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Brazil Grows, But the Global Credit Picture is Otherwise Murky

Brazil stands out as a relatively rare bright spot in an otherwise murky global creditworthiness picture, as debt concerns in Europe and the U.S. and growing risks of a double-­dip recession cloud the outlook, according to ­Institutional Investor's semi­annual Country Credit survey.

The U.S. and European economies may be sputtering, but life is good in ­Brazil. The country’s economy grew by 7.5 percent last year, its fastest pace in two decades, and unemployment is at historic lows. Trade with China is burgeoning, and entrepreneurial Americans and Europeans are moving to Ipanema. The joke that ­“Brazil is the country of the future — and always will be” is passé. The future is now, and it looks much better in Brazil than in the old industrialized world.

Brazil stands out as a relatively rare bright spot in an otherwise murky global creditworthiness picture, as debt concerns in Europe and the U.S. and growing risks of a double-­dip recession cloud the outlook, according to ­Institutional Investor’s semi­annual Country Credit survey . “The overall environment has deteriorated,” says Kevin Lai, senior economist at Daiwa Capital Markets in Hong Kong. A variety of forecasters have been dialing back their growth projections, and equity markets have fallen sharply around the world in recent months, he notes.

The average credit rating of the 178 countries covered in the II survey declines by 0.6 point from the March average, to 45.9 on a scale of zero to 100. Countries in Western Europe and the Middle East/North Africa post sizable declines, a reflection of the debt crisis in the former region and political upheavals across the latter. The U.S. posts a more modest decline, as does much of trade-­dependent Asia, on average. By contrast, Latin America/Caribbean and ­Eastern Europe/Central Asia are the only regions to score a significant increases in their average ratings.

More broadly, the survey also underscores the longer-­term shift in the global pecking order, with weakness pervasive across much of the old so-­called first world and underlying strength across many emerging-­markets countries.

The U.S., for decades the undisputed leader in the survey, falls to 12th place in the latest survey from ninth six months ago, and that’s based on responses submitted before Standard & Poor’s took away Uncle Sam’s triple-A rating. The U.K. slips two places, to No. 17, just below its former colony, Hong Kong. Italy drops five places, to 34th, and now trails such European Union late­comers as Malta and Slovakia. And Greece, which ranked 27th five years ago and was in 78th position six months ago, plummets to No. 131 this time, just below Uzbekistan and Belarus.

Most analysts expect this global reordering to continue as the industrialized countries are forced to keep tightening their belts to contain their deficits and debt, which will reduce their growth rates. Meanwhile, the emerging markets are being buoyed by sound fiscal policies and nourished by growing trade with one another. These days, the rioting is in the U.K., not ­Thailand; the political paralysis is in Washington, not Brasilia.

Western Europe remains the sick man of global finance as the region’s average rating falls to 77.9 from 80.9 in March. Five years ago the region stood at a lofty 90.3.

Greece leads the decline, plunging by 19.7 points, to 27.2. The country obtained a fresh bailout from the EU and International Monetary Fund in July, but the deal came with some bitter medicine for investors: a debt swap that for the first time in Europe’s debt crisis will force private creditors to write down their holdings of Greek debt. S&P slashed its rating on Greece to CC, the lowest level of any sovereign it rates.

The two other EU countries under EU-IMF rescue programs also post sharp declines. Ireland drops 12 points, to 49.0, and falls 22 places in the ranking, to 75th. Portugal loses 15.5 points, declining to 49.9, and tumbles 26 places, to No. 72. Ireland’s plunge since the financial crisis began has been one of the most dramatic since II launched the survey in 1979. In September 2006 the country’s score was 93.2, good for No. 14 on the list, one place ahead of Singapore. In the latest survey, Singapore ranks eighth.

Elsewhere in Europe the survey offers a reliable picture of the perceived risks of contagion in the debt crisis. Spain declines by 4.7 points, Belgium by 4.5 points, Italy by 4.0 points, the U.K. by 3.0 points and France by 1.8 points. “The concern is no longer just with the periphery of European countries,” says Daiwa’s Lai. “It has kind of spread into the core regions.”

