Indonesia the most vulnerable of a fragile five

Jeremy Weltman
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A toxic combination of large external financing gaps and US liquidity withdrawal has increased the risks of investing in triple-B rated emerging market (EM) sovereigns. With many countries facing elections this year and stalling on structural reforms, economists taking part in Euromoney’s Country Risk Survey have placed five of the larger EMs under the microscope.

Many EMs became riskier in 2013, forming part of a longer-term trend evinced in two-year score declines in Euromoney’s Country Risk Survey.

Brazil, India, Indonesia, South Africa and Turkey, huge EMs, all within the third of ECR’s five tiered risk categories, were downgraded by economists and other experts, among 400-plus participating in the survey on a regular basis.


Capital outflows sparking currency depreciation, with weakened economic growth profiles, have raised doubts over the security of sovereign bonds, especially with debt servicing costs spiralling gently upwards with drifting bond yields.

The anticipated gradual withdrawal of US monetary stimulus has cast the spotlight over larger markets dependent on huge inflows of foreign financing to sustain budget and current-account imbalances.

However, capital flows are not the sole issue to concern the experts.

Domestic factors have also contributed to their unease, with many citing structural reforms and political risks, including corruption and heavy election schedules over the coming months, for their wariness.

There are, nevertheless, many distinctions between the fragile five, with almost 10 points separating Brazil – still the safest of the group in 41st position on ECR’s global rankings – to Indonesia, lying 67th, the only country to have received a lower rating of BB+ (though only from S&P).

ECR’s comprehensive survey-based approach pinpoints many interesting differences in broad risk categories. South Africa has the highest economic risk, experts suggest. Indonesia is the worst for politics and structural risks. Brazil is still among the strongest in almost all areas (see chart).


As all five sovereigns slipped down the rankings in 2013, other, more favourable tier-three domains have ridden out the storm.

Mexico, a LatAm favourite edging ever closer towards tier-two status, having climbed to 36th in the rankings, and China – up one place in 2013, to 38th – have resisted the downdraft, with the latter receiving support from stabilizing growth, and greater efforts to weed out corruption and introduce reforms.

Russia moved up six places last year to 54th, buoyed by oil and gas prices. South Korea’s fiscal and balance-of-payments strengths also kept it in favour, gaining half a point to keep the sovereign in 30th place.

Malaysia similarly defied its critics to stay in 35th spot (just below tier two). However, Thailand, with its domestic political problems, suffered a four-place fall to 58th.


Worries over India and Indonesia

India and Indonesia’s falls have proved especially troubling for EM investors, with two of the most populous Asian nations careering down the rankings in the past couple of years.

Now lying respectively in 65th position (after a drop of four places last year) and 67th (down three), the two are in danger of slipping into tier four, commensurate with losing their triple-B status. Indonesia is only one place and less than half a point away from such misfortune, explaining S&P’s position.

Recent research points to the worst credit environment in Asia since the 1990s, while the lack of structural reform in Indonesia, the onset of parliamentary and presidential elections in April and July respectively, and its increased foreign-currency requirements stemming from a weak balance-of-payments position exacerbated by US tapering suggests Indonesian bonds will struggle this year.

As Maritza Cabezas, senior economist at ABN Amro and an ECR expert noted recently: “India and Indonesia had a difficult time during the summer when fears of Fed tapering grew. Since then their efforts have been centred on improving their weak fundamentals.”

Action taken to curtail gold imports has ameliorated India’s current-account deficit, but higher interest rates to combat inflation will slow GDP growth, which, with the added complication of elections to be held in both countries, has made experts cautious.

India’s growth prospects are nevertheless more promising than Indonesia’s. “Indonesia is more vulnerable [than India], and therefore will have more to do in terms of reducing its imbalances,” says Cabezas.


Brazil backtracks

Although still regarded as the safest of the fragile five, Brazil slipped three places last year to 43rd and lost its status as the safest Brics nation – to China – with the majority of its risk indicators downgraded. Its overall score has, as with other large EMs, been steadily trending downwards during the past two years, losing around four points in total.

Public protests have cast the spotlight over the perceived corruption and excessive public costs involved in hosting Fifa’s World Cup this year and its associated infrastructure development, which, with elections scheduled for September, could upset expectations of a victory for the incumbent president Dilma Rousseff sufficiently to cause market wobbles.

With slower growth in China and regional trade issues dampening Brazil’s economic expansion, inflation above 6% and fiscal slippages adding to concerns over a current-account deficit that is edging up closer to 4% of GDP, experts have become more agitated by Brazil’s fundamentals.