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U.S. Leads Rise in Global Economic Outlook

Sovereign creditworthiness is improving, but risk analysts note the recovery is still fragile.

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Global creditworthiness, which sank by 0.6 point from September 2012 through March, regains that lost ground — and a tiny bit more — in the most recent six-month assessment period, according to country risk analysts and economists whose opinions are tapped to produce Country Credit, Institutional Investor’s exclusive semiannual ranking of sovereign creditworthiness. The global score rises by 0.7 point, to 44.6 (out of a possible 100), but remains well below its September 2008 high of 48.

This rebound is largely fueled by optimism regarding the U.S., whose rating jumps 2.5 points — more than any other developed nation’s — to 91.3. That’s enough to lift the world’s largest market from 12th place to eighth among the 179 countries considered. See the full list of Global Rankings.

Norway returns in the No. 1 spot, with a rating of 95.3. Although down 0.4 point since March, the reigning champ is still nearly a full point ahead of Switzerland, which repeats in second place with a score of 94.4. Sweden holds steady in third; its 93.3 score reflects a loss of 0.1 point. (See the March 2013 Country Credit Survey.)

Overall, 82 countries rise by at least 1 point — the level considered statistically significant — while only 32 fall by at least that amount.

“We are seeing consistent improvement as we move away from the global crisis and repair the damage to the financial sector,” explains Laura Sarlo, senior sovereign analyst at ­Loomis, Sayles & Co. in Boston.

In late August the U.S. Commerce Department announced that annualized real gross domestic product growth from April through June was 2.5 percent, considerably higher than its July estimate of 1.7 percent and more than double the first quarter’s 1.1 percent rate. The revision prompted speculation that the Federal Reserve Board might take a more aggressive approach to tapering its program of quantitative easing, which chairman Ben Bernanke has indicated could begin later this month.

“I would expect we would see continued moderate improvement in people’s view of the U.S.,” Sarlo adds.

Panelists see trouble on the horizon for China, whose rating drops 1.4 points, to 77.5. The nation’s slowing production is less of a concern than its credit issues. Fabian Briegel, a country risk analyst at Rabobank in the Netherlands, notes that Beijing “must carefully manage debt-­related problems while maintaining sufficiently strong growth.”

In July the International Monetary Fund lowered its GDP forecasts for China from 8.1 percent to 7.8 percent for this year and from 8.3 percent to 7.7 percent in 2014 — rates that are still among the highest in the world and better even than the Chinese government’s target of 7.5 percent for 2013. But the Washington-­based economic association also underscored the need for policymakers to continue to implement structural reforms, including greater transparency, rather than become overreliant on public spending to spur growth.

Sarlo concurs. “The idea of building a more sound financial system is a good policy goal, but there is a good chance that there will be bubbles along the way,” she says. “Very messy, uncontrolled deleveraging could be damaging. I think the sovereign balance sheet can handle some contingent liabilities coming onto it, but I don’t think anybody feels terribly that we have a complete set of numbers to assess how big those liabilities could be.”

China’s slowing growth is having an impact on its export-­reliant neighbors. Hong Kong’s score falls 2.9 points, to 84.3; Australia’s slips 1.4 points, to 88.8. But the rising cost of Chinese products is helping to spur demand for cheaper goods from its more industrialized neighbors. The Philippines’ rating climbs 3 points, to 57.2; Sri Lanka’s, 2.9 points, to 35.5; Bangladesh’s, 2.8 points, to 32; and Thailand’s, 1.9 points, to 63.1.

Dainis Gaspuitis of Sweden’s Skandinaviska Enskilda Banken offers another interpretation for the modest uptick in the aggregate global score: crisis fatigue. “There are some improvements at the macroeconomic level, but these changes are still quite fragile,” the Latvia-based economist says. “When dark times or problems are long lasting, people just get tired of them and start to ignore them because they are accustomed to them.”

Some issues simply can’t be ignored, however. Take the disaster in Cyprus. In March the island nation — whose financial sector grew to at least seven times the size of its economy — became the fifth country to be bailed out by the European Union and the International Monetary Fund. Under the terms of the €23 billion ($30 billion) aid package, depositors in Cypriot banks were forced to take a haircut,
receiving bank shares in exchange for roughly 40 percent of their holdings over €100,000.

