The U.S. economy grew by an average annual 4.4 percent in 2004 -- its fastest expansion in five years. Even factoring in the soaring price of oil, inflation ran at a reasonable 3.3 percent, well shy of the red zone that galvanizes aggressive interest rate hikes by the Federal Reserve Board. President George W. Bush's reelection in November wiped out any major uncertainties about the direction of future political policy.
Yet the sovereign-risk analysts and economists who answered Institutional Investor's latest questionnaire on country creditworthiness have pushed the U.S. down in the global rankings. From No. 3 in our September survey of 173 countries, the U.S. has dropped to No. 6, with an average credit rating of 92.4 out of a possible 100, compared with 93.7 six months ago.
That incremental slip did not, however, reflect respondents' confidence in credit quality worldwide. The global average rating actually rose slightly, to 42.9, with 50 countries gaining a point or more since September, versus 48 losing as much (a 1.0-point move is considered significant). Strikingly, North America (Canada and the U.S.) is the only region whose average credit rating dropped by a point or more in the past year. At 91.6, its regional score was down 1.5 points since September and 1.3 points since March 2004. Western Europe, Sub-Saharan Africa and South and, for the year, East Asia showed smaller declines; all other regions gained.
Fiscal flabbiness in the world's biggest economy and its closest trading partners is worrying buyers of sovereign debt at the banks, money management firms and securities houses polled by II. More than 44 percent said they feared that rising global interest rates would heighten overall credit risk during the next 12 months. And a growing number of risk analysts think that global fiscal stability depends on China. Nearly a quarter of voters put an economic slowdown in that country among their top risk concerns, compared with just 9 percent in September. At the same time, many say in interviews that they would like to see Chinese growth moderate, as overheating could lead to a hard landing that would ripple through the world economy.
Much of America's credit slippage stems from investors' concerns about trade. Despite a dollar that weakened alarmingly against the euro and the yen last year, U.S. exports shrank while imports ballooned, with the gap surpassing $617 billion. According to government statistics, the trade deficit trimmed real GDP growth in 2004 by a full percentage point, and private economists estimate that for the U.S. to meet official forecasts of 3.5 percent GDP growth in 2005, exports would have to increase by 10 percent -- assuming import growth holds steady -- a virtually impossible scenario.
Many also say, however, that fears of an imminent U.S.-led global slowdown are exaggerated. "A lot of the pessimism about the U.S. is misplaced," says Farid Abolfathi, chief international economist at research firm Global Insight (formerly DRI-WEFA) in Lexington, Massachusetts. "It's the only one of the developed countries that has been growing rapidly for the past couple of years. If it weren't for the U.S., we might be in a global recession right now."
In fact, Abolfathi thinks America's budget and current-account shortfalls are getting too much attention. "The U.S. can reduce its deficits if it wants to," he declares. "But there have been more important goals -- such as rescuing the world economy and fighting global terrorism." (On the second front, at least, the U.S. seems to get some recognition: Whereas six months ago 23.1 percent of survey respondents thought terrorism would present a serious risk to global creditworthiness over the following year, 18.6 percent feel that way now.)
One force crimping the U.S. economy -- the high cost of energy -- lifted the fortunes of the survey's most dramatic winners. Rising oil prices helped Nigeria, Kazakhstan, Venezuela and Algeria ascend by 4.5 to 5.5 points in the rankings, compared with six months ago. (At 51.8, tiny Kazakhstan's Country Credit rating remains higher than Brazil's.)
When picking which countries were most likely to show a better credit profile over the next 12 months, though, respondents' rationales went beyond oil revenues. Almost one fifth of respondents cited Brazil as one of the five countries most likely to gain in credit quality in the year ahead; only Russia did better. And fully 40.2 percent of voters predicted that Brazil's credit would improve in the coming year, compared with 15.4 percent in the September survey. Brazil's rating rose by 4.1 points, to 46.7, and it climbed from No. 73 to No. 67.
Contrary to investors' expectations, the center-left government of President Luiz Inácio Lula da Silva has shown fiscal restraint, and the country has two consecutive years of current-account surpluses under its belt -- something the markets haven't seen from Brazil in decades. Strong commodity prices and huge demand for its exports from the U.S., Europe and China are fueling GDP growth of upwards of 4 percent. "The only thing limiting that is Brazil's port capacity," says Vincent Truglia, a New Yorkbased managing director at Moody's Investors Service. "They can sell everything they can send."
