ECR Survey Results Q2 2014: EM rout prompts flight to safety

By:
Jeremy Weltman
Published on:

The latest results from the ECR survey show emerging markets (EMs) becoming riskier during the first half of this year, in contrast to the increasing safety offered by developed countries across the G10 and an improving eurozone.

The crisis in eastern Europe has invariably shaken confidence in Russia and Ukraine, the two biggest fallers during the period.

Spill-over effects have led to falling scores for Bulgaria, Estonia, the Czech Republic, Belarus and other parts of the CIS (including Azerbaijan and Kazakhstan), but not for all countries across the region as Poland’s resilience highlights.

EMs more generally have suffered from an increasing loss of faith among risk experts, and for a variety of reasons. They range from fiscal and external financing in light of the US Federal Reserve tapering its bond-purchase quantitative-easing programme to the spreading conflict in the Middle East. Domestic political crises and high debts number among a list of concerns.

Internal strife affecting Croatia, Indonesia, Pakistan, South Africa, Turkey and Thailand, among others, has seen country-risk scores downgraded this year. Argentina and Venezuela’s longstanding policy and financing problems have continued, and many Asian countries – Malaysia, Singapore and Taiwan among them – have been downgraded alongside frontier markets Cambodia and Mongolia.

A large swath of Middle Eastern and African sovereigns also have lower risk scores, with the picture similarly fading for lower-risk Chile and Peru, as China’s waning copper demand has reduced their economic growth potential.

In total, 97 of the 186 countries surveyed saw their ECR scores decline (risks rise) during H1 2014, with 10 unchanged and 79 registering improvement.

Not all EMs are out of favour

Brics, Mints and other EM groupings endured a slide in their country risk scores during H1 2014.

Sovereigns more vulnerable to reduced US liquidity and/or slowing economic growth affecting their fiscal and external solvency were most affected, especially those such as South Africa, Turkey and Thailand, weighed down by domestic political instabilities hampering policymaking.

Smaller frontier markets, including the Bahamas, Barbados, Bermuda, Cambodia, Mongolia and Papua New Guinea, could not evade the rout.

Bucking the trend, South Korea was one of a robust five, along with Poland, Israel, Colombia and Uruguay, that saw their risk scores improve.

Amassing 70.5 points out of a maximum 100 – 3.7 higher since the start of the year – South Korea was 10 places higher at the end of June compared with its year-earlier position, climbing to 22nd out of 186 sovereigns on ECR’s global rankings.

Despite some political risk, the country’s macro-strengths are undeniable, with fiscal stimulus achieved without causing a substantial deterioration in the budget finances, leaving the deficit and debt burden below 2% of GDP and 40% respectively.

Poland’s macroeconomic risk factors have been upgraded, too, highlighting a promising growth outlook, narrowing of the current account in Q1 and tightening labour market.

The worst is probably over for EMs now, believes Arjen Van Dijkhuizen, senior economist at ABN Amro, with “headwinds fading as market sentiment has improved and capital flows returned”.

Still, as the lower risk scores demonstrate, downside risks remain present. The Fed could exit from monetary stimulus abruptly, “triggering a fresh round of capital outflows for countries with strong external financing needs, such as Brazil, Indonesia and Turkey”, Van Dijkhuizen warns.

Other concerns revolve around the build-up of debt in several EMs, such as Malaysia and Vietnam, flaring geopolitical risks and social unrest, such as that witnessed in Iraq and elsewhere in the Middle East reverberating in the oil market, or a failure to progress with structural reforms.

Mixed signals elsewhere in Asia

China improved in H1 2014, with its score rising by 1.2 to 61.1. This was entirely due to the sovereign’s improved access to capital. However, one of three other factors – along with debt indicators and credit ratings – added to the 15 economic, political and structural risk indicators the survey experts regularly assess.

China’s economic indicators were marked down heavily, with concerns for the health of its shadow banking system and ability to maintain stellar economic growth chief concerns for country-risk experts.

India has also improved a little, climbing three places to 62nd in the global rankings, with many economists now foreseeing stronger policy-induced growth, with a new government focusing on reforming the business environment.

Underpinned by a new growth strategy, Japan, now 26th, is also recovering slowly.

On the other hand, Thailand’s political crisis has invariably taken a heavy toll on its risk outlook with all bar one of its 15 indicators downgraded. The sovereign has nosedived 10 places to 59th during a 12-month period in the wake of the coup d’état, harming tourism and other parts of the economy.

Political instabilities and trade exposures to China have raised doubts over Singapore, Taiwan and Macau, but not Hong Kong, which is showing more resilience.

Bangladesh, Pakistan and Sri Lanka have also become riskier from a combination of economic and political factors, including the underlying risk of domestic instability, in Pakistan especially.

Ukraine crisis upsetting CEE risk patterns

The annexation of Crimea and continuing instability in the region has seen Ukraine – crashing 25 places since December – endure interrupted energy supplies as the sovereign teeters on the brink of default.

Russia’s fading stock has also seen it plummet through the rankings alongside Ukraine further than any other of the other established EMs.

With investor confidence at a low ebb, Russia has embarked on a desperate policy of state interventionism to overcome its lack of access to international markets.

