After a half-dozen years of dramatic movements in sovereign creditworthiness, calm has returned in Institutional Investor’s latest semiannual Country Credit survey. But there’s still plenty of tension beneath the surface.
The ratings of most major countries show little to no movement over the past six months. The U.S. edges up 0.3 point from September 2013, to 91.6 on a scale of zero to 100. That boosts the U.S. up one place, to seventh, in the ranking. The top five countries — Norway, Switzerland, Canada, Germany and Sweden — post insignificant declines of between 0.1 and 0.5 point. Moreover, respondents leave the ratings unchanged for China, Brazil and even Greece.
Yet a number of emerging markets suffer significant declines, and the overall average rating edges down 0.4 point, to 44.2. A full list of ratings, including a breakdown by region, can be found in the navigation on the right.
Analysts say many emerging-markets countries remain vulnerable to the big question marks hanging over the global economy: Will U.S. economic growth accelerate this year, and will the Federal Reserve Board continue to taper its bond purchases in coming months?
The small move in the U.S. rating, which follows a jump of 2.5 points in the September survey, reflects indecision among analysts participating in the survey over whether the U.S. economic glass is half empty or half full. Ben Bernanke’s Fed seemed convinced that the recovery was strong enough to begin tapering its bond-buying program in December and then tighten it another notch in January, but a weak January employment report raised questions about the pace of the U.S. recovery.
“There’s a general sense that Janet Yellen will pursue policies similar to Bernanke,” one European bank economist says of the new Fed chair, who stressed policy continuity in her first congressional testimony as head of the central bank on February 13. “The economy is growing — but slowly,” the economist adds.
John Sharma, sovereign risk economist at National Australia Bank, offers a similarly mixed view of U.S. politics. In contrast to the bitter standoff over the debt ceiling last year, which forced a shutdown of the federal government in October, a measure to raise the debt ceiling “passed quite smoothly” in February, he notes, “so the concern about a self-inflicted sovereign default is out of the way.” Yet many investors remain wary because there’s still no shortage of political rancor in Washington, Sharma adds.
When asked to predict when the Fed will make its first rate hike, 14.9 percent of survey participants said it would happen in the second half of 2014, 25.5 percent predicted it would take place in the first half of 2015, 34 percent called it for the second half of 2015, and 25.5 percent said it wouldn’t happen until 2016 or later.
The question marks hovering over the U.S. generate even more question marks for the emerging markets. There was a time when many analysts were convinced that if the U.S. sneezed, the emerging markets wouldn’t necessarily catch a cold thanks to the growing economic footprint of China and burgeoning south-south trade among emerging markets.
But the world isn’t there yet. The combination of the slo-mo U.S. recovery and China’s more modest pace of growth is having a major impact on the emerging markets, repressing purchases and prices for a variety of commodities.
Meanwhile, Fed tapering has made dollar investments more attractive and sucked money out of the emerging markets. Investors had pulled $25.2 billion out of emerging-markets stock and bond mutual funds this year as of February 5, according to fund data provider EPFR Global. Dominik Thiesen, vice president of country risk research at Commerzbank in Frankfurt, says that because “money is now moving back to the industrialized countries, it is not so easy for emerging markets to finance their debt burdens.”
Stocks and currencies have fallen sharply in a number of emerging-markets countries. When economist Jim O’Neill, then of Goldman Sachs, coined the acronym BRIC in 2003, it celebrated the four horsemen of an emerging-markets revolution: Brazil, Russia, India and China. These days, analysts talk about the Fragile Five, as Morgan Stanley analyst James Lord has dubbed Brazil, India, Indonesia, South Africa and Turkey because of their budget and current-account deficits. In January the Turkish lira and the South African rand fell to their lowest levels in five years and the Hungarian forint got hammered (see also “BRICS, MINT and a Fragile Five: Where EM Groupings Go Wrong”).
Among this group, India sees the biggest drop in its rating, down 2.2 points. Indonesia falls 0.7 point, South Africa loses 0.4, and Turkey sheds 0.2.
Beyond the global forces buffeting emerging markets, there are a host of local problems, from concerns about safety in the garment industry in Sri Lanka (–1.2) and Bangladesh (–1.6) to questions about stability in Pakistan (–0.2).