II voters still worry about Venezuela's future creditworthiness -- but far fewer than did six months ago. In September, nearly a quarter of survey respondents cited Venezuela as one of the five countries most likely to become riskier during the next 12 months; that proportion has dropped to 13.4 percent. Enjoying double-digit GDP growth, it climbed from No. 89 in the rankings in September to No. 80 in March, and its credit rating climbed five full points, to 37.9. Oil prices are by no means the whole story. A controversial referendum last August reconfirming the presidency of Hugo Chávez Frías greatly reduced political uncertainty after a period of violent demonstrations and a strike at Petróleos de Venezuela that crippled production. Doubts remain about Chávez's fiscal discretion, but the specter of default has receded.
Russia, another oil producer, brought out the schizophrenia in risk analysts. On the one hand, the country's credit rating rose to 55.2, up 1.7 points from six months ago and nearly 6 points higher than last March. (Russia remains at No. 58.) On the other hand, a higher percentage of respondents say they expect credit quality to deteriorate over the next 12 months.
In interviews, though, voters sound sanguine. "Russia's credit fundamentals are unbelievably strong at this point," says Blaise Antin, senior vice president and sovereign credit analyst at asset manager Trust Co. of the West in Los Angeles. "Foreign exchange reserves are so substantial that it would take a sustained period of low oil prices for creditworthiness to deteriorate significantly."
He and other analysts cite President Vladimir Putin's success in bringing more order to the post-Soviet chaos and practicing fiscal discipline. On January 31, Standard & Poor's joined Moody's and Fitch in promoting Russian sovereign debt to investment-grade. "Were it not for all the headline political risk," Antin says, "the Russian Federation would have had an investment-grade rating a long time ago."
Government commitment to budgetary prudence also bore fruit for Turkey, whose 44.3 credit rating was up 4.3 points since September and almost 7 points since last March; Turkey advances to No. 73 from No. 76 six months ago. Nearly twice the percentage of voters this time around placed Turkey among the five countries most likely to improve in credit quality over the next year. Eager to qualify for entry into the European Union, the government of Prime Minister Recep Tayyip Erdogan has hewed to the International Monetary Fund's economic stabilization program over the past two years, and Turkey now runs a big fiscal surplus. On December 17 the EU formally endorsed it as a candidate nation, with accession talks scheduled for this October. As one survey respondent says, "Six months ago the jury was still out on whether it would get a date." This voter notes that Erdogan's party, with a majority in Turkey's congress, is likely to continue passing budgets and legislation that make the IMF -- and investors -- happy.
The current survey took place before a devastating tsunami hit southern Asia on December 26. Although the waves inflicted incalculable damage in terms of human suffering, claiming hundreds of thousands of lives, they are expected to take only a small toll on the region's economic prospects. "Only Sri Lanka will be really affected economically," says Global Insight's Abolfathi. "The Thai economy is far too resilient to show much impact. Thailand has enough savings to fund a surge in reconstruction activity, so after a quarter or two of negative effects, the next quarter will more than make up for them." The country's healthy accounts -- Bangkok has $50 billion in foreign exchange reserves -- led respondents to promote Thailand by five places in the rankings, to No. 45 from No. 50, and its credit rating rose to 62.4, nearly 3 points higher than in September and more than 4 points higher than a year ago.
Indonesia, the country worst hit by the tsunami, got a similar vote of confidence before the disaster. Analysts moved it up the list from No. 86 to No. 81 and increased its rating to 37.7, a 4-point-plus improvement from six months earlier. More than a quarter said they expected Indonesia's credit quality to improve in 2005, compared with 9.3 percent who thought it would deteriorate. Now, they say, the country could actually benefit -- fiscally speaking -- in the storm's aftermath, from debt relief, foreign aid and reconstruction. Abolfathi even thinks Indonesia may get tourism that otherwise would have gone to Thailand or Sri Lanka; Balinese tourism is already thriving again, two and a half years after a devastating al-Qaeda nightclub bombing there.
