CEE Q4 results: disparate risks cause tier shifts across the region


Jeremy Weltman
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Risk levels increased across the Central and Eastern Europe (CEE) region during the fourth quarter of 2012, as economists continued to take stock of trade and financial linkages to the debt-ridden eurozone, and became more wary of the political and structural elements to the crisis, Jeremy Weltman reports.

However, the region’s performance varied in 2012: those countries with more severe problems fell out of favour – Cyprus and Slovenia dropped into tier two and Hungary slumped to the brink of tier four; Estonia, by contrast, remained the region’s strongest option, one of four star performers in tier two.

Indebted eurozone participants Cyprus and Slovenia were among 13 of the 18 sovereigns dotted across the CEE region – excluding the Commonwealth of Independent States – to have seen their Euromoney Country Risk scores decline between Q3 and Q4, and which lost their status among the top rankings for the region (tier two).

The survey apportions countries into five tiers, according to their risk scores, which are supposed to correspond to their credit ratings (see: ECR’s tiered groups explained). Now only four countries remain in tier two: Estonia, the Czech and Slovak Republics, and Poland. Seven are now to be found in tier three, five in tier four and high-risk Montenegro and Bosnia-Herzegovina remain anchored in tier five.

For some countries, the changes in risk perceptions witnessed during the final months of last year continued trends that were apparent throughout 2012, and that extend even further back in many cases.

For others, they simply mark corrections stemming from the general deterioration in economic prospects in export markets and the associated political and/or structural risks reverberating around Europe as the continent grapples with its sovereign debt and banking-sector problems.

These altering risk perceptions and shifting tier rankings provide important food for thought as the region faces up to its borrowing requirements this year (CEE’s big four to conquer 2013 debt wall).

The region, it seems, is still coming to terms with the eurozone crisis and its effects, particularly as growth prospects have faded again. Many of the core CEE countries are heavily dependent on the eurozone and/or the wider EU for the majority of their export earnings, which invariably has a substantial impact on economic growth, government revenue and external balances.

Terms-of-trade shocks can damage currency stability and complicate fiscal sustainability. These are just some of the 15 economic, political and structural factors that experts taking part in Euromoney’s Country Risk Survey are asked to reassess each quarter.

European parent banks, too, have not so much withdrawn from the region per se, but have tightened their lending standards and reined back on the core activities of their CEE subsidiaries – including the financing of euro trade credits – in light of the prevailing market risks, wholesale funding difficulties and increased regulations imposed on the financial sector. Businesses and households have suffered from reduced credit availability as a result.

Yet the region remains essentially quite diverse, with 18 countries spanning four of ECR’s five risk tiers. By the end of 2012, 46.6 points separated tier five and IMF-dependent, Bosnia-Herzegovina in 153rd position out of 185 countries on Euromoney’s global risk data table from Estonia, a tier-two sovereign in 23rd position, and a relative bastion of fiscal prudence.

Estonia still the experts’ favourite

Confidence in the Baltics improved last year, which might be attributable in part to the close trade and financial links between Estonia, Latvia and Lithuania on the one hand, and super-safe Sweden and Finland on the other – ranked number four and six respectively in the global rankings. The Baltics enjoyed strong growth during Q3 2012, with exporters gaining market share due to improving competitiveness.

However, Estonia remains in a league of its own. A comfortable tier-two sovereign, the borrower slipped one place in the rankings during Q4, but it climbed four places last year (to 23rd) and is 28 places higher than in 2010, a remarkable rise. Upgraded scores for government stability, government payments/repatriation and soft infrastructure were notched up in 2012 and will have buttressed investor optimism.

There are still weaknesses in Estonia’s fiscal framework, according to the OECD, which could be improved by a multi-year public spending ceiling and an independent fiscal council. However, the sovereign is enjoying positive economic growth, has a small general government deficit (estimated at 1% of GDP at the end of 2012) and a remarkably low level of gross (EU) debt – around 15% of GDP or thereabouts – which must be the envy of many European borrowers.

The ECR score differential between deteriorating France and improving Estonia has narrowed from 20.4 points in 2010 to just 2.2 points at the end of last year, a trend that does not seem to support the disparity in credit ratings any longer.

Fitch still regards France as a triple-A sovereign – albeit on review for a downgrade – with Estonia at a mere A+ stable. ECR has previously remarked on the likelihood of a downgrade for the former (Will the UK, France and US lose their remaining triple-A ratings in 2013?), but is there also a case for Estonia to be ranked Aa across the board? Its ranking would suggest so, particularly with double-A rated Kuwait and Belgium now only fractionally above Estonia on the scoreboard.

