Country risk March 2005: As spreads tighten the world gets riskier

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By:
Paul Pedzinksi
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Country risk index: The latest Euromoney country risk survey reflects a slight downgrade in the assessment of overall risk levels despite sovereign upgrades from rating agencies.

For historical country risk data please visit the Euromoney Country risk website

Methodology

IN A YEAR in which sovereign credit ratings upgrades continued to outpace sovereign downgrades, according to Standard & Poor's, there has also been a further narrowing of spreads in emerging countries' issues or credits. S&P upgraded 28 sovereigns in 2004 and lowered the rating on only seven. This upward trend looks to continue into the first part of 2005.

In our September 2004 survey we reported an aggregate upward shift in the total absolute risk score for all 185 countries rated of 4.5%. This time however, despite sovereign upgrades, there has been a decrease of 3.5% in the overall ratings this half year. This can be attributed to geopolitical instability in the Middle East and Africa.

Underpricing credit fundamentals

According to Francis Nicollas at Crédit Agricole, there has been a "sharp decrease in the price of risk worldwide". He attributes this partly to the "exceptional liquidity of the international financial market, and also the search for spread (because of the low interest rate in the US)". He notes: "One of the consequences is that we can ponder the future of the external financing needs for the countries that need these inflows badly (such as Brazil [68] and Turkey [73]) if the investor appetite for that kind of risk decreased or even vanished".

Saruhan Hatipoglu of Business Environment Risk Intelligence (Beri) also draws attention to the strong demand for relatively high-risk investments. "From Europe to Latin America, Asia and even Africa, foreign investors are showing greater interest in local bonds," he says. He points out that even Argentina (141) was able to "pull the impossible task of arm-twisting investors and forcing them to accept 32 cents on the dollar for its defaulted debt in 2001".

David Line, editor at Asia Intelligence Services, believes that growth in the global economy will "be moderate in 2005 after a robust 2004". Asia Intelligence predicts that world economic growth will be about "3.8% this year, down from around 4.8% in 2004 but above the 3.5% annual average of the past two decades".

Beri's Hatipoglu stresses that macroeconomic performance has also been impressive in the emerging markets in 2004 for such countries as Argentina, Brazil (68), Turkey (73), Russia (61) and South Africa (57). In addition to this growth, he believes that the "psychological impact of EU accession of select emerging market countries on investors played an important role in recent successful bond issuances, most recently in Lithuania (48)". He expresses confidence that the accession countries, "particularly Poland (45), Hungary (48) and Czech Republic (35), will continue on a steady path because they all have already adopted EU standard practices regulating bond issuance which is a big plus for investors".

Widespread monetary excesses

Hatipoglu believes that "what investors have lost and how they were coerced to accepting a sub-par deal such as the one in Argentina's defaulted bonds in 2001 will remain in their psyche for a long time to come". He believes that problems might surface "when Argentina or another potentially ailing emerging market needs foreign investors in rainy days and it might not get them".

William E Dugan of Summit Analytical Associates offers a somewhat more positive outlook on Argentina (141) stating that it "continues to rebound from the depths of the 2001/2002 economic crisis".

Thierry Apoteker, managing director at TAC – Applied Economic & Financial Research – believes that "while the overall country risk situation has continued to improve over the past six months, symptoms of monetary excesses are now quite widespread".  This has been an issue most notably in Asia: where he believes that "exchange rate management in a context of a weak dollar has led to large increases of domestic money supply and signs of a credit euphoria". He also points out that "it is in this background that the Chinese authorities are trying as best as they can to muddle through between the risks of bursting the bubble, of creating huge microeconomic problems, and higher regional or social issues".

Donald Mackay, executive director of the Canadian Foundation of the Americas, notes that economic growth in some areas of Latin America was also quite strong in 2004. He specifically cites Chile (43), Mexico (49) and Brazil (68), which all "turned in very strong performances, and even Argentina has started to come on strong".

The situation in Central America remains stable according to Mackay, who predicts that "US ratification of the Central America Free Trade Agreement is still not a done deal but if approved should give a big boost to exports from that region".

Asia Intelligence Services' Line believes that the outlook is a bit more bullish for most of Asia. He predicts that economic growth in east Asia "will be around 6.5% in 2005, after a 7.6% expansion in 2004 – the strongest in the region since the crisis of 1997-98".

He believes that the largest downside risks for the region are "oil prices, a disorderly adjustment of the US current-account deficit, and a hard landing in China". Line emphasizes that the last of these risks is unlikely to materialize. In his view "China's leaders have had some success in engineering a gentle slowdown in the economy to head off overheating and an inflationary bubble".

The issue of the Chinese bubble has also been a concern for Beri's Hatipoglu, who sees a "problem with the trend of Chinese growth and possible continuation of overheating". He believes that a "majority of policymakers were of the opinion that artificial quotas that they introduced on investment, particularly in construction, would be sufficient to contain overheating and set up a soft landing". However, he believes that "this proved a false sentiment as official statistics indicate a growth rate of 9.5% for 2004, but the real GDP is likely to have exceeded 10%".

Hatipoglu acknowledges "that the interest rate increase late last year was a key step, and that it was an acknowledgement by Chinese officials that excess capacity needed to be reduced in an unconventional manner for the Chinese government". With this approach, he maintains that "overheating can be avoided and a soft landing is still a possibility but the chances of that are lower than a year ago".

An increasingly important focus of country risk analysis is the growing international stance against sovereign government corruption. In order to better quantify its effect on country risk, Euromoney has for the second time incorporated Transparency International's Corruption Perception Index (CPI) 2004 into our regional breakdowns.

A total of 106 out of 146 countries score less than 5 on a scale in which a clean score is 10, according to the index, published by Transparency International, the leading non-governmental organization fighting corruption worldwide. Sixty countries score less than 3 out of 10, indicating rampant corruption. Corruption is perceived to be most acute in Azerbaijan, Bangladesh, Chad, Haiti, Myanmar, Nigeria and Paraguay, all of which score less than 2.

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