The model, which uses data from Euromoney’s Country Risk Survey, shows Bosnia-Herzegovina is one of the more alarming prospects with a default probability of 27.4% over 12 months.
Surprisingly, the country still commands a stable B-rating from Moody’s and S&P, unlike other, similarly high-risk bonds mostly C-rated or on review for a downgrade.
Still rebuilding after last year’s devastating flooding, the country’s high unemployment rate, corruption and continuing political uncertainty make it the most likely country to default on its debts.
Belarus, reliant on Russian philanthropy in the absence of other creditor support to bolster its dwindling reserves and avoid a balance-of-payments crisis, is the second riskiest sovereign, with a default probability of 25.9%, according to the model.
Unsurprisingly, Ukraine is in the top three for default risk, with an economy contracting heavily, spurred by capital flight in the wake of the political crisis, with Russian trade links and gas supplies threatened.
Reliant on extensive creditor support, including a $17 billion bailout from the IMF and $15 billion-worth of emergency aid from the World Bank, Ukraine has been the worst-performing country in Euromoney’s survey, plummeting 25 places during the first half of this year – more than any other sovereign.
Previous defaulters still a concern
Argentina and Venezuela also appear on the list. Venezuela, facing a litany of problems stoking public unrest – including exchange-rate depreciation raising import prices, an electricity infrastructure buckling under mismanagement and the government putting the budget under more strain by spending recklessly to shore up public support – entered into a selective default with domestic bondholders in May.
Argentina’s risk of default has escalated in recent days, though the markets are also pricing in the likelihood of a post-default settlement, despite the government refusing to accept a US court ruling, or negotiate with the bondholders seeking litigation for reimbursement of $1.5 billion purchased in the wake of the previous default in 2001.
Greece, another notable defaulter, remains in the top 10, despite the upturn in investor sentiment towards the country in recent years.
Greece’s probability of default is still lower than Rwanda’s, whose successful inaugural sovereign bond listing last year and the pricing of which was seen by some as proof that the search for yield in global capital markets had led to investor complacency about the likelihood of their capital being returned.
How the model works
The model, developed by quantitative researchers at Citi, provides implied market sovereign-bond-default probabilities by using a hybrid statistical and qualitative approach developed in the corporate bond market.
Applied to sovereign credits, the model utilizes ECR’s crowd-sourced methodology, whereby more than 400 economists and other country-risk experts from finance, industry, government and academia are routinely asked to provide an assessment of the economic and political risk profile of more than 180 countries worldwide.
Citi maps these forward-looking risk scores against credit agency ratings to gauge the probability of default. Triple-A rated sovereigns, such as Norway, with an ECR score of 85 or more would be assigned a default probability of 0.01% (realistically no chance of default).
Trade simulations based on these computations can identify relative value in ‘rich’ and ‘cheap’ credits contained in credit-default-swap trades compared with their imputed fair-value equilibrium levels.
“Default is a special high-risk situation that is difficult to predict ex-ante,” says Terry Benzschawel, managing director of Citi’s institutional clients group and head of the multi-asset research team that devised the model.
“Credit ratings are typically right on average, but they tend to confirm what investors are already saying. Moreover, they don’t update frequently and there is no probability of default.”
A default risk value over a one-year period helps to quantify expected loss on sovereign credit portfolios and is thus a powerful tool for marrying risk and return, and to enable portfolio losses, credit momentum and potential asset value to be measured more accurately across countries on a daily basis in the absence of other information.
Indian sub-continent risks
Pakistan and Bangladesh also feature among the highest-risk sovereign bond issuers, with default probabilities of 19.7% and 16.7% respectively.
Faith in Pakistan has been partially restored by the strong mandate for prime minister Nawaz Sharif’s PML (N)-led coalition at last year’s elections. Yet the enormity of the country’s problems has been brought home by the continuing violence, crippling electricity power-generation constraints, poor budgeting and increased reliance on the IMF and Saudi creditors to bolster the foreign-exchange reserves.
Growth continues, but is insufficient to promote development. Inflation has crept above the 8% target and reports of unpaid civil-service bills and further strains on public resources for security and disease control underpin the sovereign’s high risks.
Bangladesh similarly has established greater political stability, its 6% economic-growth projection is favourable and exports of ready-made garments (RMGs) should keep the current account in surplus.
However, with inflation high, a budget deficit still close to 4% of GDP, debts exceeding reserves, migrant workers’ remittances waning and the country still vulnerable to social unrest and rising competition in the RMG sector, its default risks cannot be ignored.
Instilling realism into Egyptian hopes and Rwandan enthusiasm
Egypt’s recent troubles are well-documented, and with growth improving and Arab investors circling it is easy to overlook the country’s heightened state of social instability and budgeting problems illustrated by a deficit of some 10% of GDP in 2014/15, worsened by extensive subsidies and corruption.
By contrast, Rwanda’s inaugural sovereign bond listing last year was undoubtedly a pivotal moment for a country riven by devastating genocide in the 1990s and one that has now become more stable and highly competitive under president Paul Kagame’s stewardship, albeit achieved with authoritarian leanings.
The country continues to register impressive economic-growth rates. However, an array of low-scoring (high-risk) economic, political and structural risk indicators is contributing to a high default probability of 21.4%, according to the model.
This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.