Country Risk: Huge differentials in risk among similarly rated sovereigns

Jeremy Weltman
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Sovereigns assigned with identical investment grades must be considered to have very similar, if not the same, levels of risk, otherwise those ratings would be a misleading indicator of creditworthiness, Jeremy Weltman reports.

However, according to Euromoney’s Country Risk Survey – using triple-B rated sovereigns for comparison – substantial variation in risk exists between sovereigns within the same agency category.

Similarly rated sovereign bonds should offer similar risks to investors. A triple-B rated sovereign should be equivalent in risk-terms to another triple-B, assuming their ratings are stable (not on review for an upgrade or downgrade).

However, a careful inspection of the B ratings currently assigned by the three main agencies – Fitch, Moody’s and Standard & Poor’s (S&P) – shows this is not always the case.

Euromoney’s Country Risk Survey reveals considerable variation in risk assessments among similarly rated sovereigns. Its detailed factor analysis, spanning 15 political, economic and structural risk indicators, helps to explain why.

Within the lowest investment grade (BBB-/Baa3), Colombia is 40 places and one tier higher than Azerbaijan. The dispersion of scores within the BBB/Baa2 and BBB+/Baa1 categories is also considerable, even among countries with stable ratings. The views of economists and other country-risk experts are pinpointing substantial failings in the credit-ratings approach, it would appear.

Disparities among the lowest investment grades

Fitch has 10 sovereigns within its lowest (BBB-) investment grade category and S&P has seven. Moody’s has 12, all of which are rated Baa3, which is equivalent to the Fitch and S&P categorization (see table, below).

However, the countries score very differently in the ECR survey. At present, 15.3 points separate Colombia – a tier-three sovereign on a total score of 58.6 out of 100, and ranking 41st out of 185 countries on the ECR global risk data table – from tier-four Azerbaijan, some 40 places lower on 43.3 points.

Interestingly, Colombia and Azerbaijan are the least and most risky sovereigns, respectively, within the lowest (BBB-/Baa3) investment-grade category of all three rating agencies.

Of course, the agencies sometimes also place their ratings on a positive or negative watch/outlook, signalling subtle differences in risks and acting as an early warning indicator to a potential upgrade or downgrade.

S&P, to be fair, does makes that distinction where Colombia and Azerbaijan are concerned; the latter is stable, but the former is marked out on review for an upgrade. This will come as no surprise to regular ECR users, who have witnessed a rapid rise through the rankings for Colombia in recent years. The sovereign has climbed 37 places since 2007 – a turning point for other countries affected by the global crisis. In response, a recent ECR piece proclaimed that Colombia’s time has come.

Yet neither Fitch nor Moody’s makes a similar distinction – in their eyes, Colombian and Azerbaijani sovereign bonds are inseparable from a risk perspective.

But is this true? Not according to S&P, and neither is it the case according to the majority of experts taking part in the ECR survey, where the differences between similarly rated sovereigns are clear from their score differentials. In all, 15 separate factors are surveyed every quarter, with economists and other country-risk experts asked to evaluate the main political, economic and structural risks that could contribute to a sovereign bond default.

These evaluations are combined with information on debt, access to capital and credit ratings to give an overall score. A tiered ranking approach is used to give an approximate credit rating equivalent. Tier-three sovereigns, on a score of between 50 and 65, are an indication of a BB+ to A- rating, ranging from highest-speculative grade to low-investment grade. Tier-four sovereigns, on a score of 36 to 50, equate to a B- to BB+ rating, which is junk/speculative status, or sub-investment grade.

In the BBB-/Baa3 example, above, Fitch has four countries – Romania, Namibia, Morocco and Azerbaijan – seemingly over-valued in risk terms. They all reside in ECR’s tier four and are more of a speculative than investment grade, according to the survey contributors. Romania, unchanged in 2012, has fallen eight places in the ECR rankings since 2007; Morocco’s instability has seen it plunge, too. Namibia and Azerbaijan have ascended in recent years, but not sufficiently to be considered for investment grade – the latter is little more than a mid-range tier-four sovereign.

Tier-four sovereigns Azerbaijan and Morocco also stand out in S&P’s ratings, whereas in Moody’s case there are five examples – Latvia, Romania, Namibia, Tunisia and Azerbaijan. The ECR survey is more cautious about these countries’ solvency prospects than the raters.

So what distinguishes Colombia from Azerbaijan?

Investors in Colombian and Azerbaijani debt encounter identical levels of risk according to Fitch and Moody’s – there is no perceived difference in creditworthiness by the two agencies. Yet the ECR survey highlights score differentials of 27.1, 13.7 and 25.7 points, respectively, for their political, economic and structural risk assessments, all in Colombia’s favour (see chart, below).