Country risk Sep 2005


Paul Pedzinksi
Published on:

Country risk index: Most countries have better access to capital than ever before and sovereign credit ratings have been on the rise for the past three years. But an increasingly tense geopolitical environment has led to marked decline in this year's country risk ratings. Research and analysis by Paul Pedzinski.

Political risks outweigh improving credit background

How the world got more risky
: 13 year review of country risk data


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


THE LATEST COUNTRY risk survey carried out by Euromoney again indicated a slight downgrade in the assessment of overall risk levels, reflected in the total country risk score decreasing by 0.5% on the figures six months before and falling a sharp 3.8% on September 2004. This was despite a general trend in the past six months towards improved sovereign credit ratings from the main ratings agencies. However the analysts polled by Euromoney are not as optimistic as the rating agencies.

There was also a moderate narrowing in bond spreads as well as a fall in stock prices in the period. Saruhan Hatipoglu, director of US-based risk analysis consultancy Business Environment Risk Intelligence (Beri), maintains that world trade is showing signs of yet another slowdown, which will have an adverse impact on exports globally but particularly on those from China.

This increase in risk is further confirmed by credit risk rating agency Coface's country rating, which downgraded Italy (for its export sector) and Greece. Overall, Coface's country risk index indicated a slight increase (in the amount of risk) by 1.2%. Italy's downgrade was motivated by the "marked deterioration in exporting businesses' payments behaviour" while Greece's negative watchlisting resulted from the "deteriorating situation for business solvency in a context of economic slowdown".

Coface analysts believe that there is a "widening gap between eurozone companies – in certain countries they are being faced with economic stagnation and possible recession – and those in North America that are operating in a more prosperous environment". In Coface's assessment, however, the emerging markets risk index remains stable after a long run of steady improvement. It notes that three countries – Gabon, Uruguay, and Macedonia – have been upgraded.

According to Thierry Apoteker, managing director of TAC-Applied Economic & Financial Research, the overall measures of country risk are "starting to show early signs of the downward leg of the world business cycle, with cyclical ratings in most countries deteriorating, especially in Asia and eastern and central Europe". He notes, though, that "oil exporting countries are reaping the benefits of many years of high energy prices", especially when such international developments coincided with reform policies (Algeria and Iran) or efficient redistribution mechanisms (Kazakhstan). In this broad context he believes that the two hottest questions concerning "major" country risks for the next one or two years relate to Turkey and Brazil.

Security concerns have also been pushed to the fore and despite the fact that "recent progress in the six-party talks has raised hopes for a possible agreement to limit North Korea's nuclear programme," it is unlikely that "Iran's ayatollahs will play ball as long as the western powers refrain from rattling their sabres forcefully" according to Farid Abolfathi, head of the Risk Center for Global Insight. He also insists that "the economic inducements of European powers will not impress anyone in Tehran since Iran's treasury is flush with oil revenues".

Beri's Hatipoglu predicts that in the next six months the recent trend towards relatively high-risk investments will continue, although investors will need to examine each country in great detail before committing capital. In his view, "better domestic macro-fundamentals in emerging markets as well as relatively lower returns in developed countries have and will continue to push investors towards the emerging markets".

He believes that if we "add to this the recent relative lack of financial crises in these countries; it is not surprising that interest in local government bonds will remain strong". Statistics show that emerging-market bonds have returned among the best values in the past five years. Furthermore, Hatipoglu notes that spreads on these bonds have "narrowed considerably during that period; they are currently at their lowest since 1997".

In China's hands

"The global economy's fate is increasingly tied to what happens in China, which is completely overshadowing Japan and Europe," notes Abolfathi. And although, unlike some other of our analysts, he sees "no impending China-related risks around the corner", he does believe that "its economy's dizzying pace is clearly unsustainable and the longer the pace is kept up, the more severe will be the inevitable payback from years of excess investment and imprudent lending to unviable state-owned enterprises".

Hatipoglu insists that the Chinese government deserves credit as it has "managed to stick to its course and adopted an effective step-by-step approach", and so far the results have been seen to be overwhelmingly favourable. He believes that despite fears of "massive overheating it appears that the Chinese economy is slowing this year and will probably grow by 8% if not a little faster in 2006, rather than the 9.5% or 10% predicted by some analysts".

He expects more "measured interest rate hikes and currency revaluations in the future" as China maintains its healthy march toward economic reform.

