Country Risk: In search of a new sovereign investment-grade

Jeremy Weltman
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With the main ratings agencies differing in their assessments of credit risk, identifying countries ripe for a future investment grade rating is a complicated task, Jeremy Weltman reports.

Utilizing the tiered approach to sovereign risk encapsulated within Euromoney’s Country Risk Survey, in conjunction with long-term score trends, highlights several borrowers with potentially bright prospects. But only one – the Philippines – is on the cusp of losing its junk bond status.

Finding the next investment grade sovereign bond issuer is an important element of investment strategy, but one that is also complicated by conflicting opinions among the raters amid the many angles to sovereign risk – be they economic, political or structural.

ECR’s scoring method of risk experts’ opinions is now a well-established alternative to the ratings agencies, not least because of its regular, quarterly updates and rankings approach, with countries placed into five tiered groups based on their total scores. Economists and country-risk experts are asked to evaluate 15 separate indicators.

The survey, with its fluid assessment of changing risks, can often unearth interesting anomalies to the agency’s views. Long-term trend movements in scores are one important aspect of Euromoney’s approach.

According to the survey, a credit rating upgrade to the Philippines is long overdue (see chart, above). The sovereign is currently placed above six investment grade borrowers – all in blue – at the top of the fourth of ECR’s five tiered groups. If there is to be a new investment grade the Philippines is a prime candidate – its long-term trend improvement suggests it will soon rise into tier three.

Currently the majority of the 35 sovereigns contained within tier three of Euromoney’s 185-country Global Risk Data Table are rated investment grade by one or more of the main agencies – Fitch, Moody’s and Standard and Poor’s (S&P).

The few exceptions (ignoring unrated, but cash-rich oil and gas producer Brunei) are 46th-placed Barbados, which lost its investment grade status last July following a downgrade by S&P (Barbados Slips from Investment Grade), bankrupt Portugal currently in receipt of a bailout programme, lying in 65th spot, and Hungary.

The lowest tier-three sovereign of all, Hungary, now at 68th, has rapidly fallen out of favour equally among ECR experts and the raters (Hungary policy blunders spook rating agencies). The borrower crashed 11 places last year and has plummeted 25 in total since 2007, before stabilizing during the second half of 2012.

What do the ratings agencies claim?

With global risks continuing to rise in 2012, leading to several ratings downgrades across all investment and speculative grade categories, and potentially putting some sovereigns in danger of junk status, an important question arises: Is there a new investment grade sovereign to be found?

The raters seem to differ quite substantially in answering this question.

Fitch currently has eight candidates close to investment grade (rated BB+). Of those, five are stable (Costa Rica, Guatemala, Hungary, Macedonia and the Philippines), suggesting that an upgrade is not likely anytime soon. An additional two (Portugal and Tunisia) are negative. Both have slipped alarmingly in ECR’s survey, too, over the past five years, justifying a downgrade. That leaves just one, Uruguay, on a positive outlook.

ECR members have been regularly tipped off about Uruguay’s relative merits with one of ECR’s contributing experts, Antonio Juambeltz, a financial advisor at the Uruguayan Ministry of Finance, providing regular updates on the country’s progress (Uruguay in focus).

But Fitch is playing catch-up it would seem. Both Moody’s and S&P already have Uruguay on investment grade, a level endorsed by its ranking of 62nd in the ECR survey, a rise of three places this year and a 23-place jump since 2007. A Euromoney special report (The 2012 guide to Uruguay) has highlighted the sovereign’s relative merits.

Moody’s currently has just one country – Turkey – rated Ba1 positive and thus on the brink of its lowest investment grade (its Baa3 category). But, although a comfortable tier-three sovereign with its indicators all pointing to only moderate risks (see: Turkey Country Report 2013, thereby underscoring its claims for investment grade status, Turkey is still perplexing the raters.

S&P is not confident enough in Turkish bond prospects just yet – its BB rating is stable – but Fitch already gives Turkey the thumbs up with its BBB- rating.

Meanwhile, of the five borrowers within S&P’s highest speculative grade (BB+), two come attached with a positive outlook: Indonesia and the Philippines. Both countries have certainly been attracting the attentions of investors lately. Fitch is positive on Indonesia, rating the country BBB-, and a Baa3 (stable) rating from Moody’s concurs with this view. Two other BB+ sovereigns – Barbados and Romania – are currently stable, and a fifth, Croatia, is negative.

That leaves the Philippines with the most interesting claims for investment grade.

