How do you know when you’re turning a corner in life? You look for signs of improved or stable health such as blood pressure, and pulse check. In the world of country risk, the short-term outlook is also about checking vital signs with high-frequency data.
In these exceptional times, the key indicator has been the number of new COVID-19 cases. As the pandemic has gone on, so has the shape of recovery. The risk rating that’s most responsive to these weekly or monthly movements is Export Development Canada’s Economics’ short-term commercial risk rating, which measures the one-year average commercial default rate in a country. The model looks at variables such as gross domestic product (GDP) per capita, movements in exchange rates and inflation, among others. So, what has the data shown?
Despite growing concerns of rising inflation at the halfway point of this year, seven markets have been upgraded versus only one downgrade. Not surprisingly, developed markets in Europe, Asia and the United States dominated the upgrades, as their economies are leading the global economic recovery. Canadian exporters are also seeing this play out—EDC’s June Trade Confidence Index (TCI) rebounded to its highest level in 20 years.
Despite this welcome optimism after such a challenging period, the economic recovery will be uneven, with many emerging markets facing vaccine shortages, high public debt, and the risk of capital outflows, when the U.S. Federal Reserve and other central banks begin tightening. The global recovery is, therefore, following a K-shaped recovery, with the poorest countries expected to grow slower than rich ones for only the third time in 25 years.
For those looking beyond the short term, what impact has the last year-and-a-half had on medium- and long-term sovereign risk ratings? Here, there are also signs that downgrades may have bottomed out. After a year of downgrades across the world, led by countries dependent on energy exports and tourism, there have only been 15 sovereign rating downgrades so far this year, versus 78 for all of 2020. Some notable downgrades include Indonesia, Guyana, Ghana and Kenya.
For many governments, the path back to a pre-pandemic, healthy balance sheet will be steep and take time. Total emerging market public debt increased by 15% since the end of 2019, and now exceeds 250% of GDP. The World Bank estimates that two-thirds of emerging markets won’t have recovered per capita income lost by 2022. For emerging markets that rely on portfolio flows to fund their fiscal deficits, there’s a risk of foreign capital outflows as credit conditions tighten. The taper tantrums of 2013 are raised as a cautionary tale. Finally, going forward, servicing their now larger stock of debt may become more expensive, as interest rates start to climb. Since the pandemic began in March 2020, emerging markets have issued more than US$130 billion in sovereign bonds.
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While the dual shocks of COVID-19 and low oil prices are temporary, it’ll likely take years for many sovereigns to regain their pre-pandemic credit ratings. Strong support by multilaterals, like the International Monetary Fund (IMF), and bilateral debt service relief by official creditors have helped address liquidity needs for poorer countries, thereby, significantly limiting the number of sovereign defaults to a handful last year (none in 2021 to date).
The peril that saw the biggest change so far this year was political violence, with 19 downgrades of EDC Economics’ political violence rating. Aside from being concentrated in the Africa/Middle East region, there’s no one unifying factor that drove the downgrades. Over the past quarter, we’ve seen tensions rise in the Taiwan Strait, a civil war erupt in Ethiopia and domestic political unrest in Cuba. EDC Economics’ ratings have five-year outlooks, but these events speak to longer-term structural challenges that preceded COVID-19 or the recent spike in food prices.
Recent think-tank studies show that perceptions of ineffective governance and corruption have increased the rate of social protests over the past few decades and that slowing economic growth, worsening effects of climate change and income inequality are additional factors.
The bottom line
Whether analyzing the short-term risk of non-payment or medium- and long-term sovereign risk, through the first two quarters of 2021, the movement in ratings indicates that the negative slide of the pandemic may be behind us. But there remain several key risks to watch for in the months to come, particularly for emerging markets. Keep abreast of country risk events with EDC’s Country Risk Quarterly.
This commentary is presented for informational purposes only. It’s not intended to be a comprehensive or detailed statement on any subject and no representations or warranties, express or implied, are made as to its accuracy, timeliness or completeness. Nothing in this commentary is intended to provide financial, legal, accounting or tax advice nor should it be relied upon. EDC nor the author is liable whatsoever for any loss or damage caused by, or resulting from, any use of or any inaccuracies, errors or omissions in the information provided.