Beyond the issue of China's unrivalled economic success has been the pressing question of its significant military build-up. Some foreign-policy makers in the US believe that the long-term challenge will be to manage China's rise as a regional and possibly global military actor, according to the July 2005 Pentagon report on China, which addressed this issue.

Yiyi Lu, a senior research fellow at London-based think-tank Chatham House, believes that the situation is not that simple. The biggest issue in her view is China's "lack of transparency" on all such matters. She emphasizes that China's military spending has grown in double digits in the past 20 years and it is "not just a recent development, despite how it is being framed in some parts of the American administration and media".

According to Ian Bremmer, president of research and consultancy firm Eurasia Group, China has acted as a "destabilizer in the region" by the fact that it has been "creating a major challenge to America's national interest by trading in arms with rogue states". In Bremmer's opinion, China has adopted too much of a "mercantilist view in its recent dealings" and he believes that such a position will "ultimately not work and that China needs to be much more responsible in its dealings with other states".

Professor Lawrence Freedman of the Department of War Studies at King's College London believes that there have been and will continue to be "elements of both cooperation and competition in China's foreign policy" and that there have been "irritations to good relations" coming from both the US and China. Freedman emphasizes that the Chinese have been "pushing a certain kind of foreign policy" that demonstrates that they "have not been going out of their way to make friends".

In his view the rest of the world can rely on both China and Taiwan to continue "playing the current game" and he foresees a situation where political change and "inept diplomacy and miscalculation" might lead to an escalation of the current situation.

The Iran/Iraq question

Eurasia Group's Bremmer says that in the next six months the biggest issues will be a discussion of "some sort of exit timeline from Iraq for the US". He believes that this will lead into some sort of US action on Iran, which Bremmer believes will be an "end of 2006 event" but no sooner.

It is clear that the status quo in both Iran and North Korea is not acceptable to the US, but "given its other commitments the US administration is not willing to do anything at the present time". However, Bremmer insists that an exit from Iraq is not a "precondition" to any sort of further action, which would probably come in the "form of sanctions or the threat of surgical strikes against specific targets", insisting that there is no real military option. Regardless of US willingness to act militarily on the issue of nuclear weapons development in Iran, he points out that it is clear that "Israel would not tolerate" these and would do whatever it deemed necessary to have them removed.

Freedman believes that one positive result of the protracted struggle in Iraq is that it has "probably made the US more reticent and more willing to take a back seat in the region and just let events play themselves out".

The G8 and Africa

Sruti Patel, head of research at specialist investment bank Afrinvest emphasizes that the dominating theme this year for Africa has been the "acknowledgement by the G8 nations of the heavy burden of debt carried by some of the poorest countries in the world". She insists that "complete success still depends on the governments of the nations that benefit from these initiatives effectively redeploying freed-up funds towards social, health and poverty alleviating projects".

Patel believes that an interesting aspect of G8's debt cancellation promise has been the "ripple effect for non-qualifying countries, such as Nigeria, whose government, after years of intense lobbying, has now finally succeeded in kick-starting talks with its creditors".

Other analysts, such as Ian Taylor, a lecturer in the School of International Relations at the University of St Andrews, are sceptical about the prevalent belief that increasing aid to Africa will solve its problems. The problem, he says, is "not a lack of aid to the continent or a lack of resources" but the fact that "corruption is so prevalent" and that governments are "not at all accountable to their populations that keeps most of the continent in poverty". He emphasizes that "developing local capacity in Africa through technical assistance" is of primary importance, rather than the current practice of just pouring cash into corrupt governments.

Taylor believes the best solution to the problem could be inter-Africa trade, if it could be made to function properly. The obstacles to this again relate to corruption, as well as the fact that the internal infrastructure has been allowed to deteriorate.

Similar arguments are advanced by Martin Kimani, an analyst at macroeconomic survey firm Exclusive Analysis, who believes that aid does "nothing more than create the same old incentives" and creates a situation where Africa's negative tendencies are "subsidized by the outside world". One example he cites is Uganda, where 45% of the government budget is donor money. He argues that aid has "kept the war in northern Uganda alive" as the government now has an "open chequebook to finance the war". This has been "highly detrimental to Ugandan democracy as all democratic incentives are undermined as the government has "no incentive to respond to the taxpayers". He dismisses the notion, currently in vogue, that with "just one big push" Africa could "get there" as this is a very old idea and has not and "will not work". Aid will only work where there is "good governance that is responsive to the needs of the people".