Poised for a breakthrough

Currently lying in 69th place in the global rankings, and at the top of tier-four, the Philippines – rated BB+ (stable) by Fitch, Ba1 (stable) by Moody’s and BB+ (positive) by S&P – is now less than half a point away from Hungary just one place above. The Philippines is also just 1.4 points behind Indonesia, an investment grade in 64th position.

The Philippines may have stumbled down three steps in the rankings last year, but it shed less than half a point in the process and was still nine places higher than in 2007.

The ECR survey indicates that contributors still harbour concerns about bank stability in the Philippines, scoring 4.8 out of 10, and corruption, with political and structural risks generally deteriorating last year.

However, the country scores reasonably well for capital non-payment/repatriation risk, and country-risk experts are less concerned by its other economic indicators, including the economic-GNP outlook and monetary policy/currency stability. Indeed, the economic assessment score improved in 2012.

An article in Asiamoney (Downgrade pressure on Asian sovereigns is rising: Nomura) toward the end of last year, noted:

“The Philippines is the most likely candidate for further upgrades in the second half of next year, due to the improvement in broadening and deepening fiscal revenues to GDP, continued infrastructure investment and falling public debt to GDP.”

A recent IMF note (Statement at the conclusion of the 2013 Article IV consultation mission to the Philippines), issued in January, highlights the country’s favourable macroeconomics, including strong growth and a robust current account surplus, as well as low inflation aided by currency appreciation.

In terms of fiscal policy, the IMF states, “the government’s strategy of generating revenue to fund priority spending while continuing to pursue a 2 percent of GDP deficit target over the medium term is appropriate. Public sector debt is expected to fall to a moderate 44 percent of GDP by 2016, thereby strengthening resilience to shocks.”

Few other claims on investment grade

Six investment grade countries lie directly below the Philippines in tier three. One of those, Tunisia, is in danger of losing that status in the onset of a new political crisis (Turmoil threatens to blow Tunisia off track). The other five – Latvia, Romania, Namibia, Kazakhstan and Morocco – appear more secure.

There then follow five countries above Azerbaijan, the lowest-scoring investment grade on just 43.3 points. The latter, an upwardly-mobile sovereign, has climbed six places since 2010 and a whopping 80 since Euromoney began its survey in 1993. The country’s oil wealth, ‘low-ish’ repatriation risks and government stability give it an edge where other countries fail to make the grade.

Of the rest Sri Lanka and Ghana are ranked the highest. Both lay claims to future investment grade status, perhaps, but neither has solid enough fundamentals at present. Sri Lanka – rated BB- by Fitch, B1 (positive) by Moody’s and B+ by S&P – slipped down the rankings six places last year, and is 10 places lower than in 2010. It scores low for monetary policy/currency stability, government finances and corruption (all less than 4.0 out of 10). But its demographics are favourable, suggesting it is a favourable long-term bet, if its political issues can be resolved and fiscal improvements accrue.

Ghana is another possibility. Rated B+ (negative) by Fitch, B1 (stable) by Moody’s and B (stable) by S&P, and with a score of 44.8, the country’s rise up the rankings to 77th has been considerable. The sovereign has climbed 18 places since 2010, with barely two points now separating it from Namibia, which is already an investment grade according to Fitch and Moody’s. Euromoney believes that Ghana may not be as risky as the credit rating agencies claim (Doesn't Ghana deserve a higher rating than B+?).

But Ghana is still some five points behind a coveted tier-three placing and an unlikely candidate for investment grade at present. Although the borrower scores well for its economic-GNP outlook, with good growth prospects, other aspects of its economic assessment are not as favourable. The government finances score of just 3.9 out of 10 highlights a deteriorating fiscal position during the run-up to the flawed presidential elections last December, which saw the deficit rise to over 12% of GDP, nearly double the 6.7% target outlined in a supplementary budget presented last July.

Other countries, including Jordan, Armenia, El Salvador, Georgia and Paraguay are still not scoring highly enough, overall, to warrant an investment grade, despite the considerable long-term upward score trends for several of those countries. Among that group only Paraguay scores more than 5.0 out of 10 for its government finances, but like other countries it fails on other aspects. While four of the five (Paraguay the exception) score higher than the Philippines for politics, they are all way lower on the economics (see differentials in chart below).

It seems that for now all eyes are fixed on the Philippines, ECR’s top tip for an investment grade.


This article was originally published in Euromoney Country Risk.