China and Japan enter red zone

Jeremy Weltman
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The slowing of China’s growth miracle, coupled with concerns over leadership transition, has caused the world’s most populous nation to lose its status as the safest of the Brics, in the latest results of Euromoney’s country risk rankings. Elsewhere, Japan, once the world’s safest sovereign, has now fallen to its lowest level, and Spain plunged 14 places with a sovereign bailout now seemingly inevitable.

China and Japan, similarly rated by the credit rating agencies, are continuing to slide in the latest results of Euromoney’s country risk survey, as country experts become more alarmed about their respective risks.

Japan has seen one of the largest score-declines this quarter of the 186 surveyed by ECR, exceeded only by Spain and Slovenia. Ranked the number-one safest country in the world in 1993, when ECR began its survey, Japan has fallen to 30th place – its lowest level.

And China, the world’s most populous nation, has lost its status as the safest of the Brics, having fallen to 39th place in the rankings, two below Brazil.

Both countries are struggling with increased economic and political risks, and these risks are partly intertwined as a result of an acrimonious territorial dispute between the two countries over islands in the East China Sea.

More than 400 economists and country risk experts from a range of financial and other institutions take part in Euromoney’s country risk survey. They evaluate the risks faced by international investors in more than 180 markets, scoring countries across a range of political, economic and structural criteria. To view the survey methodology, go to

Japan, largely ignored as a special case, has for years struggled with high and rising public debts, low growth and deflation. The country’s adaptability, its level of advancement, high foreign-exchange reserves and penchant for saving over investment – creating a current-account surplus – were factors often cited as positive for its overall risk profile. And a reconstruction boom after the earthquakes in 2011 has provided a short-term fillip to the economy.

However, these trends might be a mirage. The country’s looming demographic shock means that, according to the International Monetary Fund, Japan’s growth potential will fall to around 1% per annum without remedial action. Measures have been taken to improve budget revenue – raising the consumption tax to 8% in 2014 and 10% in 2015 – and safeguard financial stability, but in a low-growth environment, debt levels and bank profitability are still concerning.

Gross public debt exceeded 200% of GDP in 2009 and is projected to reach around 240% of GDP by the end of next year. Japan will need additional reforms – to its pension system, for example – without which the country might be facing a credit shock. All of these concerns are borne out by its fall in the rankings.

In the ECR survey, Japan’s political assessment score has fallen to 72.4 (out of 100), while its economic score is now just 50.0. All five economic sub-factors have been downgraded this quarter, led by the bank-stability risk indicator, highlighting concerns about balance-sheet strengths. Yet the economic-GNP outlook and government-finances indicators are the lowest scorers, at 4.0 and 3.1 out of 10 respectively, testament to the country’s lack of growth and high debt levels.

No longer safest Bric economy

As worrying is China’s fall. The 2.1 points decline in China’s ECR score, to 59.6, culminating in a two-place fall in its global ranking to 39, means that China has seen the largest fall in its score during the past two years of any of the Brics (Brazil, Russia, India, China and South Africa). It means that Brazil is now safer than China, according to the survey.

The attenuated risk profile is attributable to economic and political factors, including question marks over China’s growth engine – indeed, the world’s growth engine – and one of the main economic factors now perplexing ECR’s experts. Linked to this is the lingering question mark over bank stability in China, which has the lowest score of any of its five surveyed economic sub-factors.

One of ECR’s China contributors, Snehal Manjrekar, at Thomson Reuters, notes in regard to bank stability that “[China’s] non-performing loan/asset quality looks susceptible after the abrupt economic slowdown. The rise of unpaid bills is a bad omen for the banking sector”.

Jeroen van IJzerloo, head of country risk research at Rabobank, and one of ECR’s China experts, tells ECR: “Structural growth plans [in China] are not working any more, particularly investments in the export-led growth model, which is defunct because of falling export demand.

“There is also the problem of getting investments through to the economy without hampering the local banking system too much. At some point, [the authorities] will reach the boundaries of what they are able to do in maintaining a good growth level.”

Political risks in China have also heightened lately, not only driven by increased tensions with Japan but also the questioning of government stability in light of the Bo Xilai scandal and the mysterious disappearance of Xi Jinping, China’s leader-in-waiting. These episodes highlight an unusual degree of uncertainty about the transition process. They also demonstrate how country risk is a multi-faceted concept and that a proper evaluation depends on a multitude of factors.

Johan Krijgsman, of Krijgsman & Associates, and one of ECR’s survey contributors, states: “The past few months have really demonstrated how little we know about the [party’s] inner workings. The disappearance of the leader-apparent should act as a yellow flag to remind analysts that we know less than we should, making it near-impossible to make accurate predictions.”

And China and Japan’s increased risks are partly interlinked, through trade ties, and their impact on the rest of Asia and markets further afield, as well as an acrimonious territorial dispute between the two countries regarding several islands in the East China Sea.

Jimmy Kuo, senior assistant research fellow at the Taiwan Research Institute, and one of ECR’s survey contributors, adds: “[The dispute] is probably going to get worse, so the economy is going to be further affected.

“China is the main country for Japanese exports, so it’s going to hurt Japanese exports to China, which means trading will not be good for the next quarter, which means government finances will be affected negatively.”

This also means, for now, investors need to keep a close eye on both countries, given their influence in world affairs and the economic implications.