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To judge by the headlines, the world seems more fraught with risk than it did last spring. Renewed acts of terrorism, higher oil prices, the huge U.S. budget and current-account deficits, intractable sluggishness in Europe and Japan and uncertainty about China have cast deep shadows on the economic scene.
Yet for all these signs of distress, many market experts are showing increased optimism. In their view, as revealed in the latest Institutional Investor survey of country creditworthiness, sovereign risk has been improving over the past six months. Based on ratings of 173 countries by the sovereign-risk analysts, economists and portfolio managers participating in our survey, the average national rating stands at 44.1 out of a possible 100, up from 42.9 in March. The measure has been rising steadily over the past two years, from 39.6 in September 2003 to 42.7 a year later. In all, 88 countries are up by 1.0 point or more since the last survey; 50 rose by that amount in the March survey. Only 15 countries have seen their credit ratings decline by 1.0 point or more over the previous six months, versus 48 in March.
Among the winners are the Northern European countries -- particularly the Scandinavian ones -- which have established a strong grip on the highest rankings. Norway adds 0.5 point, for an average of 94.2, to maintain its second-place position, while Finland gains 0.1 point, to 92.8, but slips from fourth to fifth, switching places with the U.K., which gains 0.4 point, to 93.1. Denmark increases by 0.6 point, to 92.7, and advances two places to sixth. The Netherlands also gains 0.6 point, to 92.6, rising from ninth place to seventh, while Sweden improves by 0.9 point, to 92.5, and jumps to eighth place from No. 11.
Retaining its No. 1 place, although its rating dips by 0.1 point, to 94.4, is Switzerland. Argentina and Laos tie for the greatest six-month rating increase, rising by 6.3 points each, to No. 115 from No. 137 and from No. 143 to No. 125 place, respectively.
Still, sovereign-risk analysts are paid to look for trouble, or at least the potential for trouble, and they see plenty of it, not least in France, Germany and the U.S. France declines by 0.1 point and falls to tenth from seventh in March, while Germany slips 0.4 point, to fall from tenth to No. 13. The U.S. rises by 0.1 point, to 92.5, but its ranking falls from sixth to ninth. “The budget situation in the U.S. looks horrible,” says Eduardo Cortes, a New Yorkbased managing director at Reich & Tang Capital Management’s Global Investment Advisors. He points to the costly Iraq war and looming Social Security and Medicare obligations as causes for worry in the short and long terms.
Western Europe’s problems are no less disturbing. The French economy, expected to grow by about 2.0 percent this year, seems perpetually stalled, in large part by labor laws that inhibit both hiring and firing. Germany, also hobbled by labor rigidities, has endured five years of economic stagnation and is on track to post its fourth straight year of budget deficits that exceed the euro zone’s limit of 3.0 percent of GDP. “Germany is the driver of the euro zone, but it’s flying on just one engine,” says Neil Williams, the London-based chief sovereigns strategist at Mizuho Securities Co. He believes that the euro zone will be the world’s main economic trouble spot for years to come, because the region is unlikely to grow and add jobs and because the European Central Bank favors medium-term inflation control over growth. Mediterranean Europe is not particularly sunny, either. Italy drops 0.4 point, to 83.2, and slips a notch to No. 21. Although Portugal keeps its No. 22 ranking in the current survey, it falls 0.2 point, to 81.4. Greece drops two positions, to No. 27, off 1.2 points, to 74.8.
“European countries are not able to adjust to changing market conditions as easily as the U.S.,” says Conrad Schuller, chief economist at Erste Bank in Vienna. He doesn’t see significant credit worries in Europe but believes that the failure of European Union leaders to forge a budgetary agreement following the defeat of a European constitution could mean that “the goal of a true common market won’t happen soon.”
In the estimation of analysts, the biggest improvement in creditworthiness comes in emerging-markets nations, especially among commodity exporters that have been benefiting from soaring prices. From Eastern Europe to South America to Asia, the ratings of once-troubled countries are improving as they better manage their debts, control their deficits and, most of all, put to use the shower of cash coming from commodity buyers, led by China.
“Emerging markets are being rewarded for sound fiscal policies,” says James Barrineau, an Alliance Capital Management economist based in New York. Low interest rates in the developed world have made it easier for formerly debt-crippled countries to service their debts, he says, and have driven portfolio investors to seek the emerging markets’ higher returns.
