ECR Survey Results Q1 2015: Russia crisis, China fragility and EMs’ capital-flow shock

Emerging markets (EMs) with fiscal and external imbalances, vulnerable to capital outflows – including oil and other commodity producers struggling to balance their budgets – are among the 72 sovereigns downgraded since the end of 2014 by more than 440 economists and other country-risk experts.

Virtually all of the Brics and Mints (see chart below) – the large, rapidly expanding countries with enormous long-term investor potential, dominating EM portfolios – have seen their risks attenuate (and therefore their scores fall) during the first months of 2015.

Most are harbouring fiscal and current-account deficits, and are vulnerable to capital outflow with monetary tightening on the cards in the US and China’s economy 'correcting’.

India, the main exception, has a rising risk score thanks to the reforms and other policy improvements the government is introducing to address those deficits.


China’s growth concerns, exaggerated by a flaky real-estate market and an iron-ore industry now in a tailspin, have seen its risk score weaken since 2014.

Consequently, Arjen Van Dijkhuizen, senior economist at ABN Amro, believes "India is set to surpass China as the fastest-growing emerging giant".

"In our view, the region is generally well-positioned to cope with [more] dollar strength," he says. "The main risks are a China hard landing, disappointing growth in advanced economies and contagion from a [faster-than-expected] Fed exit."

Brazil and South Africa were among the sovereigns downgraded the most by country-risk experts in Q1 2015.

Brazil – with street protests in the wake of rising prices, water rationing and a high-profile corruption scandal highlighting the mishandling of an economy now in recession – is struggling to convince the experts, with currency depreciation worsening its inflation and external borrowing profile.

South Africa has become hamstrung by a lack of reform in the electricity sector, which is holding back its economic growth potential, and by a commodity-backed currency under pressure.

Mexico, Indonesia and Nigeria have been downgraded too in response to political and/or economic weaknesses, fuelled by the negative oil shock, and an increased interest in their fiscal/external imbalances, which are now vulnerable to outflows of US and other foreign-sources of financing.

EMs have suffered their largest outflow of capital since the 2007/08 global financial crisis. EM currency reserves declined last year for the first time since records were first compiled in the mid-1990s, according to the IMF.


Experts remain negative on Russia

Russia’s mounting problems caused by the sanctions and low oil prices undermining the rouble extended its trend decline into Q1 2015, resulting in a total score of just 44.8 points from a maximum 100.

All 15 of Russia’s risk indicators were downgraded in Q1 2015, which, coupled with a reduced credit rating score – one of three other risk parameters, alongside debt indicators and access to capital, comprising the total risk score – sent the sovereign crashing to 74th in Euromoney’s global rankings, and firmly into the fourth of five tiered groups denoting sub-investment grade (or junk status).

Several of Russia’s close trading partners and former Soviet satellite states were among the biggest fallers, affected by the negative oil shock, their own currency’s plight, and weakened trade and capital flows. They include Kazakhstan, Moldova, Turkmenistan and Ukraine.

Several others – Angola, Gabon, Kuwait, Oman, Nigeria and Venezuela – are all oil producers struggling in a new era of depressed tax revenues and plunging currencies weakening their fiscal metrics.

Greek tragedy; Austro-Swiss worries

Invariably, Greece was another of the sovereigns with one of the largest score declines in Q1 2015, thanks to the tail-risks associated with negotiating its debt resolution, it suffering a setback in its economic recovery and it still being at risk of exiting from the eurozone.

The mutating debt crisis in Europe has not only seen Greece waver but also Austria linked to the bankruptcy and a previously undetected black hole in the bad bank formed from the failed Hypo Group Alpe Adria.

Risk experts do not believe the bank’s problems are about to plunge Austria into the fate that befell Cyprus, Iceland or Ireland, but it is nevertheless a reminder of the weaknesses still prevailing in the global financial system and the need to execute new legislation bailing-in creditors using the European Union’s bank recovery and resolution directive.

It also highlights how it is the brighter fortunes of the US that are mostly attributable to the stabilization of the G10 risk profile.

However, Europe, more generally, is now stabilizing as its economies grow due to more competitive currencies spurring exports, and lower oil prices underpin consumer demand by reducing energy and transport bills.

Experts remain unconvinced by the fiscal metrics in many of the larger sovereigns in Europe, and even low-risk Switzerland has succumbed to a downgraded score since it decided this year to decouple the Swiss franc from the depreciating euro.

Yet prospects for the UK and even Italy are improving.

And more widely across Europe, Hungary, Romania and Slovenia, which have lower scores compared with 2010, have seen their risks ease this year as better policymaking and improving economic fortunes alleviate the threats of late or none payment.


Negative oil shock still reverberating in MENA

Although many of the Middle East and North African net oil producers have substantial fiscal buffers to ride out temporary negative price shocks, half of the 18 countries across the region saw their country risk scores downgraded in Q1 2015 as they adjust to the effects.

As Marwan Barakat and his Bank Audi colleagues taking part in Euromoney’s survey noted in a recent review, "oil exporters’ overall growth will moderate and the large fiscal surpluses will decline or shift to significant deficits".