What a difference a few months makes.
In the summer, Export Development Canada’s Economics team noted that the global economy was in full—if uneven—recovery mode. But the growing gap between advanced and developing countries, reflected in the latest Global Economic Outlook, is becoming ever clearer this quarter.
Despite concerns over inflation, continued supply chain and labour constraints, and an energy crunch hitting much of Asia and Europe, EDC Economics short-term commercial ratings appear to have bottomed out and are on the rise. This is happening almost exclusively in wealthier economies, which have benefited from both massive government fiscal and monetary stimulus during the pandemic, as well as higher vaccination rates.
Of course, some perspective is needed here. Even as several markets were upgraded so far this year, there’s a long way to go to make up for the downgrades we saw during the height of the pandemic period of 2020. While the next year or two look brighter for corporations, it likely won’t be a linear rise. As governments start to slowly withdraw stimulus from the economy, a wave of bankruptcies is possible. Those at greater risk include sectors and countries that went into the crisis with more leverage or built up more leverage during that time.
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If the trend for short-term risk has been positive, what is the country risk outlook for the medium- to long-term? After one and a half years of soaring sovereign debt, we’re now seeing smaller increases. While sovereign risk appears to have plateaued, we’re not fully out of the woods yet. One would have expected to see more sovereign defaults over the pandemic period, but the combination of low interest rates and the suspension of debt service for distressed markets cushioned the blow. Some might still default as interest rates start to rise and bilateral support expires.
With central banks—particularly the U.S. Federal Reserve—likely to start raising rates next year, governments will face higher borrowing costs. Central banks in large emerging markets, like Brazil, Russia and Mexico, have already started to increase rates to put the brakes on inflationary pressures. Unlike the “Taper Tantrum of 2013,” so far this year, capital inflows to emerging markets have remained steady.
One comprehensive indicator to gauge systemic risk is the Emerging Market Bond Spread Index, which is currently close to its 10-year average and significantly lower than at the height of the pandemic in 2020.
All three of the political risks that EDC Economics rates—namely, political violence, expropriation and transfer and conversion—showed more upgrades than downgrades last quarter. The improvements were led by upgrades in transfer and conversion risk, which assesses the risk that an obligor may be unable to convert local currency into foreign exchange and transfer it out of a given country. Emerging markets led the way, in particular the Gulf countries, which largely benefited from the higher oil price outlook. Again, context is important here: Since COVID-19 began, the ratio of downgrades to upgrades of political risks is approximately 3:1, so the return to normal will take time.
While political violence also saw slightly more upgrades than downgrades due to country specific dynamics, the overall trend remains of growing unrest. According to the Institute for Economics and Peace, prior to the pandemic, big protest movements had been increasing around the world, growing 2.5 times between 2011 and 2019. The drivers of political violence such as income inequality, government ineffectiveness and state-led repression have only been heightened during the pandemic. Discontent has been brewing particularly in middle-income countries such as Brazil and Thailand where mismanagement of the pandemic has been highest.
The bottom line?
While still facing considerable downside risks, which are increasingly interconnected, the global recovery picture is becoming clearer. After an extended period of downgrades due to the COVID-19 shock, our rating changes over the past quarter indicate that country risk has bottomed out and is on the mend. While this is good news, if we remove our COVID-19-induced gloomy glasses, we can see that many countries are more vulnerable than they were two years ago.
Check out EDC Economics Country Risk Quarterly to stay up-to-date on the latest developments across the markets that most interest you.