Will the UK, France and US lose their remaining triple-A ratings in 2013?

By:
Jeremy Weltman
Published on:

France has kept its top rating from Fitch, and the US has suffered the ignominy of a downgrade only from S&P, but both are still in danger of being completely stripped of their triple-A status, according to Euromoney’s Country Risk Survey.

And despite UK Chancellor George Osborne putting his own credibility on the line in terms of preserving the UK’s ratings, country-risk experts are questioning how long it can remain so creditworthy, particularly when a comparison is made with New Zealand.

The latest results of Euromoney’s Country Risk Survey make uncomfortable reading for the UK, France and the US, large industrialized economies that until recently enjoyed stellar credit ratings from the agencies.

Survey data indicate that the UK, which lies in the second tier of the Euromoney rankings’ five-tier system and below tier-one-rated New Zealand, is likely to be downgraded in 2013, as rising public debt and a flagging economy erode analysts’ confidence in the coalition governments’ fiscal strategy. And while some of the rating agencies have passed judgement on France and the US, their counterparts might yet remove each country’s remaining Aaa ratings, if ECR experts are to be believed.

Analysts see vulnerabilities for France, the UK and US

Data from the ECR survey, which aggregates the views of more than 400 international economists into a credit score out of 100, have illustrated since its first publication in 1993 that countries occupying tier-one status – ranging from Norway in top spot, on a score of 90 out of 100, to Austria in 14th on 79 – have historically tended to receive an Aaa credit rating.

These countries each receive excellent scores from economists across the Euromoney survey’s range of economic and political criteria – from government finances and the economic outlook to assessments of political risk such as corruption, information access and institutional risk.

However, countries with scores below this level are included in tier two, which has historically been consistent with a rating of Aa. Sovereigns in this tier are normally wealthy, industrialized economies with functioning democratic systems of government. However, near-term factors such as economic growth and unemployment often show signs of weakness. Towards the lower end of this tier countries might also exhibit signs of being over-reliant on a narrow set of economic sectors such as natural resource extraction, public finances or financial services.

The countries presently occupying tier one in the Euromoney rankings are invariably rated Aaa. Nine receive stable Aaa ratings from all three of the main credit rating agencies: Fitch, Moody’s and Standard & Poor’s (S&P) – they are Australia, Canada, Denmark, Luxembourg, the Netherlands, Norway, Singapore, Sweden and Switzerland (coloured orange in the table below). All have ECR scores within a 7.8 point range, with no risk of default.

 
                                                Source: Euromoney Country Risk        

Another two – Finland and Germany – are still ranked AAA, but have been put on review for a downgrade by at least one agency: Finland is on negative watch by S&P and Germany by Moody’s. Weak economies and fiscal contingencies are mostly to blame; Germany has the added risk of elections next year.

Some would claim Denmark should be in a similar position – a weak economy and a deficit that is larger than Finland’s might endorse this view. However, the deficit was exaggerated by a technical change to the Efterløn early retirement scheme – resulting from a reform of the pension system – and debt seems stable at around 45% of GDP, a testament to the authorities’ well-established and credible debt management programme.

However, the UK, France and the US are all included in ECR tier two, with scores several points below the cut-off point for inclusion in tier one. Economists’ views of the political and economic backdrop to these countries are not favourable enough to support a country risk score equivalent to those of the safest countries, such as the Nordics and Singapore.

Economic and political deficit

Three tier-one sovereigns, meanwhile, have been downgraded by at least one agency. Of those, Austria is a peculiarity, it seems, as none of the three agencies can agree on its credit status: Fitch has it stable at Aaa; Moody’s on review for a downgrade; and S&P at Aa+. The sovereign’s borderline tier-one status explains the divergence of opinions – at 14th, it is the lowest ranked of the tier-one grouping, just one place above the US, but 4.3 points better off.

Austria’s fiscal consolidation programme appears credible, but the deficit widened to 3.1% of GDP in 2012 and even under an assumed return to probity, the debt burden is predicted to rise to just short of 80% of GDP by 2014. Further support for troubled banks provides the main question mark over its creditworthiness – not that it seems to have rattled the bond markets; Austria’s 10-year bond is trading at a slightly lower yield to the Canadian benchmark.

 

                                  Source: Euromoney Country Risk

That leaves three sovereigns still receiving at least one Aaa rating, but currently residing in ECR’s tier-two category, normally equivalent to a rating of A- to AA. France is still rated Aaa by Fitch (albeit on negative watch), the UK is ranked Aaa by all three agencies, but is on negative watch by Fitch and Moody’s, and the US, also on negative watch by the same two agencies, has been lowered to Aa+ by S&P, highlighting the fiscal predicament causing anguish for president Barack Obama’s second term.

According to ECR’s survey, all three sovereigns should have lost their Aaa status by now. Indeed, there are three sovereigns rated lower than top-rated UK by at least one agency – Austria, Hong Kong and New Zealand, despite all three being higher up the ECR scoreboard. While the UK has been reviewed lately alongside France and the US, a comparison with New Zealand also throws up interesting dimensions.

 

                                         Source: Euromoney Country Risk

How long can the UK remain higher rated than New Zealand?

