EM Sovereign Rating Model for Q3 2015

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We have produced the following Emerging Markets (EM) ratings model to assess relative sovereign risk. 

INTRODUCTION

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 only two EM rating actions since our last update in May.  S&P moved the outlook on Indonesia’s BB+ rating from stable to positive, and also raised Uruguay’s rating a notch to BBB.  So far this year, there have been 13 actions recorded; 6 were positive and 7 were negative.  However, we note that most of the negative actions have been on Russia (4) and Venezuela (2).  Netting out those 6, then EM rating actions look much better and are tilted much more to the positive side (6-1).

EMERGING MARKETS RATINGS OUTLOOK

Many of the stronger EM credits (mostly in Asia) saw their scores improve or remain steady, and easily maintained their positions this round.  On the other hand, some of the weaker credits saw their scores deteriorate, underscoring what we view as growing divergences within EM.  Many of those seeing the worst deterioration are commodity exporters, as the ongoing drop in prices is weighing on fundamentals.  Our model still suggests some noteworthy misalignments remain in place across EM.

Latin America

Most scores worsened this round.  This was largely due to the commodity-centric nature of the region.

Brazil’s implied rating fell a notch to BB+/Ba1/BB+, and the rating is subject to downgrade risk as the fiscal numbers continue to worsen.  The recent cut in the primary surplus target for this year could be the trigger for a downgrade.  Brazil has been rated investment grade by all three agencies since 2009.

Ecuador’s implied rating fell a notch to B+/B1/B+.  Upgrade potential has evaporated, as our model rating is pretty much at actual ratings of B+/B3/B.

Mexico and Colombia saw their scores worsen, but not by enough to change their implied ratings.  Mexico appears correctly rated by S&P and Fitch at BBB+, while Moody’s seems to have been premature in upgrading it to A3 back in February 2014.  Colombia still has modest upgrade potential, but we suspect this will fade as the economic numbers worsen in H2.

Chile saw a modest improvement in its score, but not by enough to change the implied rating of A/A2/A.  Thus, there are still some downgrade risks for Chile, which we think is rated too high at AA-/Aa3/A+.
Peru’s score was steady and appears correctly to be rated by S&P and Fitch at BBB+.  Here too, Moody’s seems to have been premature in upgrading it to A3 back in July 2014.  Implied ratings for Panama and Uruguay remained steady.

Asia

India continues to see reduced downgrade risk.  Its score improved again, moving it further into BBB-/Baa3/BBB- territory.  This is right at India’s actual ratings.  If the new government can deliver deeper fiscal reforms, we believe that it could move into BBB/Baa2/BBB territory over the next year.

Malaysia saw its implied rating fall a notch to BBB+/Baa1/BBB+, which suggests downgrade risk to actual ratings of A-/A3/A-.  Indeed, we disagreed with Fitch’s recent decision to move the outlook on its A- rating from negative to stable.
Thailand’s implied rating was steady at BBB/Baa2/BBB, but still faces downgrade risks to actual ratings of BBB+/Baa1/BBB+.  Political uncertainty is likely to continue weighing on the economy.

Singapore, Korea, China, and Taiwan all saw steady scores, while Hong Kong’s improved a bit.  Indonesia’s score worsened modestly.  All of these countries appear to be more or less correctly rated.  The Philippines implied rating was steady at A-/A3/A- and still appears to be vastly underrated with actual ratings of BBB/Baa2/BBB-.

EMEA

Russia’s implied rating fell another notch to BB-/Ba3/BB-, and so we see downgrade risks to actual ratings of BB+/Ba1/BBB- that should push it deeper into sub-investment grade territory.   Fitch’s investment grade BBB- rating is clearly too high.  Low oil prices and ongoing sanctions continue to bite.

Turkey’s implied rating was steady at BB/Ba2/BB but continues to face strong downgrade risks to its BB+/Baa3/BBB- ratings.  The investment grade given by Moody’s and Fitch seem premature now, but even S&P’s BB+ rating is subject to downgrade risk.

South Africa’s score improved slightly but its implied rating was steady at BB/Ba2/BB.  We believe actual ratings of BBB-/Baa2/BBB are still subject to strong downgrade risk, and loss of investment grade is a real possibility.

Hungary’s implied rating was steady at BB/Ba2/BB.  It remains right on the cusp of moving into BB+/Ba1/BB+ territory and so we see only very slight downgrade risk to Hungary.  Czech Republic saw its implied rating rise a notch to A+/A1/A+, and appears correctly rated now.

Poland’s score improved again but the implied rating remained steady at BBB+/Baa1/BBB+.  While our model still suggests modest downgrade risks to actual ratings of A-/A2/A-, the S&P decision earlier this year to move the outlook from stable to positive suggests a downgrade is unlikely now.  Furthermore, Poland’s implied rating is right on the cusp of A-/A3/A-.

UAE’s implied rating fell a notch to A/A2/A, and faces stronger downgrade risk to its Aa2 rating from Moody’s.  Elsewhere, Qatar and Israel appear to be more or less correctly rated.

CONCLUSIONS

Downgrades concentrated in Russia and Venezuela so far this year suggest that there are still some idiosyncratic negative risks within EM.  Lower commodity prices are also likely to continue having a negative impact on the commodity exporting countries, while benefiting the importing countries.  As such, 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 to consider.