Survey respondents complain that everything EU leaders do to address the crisis is either too little or too late. Nonetheless, “I don’t see the euro zone falling apart,” says Victoria Marklew, head of country risk management at Northern Trust Co. “There is too much political will to succeed. Its birth was relatively straightforward. It’s now facing tumultuous adolescence. It will come out of this with a more mature institutional structure, but getting from here to there will be painful.”

Respondents certainly agree with that last part. When asked which of the world’s countries would exhibit higher credit risk in six months’ time, raters say the top five will be European: Greece, Portugal, Spain, ­Ireland and Italy. Even more telling, when asked the likelihood of various countries’ defaulting on their debt within the next five years, 86.7 percent of respondents say Greece is “likely” or “highly likely” to do so. Portugal and Ireland are next, with 46.7 and 38.3 percent of respondents, respectively, giving them a vote of no confidence.

Iceland provides an upside surprise in Western Europe as its rating rises by 7.1 points, the biggest gain in the survey. The crisis devastated the island country and its banking system, but thanks in no small part to its currency independence, the economy is on track to expand this year for the first time since 2008. “I think they’ve crawled their way into some semblance of growth,” Marklew says.

The Middle East also sees plenty of declines. The Arab Spring may ultimately bring political and economic advances, but the current uncertainty leaves many raters worried. The political battleground states experience the biggest declines. Libya suffers the biggest drop in the ratings and one of the largest six-month declines in the survey’s history, plummeting 23.1 points, to 31.5. Elsewhere, ­Tunisia is off by 8.1 points, Bahrain falls 7.8 points, Egypt is down 5.4 points and Yemen drops 4.9 points. The ferment in the region causes ratings to decline for the oil-rich but democracy-­starved countries in the Gulf.

The percentage of respondents who expect regime change “over the next two to three years” is high not only for Libya (96.2 percent) but also Syria (89.6 percent), Algeria (72.3 percent) and Bahrain and Lebanon (70.2 percent each). By contrast, scores for United Arab Emirates and Saudi Arabia are far lower, at 14.6 and 13.7 percent, respectively.

Marklew compares today’s Middle East with Europe in 1848, when revolutionary upheavals broke out in dozens of countries. “How all this works out will vary enormously from country to country,” she warns.

Another notable decliner is Cyprus, which falls by 9.5 points. Although that nation sits in the Middle East/North Africa category in the survey, it marches to a different drummer financially. “It’s related to Greece’s problems,” Haluk Burumcekci, chief economist at EFG Istanbul ­Equities, says of the country’s rating tumble. John Sharma, an economist at National Australia Bank in Melbourne, agrees. “The link to Greece is very strong” through trade and banking, he says. Cyprus is an offshore financial center for the Eastern Mediterranean, with an outsize banking industry. The concern is that Cyprus will become the new Ireland, “where the financial center blew up the economy,” Sharma says.

In contrast to the frenetic rating revisionism in these two regions, much of the rest of the world sees only modest ­adjustments.

The U.S., for example, drops a mere 0.9 point. But if the survey had been conducted after the S&P downgrade, “there would have been a significant shift downward, although in a narrow economic sense, little had changed,” says Markus Diehl, senior country analyst at WestLB in ­Düsseldorf, ­Germany. “The political process is the only news.”

The debate over the debt ceiling may have been understood as political theater within the U.S., but in the rest of the world it was scary, suggesting that the global superpower is too paralyzed politically to act and has little concern for the financial implications of its actions for global markets.

One of the paradoxes of the U.S. downgrading has been a heightened demand for U.S. Treasuries. The reason is simple, explains Daiwa’s Lai: “When there are concerns about global growth, people choose to park their money in safer havens.” Even if the U.S. is the cause of turmoil, “there are not many alternatives to U.S. Treasuries,” says NAB’s Sharma. Besides, he adds, “if you look at market measures, like credit default swap spreads, they haven’t reacted much.” Marklew also shrugs off the significance of the downgrade. “Double-A-plus is the new triple-A,” she says. Investors’ real concern is the economic slowdown, she adds.

Asia also offers limited movement. A number of countries rise, including the Philippines (up 1.1 points) because of recovering fundamentals and Sri Lanka (ahead 1.7 points) because of reduced political tensions. Japan falls by 2.3 points, amid concern that its nuclear disaster will further crimp a faltering economy.