The 15 economic, political and structural risk indicators rated by ECR’s contributing economists and other country-risk experts can help to shed some light on why these three sovereigns are more at risk than others and why the UK (ranked 19th and tier two on ECR’s scorecard) is less creditworthy than New Zealand (a tier-one sovereign in 12th place).

The markets still clearly have confidence in the UK coalition’s plan to nurse its battered fiscal accounts back to health. The UK’s cost of borrowing over 10 years, floating around the 1.87% mark in the run-up to Christmas, represents a 52 basis point premium on the equivalent Bund, but is also lower than the 3.62% interest rate on New Zealand’s 10-year debt.

Yet, the UK government’s task remains highly challenging, both because of the weakened economic situation and political resistance to even deeper expenditure cuts and tax rises. From a position of outright contraction in 2012, the UK is expected to grow by 0.9% in 2013, according to the OECD –most other forecasters anticipate something similar – whereas New Zealand’s prospects appear to be more favourable.

Growth of 1.6% in New Zealand in 2012 is likely to be followed by 2.4% growth in 2013, the OECD suggests. Deficit and debt levels (the latter shown below) also favour New Zealand, and strikingly so. The UK’s debt burden will reach 95% of GDP by 2014 and that’s assuming that the projections are not blown off course by a weaker-than-expected economy. However, New Zealand, with its more favourable medium-term deficit-reduction programme, will see its debt rise to approximately 56% of GDP, some 39% of GDP lower than the UK.

 

                                             Source: European Commission, OECD

In all, New Zealand scores higher than the UK on 14 of ECR’s 15 sub-factors – the only exception is the regulatory and policy environment: the UK is, after all, highly competitive, corporate tax is falling and there is a defined medium-term strategy to stop the debt from rising.

For some indicators the disparity is considerable. New Zealand’s score of 8.1 for bank stability is some 2.1 points higher than the UK’s, its employment/unemployment outlook is 1.9 points better off, demographics 1.6, and so it goes on.

Plus “there is some risk of further fiscal slippage in the UK”, according to Philip Rush, an economist at Nomura, as “the government is probably too optimistic on growth”.

His latest report (Bending the fiscal rules) asserts that “S&P’s downgrade of the US and France makes the UK’s Aaa rating an odd outlier. Fitch sees a greater than 50% probability of a downgrade and Moody’s concerns are crystallizing. We expect the UK’s credit rating to be downgraded before May 2015 (70%) and do not rule out it happening in the next several months (25%).

“A UK sovereign rating downgrade would be more a political event than a market one, in our view. We do not expect it to tarnish gilt demand significantly.”

What about France?

The French score has fallen by 8.3 points since 2010 and by 2.1 points this year, to 73.7, barely a whisker above the 73.5 the UK receives.

France’s general government deficit has narrowed to an estimated 4.5% of GDP this year from 5.2% in 2011, according to the European Commission, and is forecast to narrow further still to 3.5% of GDP in 2013. The structural and cyclically adjusted deficits are similarly predicted to follow a favourable path – a considerably better fiscal position than the UK, it would seem.

However, fiscal challenges remain, not least in connection with the moribund economy and policy uncertainties of the Socialist government led by president François Hollande, as well as the lack of a central bank able to simply print money if it wants. The ECR survey highlighted French weakness before Moody’s downgrade, with downgraded sub-factor scores for the economic/GNP outlook (down to 5.2 out of 10) and the regulatory and policymaking environment (still reasonably favourable at 7.5, but downgraded from 8.4 in 2010).

The survey also highlights the risks attached to the French labour market, with downgraded scores for the employment/unemployment outlook and for industrial relations. Strikes and other labour market tensions connected to corporate restructuring, in a country that is no stranger to industrial action, demonstrate the risks of additional burdens on the government finances.

Plus, as the ECR bank stability indicator illustrates (down from 7.7 in 2010 to 6.4), France still has considerable financial sector risks, including the largest eurozone exposures to Greece.

A straw poll of ECR’s website users, asking Do you agree with Moody's that France is no longer worthy of a triple A rating? found just over three-quarters of respondents stating “yes”.

... and the US?

The US situation is similarly parlous. The sovereign’s ECR score (down 6.8 points during the past two years, to 75.3) has not fallen quite as sharply as that for France or the UK, but the government finances indicator has been languishing at 4.7 for a considerable period of time, highlighting the main source of uncertainty for investors.

No one truly expected the massive fiscal cliff of tax rises and expenditure cuts (worth upwards of 5% of GDP) to remain unresolved by January 1 or for the government to shut down under the weight of its unpaid bills, but the lack of a credible medium-term consolidation programme, rather than the quick-fix temporary solutions to the US debt problem, by simply raising the debt-ceiling, will continue to undermine its creditworthiness.

If the US were a eurozone member, its 8.5% of GDP deficit and 110% of GDP debt burden would have probably had the markets more concerned by now. As it is, the US can still borrow over 10 years at around 1.84%, lower than the UK and France.

However, there cannot be too long before these inconsistencies must be resolved, synchronizing the opinions of the raters more in line with the views of experts taking part in ECR’s survey.

Further information on the survey is available from Euromoney Country Risk.