EM Sovereign Rating Model for Q1 2018

Blog icons - SovRatings-EmergMktsWe 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 14 EM rating actions since our last update.  7 were positive and 7 were negative.  For all of 2017, 30 negative actions made up 60% of the total moves, down from 71% in 2016 and 62% in 2015.  The outcome represents marginal improvement over previous years, and suggest that EM ratings are starting to stabilize after several years of downward momentum.  We also note that many of the negative actions were concentrated in Venezuela.

S&P was the most negative agency this past quarter with 5 negative actions.  S&P downgraded Venezuela twice, from CCC- to CC and then again from CC to Selective Default (SD).  S&P also downgraded South Africa from BB+ to BB, Colombia from BBB to BBB-, and Brazil from BB to BB-, all with stable outlooks.  S&P’s lone positive action was upgrading the outlook on its B- rating for Egypt from stable to positive.

One negative move came from Fitch.  It downgraded Venezuela from C to Restricted Default (RD).  On the flip side, Fitch was the most positive agency with 4 moves.  Fitch moved the outlook on Hungary’s BBB- rating from stable to positive and moved the outlook on Egypt’s B rating from stable to positive.  Fitch upgraded both the Philippines and Indonesia from BBB- to BBB with stable outlooks.

Moody’s only had one negative move.  The agency put South Africa’s Baa3 rating on review for possible downgrade.  On the flip side, Moody’s upgraded India from Baa3 to Baa2 with stable outlook and moved the outlook on Russia’s Ba1 rating from stable to positive.

EM Sovereign Rating Model for Q1 2018

EMERGING MARKETS RATINGS OUTLOOK

Latin America

Brazil’s implied rating was steady at BB+/Ba1/BB+.  Actual BB-/Ba2/BB ratings have modest upgrade potential, but agencies are giving nothing to Brazil until pension reforms are completed.

Chile’s implied rating was steady at BBB+/Baa1/BBB+.  The fall in copper prices has taken a toll and actual ratings of A+/Aa3/A are still facing downgrade risks, as Fitch’s recent downgrade suggests.  Ecuador’s implied rating was steady at BB-/Ba3/BB-, but is still seeing upgrade potential for actual ratings of B-/B3/B.

Colombia’s implied rating fell a notch to BBB-/Baa3/BBB-.  This supports S&P’s recent downgrade to BBB-, and suggests pressure on Moody’s and Fitch’s ratings of Baa2 and BBB, respectively.

Mexico’s implied rating remained steady at BBB/Baa2/BBB.  Actual ratings of BBB+/A3/BBB+ are still facing downgrade risks, and we disagree with Fitch moving the outlook from negative to stable last year.

Peru’s implied rating was steady at BBB+/Baa1/BBB+.  As a major copper exporter, the fall in prices have fed through into weaker fundamentals.  However, the outlook has improved and actual ratings of BBB+/A3/BBB+ appear to be largely on target.

Uruguay’s implied rating was steady at BBB+/Baa1/BBB+ after improving a notch the previous quarter.  This still suggests upgrade potential for actual ratings of BBB/Baa2/BBB-.  On the other hand, Panama’s implied rating fell a notch for the second straight quarter to BBB-/Baa3/BBB-.  This puts it below actual ratings of BBB/Baa2/BBB and suggests growing downgrade risks.

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 deepening social upheaval.

Asia

China’s implied rating was steady at A+/A1/A+.  S&P’s downgrade last year to A+ moves it into line with our model, as well as with Moody’s and Fitch.

Hong Kong’s implied rating was steady at AA/Aa2/AA.  S&P’s recent downgrade to AA+ brings it closer to our model.  Singapore and Taiwan saw fairly steady scores, with the latter still facing modest downgrade risks.

India’s implied rating fell a notch to BBB/Baa2/BBB, giving back last quarter’s improvement.  Several quarters ago, India was facing downgrade risks to its BBB-/Baa2/BBB- ratings.  Now, we are still seeing some modest upgrade potential.

Indonesia’s implied rating rose a notch to BBB+/Baa1/BBB+.  Actual ratings of BBB-/Baa3/BBB are still enjoying some upgrade potential.

Korea’s implied rating was steady at AA-/Aa3/AA-.  As such, Korea still faces some downgrade risks to S&P’s AA and Moody’s Aa2 ratings.  Fitch’s AA- appears to be on target.

Malaysia’s implied rating was steady at BBB+/Baa1/BBB+.  As such, modest downgrade risks to actual ratings of A-/A3/A- remain on the table.  Thailand’s implied rating was steady at BBB+/Baa1/BBB+, in line with actual ratings.

The Philippines’ implied rating was steady at BBB+/Baa1/BBB+.  There is still some modest 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 Duterte government.

EMEA

The Czech Republic’s implied rating was steady at A+/A1/A+ after falling a notch last quarter.  We no longer see much upgrade potential for its A1 and A+ ratings from Moody’s and Fitch, respectively.

Hungary’s implied rating was steady at BBB-/Baa3/BBB-.  This matches its actual ratings, and suggests upgrades are not justified for now.

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+ was just the first of several to come.

Russia’s implied rating was steady at BBB-/Baa3/BBB-.  S&P’s and Moody’s ratings of BB+ and Ba1, respectively, appear to still have some upgrade potential.  Fitch’s investment grade BBB- rating now seems to be correct.

South Africa’s implied rating rose a notch to BB/Ba2/BB, reversing last quarter’s drop.  Still, we believe Moody’s and Fitch’s ratings of Baa3 and BB+, respectively, are seeing continued downgrade risk.  The loss of investment grade from Moody’s seems likely soon.

Turkey’s implied rating fell a notch to B/B2/B after remaining steady last quarter after two straight quarters of decline.  We think Turkey faces even greater downgrade risks to its BB/Ba1/BB+ ratings.

Qatar’s implied rating fell two notches for the second straight quarter to BBB-/Baa3/BBB-, and faces even stronger downgrade risks to actual ratings of AA-/Aa3/AA-.  The UAE’s implied rating was steady at A-/A3/A-, which still suggests strong downgrade risk to its lone Aa2 rating from Moody’s.

Elsewhere, Egypt’s implied rating was steady at B+/B1/B+.  Actual ratings of B-/B3/B are enjoying some upgrade potential.  Israel’s implied rating fell a notch to A+/A1/A+, putting it right at actual ratings.  Morocco’s implied rating was steady at BBB+/Baa1/BBB+ after rising a notch last quarter.  Upgrade potential to actual ratings of BBB-/Ba1/BBB- remains in play.

CONCLUSIONS

The heavy weighting of negative moves in EM in recent years seemed to ease as we moved through 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.