Another surprise is China, whose rating is unchanged at 80.2 after years of steady increases. “Nobody knows what to make of China,” says Marklew. “Is it an unstoppable juggernaut or a bubble waiting to burst? Or both?” In August, Bart van Ark, chief economist of the Conference Board, joined the ranks of those predicting a slowdown in growth. But 22.2 percent of respondents say China will have a higher rating in six months. Only Brazil gets a bigger vote of confidence, with 31.5 percent predicting a higher rating in six months.

In Latin America the numerous gainers “are the beneficiaries of the commodities boom,” says Daiwa’s Lai. But resources aren’t the only reason for the improving trend, says Marklew. Governments in the region “have managed their way through the turmoil of the last few years very well,” she says. According to IMF figures, Latin America’s external debt will fall from 38.2 percent of GDP in 1990 to a projected 20.6 percent by 2012.

The ratings gains of Latin America’s two largest countries, Brazil (up 1.0 point) and ­Mexico (ahead 0.6 point), are modest. One country risk analyst at a U.S. asset management firm says Brazil “is probably the most prominent example of sustained development.” As for Mexico, he says, its rating improvement “is less than other countries’ because the internal political problems are increasing related to drug traffic and all that, so there is an increasing problem in Mexico with internal security.” Only 5.6 percent of respondents expect Mexico’s rating to be higher in six months.

In Eastern Europe/­Central Asia, the rating rises by 1.0 point. The Baltics are up again, based on a strong comeback from the recession and Estonia’s entry into the euro area in January. Russia rises by 1.3 points because “there was a sharp increase in oil prices,” says EFG’s ­Burumcekci, and that rise trumps any continuing concerns about governance. Analysts attribute increases elsewhere attributed to strong commodities exports and improved finances.

Meanwhile, among the region’s cellar dwellers, Belarus drops 1.9 points over concern about its repressive regime, and governance issues also damage the ratings of three of the stans: ­Turkmenistan (down 4.4 points), ­Tajikistan (3.9 points lower) and ­Uzbekistan (off 3.6 points).

The picture is mixed in Africa/Sub-Saharan, with most of the gains reflecting commodities-­based economic strength and many of the declines stemming from political uncertainty. The gainers include Gabon (up 5.5 points), Niger (ahead 5.3 points), South Africa (advancing 3.5 points), Guinea (up 3.4 points) and Angola (gaining 2.6 points). On the other side of the ledger, ­Swaziland declines by 5.2 points, Rwanda falls 4.1 points, Namibia drops 3.1 points and Cameroon is off 2.5 points.

A couple of years ago, Africa finally seemed to be taking off after years of bottom-­dwelling, but the continent’s onward march slows in this survey as the regional average moves up a minuscule 0.2 point. Still, the current regional rating, 26.3, is well above the 21.6 rating of five years ago, despite the financial crisis and resulting recession, and there is growing conviction that Africa is getting its act together. Many applaud Nigeria (up 2.8 points) for getting through an election with minimal disruption.

Many respondents see the overall global results, lukewarm at best, as a reflection of the global economic slowdown. Some raters expect further significant declines for the industrialized nations and widespread, albeit modest, gains for the emerging markets — but ultimately the economy holds the key.

“I still don’t expect a double-dip recession,” says EFG’s Burumcekci, “but I expect very sluggish growth.” Daiwa’s Lai concurs. “I think double dip would be about a 40 percent probability. The other 60 percent is, growth will be close to zero,” with Europe and the U.S. “barely able to avoid a ­recession.”

That subdued outlook will leave many governments unable to either grow or inflate their way out of debt, according to WestLB’s Diehl. “Sovereign debt will become an even bigger problem than in the last year, and fiscal policies will become even more restrictive to convince the markets that there is a true shift in policies rather than a cosmetic change,” he says. Such austerity will dampen the economic outlook in the near term, Diehl expects, but should ultimately pave the way for a rebound in growth and creditworthiness: “After some time of having demonstrated fiscal policies are getting more restrictive, ratings will increase again — but that is not going to happen in six months’ time.”

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