ECR Survey Results Q1 2015: Russia crisis, China fragility and EMs’ capital-flow shock
Emerging markets (EMs) with fiscal and external imbalances, vulnerable to capital outflows – including oil and other commodity producers struggling to balance their budgets – are among the 72 sovereigns downgraded since the end of 2014 by more than 440 economists and other country-risk experts.
Virtually all of the Brics and Mints (see chart below) – the large, rapidly expanding countries with enormous long-term investor potential, dominating EM portfolios – have seen their risks attenuate (and therefore their scores fall) during the first months of 2015.
Most are harbouring fiscal and current-account deficits, and are vulnerable to capital outflow with monetary tightening on the cards in the US and China’s economy ‘correcting’.
India, the main exception, has a rising risk score thanks to the reforms and other policy improvements the government is introducing to address those deficits.
China’s growth concerns, exaggerated by a flaky real-estate market and an iron-ore industry now in a tailspin, have seen its risk score weaken since 2014.
Consequently, Arjen Van Dijkhuizen, senior economist at ABN Amro, believes “India is set to surpass China as the fastest-growing emerging giant”.
“In our view, the region is generally well-positioned to cope with [more] dollar strength,” he says. “The main risks are a China hard landing, disappointing growth in advanced economies and contagion from a [faster-than-expected] Fed exit.”
Brazil and South Africa were among the sovereigns downgraded the most by country-risk experts in Q1 2015.
Brazil – with street protests in the wake of rising prices, water rationing and a high-profile corruption scandal highlighting the mishandling of an economy now in recession – is struggling to convince the experts, with currency depreciation worsening its inflation and external borrowing profile.
South Africa has become hamstrung by a lack of reform in the electricity sector, which is holding back its economic growth potential, and by a commodity-backed currency under pressure.
Mexico, Indonesia and Nigeria have been downgraded too in response to political and/or economic weaknesses, fuelled by the negative oil shock, and an increased interest in their fiscal/external imbalances, which are now vulnerable to outflows of US and other foreign-sources of financing.
EMs have suffered their largest outflow of capital since the 2007/08 global financial crisis. EM currency reserves declined last year for the first time since records were first compiled in the mid-1990s, according to the IMF.
Experts remain negative on Russia
Russia’s mounting problems caused by the sanctions and low oil prices undermining the rouble extended its trend decline into Q1 2015, resulting in a total score of just 44.8 points from a maximum 100.
All 15 of Russia’s risk indicators were downgraded in Q1 2015, which, coupled with a reduced credit rating score – one of three other risk parameters, alongside debt indicators and access to capital, comprising the total risk score – sent the sovereign crashing to 74th in Euromoney’s global rankings, and firmly into the fourth of five tiered groups denoting sub-investment grade (or junk status).
Several of Russia’s close trading partners and former Soviet satellite states were among the biggest fallers, affected by the negative oil shock, their own currency’s plight, and weakened trade and capital flows. They include Kazakhstan, Moldova, Turkmenistan and Ukraine.
Several others – Angola, Gabon, Kuwait, Oman, Nigeria and Venezuela – are all oil producers struggling in a new era of depressed tax revenues and plunging currencies weakening their fiscal metrics.
Greek tragedy; Austro-Swiss worries
Invariably, Greece was another of the sovereigns with one of the largest score declines in Q1 2015, thanks to the tail-risks associated with negotiating its debt resolution, it suffering a setback in its economic recovery and it still being at risk of exiting from the eurozone.
The mutating debt crisis in Europe has not only seen Greece waver but also Austria linked to the bankruptcy and a previously undetected black hole in the bad bank formed from the failed Hypo Group Alpe Adria.
Risk experts do not believe the bank’s problems are about to plunge Austria into the fate that befell Cyprus, Iceland or Ireland, but it is nevertheless a reminder of the weaknesses still prevailing in the global financial system and the need to execute new legislation bailing-in creditors using the European Union’s bank recovery and resolution directive.
It also highlights how it is the brighter fortunes of the US that are mostly attributable to the stabilization of the G10 risk profile.
However, Europe, more generally, is now stabilizing as its economies grow due to more competitive currencies spurring exports, and lower oil prices underpin consumer demand by reducing energy and transport bills.
Experts remain unconvinced by the fiscal metrics in many of the larger sovereigns in Europe, and even low-risk Switzerland has succumbed to a downgraded score since it decided this year to decouple the Swiss franc from the depreciating euro.
Yet prospects for the UK and even Italy are improving.
And more widely across Europe, Hungary, Romania and Slovenia, which have lower scores compared with 2010, have seen their risks ease this year as better policymaking and improving economic fortunes alleviate the threats of late or none payment.