Czech and Slovak Republics holding firm

The Czech and Slovak Republics are still clinging on to Estonia’s coat-tails, with neither country succumbing to any substantial risk aversion last year. The Czech Republic slipped one place in Q4, mainly because of its darkening economic outlook, but for the year as a whole both countries were unmoved in the rankings within the tier-two category.

In the Czech Republic, fiscal consolidation is taking place at a steady pace to limit its economic and social impact. Prague’s general government deficit is around 3.3% of GDP and projected to fall sufficiently to ensure that its Maastricht-defined debt ratio remains well below the 60% of GDP criterion – hitting a still-manageable 50% of GDP by 2014.

Bratislava’s problems are similarly less challenging given a successful attack on its bigger deficit problem, which should now fall below 3% of GDP this year and will slow down the accumulation of debt to around 56% of GDP by the end of next year.

The risk of slippage is considerable for both countries, but they retain the confidence of experts, and their banking systems are considered safer than in France or the UK, scoring 7.7 and 7.6 out of 10 respectively.

Poland clinging on to tier two

However, Poland is different. It has climbed seven places in the rankings since 2010 to a seemingly respectable 33rd place, and barely a whisker away from Japan (now down to 32).

And like many countries in the region, it has made great strides in distancing itself from a legacy of institutional and other risks associated with the long-gone eastern bloc days. Market reforms and deeper integration with the European Union have transformed the economy and a strong policy framework has underpinned market confidence.

However, having slipped two places in Q4 2012, and three overall during 2012, Poland lies at the bottom of ECR’s tier two and is in danger of trading places with Malaysia, with little more than a single point out of 100 now separating the two states.

Poland has enjoyed amelioration in its banking stability score this year, but Polish experts have also become more cautious regarding its other economic risk sub-factors. The economic/GNP outlook and monetary policy/currency stability indicators have been downgraded, the latter highlighting the costs involved of remaining outside the euro area, with the zloty still an independently floating currency.

The employment/unemployment and government finances indicators have also seen reduced scores. The latter, the worst of the five in absolute terms, scoring just 5.2 out of 10, might seem illogical given that Poland does not appear to have quite the same financing problems irking the indebted eurozone periphery, but its rosy economic outlook is rapidly wilting as exports and investment spending wane.

Poland has seen its 2013 GDP growth projection downgraded the most of any country included in the European Bank for Reconstruction and Development’s latest forecasting update (Regional economic prospects in EBRD countries of operation, January 2013), to 1.5% from a previous forecast of 2.5% in October 2012.

This will invariably undermine the country’s fiscal deficit reduction programme and prevent a moderately rising debt ratio from peaking. Poland is not a basket-case in Europe – far from it – but its risks were underlined this month by the IMF when it approved a flexible credit line of $34 billion as a precautionary measure.

Cyprus and Slovenia fall out of CEE’s top tier

Still, there are riskier bond issuers, such as Cyprus and Slovenia, the two countries that endured the largest slide in Euromoney’s global rankings last year (Euromoney Country Risk Results: G10 economies become riskier in 2012).

Cyprus shed 8.1 points in 2012 and has seen a cumulative fall of 21 points since 2010, resulting in a drop of 20 places in the rankings over two years, to 42nd out of 185 countries worldwide. Slovenia, a 13 place faller to 37th, saw its score plummet 11.1 points in 2012 and 18.2 since 2010.

Both sovereigns moved into the tier-three category and their credit ratings fell commensurately, with both on review for a downgrade by the main agencies. Moody’s downgraded Cyprus this month from B3 to Caa3, catching up with the downward slide in its ECR score.

Slovenia’s problems have been well documented by ECR and its contributors (Slovenia analysis). With the economy contracting via a squeeze on domestic demand, the general government deficit is not falling fast enough to prevent a projected rise in the debt ratio of more than 20% of GDP between 2010 and 2014, to 61% or so.

The new government might be committed to fiscal reforms and bank restructuring, but the task is being made harder by its impact on the economy at a time of slowing export demand. It suggests that the country’s risks should not be ignored, in spite of a positive pre-funding deal (Slovenia 144A debut opens up market options).

Cyprus, meanwhile, is now on the brink of default. And despite being only a tiny piece of the eurozone jigsaw, its problems highlight the difficulty in piecing the damaged single-currency project back together.

Among the many factors in Cyprus to have been downgraded this year, lower scores for institutional risk and labour market/industrial relations are notable, alongside the economic outlook and government finances sub-factors – the latter now scores just 4.7 out of 10.

