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This article was published using data from Euromoney Country Risk (ECR), the online service from Euromoney dedicated to country and sovereign risk. To view the latest country rankings go to www.euromoneycountryrisk.com |
FOUR YEARS AGO, the sovereign debt of eurozone member states was perceived as having zero risk of default. Concern about the risks posed by high debt levels in the region was dismissed as paranoia by those who thought the price of a Greek bond could be judged simply by movements in the instrument’s spread over German Bunds. The tail risk of a eurozone sovereign default was ignored by investors, who focused instead on inflation and interest rate risk.
Fast forward to the summer of 2011 and the eurozone faces the overwhelming likelihood that one or more member states will default on their sovereign debt and leave the single currency in the process. The prospect has sent shockwaves through financial markets and clouded the economic prospects of an already embattled region. When default happens, as the market believes it must, no one can say how badly European banks will be hit, or with what severity global markets for credit, derivatives and foreign exchange might become dislocated.
| Top 10 largest deteriorations in country risk scores |
|
Country |
Crisis period |
Pre-crisis score |
Post-crisis score deterioration * (out of 100) |
Sept 2011 score |
| 1 |
Indonesia |
Mar 1996–Mar 2000 |
73.2 |
-40.4 |
58.2 |
| 2 |
Greece |
Sept 2008– |
82.7 |
-33.0 |
40.6 |
| 3 |
Malaysia |
Mar 1996–Mar 1999 |
84.5 |
-32.8 |
66.6 |
| 4 |
Russia |
Sept 1997–Mar 1999 |
50.7 |
-29.9 |
56.9 |
| 5 |
Ireland |
Sept 2008– |
92.4 |
-29.0 |
60.8 |
| 6 |
Argentina |
Sept 1999–Sept 2003 |
53.8 |
-28.0 |
43.7 |
| 7 |
Thailand |
Mar 1996–Mar 2000 |
82.1 |
-27.4 |
61.7 |
| 8 |
South Korea |
Mar 1996–Mar 1999 |
85.0 |
-23.4 |
73.3 |
| 9 |
Portugal |
Sept 2008– |
83.0 |
-22.3 |
55.9 |
| 10 |
Spain |
Sept 2008– |
86.6 |
-20.1 |
66.0 |
| * For countries still considered in crisis, the most recent country risk score from Sept 2011 is included | |
In quantitative terms, Europe’s problems dwarf those of all other distressed sovereigns in recent history. Greece’s indebtedness, forecast to reach 145.5% of GDP in 2016 by the IMF, puts even pre-default Argentina in the shade. Italy, a core member state recently drawn into the crisis, has the third-biggest bond market in the world after the US and Japan. Few believe that it can be rescued by either the European Central Bank or the European Financial Stability Facility (EFSF). The big current account imbalances between the surplus economies of the north and the deficit addicts of the south have existed for decades.
The eurozone’s ailments bear a closer resemblance to Latin America’s in the 1990s than the lightning strikes that hit Asia in 1997 or Russia in 1998. Europe’s is a slow-burning crisis, with each piece of bad news provoking pessimism, followed by a counter-measure that only brings short-lived relief. But the periods of calm are becoming shorter. Now that the markets have threatened to deny core member states such as Spain, Italy and even France access to international capital, the viability of the euro itself has come into question.
Historical data from Euromoney’s country risk survey illustrate the sharp deterioration of affected sovereigns from Mexico’s Tequila Crisis in 1994 to the Dominican Republic’s restructuring in 2005. The results show the lasting effect financial crises can have on risk perception of the countries involved. Already, they show something potentially more serious: the present crisis is more severe than any in the past 20 years.
Since 2008, Greece’s fall from grace has already been more profound than that of any country but Indonesia after the devaluation of the rupiah in 1997. Greece has fallen further than Malaysia during its own crisis in the same period, and further than Argentina when it defaulted on external debt owed to private and official bilateral creditors in 2001.
Ireland, forced to accept an €85 billion bailout package last year after its banks were wiped out by exposures to the domestic real estate bubble, has already suffered a 29-point fall in its country risk score. Ireland’s score had previously peaked at sixth in the world in March 1998. Its position mirrors Thailand, whose own real estate boom contributed to the severe recession it suffered in the late 1990s. Thailand had previously been ranked as high as 26th globally, a position it has never regained.
Portugal and Spain have also suffered falls in their scores of more than 20 points since the collapse of Lehman Brothers. Indeed, country risk data show that the scores of the peripheral eurozone economies have been reduced to a level not seen since they joined the euro. In other words, the dream that Greece, Italy, Spain and Ireland would converge with the core economies has been reversed: the Piigs have diverged.
But it is at the policy level that Europe faces its biggest challenges. Eurozone leaders have been found badly wanting by the crisis. Jerome Booth, head of research at Ashmore Investment Management, says: "The ability and the willingness of a sovereign to change its debt ratios, and so alter market perceptions towards itself, is not a function of numbers: it’s a function of policymakers and political constraints. What Europe’s crisis has brought into stark relief is that its policymakers have proved to be inflexible and unable to react to events in real time. In some ways this is unsurprising, since policymakers in Europe have little experience of dealing with crises, in contrast with many of their emerging market peers."
Can Europe recover?
The history of sovereign defaults in emerging markets provides little comfort to those tasked with solving Europe’s deep-seated fiscal and structural problems. Of those sovereigns that have restructured their debts or defaulted, only a handful have recovered their previous country risk scores. The lengthy recovery times illustrate both the damage default can have on investor sentiment and the lengthy recessions that have frequently followed financial crises.