Many analysts remain convinced of the long-term potential of emerging-markets economies, but for now “differentiation is very much the watchword,” says Nicholas Spiro, founder of Spiro Sovereign Strategy in London. Some ratings in Africa, Central Europe and Latin America are going up and others down, he says, because “there is a much more discerning investor base” than during earlier eras marked by concern about contagion. And these investors are reaching different conclusions about various countries, Spiro says, adding that “sentiment doesn’t always match fundamentals.”
In contrast to the uncertainty about the emerging markets, many analysts seem to have decided what to make of developments in China. After years of thinking the Chinese juggernaut was unstoppable, the initial signs of a slowdown seemed scary: Would there be a hard landing? Would bubbles burst? Many now say no, that China is just easing into a lower growth trajectory and will perk along at a modest — for China — 6 or 7 percent growth rate instead of 9 or 10 percent.
What about the hard landing risk? “What we have seen in China is more or less local bubbles,” says Commerzbank’s Thiesen, “not a bubble like in Spain or Ireland which hurt the whole economy.” Aidan Garrib, a senior country risk analyst at Canadian Imperial Bank of Commerce, adds, “There is concern about shadow banking, but China won’t let any banks get into trouble.”
China is the unmoved mover in its region. Although analysts didn’t give its rating a haircut despite lower growth, the country’s slowdown helped undermine the ratings of other Asian countries whose economies depend heavily on China. Australia is down 0.4 point, Hong Kong falls 0.5 point, and other countries post even larger declines, including New Zealand (–1.1), Singapore (–1.9) and Taiwan (–1.4).
In addition to China, the other big question that seems to have been answered is about the euro zone. A continued easing of the bloc’s debt crisis and the return of growth, however tepid, have calmed fears about a breakup of the single currency and bolstered investor confidence. “Sentiment has changed dramatically,” says Spiro. Five euro zone countries rise by a point or more, led by two big comeback stories. Ireland jumps 3.7 points from September and is up 7.1 points from March 2013; in December the country became the first of the euro zone’s troubled debtors to exit its bailout program, after three years and €67 billion in aid. Spain posts a gain of 2.0 points from six months ago. The country completed its €41 billion bank recapitalization program at the start of this year and won a rapturous response from investors for a big bond issue in January. Elsewhere, there are also good gains for Belgium (+1.2), Luxembourg (+1.0) and the U.K. (+1.0).
“Many parts of Europe are doing better than many of those in the market thought they would,” says Jonathan Lemco, principal and senior analyst at Vanguard Group. “It all comes back to [European Central Bank President Mario]Draghi’s statement that the ECB would do ‘whatever it takes.’ That has instilled confidence in the region and spurred some investment.” Draghi’s “seven or eight words changed the world,” adds Spiro.
Even beleaguered Greece radiates the rise in confidence. After several years in free fall, its rating is unchanged this time around. Moreover, 54.3 percent of respondents said Greece was “likely” or “very likely” to default within two years, down from 73 percent a year ago.
Western Europe’s upward trajectory, which has also lifted several Eastern European countries’ ratings, is reflected in survey participants’ selection of countries deemed “most likely to exhibit reduced credit risk” in 12 months’ time. Eight of the top 15 on the list are in Western Europe — and three more are in Eastern Europe. (The other four are the U.S., Mexico, Japan and Peru.)
On the other hand, when asked to list the most likely candidates for higher credit risk, respondents again cited several European names: France, Greece, Portugal, Spain and Italy — the latter ranks near the top on both the higher- and lower-risk lists. (The other higher-risk candidates include, in descending order, Ukraine, Venezuela, Argentina and Brazil while Turkey and Egypt move into the top ten.)
Sharma of National Australia Bank says Europe is not out of the woods yet: “We need to see more clarity regarding the banking system, and there needs to be an impact on the real economy.”
So what comes next? “It depends on where commodity prices are going to be,” says CIBC’s Garrib. Higher commodities prices not only benefit emerging markets, “they also suggest manufacturing is picking up” in the industrialized countries, he adds, “so all the boats will rise.”
Vanguard’s Lemco cites potential geopolitical surprises, including the risk of a clash between Japan and China. He also expects “another military provocation from North Korea soon — it’s in their interest to do that.” Still, Lemco adds, “by far what’s most important is U.S. economic and political performance.” • •