The impact of the rescue strategy is still being assessed, but it stretches far beyond that country’s financial sector. Capital controls remain in effect, businesses face challenges in securing loans, and joblessness is rising as GDP growth falters. The Cypriot economy shrank 4.3 percent year-over-year in the first quarter and 5.6 percent in the second, according to Eurostat. The unemployment rate jumped to 17.3 percent in July, the agency reported, compared to 12.2 percent one year earlier.

Cyprus’s rating takes the biggest hit in II’s survey, plunging 11.6 points, to 32.3; the nation falls from No. 76 to No. 105.

Not all the news out of the region is bad, however. Western Europe edges up 0.4 point, as respondents who see green shoots of renewal are counterbalanced by those who feel its policymakers have mastered muddling through a permanent crisis. Some of the strongest gains are in countries that, until recently, have been seen as the most troubled: Greece’s rating climbs 3.8 points, to 25.5, while Ireland’s rises 3.4 points, to 59.4. Even Italy, whose sovereign debt Standard & Poor’s downgraded in July, notches a 1.6-point advance, to 66.1.

Moreover, the risk of a financially strapped euro zone nation defaulting on its debts is declining, at least in the near term, survey participants say. But they’re far less optimistic about the longer term.

Approximately 75 percent of the economists polled for the March installment said Greece was either likely or highly likely to declare itself bankrupt within two years. In the current survey that figure drops to 59.1 percent.

Even so, fully three quarters of the respondents believe that the Hellenic Republic will default within five years.

Survey participants project similar risk profiles for two other bailout recipients. In March, 18.9 percent of them thought that Portugal would default within two years; today that figure slips to 15.2 percent — but nearly one third still expect the country to be insolvent within five years. Portugal’s economy expanded by 1.1 percent from the first quarter to the second, faster than any other European Union member country’s, after receding for ten consecutive quarters. But its sovereign debt is huge — more than €214 billion, or roughly 131 percent of its annual output, according to figures released by the Bank of Portugal in August — and its unemployment rate tops 16 percent.

Still, that’s far better than the performance of Spain, where more than one in four people are out of work. Six months ago 23.6 percent of the Country Credit analysts predicted that the nation would default by the end of next year. That figure tumbles to 10.8 percent, but it shoots back to 19.4 percent when a five-year time horizon is considered. In August the IMF reiterated its belief that Spain’s economy will shrink by 1.6 percent this year — it slipped 0.1 percent from April through June — and slashed its 2014 growth forecast from 0.7 percent to zero. Spain’s public debt is nearly €944 billion, or about 90 percent of yearly GDP, according to the Bank of Spain.

Positive attitudes toward Western European economies are also spreading beyond the immediate region. Ratings of 17 countries in Eastern Europe and Central Asia are each up 1 point or more; only four are down by at least that much.

“The Polish economy has turned the corner and is improving again,” reports Rabobank’s Briegel. “Poland’s government is committed to fiscal discipline, and it is quite stable.” That country’s rating climbs 1.7 points, to 72.2.

And despite its troubles, Hungary rises 0.9 point, to 50.5. “The improved rating can be explained by current economic performance,” he adds. “Plus, it is no longer being supervised by the EU on budget policies.”

“If there is an improvement in Western Europe, we can expect an increase in Central and Eastern Europe — especially for EU members,” Briegel observes.

The emerging markets of Latin America and Africa are a mixed bag, largely owing to the impact of slowing demand and falling prices for commodities, key exports of many of these countries. Another reason? “In the second quarter we had a rapid deleveraging of emerging-market risk among U.S. investors,” explains Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott in Philadelphia. “That wasn’t really linked to economic conditions in those nations, it was linked to the end of the dollar’s currency deterioration.” As the Fed hints at a less accommodative U.S. monetary policy, the dollar has been rallying against emerging-markets currencies, he adds, making their dollar debts more expensive to service — and thus driving away hot-money investors. • •

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