We have produced the following ratings model to assess relative sovereign risk in Frontier Markets. A 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.We have replaced FDI as a share of GDP with Net International Investment Position (NIIP) as a share of GDP. We believe NIIP gives a better read on a nation’s vulnerability to shifts in international investment flows. However, we likely saw some larger than usual changes in the implied scores this quarter as a result of the change in methodology.

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 Frontier Markets covered by our model is currently 36 after the recent decision by MSCI to reclassify Argentina and Saudi Arabia from Frontier to Emerging status.

FRONTIER RATINGS SUMMARY

There have been 7 rating actions since our last update in May. There were 5 positive actions and 2 negative. For 2018 so far, positive actions make up 55% of the total. For all of 2017, the actions were 29 positive and 33 negative, which represents a 47% share for the positives. Both are improvements over 2016, where only 13 actions out of 73 total (18%) were positive.

The deterioration in credit quality of the Frontier Markets in recent years largely reflects the negative impact from slower global growth and low commodity prices. Given that this trend appears to have reversed, we look for further improvement in Frontier ratings as we move through H2 2018. Of course, there will be divergences within Frontier Markets, just as we have seen divergences in the Emerging Markets.

Since our last update, Fitch has been the most positive with three moves. It upgraded Vietnam from BB- to BB with a stable outlook. Fitch also upgraded Mongolia from B- to B with stable outlook. Lastly, it moved its outlook on Croatia’s BB+ rating from stable to positive.

Moody’s and S&P each had one positive move. Moody’s moved its outlook on Jamaica’s B3 rating from stable to positive. S&P moved its outlook on Bulgaria’s BBB- rating from stable to positive.

S&P and Fitch each had one negative move. S&P downgraded Bolivia from BB to BB- with stable outlook. Fitch moved its outlook on Tunisia’s B+ rating from stable to negative.

FRONTIER RATINGS OUTLOOK

Despite improving global growth and higher commodity prices, we see persistent downgrade risk ahead as signaled by the negative outlooks that are still hanging over many of the countries. Improving credit metrics for the commodity exporters will most likely be an early 2018 story. Again, there will be some exceptions as divergences are likely to remain in play.

Asia

Every country in this region saw steady implied ratings. Bangladesh’s implied rating was steady at BBB/Baa2/BBB and we still see strong upgrade potential to actual ratings of BB-/Ba3/BB-. Sri Lanka saw its implied rating steady at BB-/Ba3/BB-, and we still see upgrade potential for actual ratings of B+/B1/B+. Mongolia’s implied rating was steady at B-/B3/B-, which keeps it pretty much right at actual ratings of B-/B3/B. Vietnam’s implied rating remained steady at BBB-/Baa3/BBB-. We still see upgrade potential for actual ratings of BB-/B1/BB.

Africa

Most countries in this region saw steady implied ratings this quarter. Botswana’s implied rating was steady at A/A2/A after rising a notch last quarter. This still suggests very little upgrade potential for actual ratings of A-/A2. Mauritius’ implied rating was steady at BBB-/Baa3/BBB- after falling a notch last quarter. This still suggests ongoing downgrade risks to Moody’s sole rating of Baa1. Cote d’Ivoire’s implied rating was steady at BB+/Ba1/BB+ after falling several notches over the course of last year, but we still see upgrade potential for actual ratings of Ba3/B+.

Tanzania’s implied rating was steady at BBB-/Baa3/BBB-. However, it is not rated by the major agencies. Algeria’s implied rating was steady at BBB-/Baa3/BBB- but it too remains unrated by the agencies. Namibia’s implied rating was steady at BB-/Ba3/BB- after falling a notch last quarter. This still suggests downgrade risks to actual ratings of Ba1/BB+. Uganda’s implied rating was steady at BB-/Ba3/BB- after falling a notch last quarter. This still suggests some modest upgrade potential to actual ratings of B/B2/B+.

Ghana’s implied rating was steady at B+/B1/B+ after falling a notch last quarter. We still see modest upgrade potential to actual ratings of B-/B3/B. Zambia’s implied rating was steady at B/B2/B after falling an entire step last quarter. This pretty much keeps it at actual ratings of B/B3/B. Mozambique’s implied rating was steady at B-/B3/B- after a one notch improvement last quarter and a two-notch improvement the quarter before that. This still keeps it above actual ratings of SD/Caa3/RD.