Negative oil shock still reverberating in MENA
Although many of the Middle East and North African net oil producers have substantial fiscal buffers to ride out temporary negative price shocks, half of the 18 countries across the region saw their country risk scores downgraded in Q1 2015 as they adjust to the effects.
As Marwan Barakat and his Bank Audi colleagues taking part in Euromoney’s survey noted in a recent review, “oil exporters’ overall growth will moderate and the large fiscal surpluses will decline or shift to significant deficits”.
However, the situation is not one-sided. Referring to a recent Institute of International Finance report – which shows stronger regional economic growth and points to oil prices slowly recovering during the second half of this year – Bank Audi economists add: “Low oil prices may encourage an acceleration and deepening of structural reform efforts to improve energy efficiency and diversify their economies.”
Besides, prospects for Morocco (upgraded this quarter) and Iran (presently stable, pending the outcome of the nuclear negotiations) have shown resistance. And despite the heightened political and conflict risks still undermining Lebanon, Libya and Syria, Egypt’s fortunes are notably now improving.
The sovereign is still a high-risk option, “vulnerable to geopolitical risk due to the tensions in the region; Islamist terrorism in particular”, says Mohamed Elsherbiny, Egyptian-based head of portfolios with CI Capital Asset Management, but its score has increased.
Elsherbiny believes Egypt’s diversified foreign-currency sources – from the Suez Canal, gas export revenue, tourism receipts, remittances and other transfers – are one of its strengths.
The country is making progress, too, in cutting subsidies, raising taxes and investing more – plus, as a net energy importer, lower oil prices are a benefit to Egypt’s investor profile.
Asia’s uncertain prospects; Indonesia’s currency plight
The effects of falling oil prices, dampening inflation and spurring a round of interest-rate cuts in the region, have caused concern for Asian borrowers, such as Indonesia, with larger fiscal and/or current-account deficits.
The sovereign is one of only a handful – including China, Myanmar, Pakistan and safe-haven Singapore (still ranking third globally) – to have endured risk score downgrades in Q1 2015.
Slowing growth and inflation have encouraged Bank Indonesia to loosen monetary policy to manage a moderate depreciation as a conduit to export growth.
However, the dual effect of competitive currency depreciations across the region and a sharper-than-expected fall in the rupiah have forced the central bank to reassess this strategy, casting a spotlight on the reserves available to prevent capital outflows from causing a larger currency rout – especially considering the increased imports required to support infrastructure spending.
Similar nervousness hangs over other commodity producers with imbalances in the region, such as Malaysia and Thailand – both of which have evinced falling scores compared with a year ago.
Mexican and Brazilian concerns dominate LatAm score shifts
An economy in recession with water and electricity shortages, a deteriorating fiscal situation, currency depreciation adding to inflation and a corruption scandal led to street protests last month in various cities across Brazil.
Marijke Zewuster, head of EM research at ABN Amro, believes that Nelson Barbosa and Joaquim Levy, who are respectively the new ministers of planning and finance, have the faith of the markets, but also notes that the necessary economic adjustments “will initially have a further negative impact on growth and inflation”.
Brazil is one of several countries that have had their scores downgraded in Q1 2015. Further falls for Argentina and Venezuela merely reiterate their long-term declines and default risks.
However, slower growth in China putting a damper on commodity prices and the prospective tightening of US monetary policy weakening capital inflows are also outweighing the positive influence on regional trade from a strong US economy.
Consequently, there have been some notable corrections in scores for the region’s safer prospects, among them Chile (15th globally), Colombia (40th) and notably Mexico (37th), an oil producer.
Peru and Uruguay are still holding up, but other parts of Central and South America have seen their country risk scores lowered during the first months of 2015, notably Bolivia, Costa Rica and Ecuador, which defaulted on its debt in 2008.
South African electricity shock adds to SSA woes
South African risk continued to increase in the first months of this year, as rolling power blackouts constraining mining and manufacturing production – previously hindered by damaging labour strikes last year – have seen economic growth undermined.
The problems at Eskom, South Africa’s virtual monopoly electricity provider, caused by huge under-investment and financing troubles highlights the slow pace of reforms holding back the EM’s investor potential and causing increased debt distress against the backdrop of depreciation of the rand.
Falling scores for Angola, Gabon and Nigeria, while also partly driven by domestic political risk, emphasize the impact of falling oil prices on the region’s net oil exporters, which have suffered the most from adverse fiscal metrics caused by weakening economies and plunging currencies.
Net oil importers, and especially those considered more stable politically, have seen their risks ease. Botswana in particular – now comfortably five places better off than South Africa in the survey, an outcome predicted years ago by Euromoney – is one of several countries, including Namibia, Ghana and Kenya, that have become safer so far this year.
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.