Before fully shifting focus to 2019, let’s take stock of the last twelve months: its ups and downs, and how EDC Economics sees the past year’s events affecting 2019.
2018 saw several key events that shifted country risk globally and EDC Economics’ country risk ratings moved with this tide. The Country Risk Quarterly covers 100 countries, with each country being assigned six risk ratings measuring different risks affecting business. Last year was marked by a divergence; developed markets gained steam while emerging markets felt the pinch. And, around the world, political headwinds resulted in some unexpected turbulence. Specifically, a strengthening United States economy, increasing interest rates shifting financial flows and rising political polarization were key themes this past year and we will continue to see the impacts flow into the next twelve months.
In terms of risk rating changes, unlike a balanced 2017, 2018 was weighted on the downside. Despite a growing global economy, EDC country risk ratings experienced over 60% more downgrades than upgrades, with almost all occurring in emerging markets. Let’s breakdown those movements and tease out some key trends to keep an eye on going in to 2019.
Let’s start with the Americas. While the regional economic trend somewhat improved relative to the year before, the majority of the 21 rating movements in 2018 were downgrades. Specifically, three downgrades to the sovereign’s probability of default, three to expropriation and government intervention and two downgrades to our political violence rating. What led to these changes? Many of them were driven by the more fleshed out impacts from multiple years of weak economic activity, falling international investment and inability to economically diversify, particularly for the Caribbean. Persistently weak socioeconomic conditions and an uptick in corruption allegations dragged down our expropriation and government interference and political violence ratings. In Venezuela, local conditions have created a migrant crisis. Regionally, countries receiving the millions of migrants are straining financially to assist particularly as they attempt fiscal austerity. Guatemala is following in Brazil’s footsteps and is facing its own corruption crisis. Ongoing investigations into key political players throughout the region drive up political risks. Moving forward, modest economic activity and higher costs of capital will strain several government’s coffers, particularly as policy making faces increased political division in several countries including Brazil and Mexico.
Across the Atlantic, Emerging Europe is riding a wave of economic optimism, leading rating upgrades to outnumber downgrades. Several European countries continued to reap the benefits of a growing Euro Area resulting in sovereign rating upgrades for Poland, Portugal, Slovenia and Uzbekistan. Concurrently, recovering economic activity is improving a number of key external metrics and in turn reducing transfer and conversion risk, namely in Albania, Montenegro and Uzbekistan. Darkening the outlook heading into 2019 is the swell in populism which has given rise to BREXIT, anti-EU and anti-globalization sentiments. These views are likely to be a factor in upcoming European Parliament elections in May of this year. Turkey experienced one of the swiftest currency crises since the Great Recession – the first of major emerging market currency depreciations – leading to two risk rating downgrades in the country (sovereign probability of default and transfer and conversion). Although conditions are improving, emerging markets will continue to face an uphill battle, particularly those dependent on foreign capital. Economically, we are likely to continue seeing market optimism but in an environment of rising political risk, we shouldn’t underestimate the potential impact on the region.
Moving south to the Middle East and Africa, economic and political turmoil continued to weigh down country ratings, resulting in 28 downgrades. Of importance, the region was hit with seven downgrades to our best commercial risk rating, five to sovereign probability of default and six to expropriation and government interference. Persistent political and inter-regional tensions, rising insecurity and comparatively weaker commodity prices drove a year of downside risks. Bahrain and Iran continue to be dragged down by low oil prices while Ethiopia’s dependence on agriculture has driven external borrowing to high levels and increased its risk of sovereign default. Like the Americas, worsening our political violence ratings are continued socioeconomic vulnerabilities that were not helped by at times violent elections. Governments in an increasing number of countries are feeling the electorate’s discontent, including in South Africa and Guinea. EDC’s Global Economic Outlook expects crude oil prices to average around $63/bbl in 2019, significantly below the commodity boom highs. To watch in 2019 is the impact on the region of modest commodity prices combined with rising cost of capital on public finances and debt sustainability risks.
On to Asia. After Europe, the region had the most upgrades, a total of 10, but were almost equally matched by eight downgrades. Sovereign probability of default in Indonesia and Malaysia experienced a worsening risk outlook. For both countries, this was partially driven by high external debt in an environment of rising interest rates. Additionally, Malaysia went through a political transition that exposed fraudulently underreported debts. Both transfer and conversion and political violence risks have improved in most of the region with a few notable exceptions. Pakistan faced significant cash shortages, forcing a scramble to garner financial support from key allies. Myanmar saw a rise in political violence risks as domestic tensions turned violent, particularly affecting the country’s Rohingya minority. Overall, the region is expected to see a mixture of strong economic growth, particularly in India, leading to improved economic conditions. However, governments will face tighter credit access and may start to feel the backlash from global trade tensions.
2018 was a year of divergence but there were key themes. Continuing from 2017, weak commodity prices and political turmoil made their presence felt in 2018. Emerging markets in particular bore the brunt of the downward pressure, and in some cases, demonstrated the fundamental financial fragility they face. Developed markets didn’t get off scot free, however, as a growing number of them face rising political discontent and populism. What can we say for 2019? Emerging markets will feel the pinch of reduced financial and investment flows while developed markets continue their upward economic trend. But, political risks will be central to country risk stability this year. Keep a close eye on populism and protectionism; some countries will be able to withstand the tension much better than others and it will likely be those that benefit from domestic political stability.
Average default rate on credit commitments of 1 year or less on the part of commercial obligors in a country.
Commercial Country Ceiling
The Commercial Country Ceiling (CCC) is meant to represent the best possible rating that can be assigned to commercial obligors domiciled in a country. The CCC is impacted by the Sovereign Probability of Default, political risks (transfer and inconvertibility, political violence, expropriation) and other mitigating or exacerbating factors.
The likelihood over the medium- to long-term of government action (e.g. outright seizure of an asset/invest- ment or less pronounced interference such as unjustified non-renewal of required permits or licenses) or weak governance conditions (e.g. a weak rule of law or high levels of corruption) having a significant impact on a country’s commercial environment.
Transfer and conversion
The likelihood, over the medium- to long-term, of a government imposing conversion or transfer restrictions that significantly effects the commercial environment. Conversion restrictions could include measures that prevent companies from converting local currency to hard currency, while transfer restrictions would be measures that inhibit the transfer of said hard currency out of the host country by legal means.
The likelihood, over the medium- to long-term, of an act of political violence occurring in a country that significantly impacts the country’s commercial environment. Political violence events can include: acts of war (declared or undeclared), insurrection, revolution, rebellion, riot, terrorism, sabotage, civil disturbance, or other such violent acts that are politically motivated.
Sovereign Probability of Default
The Sovereign Probability of Default (SPD) measures the ability and willingness of a sovereign to honour its financial obligations over the medium-long term.