EM Sovereign Rating Model for Q1 2017

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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 were 34 EM rating actions in 2016. 24 of them were negative, and were spread out amongst many countries. Negative actions made up 71% of the total moves last year, up from 62% in 2015 and 53% in 2015.

Since our last update November 1, there were 6 actions. The outcomes were much more balanced, with 3 positive moves and 3 negative ones.

All three negative moves this past quarter were made by Fitch. The agency moved the outlooks from stable to negative for Mexico, South Africa, and Chile.

On the other hand, Fitch also made two positive moves. Israel was upgraded from A to A+ with a stable outlook, while its outlook on Indonesia’s BBB- rating was moved from stable to positive. Moody’s provided the other positive action, upgrading Hungary from Ba1 to Baa3 with a 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 begins this 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 improved a notch to BBB/Baa2/BBB. The drop in oil prices really took a toll on the economy, but it should bounce back now that the central bank started the easing cycle. Downgrade risks to actual ratings of BBB/Baa2/BBB have dissipated for now, though Fitch has kept its outlook for Colombia at negative since July.

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 last March could presage an eventual cut to Baa1, as our model suggests.

Peru’s implied rating recovered a notch to BBB+/Baa1/BBB+. As a major copper exporter, the fall in prices has fed through into weaker fundamentals. However, the outlook has improved and actual ratings of BBB+/A3/BBB+ appear safe now from downgrade risks.

Uruguay’s implied rating recovered a notch to BBB/Baa2/BBB. This suggests that downgrade risks to actual ratings of BBB/Baa2/BBB- have dissipated for now. 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, though its score worsened significantly. 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 deepening 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 was steady at 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 was steady at 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 still seeing upgrade potential.

Malaysia’s implied rating fell a notch to BBB+/Baa1/BBB+, reversing last quarter’s improvement. As such, downgrade risks to actual ratings of A-/A3/A- are back on the table.

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

EMEA

Russia’s implied rating was steady at BB+/Ba1/BB+. S&P and Moody’s appear to have the correct ratings. Fitch’s investment grade rating seems too high. However, Fitch’s decision in October to move the outlook on its BBB- rating from negative to stable suggests little downgrade risk there.

South Africa’s score improved, but not by enough to raise its implied ratings of BB/Ba2/BB. As such, we believe actual ratings of BBB-/Baa2/BBB- remain subject to significant downgrade risk. The loss of investment grade seems likely this year as the growth and fiscal outlook remains poor.

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 downgrade risks to its BB/Ba1/BBB- ratings. The investment grade rating from Fitch seems way out of line now, and its negative outlook suggests an adjustment will eventually be made.

Hungary’s implied rating rose a notch to BBB-/Baa3/BBB-. It has finally regained its investment grade rating from all three agencies, but further upgrades are unlikely for now. 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+ last year was just 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 fell a notch to BBB+/Baa1/BBB+, which suggests stronger 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 was steady at AA-/Aa3/AA-. As such, actual ratings of A+/A1/A face some upgrade potential. Morocco’s implied rating rose a notch to BBB+/Baa1/BBB+, reversing last quarter’s drop. As such, there is some growing upgrade potential to actual ratings of BBB-/Ba1/BBB-.

CONCLUSIONS

The heavy weighting of negative moves last year suggests that there are still negative risks within EM as we move into 2017. 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. 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.