Indonesia the most vulnerable of a fragile five
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Indonesia the most vulnerable of a fragile five

A toxic combination of large external financing gaps and US liquidity withdrawal has increased the risks of investing in triple-B rated emerging market (EM) sovereigns. With many countries facing elections this year and stalling on structural reforms, economists taking part in Euromoney’s Country Risk Survey have placed five of the larger EMs under the microscope.

Many EMs became riskier in 2013, forming part of a longer-term trend evinced in two-year score declines in Euromoney’s Country Risk Survey.

Brazil, India, Indonesia, South Africa and Turkey, huge EMs, all within the third of ECR’s five tiered risk categories, were downgraded by economists and other experts, among 400-plus participating in the survey on a regular basis.


Capital outflows sparking currency depreciation, with weakened economic growth profiles, have raised doubts over the security of sovereign bonds, especially with debt servicing costs spiralling gently upwards with drifting bond yields.

The anticipated gradual withdrawal of US monetary stimulus has cast the spotlight over larger markets dependent on huge inflows of foreign financing to sustain budget and current-account imbalances.

However, capital flows are not the sole issue to concern the experts.

Domestic factors have also contributed to their unease, with many citing structural reforms and political risks, including corruption and heavy election schedules over the coming months, for their wariness.

There are, nevertheless, many distinctions between the fragile five, with almost 10 points separating Brazil – still the safest of the group in 41st position on ECR’s global rankings – to Indonesia, lying 67th, the only country to have received a lower rating of BB+ (though only from S&P).

ECR’s comprehensive survey-based approach pinpoints many interesting differences in broad risk categories. South Africa has the highest economic risk, experts suggest. Indonesia is the worst for politics and structural risks. Brazil is still among the strongest in almost all areas (see chart).


As all five sovereigns slipped down the rankings in 2013, other, more favourable tier-three domains have ridden out the storm.

Mexico, a LatAm favourite edging ever closer towards tier-two status, having climbed to 36th in the rankings, and China – up one place in 2013, to 38th – have resisted the downdraft, with the latter receiving support from stabilizing growth, and greater efforts to weed out corruption and introduce reforms.

Russia moved up six places last year to 54th, buoyed by oil and gas prices. South Korea’s fiscal and balance-of-payments strengths also kept it in favour, gaining half a point to keep the sovereign in 30th place.

Malaysia similarly defied its critics to stay in 35th spot (just below tier two). However, Thailand, with its domestic political problems, suffered a four-place fall to 58th.


Worries over India and Indonesia

India and Indonesia’s falls have proved especially troubling for EM investors, with two of the most populous Asian nations careering down the rankings in the past couple of years.

Now lying respectively in 65th position (after a drop of four places last year) and 67th (down three), the two are in danger of slipping into tier four, commensurate with losing their triple-B status. Indonesia is only one place and less than half a point away from such misfortune, explaining S&P’s position.

Recent research points to the worst credit environment in Asia since the 1990s, while the lack of structural reform in Indonesia, the onset of parliamentary and presidential elections in April and July respectively, and its increased foreign-currency requirements stemming from a weak balance-of-payments position exacerbated by US tapering suggests Indonesian bonds will strugglethis year.

As Maritza Cabezas, senior economist at ABN Amro and an ECR expert noted recently: “India and Indonesia had a difficult time during the summer when fears of Fed tapering grew. Since then their efforts have been centred on improving their weak fundamentals.”

Action taken to curtail gold imports has ameliorated India’s current-account deficit, but higher interest rates to combat inflation will slow GDP growth, which, with the added complication of elections to be held in both countries, has made experts cautious.

India’s growth prospects are nevertheless more promising than Indonesia’s. “Indonesia is more vulnerable [than India], and therefore will have more to do in terms of reducing its imbalances,” says Cabezas.


Brazil backtracks

Although still regarded as the safest of the fragile five, Brazil slipped three places last year to 43rd and lost its status as the safest Brics nation – to China – with the majority of its risk indicators downgraded. Its overall score has, as with other large EMs, been steadily trending downwards during the past two years, losing around four points in total.

Public protests have cast the spotlight over the perceived corruption and excessive public costs involved in hosting Fifa’s World Cup this year and its associated infrastructure development, which, with elections scheduled for September, could upset expectations of a victory for the incumbent president Dilma Rousseff sufficiently to cause market wobbles.

With slower growth in China and regional trade issues dampening Brazil’s economic expansion, inflation above 6% and fiscal slippages adding to concerns over a current-account deficit that is edging up closer to 4% of GDP, experts have become more agitated by Brazil’s fundamentals.

South Africa’s lustre fades

It was South Africa, however, that proved to be the most fragile of the larger EMs last year, with a 2.7 points decline – 1.7 in Q4 alone – pushing the sovereign down six places in Q4 to 52nd, although only two places overall after a turbulent year.

It remains the safest country in sub-Saharan Africa, but only by a wafer thin margin of less than half a point to Namibia, thanks to the latter staging a remarkable 16-place jump in the rankings to 56th, and is not far above Botswana either.

Country-risk experts have become more cautious over South Africa’s economic-GNP outlook in light of low levels of business and consumer confidence, and a slump in manufacturing output lately, as well as its monetary policy/currency stability and government finances – three of the 15 sub-factors used to formulate the country-risk scores.

Political indicators, including corruption, institutional risk and the regulatory/policy environment are adding to their concerns.

The government’s policy deliberations, combined with the damaging effect of labour strikes in the mining sector – with more industrial unrest seemingly planned for the platinum sector – has pushed the deficit closer to 5% of GDP.

With GDP growth languishing below 2% – its worst since the post-global-crisis low in 2009 – the current account rising to almost 7% of GDP and inflation threatening to rise above the upper band of the central bank’s 3% to 6% target as the rand plunges and corn prices escalate – prompting expectations of higher interest rates – investor risks have invariably heightened ahead of a general election due at some point between April and July.

Turkish troubles continue

Turkey also suffered last year from a combination of domestic and external problems, shedding 1.2 points in total, but “driven by the flaring up of domestic political turmoil rather than by the start of Fed tapering”, according to ECR expert Arjen van Dijkhuizen, senior economist at ABN Amro.

All 15 of Turkey’s economic, political and structural risk indicators were downgraded – political stability the most. Experts are nervously eyeing the country’s large current-account deficit, which is estimated to have risen above 7% of GDP last year, increasing the financing burden.

The lira, weakened by US tapering fears, has seen its value further eroded by the political crisis enveloping prime minister’s Recep Tayyip Erdogan’s administration, which has seen three of his cabinet colleagues dismissed for corruption ahead of municipal and presidential elections this year, to be followed by parliamentary elections in 2015.

As ECR previously noted, Turkey’s risks – ranging from an unbalanced economic expansion and credit boom to an over-reliance on short-term portfolio inflows and the need for structural reforms – should not be ignored. That’s why it ranks in tier three and no higher.

However, the risks attached to the increased current-account deficit are counterbalanced to some extent by healthy foreign direct investment inflows, strong growth of 3.5% to 4% and an improved fiscal situation in recent years that has brought the budget deficit down to more manageable levels.

This has led experts to believe Turkey can ride out the storm, especially if fiscal discipline is maintained to keep the budget deficit below 3% of GDP.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.

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