ECR Survey Results Q2 2014: EM rout prompts flight to safety

The latest results from the ECR survey show emerging markets (EMs) becoming riskier during the first half of this year, in contrast to the increasing safety offered by developed countries across the G10 and an improving eurozone.

The crisis in eastern Europe has invariably shaken confidence in Russia and Ukraine, the two biggest fallers during the period.

Spill-over effects have led to falling scores for Bulgaria, Estonia, the Czech Republic, Belarus and other parts of the CIS (including Azerbaijan and Kazakhstan), but not for all countries across the region as Poland’s resilience highlights.

EMs more generally have suffered from an increasing loss of faith among risk experts, and for a variety of reasons. They range from fiscal and external financing in light of the US Federal Reserve tapering its bond-purchase quantitative-easing programme to the spreading conflict in the Middle East. Domestic political crises and high debts number among a list of concerns.

Internal strife affecting Croatia, Indonesia, Pakistan, South Africa, Turkey and Thailand, among others, has seen country-risk scores downgraded this year. Argentina and Venezuela’s longstanding policy and financing problems have continued, and many Asian countries – Malaysia, Singapore and Taiwan among them – have been downgraded alongside frontier markets Cambodia and Mongolia.

A large swath of Middle Eastern and African sovereigns also have lower risk scores, with the picture similarly fading for lower-risk Chile and Peru, as China’s waning copper demand has reduced their economic growth potential.

In total, 97 of the 186 countries surveyed saw their ECR scores decline (risks rise) during H1 2014, with 10 unchanged and 79 registering improvement.

Not all EMs are out of favour

Brics, Mints and other EM groupings endured a slide in their country risk scores during H1 2014.

Sovereigns more vulnerable to reduced US liquidity and/or slowing economic growth affecting their fiscal and external solvency were most affected, especially those such as South Africa, Turkey and Thailand, weighed down by domestic political instabilities hampering policymaking.

Smaller frontier markets, including the Bahamas, Barbados, Bermuda, Cambodia, Mongolia and Papua New Guinea, could not evade the rout.

Bucking the trend,  South Korea was one of a robust five, along with Poland, Israel, Colombia and Uruguay, that saw their risk scores improve.

Amassing 70.5 points out of a maximum 100 – 3.7 higher since the start of the year – South Korea was 10 places higher at the end of June compared with its year-earlier position, climbing to 22nd out of 186 sovereigns on ECR’s  global rankings.

Despite some political risk, the country’s macro-strengths are undeniable, with fiscal stimulus achieved without causing a substantial deterioration in the budget finances, leaving the deficit and debt burden below 2% of GDP and 40% respectively.

Poland’s macroeconomic risk factors have been upgraded, too, highlighting a promising growth outlook, narrowing of the current account in Q1 and tightening labour market.

The worst is probably over for EMs now, believes  Arjen Van Dijkhuizen, senior economist at ABN Amro, with "headwinds fading as market sentiment has improved and capital flows returned".

Still, as the lower risk scores demonstrate, downside risks remain present. The Fed could exit from monetary stimulus abruptly, "triggering a fresh round of capital outflows for countries with strong external financing needs, such as Brazil, Indonesia and Turkey", Van Dijkhuizen warns.

Other concerns revolve around the build-up of debt in several EMs, such as Malaysia and Vietnam, flaring geopolitical risks and social unrest, such as that witnessed in Iraq and elsewhere in the Middle East reverberating in the oil market, or a failure to progress with structural reforms.


Mixed signals elsewhere in Asia

China improved in H1 2014, with its score rising by 1.2 to 61.1. This was entirely due to the sovereign’s improved access to capital. However, one of three other factors – along with debt indicators and credit ratings – added to the 15 economic, political and structural risk indicators the survey experts regularly assess.

China’s economic indicators were marked down heavily, with concerns for the health of its shadow banking system and ability to maintain stellar economic growth chief concerns for country-risk experts.

India has also improved a little, climbing three places to 62nd in the global rankings, with many economists now foreseeing stronger policy-induced growth, with a new government focusing on reforming the business environment.

Underpinned by a new growth strategy, Japan, now 26th, is also recovering slowly.

On the other hand, Thailand’s political crisis has invariably taken a heavy toll on its risk outlook with all bar one of its 15 indicators downgraded. The sovereign has nosedived 10 places to 59th during a 12-month period in the wake of the coup d’état, harming tourism and other parts of the economy.

Political instabilities and trade exposures to China have raised doubts over Singapore, Taiwan and Macau, but not Hong Kong, which is showing more resilience.

Bangladesh, Pakistan and Sri Lanka have also become riskier from a combination of economic and political factors, including the underlying risk of domestic instability, in Pakistan especially.