Thursday, July 07, 2016

Sovereign Downgrades Hit New Record
Elaine Moore
Financial Times

The creditworthiness of nations as judged by one of the world’s largest rating agencies has deteriorated at a record pace in the first six months of the year.

Fitch Ratings has downgraded 14 sovereign borrowers so far in 2016, including the UK — citing falling oil prices, a stronger US dollar and Britain’s pending exit from the EU.

The decline highlights the sensitivity to geopolitical shocks felt by the world economy as a result of sluggish growth and rising debts.

Fitch attributes the scale of downgrades in large part to lower commodity prices, noting that borrowers in the Middle East and Africa account for more than half of its 15 negative rating actions.

However, it added that the significance of the UK’s exit from the EU was “difficult to overstate”.

“The short-term economic impact of the Brexit referendum will be decidedly negative in the UK,” said James McCormack, global head of sovereign ratings, adding that the ramifications of the vote would spread beyond the country’s borders.

“Europe’s political backdrop could have negative implications for sovereign ratings . . . 
Comparatively high government debt levels are observed in several eurozone sovereigns, and are likely to remain effective rating constraints.”

Following the referendum, rival rating agencies S&P also cut the UK’s rating, stripping it of its final triple A grade and predicting the country would “barely escape” recession.

So far this year, S&P has downgraded 16 sovereigns — a half-year figure only exceeded once, at the height of the eurozone crisis in 2011. Moody’s has downgraded 24, compared with 10 at the same point last year.

The role of credit rating agencies has been questioned in recent years — with some accusing them of biased ratings and irrelevance. However, their decisions remain crucial to investors subject to mandates that determine what sort of assets they can own.

“I see parallels between the downgrades in peripheral Europe during the eurozone crisis and what is happening in emerging markets right now,” said Bhanu Baweja, emerging market strategist at UBS.

“It’s a very strange time — the credit is undoubtably weakening but investors are still crowding in because there are so few places to find positive yields.”

The crowding has caused the average borrowing rate of emerging markets calculated by JPMorgan’s index of EM bond yields to fall to a two-year low of 5.25 per cent.

“The problem is growth,” said Mr Baweja. “It is so weak that leverage is increasing and credit is weakening. This doesn’t mean there is a crisis but it does mean we haven’t seen the last of the downgrades.”

This year, the IMF expects emerging markets to grow 4.1 per cent — a modest increase on the previous year.

While there have been some improvements to current account deficits in the so-called “Fragile Five” — countries including India that caused concern a few years ago — other weaknesses have emerged thanks to falling commodity prices. As oil prices have fallen, Opec’s own “Fragile Five”, including Iraq and Nigeria, are now struggling to replace lost revenues.

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