Country risk: In search of the next investment grade

By:
Jeremy Weltman
Published on:

Euromoney’s risk survey successfully predicted the move to investment grade for the Philippines in 2013, and it is once again highlighting other sovereign borrowers – in particular Hungary and Paraguay – with prospects for a similar upgrade.

Paraguay lapacho tree-R-600
Paraguay is blooming in more ways than just its national tree, the lapacho


Three years ago, in line with its score trend in Euromoney’s survey, the Philippines achieved investment-grade status from all three rating agencies when Moody’s finally moved in line with Fitch and S&P.

The survey signalled a Filipino upgrade was long overdue due to its solid growth fundamentals, fiscal consolidation, strong external balances, political stability and good governance.

These features were highlighted in an array of ameliorating risk indicators for two years, taking the sovereign to the top of the fourth of ECR’s five tiered groups.

Its upward score trend was signalling stronger creditworthiness compared to no fewer than six investment-grade borrowers, namely Latvia, Romania, Namibia, Kazakhstan, Morocco and Azerbaijan, listed in descending order.

The suggestion this would see the Philippines soon rise into tier three – commensurate with investment grade – was subsequently proven correct.

The question now is whether there are any other sub-investment grades which can similarly make the leap. 


The task of finding the next investment-grade sovereign issuer is complicated by the conflicting opinions among the rating agencies over the various aspects of risk – be they economic, political or structural.

No methodology is infallible, but Euromoney’s crowdsourcing approach has developed a reputation as an important early warning system, alerting its users to changing risk patterns, and often unearthing interesting anomalies in the views of the credit rating agencies.

The survey utilizes the opinions of more than 400 economists and political risk experts to calculate a total risk score out of 100 points. It is updated quarterly, ranks 186 countries, and collates them into five tiered categories based on their risk scores, where tier one contains the safest triple-A sovereigns and tier five the world’s worst default risks.

Trend movements in ECR scores have predicted the changes in ratings in many countries worldwide, both before and after the global financial crisis in 2008, and in both directions too.

Indeed, there are numerous examples of the survey pre-empting countries losing their investment grades from one or more agencies, as Brazil, Russia and even Azerbaijan recently attest.


What the agencies say

In light of the uncertainties affecting emerging markets and the problems in Europe linked to the debt crisis, investors might be wondering whether a new investment grade can be found.

Typically, the rating agencies differ in providing an answer.

Fitch has six candidates close to triple B investment grade, all rated BB+.

Of those, four are on a negative outlook, namely Azerbaijan, Brazil, Costa Rica and FYR Macedonia, coinciding with their declining ECR score trends.

One is stable (Portugal), matching the ratings from both Moody’s and S&P, and signalling an upgrade is not likely anytime soon, although interestingly Euromoney’s survey suggests it should be.

Portugal is comfortably within ECR’s tier three, and is ranking higher than many investment-grade sovereigns, in 53rd spot out of 186 countries surveyed.

Cyprus, another sub-investment grade, is 50th in the survey. Both countries are now tackling their problems head on with reforms.


Any others?

In addition to Portugal, Moody’s agrees with Fitch on Azerbaijan and Costa Rica.

It also rates Bahrain, Guatemala and Russia Ba1 (the equivalent of BB+).

Bahrain and Russia are investment grade, according to Fitch, but are on review to lose that status, and all three are negative according to Moody’s.

Morocco is the only stable Ba1 sovereign, according to Moody’s, but it is already investment grade, say Fitch and S&P.

S&P, meanwhile, has seven sovereign borrowers commanding BB+, its highest speculative (sub-investment) grade.

One, Indonesia, is on review for an upgrade, but is lagging the other two agencies already rating the sovereign as investment grade.

Turkey and Russia are on a negative review, while Azerbaijan and Bulgaria are stable; the latter in any event is investment grade, say Fitch and S&P.


Hungary for an upgrade

Apart from Cyprus, Portugal and Brazil – and ignoring Brunei, which isn’t rated – the only other tier-three sovereign on sub-investment grade is Hungary.

On a score of 52.1 out of a maximum 100 points, Hungary is holding its own in 60th position in the global rankings, safer than seven other investment-grade borrowers in tier three, ECR’s survey suggests.

Hungary’s risk score slipped a little during Q1 2016, but was still more than three points higher on a 12-month basis, and more than five points better off on a three-year comparison.

ECR has remarked upon Hungary’s improving prospects for several years, noting a year ago that “decent economic growth, an external surplus and falling unemployment are a recipe for decent returns, reinforced by a move towards more orthodox policy prescriptions”.

Economic growth is decelerating compared with the pace in 2014-15, but is still faster than in many eurozone countries.

Forecasts by the European Commission show the unemployment rate falling to 5.2% by next year, the current-account surplus increasing to 6.3% of GDP, and fiscal indicators improving.

The general government deficit is seen narrowing to 1.9% of GDP, and the gross debt burden might ease to 72.4% of GDP. There are some concerns the government might not meet its fiscal targets, but Hungary’s ECR debt indicator has improved, alongside four of its five economic risk indicators during the past year.

The borrower remains above Romania and Bulgaria in the global rankings, as well as South Africa and Bahrain, which are both fading. It is higher than Namibia and Indonesia, which are also considered investment grade by one or more of the rating agencies.


Paraguay has claims

A few of ECR’s top tier-four countries are also investment grade, such as Mauritius, the Bahamas, Kazakhstan and Morocco.

A notable exception is Croatia, the top tier-four sovereign, but its score is on a declining trend. The same is true of Costa Rica, five places lower in the global rankings.

Of the improvers, namely Jordan, Georgia and Vietnam, political and structural risk factors tend to be huge drawbacks. Gabon, meanwhile, is hamstrung by its oil dependency, amid the collapsing price of crude.

That leaves just one country, Paraguay, with longer-term potential.

Although the sovereign borrower is 75th in ECR’s global rankings, on a score of 44.2 from a maximum 100 points, it has steadily improved over time, climbing six places since 2010.

Paraguay has solid economic growth prospects, resilient to the Brazilian crisis and wider regional slowdown.

The government is diversifying the economy away from its agricultural dominance, and is investing through public-private partnerships, which is bolstering the construction industry and its structural risk factor score for “hard infrastructure”.

Almost all sectors are open to trade and foreign direct investment, which has been improving since the election in 2013 of businessman Horacio Cartes as president, whose government has successfully embarked on banking sector reform, and is reforming the public sector and pensions system.

Paraguay’s government stability score has improved, public debt is fairly low and fiscal management is moreover benefiting from the fiscal responsibility bill.

If Cartes manages to further raise the country’s potential, by strengthening its institutions and maintaining fiscal progress, it might be a candidate for investment grade in the not-too-distant future.

Access to the survey data, including the latest country rankings, is available via subscription at www.euromoneycountryrisk.com.

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