Kimani believes that aid should be conditional and insists that any accountability can only begin when African governments become "accountable to their own people". On the political risk front he believes that conditionality has "created better conditions for business" and that privatization has been able to work where the "political classes were sold on its benefits" such as in Kenya. One other issue that he insists is of key importance is for African governments to "reduce the barriers to entrepreneurship" so that small and middle-size enterprises can prosper," as was recently spelt out in an OECD report entitled African Economic Outlook 2004/2005.

Clouds over Turkey and Brazil

TAC's quantitative tool RiskMonitor show that the risks of a major disruption in Brazil or creeping difficulties in Turkey are much higher than is deemed to be acceptable.

"The political scandals, the electoral schedule and the success of Argentina in coming back to international financial markets are all putting a tremendous pressure on the authorities to renegotiate Brazil's external debt burden, which remains far too heavy in the long-term," says Apoteker. He believes that such a renegotiation could "imply a voluntary restructuring or some more disruptive developments between now and the end of 2006, and would certainly be associated with a depreciation of the exchange rate, notwithstanding the current competitiveness of the real".

However, there is somewhat more optimism from within the country. Mario Mesquita, an analyst in ABN Amro's Brazil team, believes that there is "very limited risk of a debt restructuring as, if the government did not do it back in 2003, when the sovereign spread was at 1400bp, it is not likely to do it now". Moreover, he notes that unlike the Argentine situation, "most public debt is owed to Brazilians, so the political gains from restructuring would be far from clear". He believes that Brazil's external debt is in fact sustainable since as it "currently stands sovereign bond debt is $60 billion to $65 billion, against reserves of about $55 billion, and a GDP of about $700 billion."

Apoteker states that in Turkey: "TAC's risk predicting tools indicate difficult times ahead, but also suggest that the country has improved its fundamentals enough to avoid as brutal and violent a crisis as the one registered in 2001." He believes that "the combination of domestic growth, high energy prices and overvaluation of the currency are not sustainable, and something has to give: in all likelihood, Turkey will see both a significant slowdown in GDP growth and a depreciation of the lira".

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

Euromoney would like to thank the analysts and economists and institutions below who contributed to the Political Risk and Economic Performance ratings.

Barbara Huynh-Dernovsek, UBS; Francis Nicollas, Crédit Agricole; Sruti Patel, Afrinvest; Maxine Koster, CSFB; Conrad Schuller, Erste Bank; Mary Lou Walsh, PRS Group; Barbara Thomas, D&B; Alex Durrer, LGT Capital Management; Gregor Eder, Dresdner Bank; Thierry Apoteker, TAC Research; William Dugan, Summit Analytical Associates; James Ker-Lindsay, Civilitas Research; Ladan Mahboobi, Royal Bank of Canada; Helmut Bernkopf, HVB; Sylvia Griesman at Coface at; Luigi Ruggerone, Banca Intesa; Bernard Musyck, Frederick Institute of Technology; Sarahun Hatipoglu, BERI Risk Intelligence; Stefan Frank, Helaba; Hans Slock, ONDD; Cyril Widdershoven, MERC; William Dugan, Summit Analytical Associates; Serdar Kaya, Fiscal Study; Femi Babarinde, Thunderbird School of International Management; Fusako Tsuchiya, Nomura Securities; Richard Segal, Argo Capital; Conrad Schuller, Erste Bank; Eduardo de Buey, Canadian Foundation for the Americas; Alexander Lehmann, EBRD; YiYi Lu, Institute of International Affairs, Chatham House; Mauro Toldo, DekaBank, Deutsche Girozentrale; Rashna Writer, Merchant International Group; Mario Mesquita, ABN Amro Brazil; Orsalya Nyste, Erste Bank, Hungary; Ian Taylor, University of St Andrews; Victor Luhovyk, Dragon Capital; James Lorge, Institute for Public Policy Research; Linda Yueh, London School of Economics; Ivanka Petkova, EPI Bulgaria; Elliot Murphy, Caribbean Development Bank; Naoko Oka, Sumitomo Shoji Research Institute; John Thomas, Harvard University; Gerhard Kinzelberger, Oesterreichische Kontrollbank; Plamen Pantev, ISIS.

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