“Short-term developments very much depend on whether there will be any further sanctions on Russia”, according to Vasily Astrov, senior economist at the Vienna Institute for International Economic Studies.

“Russia is trying not to intervene directly and any sanctions on its energy exports would be counter-productive. In any event, most of the negative effects of the crisis, in terms of investment for instance, have already materialized.”

With both economies in decline, several other countries in the region have become sucked in, notably those with extensive trade and capital exposures, such as Belarus and Kazakhstan.

“Bulgaria and the Baltic countries are also at risk” claims Astrov. Bulgaria’s score has notably dipped 3.3 points this year, pushing the sovereign down eight places to 70th and into the fourth of ECR’s five tiered groups – symbolizing a B- to BB+ credit rating – below its current triple-B status.

Europe improving despite setbacks

The eurozone has seen the biggest improvement in average risk score so far this year of any regional group, with every country bar Estonia and Finland staging a comeback.

Italy, Ireland, Portugal and Spain are among the highest climbers through the rankings, with economists upgrading their scores in response to completed bailout programmes in Ireland and Portugal, and as macro indicators have turned in a more positive direction symbolizing a return to growth.

However, the predominance of tail risks stemming from weak and vulnerable economies, with deflation trends, excessive debts and banking sector problems – lately affecting Portugal – putting the recovery in context, all of the periphery are still heavily marked down compared with their scores in 2010.

Riccardo Fiorito, professor of economics at the University of Siena, Italy, notes that Spain is seemingly the only country reasonably improving so far this year (based on the Q1 GDP data).

“In France, the macroeconomic outlook is not promising, partly for political reasons, with growth less than 1%, and Italy is in a difficult situation because the cyclical recovery is still not showing up, adding to the well-known structural problems.”

G10 offers safety

Led by Italy, Belgium and the Netherlands, all of the G10 members have seen their risks recede this year.

With economies improving, confidence in the US (16th), UK (20th) and even Japan (26th) has increased, but experts are less certain about France (23rd), as Fiorito has remarked, with only marginal improvement in a score that is still considerably lower than a year ago.

As usual, the safest G10 nation Switzerland ranks virtually on a par with Norway, the world’s safest sovereign on an incredible 90.6 points out of a possible 100.

South Africa’s troubles epitomize a region becoming riskier

Just under two-thirds of the 45 sovereigns across sub-Saharan Africa (SSA) have become riskier this year, according to the experts, highlighting the region’s difficulties in becoming more stable and self-financing.

South Africa’s falling score trend has worsened in response to strikes by metalworkers and miners, undermining the country’s economic growth outlook and its sovereign-debt trajectory.

Fears over China’s continuing strengths keeping commodities in demand are a concern for the region.

A mixture of domestic political, economic and structural risks, including civil unrest, endemic corruption and weak institutional underpinnings, have also come to weigh down many sovereigns, including Botswana, Namibia, Ghana, Nigeria – hitherto the safer domains across SSA – along with many higher risk issuers, such as Angola, Malawi and Uganda to name a few.

North African parts escape MENA rout

Invariably, the majority of the Middle East has become riskier this year because of the turmoil spewing from the internecine conflicts in Iraq, Libya, Syria and Yemen, arising from the tensions between Shia and Sunni Muslims and other political and tribal influences.

Gulf states still offer comparative safety across the region. However, Qatar’s lofty status has been called into question over corruption, labour rights and its support for the Muslim Brotherhood creating tensions with its emirati neighbours.

Saudi Arabia, Oman and Bahrain have also seen their scores slide – the latter extending a double-digit decline as the after-effects of the Arab Spring uprising continue to challenge the kingdom’s authority and its investor potential.

Egypt by contrast has enjoyed a modest rebound in its score in response to an evolving political process, although at 118th on ECR’s global rankings on a score of 33.2 and evidently vulnerable to unrest, it remains a high-risk option.

Morocco on 44.6 points (up 1.1 this year) and Tunisia on 43.5 (climbing 2.8) have defied the worsening regional trend with their relative stability, gradual fiscal reforms and more encouraging economic growth prospects.

Mexico impervious to LatAm’s risks

Of the eight Latin American sovereigns succumbing to increased risk during the first half of this year, Chile (the region’s safest) and Peru, both leading copper producers, have slipped on the back of growing concerns over their respective economic strengths, with Chinese commodity-demand waning.

Brazil’s disappointing World Cup has been matched by frustrations shown toward a moribund economy struggling to cope with weakened Chinese commodity demand and facing elections this October.

Their risks are nothing in comparison to Argentina and Venezuela, still following a heterodox policymaking path and either in, or on the brink of, default with bondholders. The two countries have merely extended long-term score trends this month to remain among the highest-risk sovereigns globally.

Mexico’s strengths have continued, however, as the government’s reforms and a stronger US economy combine to revive GDP growth, with fiscal and external imbalances contained. In conjunction with Colombia, Uruguay and certain other higher-risk, but improving, sovereigns, Latin America presents a mixed picture for investors balancing risk with potential return.

More than 400 economists and other 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. These are added to values for capital access, credit ratings and debt indicators, and aggregated each quarter to provide a total risk score.

To view the survey methodology, go to: www.euromoneycountryrisk.com

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