EM Sovereign Rating Model for Q4 2016

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We have produced the following Emerging Markets (EM) ratings model to assess relative sovereign risk. An EM country’s score directly reflects its creditworthiness and underlying ability to service its external debt obligations. Each score is determined by a weighted compilation of fifteen economic and political indicators, which include external debt/GDP, short-term debt/reserves, import cover, current account/GDP, GDP growth, and budget balance.

These scores translate into a BBH implied rating that is meant to reflect the accepted rating methodology used by the major agencies. We find that our model is very useful in predicting rating changes by the major agencies. The total number of Emerging Market countries covered by our model stands at 30.

EMERGING MARKETS RATINGS SUMMARY 

There have been 28 EM rating actions so far in 2016. 21 of them were negative, and were spread out amongst many countries. This past quarter, the outcomes were more balanced with 5 positive moves and 5 negative ones.

Negative moves this past quarter were concentrated in Turkey. S&P quickly downgraded it after the coup attempt by one notch to BB and maintained a negative outlook. Moody’s put it on review for a downgrade and then followed up with a one notch move to Ba1. Fitch moved the outlook on its BBB- rating from stable to negative, but has yet to downgrade Turkey.

The only other negative move this past quarter was in Colombia. Fitch moved the outlook on its BBB rating from stable to negative.

On the other hand, Russia saw two positive moves. Both S&P (BB+) and Fitch (BBB-) moved their outlooks from negative to stable. S&P upgraded Korea a notch to AA with stable outlook, and then upgraded Hungary a notch to BBB- with stable outlook. Lastly, Fitch upgraded Taiwan a notch to AA- with stable outlook.

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EMERGING MARKETS RATINGS OUTLOOK 

Latin America 

Brazil’s implied rating remained steady at BB/Ba2/BB. Actual BB/Ba2/BB ratings thus appear to be correct. The economic outlook this year is poor, but we see scope for further improvement in Brazil’s implied rating if the cyclical recovery is seen next year.

Chile’s implied rating remained steady at A-/A3/A-. The fall in copper prices has taken a toll, however, and actual ratings of AA-/Aa3/A+ are still facing some downgrade risks. Ecuador did not see any change to its implied rating of B+/B1/B+, but actual ratings of B/B3/B appear to be slightly on the low side.

Colombia’s implied rating remained steady at BBB-/Baa3/BBB-. The drop in oil prices has really taken a toll on the economy. Downgrade risks to actual ratings of BBB/Baa2/BBB are picking up, and we agree with Fitch’s decision to move its outlook to negative.

Mexico’s implied rating was steady at BBB+/Baa1/BBB+. Both S&P and Fitch appear to be on target with their BBB+ rating. However, we note that Moody’s decision to move the outlook on Mexico’s rating from stable to negative earlier this year could presage an eventual cut to Baa1, as our model suggests.

Peru’s implied rating fell a notch to BBB/Baa2/BBB. As a major copper exporter, the fall in prices has fed through into weaker fundamentals. Actual ratings of BBB+/A3/BBB+ are subject to growing downgrade risks.

Uruguay’s implied rating was steady at BBB-/Baa3/BBB-. This still suggests some downgrade risks to actual ratings of BBB/Baa2/BBB-. Panama’s implied rating was steady at BBB+/Baa1/BBB+, but this still suggests some upgrade potential to actual ratings of BBB/Baa2/BBB.

Venezuela’s implied rating remained steady at D. While the recent recovery in oil prices will help most oil producers, we think years (decades?) of economic mismanagement have pushed Venezuela to the brink of default and further social upheaval.

Asia 

China’s implied rating was steady at A+/A1/A+. This supports the decisions earlier this year by both S&P and Moody’s to move their outlooks from stable to negative. We see growing downgrade risks to their actual ratings of AA- and Aa3, respectively. Fitch’s A+ appears to be on target.

Hong Kong, Singapore, Korea, and Taiwan all saw fairly steady scores. All of these countries also appear to be more or less correctly rated.

India’s implied rating rose a notch to BBB/Baa2/BBB. Several quarters ago, India was facing downgrade risks to its BBB-/Baa3/BBB- ratings. Now, we are seeing growing upgrade potential.

Indonesia’s implied rating rose a notch to BBB/Baa2/BBB. This makes it even more surprising that S&P did not upgrade Indonesia to investment grade BBB- to match the other two agencies. Indeed, those ratings are seeing growing upgrade potential.

Malaysia’s implied rating improved a notch for the second straight quarter to A-/A3/A-. As such, downgrade risks have basically evaporated.

The Philippines’ implied rating fell a notch to BBB+/Baa1/BBB+. There is still some upgrade potential to actual ratings of BBB/Baa2/BBB-. However, we suspect that the agencies will be cautious in light of the planned fiscal loosening by the new government. Thailand saw its implied rating steady at A-/A3/A-, and points to some upgrade potential to actual ratings of BBB+/Baa1/BBB+.

EMEA 

Russia’s implied rating rose a notch to BB+/Ba1/BB+. S&P and Moody’s now appear to have the correct rating. We disagree with Fitch’s investment grade rating. However, Fitch’s recent decision to move the outlook on its BBB- rating from negative to stable suggests little downgrade risk there.

South Africa’s score was virtually unchanged, leaving its implied ratings steady at BB/Ba2/BB. Still, we believe actual ratings of BBB-/Baa2/BBB- remain subject to downgrade risk, and the loss of investment grade seems likely this year as the growth and fiscal outlook deteriorates.

Turkey’s implied rating was steady at BB/Ba2/BB. Despite some negative moves already seen after the coup attempt, we think Turkey continues to face strong downgrade risks to its BB/Ba1/BBB- ratings. The investment grade rating from Fitch seems way out of line now.

Hungary’s implied rating rose a notch to BB+/Ba1/BB+. It remains right on the cusp of moving into investment grade territory. However, both S&P Fitch have already upgraded Hungary to investment grade. The Czech Republic’s implied rating was steady at AA-/Aa3/AA-, and so we still see upgrade potential for its A1 and A+ ratings from Moody’s and Fitch, respectively.

Poland’s implied rating remained steady at BBB/Baa2/BBB. As such, our model still suggests downgrade risks to actual ratings of BBB+/A2/A-, and we believe S&P’s initial cut to BBB+ earlier this year was the first of several to come.

Qatar’s implied rating was steady at A/A2/A, but still faces strong downgrade risks to actual ratings of AA/Aa2/AA. The UAE’s implied rating was steady at A-/A3/A-, and our model still suggests strong downgrade risk to its lone Aa2 rating from Moody’s.

Elsewhere, Egypt’s implied rating was steady at B/B2/B. Actual ratings of B-/B3/B appear more or less correct now. Israel’s implied rating rose a notch to AA-/Aa3/AA-. As such, actual ratings of A+/A1/A could see some growing upgrade potential. Morocco’s implied rating fell a notch to BBB/Baa2/BBB, but there is still some upgrade potential to actual ratings of BBB-/Ba1/BBB-.

CONCLUSIONS 

The sheer number of downgrades this year suggests that there are still negative risks within EM. Low commodity prices have had a negative impact on the commodity exporting countries, but those ratings should stabilize if the bounce in commodity prices continues. Indeed, this past quarter saw an even split (5-5) between negative and positive rating actions. We continue to warn investors that EM fundamentals will still diverge across countries. The investment climate remains challenging, with fundamentals remaining the most important factor for global investors to consider.