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COUNTRY CREDIT - A Turn in the Tide?

Global creditworthiness rises again, but economists fear a downturn is near.

Country risk managers have had an easy time in recent years, as robust world growth and a surge of liquidity have fueled an unprecedented rise in global creditworthiness. But as the U.S. subprime lending crisis continues to roil credit markets and cast a cloud over the global economy, there is a growing sense that the bloom is off the rose.

"We're on the verge of a shift in sentiment," says Victoria Marklew, a Philadelphia-based country risk manager at Northern Trust Co. She cites concerns about the spreading fallout from the subprime crisis, the potential unwinding of the yen carry trade -- which has pumped up asset prices around the world in recent years -- and the prospect that growth may have peaked in Europe.

For Hans Holzhacker, a senior economist at Bank Austria Creditanstalt in Vienna, the long bull market in creditworthiness is showing distinct signs of fatigue. "The world economy has been doing quite well," he says, but adds, "basically this cannot go on at such a pace forever."

The new wariness is evident in Institutional Investor's September 2007 Country Credit survey. The average credit rating of all 174 countries covered is up 0.8 point over the past six months, to 46.9. That marks the sixth rise in the past seven surveys, but the improvement is much smaller than the 2.2-point rise in the previous six-month period. The number of countries that see their scores rise by one or more points -- the amount considered statistically significant -- drops to 79 in the current survey, from 132 in the previous one; meanwhile, 23 countries' ratings fall by at least a point, compared with four last time.

The biggest gains are in the developing world, continuing the trend of recent years. The average rating is up by 1.5 points for countries in Latin America/Caribbean and by 1.2 points for Africa/Sub-Saharan as well as the Middle East & North Africa. Asia-Pacific/Far East countries rise by an average of 1.3 points. China remains strong but shows signs of cooling; its rating is up by 2.0 points, compared with a 4.1 point gain in the previous six months.

Western Europe and North America, meanwhile, are little changed. The U.S. rating edges up 0.1 point, to 94.1, allowing the country to move up one place overall, to No. 12, while Western Europe's average rating slips 0.1 point, to 90.9. Western European countries maintain a lock on the top ten places, with Switzerland, Norway and Luxembourg returning in order as Nos. 1, 2 and 3.

The difference in regional trends reflects the fact that the biggest worries emanate from developed countries. When survey respondents were asked to rate the issues likely to have the biggest negative impact on ratings, U.S. housing prices and fears of a rise in trade protectionism ranked first.

By contrast, emerging markets continue to benefit from a favorable combination of strong economic growth and buoyant commodities prices, stemming in no small part from the ongoing strength of China's juggernaut economy. Survey respondents cited Chinese economic growth as the biggest positive factor for global credit risk over the next 12 months.

China's rating rises to 75.9, good for No. 32 overall, up from No. 34 in the previous survey. The China effect also helps lift Taiwan, by 2.1 points; Hong Kong, by 1.6 points; and South Korea, by 2.8 points. Other Asia-Pacific industrial countries post more-modest gains, with Japan, Australia and New Zealand each rising by less than a point.

Many countries in Asia-Pacific/South & East enjoy strong gains, led by Vietnam, whose rating shoots up by 4.5 points. The country grew at an 8.2 percent pace last year -- second in Asia only to China -- and joined the World Trade Organization in January. "People compare it with China 20 years ago," says Rainer Siegelkow, a risk analyst at WestLB in Frankfurt. "The country has quite a bit of resources, quite a bit of potential and attitudes that resemble the Chinese mentality."

Many other big countries in the region also post strong gains, with the Philippines up 4.2 points, Indonesia up 3.2 points, India up 2.4 points and Pakistan up 2.7 points. But Thailand, which was the epicenter of the Asian currency crisis a decade ago and continues to suffer from political instability one year after a military coup, is up just 0.4 point.

Latin America/Caribbean's average rating climbs 1.5 points, to 44.7. That is the region's highest score since 1981, just before the outbreak of the Latin debt crisis, and up 10.3 points from just four years ago. Ratings for 17 of the 27 nations in this region rise by a point or more, while only two fall by at least that amount.

"You've got several years now of current-account surpluses in many Latin American countries," says Carl Ross, head of emerging-markets research at Bear, Stearns & Co. "You've got significantly better fiscal performance, and you've got macro fundamentals that are better than trend." Credit rating agencies have been upgrading Latin countries, he notes, predicting that over the next 24 months the agencies are likely to give investment-grade ratings to Brazil (up 3.0 points in the latest survey) and Peru (up 4.3 points), and "possibly even Colombia" (up 2.9 points).

Argentina scores the biggest gain of any major Latin American country, with its rating rising 4.2 points. Although there are concerns that the country could face energy constraints to growth, analysts are sanguine for now, Ross says. "The bottom line is that its macroeconomic performance has been better than expected."

Latin America's gains are mirrored by Africa/Sub-Saharan, which climbs to an average of 25.4. That is the highest rating the region has tallied since the early 1980s, when only a small number of the most-developed African nations were even included in the survey.

"China has a lot to do with it," notes George Estes, a credit analyst for emerging-market debt portfolios at fund manager GMO in Boston, referring to the country's insatiable appetite for commodities. "Nigeria and Gabon are benefiting from higher oil prices; Ghana has gold; Zambia has copper -- and copper prices have gone through the roof; Cameroon has some oil." Côte d'Ivoire has found oil, he notes, "and they seem to have put an end to their civil war, with a national unity government, so it seems to be coming back into the global financial system; it's paying back arrears with the World Bank." Nigeria and Côte d'Ivoire rank among the top ten gainers in the survey, rising by 5.8 points and 5.3 points, respectively.

Countries of the Middle East & North Africa rise by 1.2 points, although the average is held back mainly by declines in Iran (down 1.2 points) and Iraq (down 1.9 points). Major oil and gas producers post the strongest gains, with Saudi Arabia up 2.1 points, Algeria up 3.0 points and Tunisia up 2.6 points. Egypt's improving economy, which is forecast to grow by 5.6 percent this year, lifts that country's rating by 1.6 points.

Eastern Europe/Central Asia shows the smallest gain among emerging markets, rising by 0.7 point, on average. The major countries of Eastern Europe are little changed, but concerns about external deficits hurt Lithuania (down 0.4 point) and Latvia (down 1.0 point). Russia gains 1.3 points, compared with a 5.8-point rise previously.

Overall, the slowdown in the pace of improvement in creditworthiness looks set to continue, says GMO's Estes. Global growth is "bound to start topping out," he contends, and commodities prices are not likely to keep rising at the pace of recent years. As a result, he says, "there's not a lot of room to keep improving at the same rate."