Several countries saw improvement this quarter. Nigeria’s implied rating rose a notch to BB/Ba2/BB, moving it further above actual ratings of B/B2/B+. Angola’s implied rating rose a notch to BB/Ba2/BB. This moves it further above actual ratings of B-/B3/B. Kenya’s implied rating rose a notch to B/B2/B after falling two notches last quarter. This still suggests downgrade risks to actual ratings of B+/B2/B+.

Tunisia was the only country in this region to see deterioration. Its implied rating fell a notch for the second straight quarter to CCC+/Caa1/CCC+, which moves it further below actual ratings of B2/B+. This suggests growing downgrade risks.

Latin America and Caribbean

A couple of countries in this region saw falling implied ratings. El Salvador’s implied rating fell a notch for the second straight quarter to B+/B1/B+, moving it closer to actual ratings of CCC+/B3/B-. The Dominican Republic’s implied rating fell a notch to BB+/Ba1/BB+, giving back last quarter’s improvement. This still suggests some upgrade potential to actual ratings of BB-/Ba3/BB-.

Elsewhere, implied ratings were steady. Costa Rica’s implied rating was steady at BB+/Ba1/BB+ after falling one notch last quarter. This keeps it close to actual ratings of BB-/Ba2/BB. Jamaica’s implied rating was steady at BB-/Ba3/BB- after falling a notch last quarter. This still suggests some upgrade potential for actual ratings of B/B3/B. Guatemala’s implied rating was steady at BBB/Baa2/BBB, but still sees some upgrade potential to actual ratings of BB-/Ba1/BB. Trinidad & Tobago’s implied rating was steady at BB+/Ba1/BB+. This suggests ongoing downgrade risks to S&P’s BBB+ rating. Moody’s Ba1 rating is on target, however. Bolivia’s implied rating was steady at BB/Ba2/BB, which keeps it close to actual ratings of BB-/Ba3/BB-. 

Eastern Europe

Virtually every country in this region saw steady implied ratings. Only Bulgaria saw deterioration, as its implied rating fell a notch to BBB/Baa2/BBB. This suggests no more upgrade potential for actual ratings of BBB-/Baa2/BBB.

The rest of the region saw steady implied ratings. Ukraine saw its implied rating steady at CCC+ after rising three straight quarters. This is still largely below actual ratings of B-/Caa2/B-, however. Kazakhstan’s implied rating was steady at BB/Ba2/BB after rising a notch last quarter, but there are still ongoing downgrade risks to actual ratings of BBB-/Baa3/BBB.

Serbia’s implied rating remained steady at BB+/Ba1/BB+. This still suggests some upgrade potential for actual ratings of BB/Ba3/BB. Romania’s implied rating was steady at BBB-/Baa3/BBB-. We do not see any upgrade potential to actual ratings of BBB-/Baa3/BBB-. Croatia’s implied rating was steady at BB+/Ba1/BB+ after falling a notch last quarter. This pretty much keeps it at actual ratings of BB+/Ba2/BB+. 

Middle East

The countries in this region saw mostly steady implied ratings. The exception was Lebanon, whose implied rating fell a notch to CCC-/Caa3/CCC-, which suggests stronger downgrade risks to actual ratings of B-/B3/B-.

Jordan’s implied rating was steady at B+/B1/B+ after falling a notch last quarter. This puts it right at actual ratings of B+/B1/NR. Oman’s implied rating was steady at BBB-/Baa3/BBB- after falling a notch for two straight quarters. This keeps it pretty much at actual ratings of BB/Baa3/BBB-, though the agencies are split. Bahrain’s implied rating was steady at B/B2/B, which still suggests downgrade risks to actual ratings of B+/B1/BB-. Kuwait’s implied rating was steady at A/A2/A after rising two notches last quarter. This compares to actual ratings of AA/Aa2/AA.

CONCLUSIONS

It is clear that fundamentals are still worsening for some countries across the Frontier Markets universe. Much of this was driven by slow global growth and low commodity prices. These trends have already started to reverse, however, and so we expect to see more of an improving sovereign credit story as we move through 2018. We believe that our model will help to identify the potential winners and the losers within this divergence theme.