The Philippines, by contrast, had the unenviable distinction of being cited more frequently than any other country as among the ones most likely to show deteriorating credit quality. Almost 26 percent of voters named it among the five countries in which they most anticipated further credit problems in the coming year. It fell from No. 68 to No. 75 in the rankings and lost 1.4 points from its September credit rating, scoring 43.5. Respondents question President Gloria Macapagal-Arroyo's ability to implement healthy and sustainable economic policies. Says Robert de Lure, a Melbourne-based country risk economist at the National Australia Bank: "For one thing, the Philippines is very dependent on oil. There are concerns about continued slippage in its fiscal accounts. And there's a general trend of slowing growth throughout the region." Adds a Toronto-based voter: "I've been pessimistic on the Philippines for a long time. There's no action from the government to improve revenue collection, perhaps because there are significant investor interests that don't want higher taxes. So Arroyo is in a bind."
Asia's 800-pound gorilla, China, is the source of much anxiety among survey respondents -- but not because of its creditworthiness. The Asian juggernaut moved up one notch in the rankings, to No. 37; fewer voters expressed concern about its future credit quality than in September (20.6 percent, versus 26.9 percent six months ago); and at 66.0 its credit rating was up 0.3 point. Rather, respondents are obsessed with its growth rate. China now carries so much weight in the world economy that expectations regarding its economic performance directly affect global commodities prices.
Although slower growth in China was one of three factors most often cited by survey respondents as one of the greatest risks to global credit quality over the next 12 months, in interviews voters seem equally fearful that the country's economy will overheat. Chinese GDP rose by an estimated 9.5 percent in 2004 -- and that growth went straight into demand for foreign goods, especially oil, of which China buys more than any country besides the U.S. The fear is that China's bottomless appetite for imports will boost inflation and add to the risk of a hard economic landing in the next year.
China is also the focus of anxieties about the weak dollar. Because the renminbi is dollar-linked, a cheap greenback boosts Chinese exports. That not only spurs growth, it also worsens the trade-deficit problem in the U.S. -- which bought 5.6 times more goods and services from China than it sold there in 2004. As a result, Washington is clamoring for Beijing to revalue the renminbi. But few analysts expect the Chinese to listen. Says one Canada-based analyst who voted in the II survey: "I believe China will hold on. Revaluing their currency won't help them overcome their domestic concerns, like the weak banking sector, bad loans and overcapacity in the property sector."
So what will it take to improve America's finances? A big percentage of respondents think the only answer is a change of administration. When asked whether U.S. creditworthiness would improve or deteriorate as a result of President Bush's reelection, 36.1 percent said it would deteriorate, versus 3.1 percent who said it would improve. One third thought the U.S. economic outlook would dim in 2005, compared with 15.5 percent who were optimistic. "The general reaction after the election was that the problems the U.S. faces in its current-account and budget deficits probably weren't going to be addressed with any urgency," says Nigel Gault, Global Insight's chief U.S. economist.
Survey voters, speaking anonymously, confirm that sentiment. "The U.S. is a deteriorating credit story," declares one. "We've gone from big surpluses to big deficits in a relatively short time. I don't see much prospect for that turning around." Obviously, says another, the war in Iraq is a continuing budget drain that can't be reversed anytime soon. "But continued tax cuts won't help the situation," he says.
Fortunately for Washington, buyers of American sovereign paper don't seem to share the country-risk experts' gloom. "What we haven't yet seen is any significant sell-off in the Treasury market," says Gault. As a result, while the Federal Reserve continues tightening short-term money at a "measured" pace -- raising the federal funds rate by 25 basis points, to 2.5 percent, on February 2, the sixth such move since last June -- long-term yields have held steady. "So far the markets haven't priced long-term debt as if they are extremely worried about a dramatic move in short-term rates," says Gault. Barring a jump in inflation, then, II survey respondents' fears of tight money may be overblown.
Furthermore, economists point out, the current U.S. budget deficit is not as big a percentage of U.S. GDP as it was during the 1980s. And in a February 4 speech in London, Fed chairman Alan Greenspan said the budget deficit may stabilize, as pressure has been building in Washington for more restraint on spending. He also pointed out that the U.S. economy promises to continue growing much more rapidly than those of other triple-A developed countries.
In early December a handful of credit analysts provoked an uproar by suggesting that unless Washington addressed its budgetary and trade woes, the U.S. could lose that stellar credit rating, pulling the rest of the world into a vortex. They managed to spark another dollar dump, but they were in a tiny minority. "It would take years of deterioration before that rating would be challenged," says Moody's Truglia. As the II survey results show, despite the dire warnings, global creditworthiness hasn't suffered a whit.
Associate Editor Donovan Hervig compiled the statistics for this feature.