Given the country’s large financial system relative to its country size, and exposures to Greece, current estimates suggest that bank recapitalization costs could reach as high as €10 billion. With a sovereign refinancing bill placed on top, the debt burden could rise to approximately 150% of GDP this year, according to Moody’s.

Restructuring its loans creates tricky legal and administrative problems for Cyprus, in terms of the conditions to be imposed on any German-inspired bailout programme and the difficulties raised by Cypriot borrowings from Russia, not to mention other high political stakes stemming from the elections this year in Cyprus and Germany.

The country’s institutional and information access/transparency risks increased in 2012, and scores for its soft infrastructure and labour market/industrial relations were downgraded alongside three economic factors, including the government finances.

Low-risk Turkey receives clean bill of health

Turkey, meanwhile, has held firm in tier three since 2010, having risen two places in the rankings, despite slipping one place in Q4 2012 to 48th. The country’s long-term ascent in ECR’s rankings has not gone unnoticed and its diminishing risk profile was rewarded by an investment-grade rating by Fitch in 2012.

Bank stability concerns might have increased, but Turkey’s political and structural risks have eased and its score improved for the employment/unemployment indicator. Moreover, country risk experts have not become unduly concerned by the country’s diminishing GDP growth, which slowed sharply last year as tight monetary policy constrained credit availability and business confidence was affected by rising oil import prices and other external concerns.

Tourism inflows and exports remained strong, particularly to the MENA region, helping to improve the current account deficit, and Turkey’s economic prospects remain comparatively bright, with stronger growth predicted by many forecasters for this year, signalling a lower level of risk than for fellow tier-three sovereigns Lithuania, Croatia or Bulgaria.

Hungary on the brink of tier four

While Turkey retains its appeal, economists are less keen on Budapest. Hungary’s score remained unchanged in Q4 at 49.5, but it was one of four countries to endure a double-digit decline in 2012 – alongside Cyprus, Slovenia and Bosnia-Herzegovina – resulting in an 11-place drop in the rankings to 68th and a worrying slide to the bottom of tier three.

The country entered recession last year, with GDP contracting by around 1.5% to 2% in real terms, and with the decline in fixed investment seen during the past few years continuing. The EBRD notes that Hungary has seen “the most rapid pace of bank deleveraging of any transition country”.

Its economic indicator scores have slid to alarmingly low levels, in all cases scoring less than 5.0 out of 10 (less than 4.0 for the economic outlook and government finances) and the forint has been hit accordingly.

A succession of unorthodox policies has weakened investor confidence (Hungary policy blunders spook rating agencies). Institutional and government stability risks have increased sharply, as the country’s overall risk profile has been undermined by the suspension of talks with the EU and IMF over a borrowing programme that now seems unlikely to happen.

Concerns about government interference in monetary policymaking are also surfacing, with a soon-to-be-appointed pliant governor of Magyar Nemzeti Bank raising question marks about the independence and market credibility of the central bank, which is slowly becoming a government conduit for relaxing monetary policy in spite of the risk to inflation and an already depreciating currency – Hungary’s monetary policy/currency stability indicator has now fallen to 4.1 out of 10.

Hungary might have sufficient investor interest to tap the bond markets rather than rely on multilateral lending, but its controversial policies underpin the high risks involved.

Eurozone travails weigh on Romania

Romania, on the other hand, is treading water it seems, having failed to climb higher than 71 in the global rankings last year, or narrow its considerable points-differential to the region’s safest economies.

A stubbornly low tier-four country, on a score of just below 47 points, the borrower is only just above fast-climbing Namibia in the global rankings, and has failed to break out of its moderate-to-high risk zone since the survey began in 1993, when it then ranked 74.

The country’s economic-GNP outlook, monetary policy/currency stability and government finances indicators were all downgraded in 2012, highlighting the impact of slower growth in the eurozone – punishing local industry – and in the agricultural sector.

And its risks were underlined by the IMF’s Article IV consultation in October, which described the country’s post-crisis outlook as “fragile and challenging”.

Yet the fact Romania has resisted the score declines seen in other countries is notable in its own right. The employment/unemployment score improved last year, along with almost all of the political indicators, as confidence returned after an election outcome that raised hopes of consensual policymaking and has encouraged investors seeking diversification (Romania becomes ‘a darling of investors’ once again).

Still, even if its political risks have eased, Romania’s low ECR score indicates it still has a multitude of problems associated with a low level of inward investment, a widening current account deficit, unresolved arrears accruing to state-owned enterprises and a low absorption capacity to implement EU funds – with only €2 billion of the available €19 billion available to Romania being utilized to date.

This article was originally published in Euromoney Country Risk.