-risk sovereigns. An enormous debt burden – peaking at 177% of GDP this year, according to the European Commission – a tricky political climate and the longer-term tail-risk of a Grexit are still hanging over Athens.

Synchronized improvement in G10 risk profile

Beyond the eurozone, and for the first time in more than four years, all of the G10 countries saw a synchronised improvement in their risk scores during Q1, with Italy, Belgium and the Netherlands leading the way.

Making headway, too, were the US in 16th place, rising 0.6 to 75.4, and 26th-placed Japan, up 0.8 to 67.9. The UK, lying in 20th position, with its strengthening economy, similarly climbed 0.5 to 72.0.

With the relative rankings broadly unchanged, Switzerland remains the safest G10 nation – second only to Norway globally – and Italy the worst in 49th place, but four places better off compared with December.

Ebrahim Rahbari, economist at Citi, views the main risks to the G10 as “external, idiosyncratic or long-term”, noting that neither a leading EM or a commodity price shock, nor debt deflation or heightened political risk in Europe, can be ruled out.

However, with ample spare capacity, monetary policy support and plenty of room for growth to catch-up, Rahbari sees “a robust recovery in the industrial countries”.

He says: “The reasons for this are very easy to spot as they are the same ones that held us back before, with fiscal tightening fading and private deleveraging pressures now less acute.”

Asia still vulnerable

A combination of domestic and global factors has heightened the risks across Asia, affecting many emerging and frontier markets, including Taiwan, Macau, Malaysia, Mongolia and invariably Thailand, with its political crisis resulting in a further fall to 60th in the rankings on the back of a 2.1 point score slide since December, and 4.7 in all since Q1 2013 – the largest drop among its peers.

The entire Indian sub-continent has been similarly caught up in the attenuated regional risk profile, with not only India but also Bangladesh, Pakistan and Sri Lanka succumbing to lower scores.

Bucking the trend is South Korea, which is considerably less risky in spite of the tensions with North Korea ratcheting up a notch lately. Its short-term risk outlook is improving as fiscal stimulus powers up the economy without weakening the strong and stable budget, and current-account surpluses, or aggravating inflation.

John Sharma, macroeconomist in sovereign risk at National Australia Bank, says: “There are still challenges, the most notable being high household debt as well as stresses in second-tier chaebol [conglomerates], and although remote the possibility of conflict [with the North] cannot be ruled out.”

However, with the economy gaining momentum, South Korean risk is waning.

“We expect GDP growth to accelerate to 3.6% and 3.8% in 2014 and 2015 respectively,” he says. “FX reserves have swelled, the current-account surplus is close to around 6% of GDP, inflation was just 0.7% year-on-year in October and Korean banks have improved their external liquidity profiles.”

Deteriorating sentiment spreads to sub-Saharan Africa

Almost three-quarters of the sovereigns across sub-Saharan African endured sliding risk-scores during Q1, with currencies dragged down on the coattails of increased uncertainty toward EMs.

Substantial falls occurred in high-risk markets from Lesotho and Malawi to Sierra Leone and Djibouti, highlighting a mixture of domestic political, economic and structural risks.

Even Africa’s safer sovereigns, South Africa, Botswana and Namibia – the only three scoring more than 50 points out of 100 – and those issuers bubbling just below, including Gabon, Ghana and Nigeria, endured lower scores.

These increased risks are encapsulated in Ghana’s struggles to arrest the decline in its currency, the cedi, with large fiscal and current-account deficits and modest FX reserves pointing out its vulnerability to an economic shock.

Mena region a mishmash

North African sovereigns have fared better. However, the picture remains nuanced with Morocco, Tunisia and higher-risk Egypt all improving to a lesser or greater degree.

Scores for Algeria and Libya, on the other hand, have fallen, along with countries affected by the Syrian crisis – Jordan, Lebanon – or still facing domestic considerable political and/or economic problems, such as Iran, Yemen and Bahrain.

Qatar is still regarded as the safest sovereign in the MENA region, ranking 17th globally, but its risk-score has noticeably declined since December, by 1.7 points.

Question marks over its labour regulations, highlighted by poor working conditions, and rising tensions with Gulf partners over its support for the Muslim Brotherhood have eroded its score.

LatAm a mixed bag

Latin America has been less affected by the EM rout, with fewer than half of the region’s sovereigns succumbing to score declines in Q1.

Brazil’s score has stabilized, but is still down by 1.4 points compared with a year ago on the back of worries over a tightening of monetary policy to combat inflation, further eroding GDP growth and the fiscal deficit.

Argentina and Venezuela are still struggling in tier five, with their risk profiles remaining heightened by domestic political and economic problems, questioning their longer-term fiscal sustainability.

Mexico and Uruguay on the other hand have maintained their rising score trends. Mexico is still in 36th spot, sandwiched between Malaysia and China in the global rankings as structural reforms underpin economic growth and keep the external imbalance under control.

Uruguay has climbed two places to 48th, to rise above Turkey, with its fiscal deficit narrowing, GDP growth strong in spite of a cyclical slowdown, and policymaking certainty assured by the ruling coalition on course for victory at the October elections.

More than 400 economists and other experts from a range of financial and other institutions take part in Euromoney’s Country Risk Survey. They evaluate the risks faced by international investors in more than 180 markets, scoring countries across a range of political, economic and structural criteria. These are added to values for capital access, credit ratings and debt indicators, and aggregated each quarter to provide a total risk score.

To view the survey methodology, go to: www.euromoneycountryrisk.com.

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