Buoyed by record oil prices, five of the eight biggest gainers in perceived improved creditworthiness over the past 12 months are net oil exporters: Algeria, Indonesia, Kazakstan, Venezuela and Russia. Analysts say the exporters’ outlook remains good, although some wonder whether persistently high oil prices may encourage greater conservation and the development of alternative fuels. Few countries have benefited from higher oil prices as much as Russia, where oil accounts for 20 percent of GDP. Thanks to export income and new investment flows, Russia’s economy grew at an annualized 5.6 percent through the first six months of this year and its stock market was up 28.2 percent in dollar terms through the end of July. Early repayments on Paris Club and International Monetary Fund debt also inspire confidence, says George Estes, a sovereign-credit analyst at Grantham, Mayo, Van Otterloo & Co., an investment management firm in Boston. With Russia’s creditworthiness improving by 3.8 points, moving the country up three slots, to No. 55, he says, “there are no credit worries there.” Still, Erste Bank’s Schuller advises caution, noting that the Kremlin’s breakup of Yukos Oil Co. demonstrates the “big difference between the creditworthiness of a government and that of its corporates.”
Many nonoil exporters are enjoying renewed strength, as well. Ratings of Latin American nations with few or no petroleum exports -- Chile, Guatemala, Honduras and Uruguay, for example -- have risen over the past six months. In East Asia, with the exception of the politically troubled Philippines, virtually every major nation improves its creditworthiness, and in Eastern Europe rating gains have come on the heels of double-digit growth in export volumes and significant increases in foreign direct investment. Says Dresdner Bank’s Gregor Eder, a Frankfurt-based economist who notes that short- and long-term debt profiles are improving, “We’ve seen a tremendous improvement in liquidity.”
Politics, of course, plays a significant role in sovereign-credit analyses. The experts surveyed by II place Venezuela, Ecuador and Brazil -- despite their status as oil exporters -- among the five countries most likely to become greater credit risks over the next 12 months. Analysts worry that President Hugo Chávez of Venezuela, which rises 0.9 point from March, to 38.8, but slips from No. 80 to No. 83, is spending too much of his country’s oil windfall on military expansion. In Ecuador, where three of the country’s seven leaders since 1997 have been run out of office, President Alfredo Palacio has raised the specter of default by saying that it is “immoral” for his country to spend 40 percent of its budget on debt service. In June, Ecuador’s Congress voted to direct $745 million from debt repayment to a variety of social programs. Ecuador’s credit rating falls by 1.5 points, to 28.0, from March, as the country tumbles to No. 111 from No. 96. Thus far the ongoing political troubles of Brazilian President Luiz Inácio Lula da Silva have not damaged the nation in the eyes of potential lenders. Brazil’s rating of 48.2 is up 1.5 points from March, and the country gains one position in rank, to No. 66. But observers say that allegations of vote buying and cronyism by the ruling Workers Party could destabilize the government. Francis Nicollas, chief of emerging-markets analysis at Crédit Agricole in Paris, believes investors have been so smitten by recent returns that they have been overly dismissive of Brazil’s political instability and aren’t being compensated for it.
Other countries rated as likely to see a deteriorating credit profile are the Philippines and, in a three-way tie, Argentina, China and Turkey. Respondents apparently hold contrary views of creditworthiness because Brazil, Argentina and Turkey also are cited as three of the countries most likely to enjoy better credit profiles over the next 12 months, along with Russia and Bulgaria.
As they look ahead, sovereign-risk analysts worry most about the potential for a worldwide increase in interest rates. This is a concern cited by 52.2 percent of respondents asked to identify the two issues most worrisome to them. The U.S. budget and trade deficits are considered serious threats to worldwide creditworthiness by 30.4 percent of respondents, while 29.3 percent fret that a slowdown in China could translate into less demand for the copper, soy and steel exports that have been such a boon to Latin American and Asian countries.
China’s decision in July to revalue the renminbi against a currency basket instead of the dollar peg probably won’t have immediate impacts on trade and growth, either in China or globally, analysts say. The 2.1 percent initial revaluation is too small to have much effect, says Mizuho’s Williams, and a 15 to 20 percent revaluation, which is what the international markets and the Bush administration seem to be demanding, is unlikely because it would “mean a slower China and a slower world,” he says. For now, though, II voters -- surveyed before the July revaluation -- give China a higher mark, increasing its rating by 2.2 points since March, to 68.2. It continues to be ranked No. 37.
Surveyed before the July London bombings, investors were seemingly unconcerned that global terrorism would damage international creditworthiness. Just 3.0 percent of respondents said that terrorism is one of the top two threats to the world’s debt repayment capacity, down from 18.0 percent in March. That assessment is bound to change. And soon.
Associate Editor Donovan Hervig compiled the statistics for this feature.
