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ON THE LEFT: Global recovery still vulnerable


ON THE LEFT: Global recovery still vulnerable

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OUR OUTLOOK for sovereign credit worthiness in 2016 is stable overall, supported by a shallow economic recovery. We see little likelihood of a widespread upward shift in sovereign ratings in 2016.

However, two broad types of risks could undermine sovereign credit quality. A sharper than expected slow down in global growth, linked to the slowdown among the previous engines of growth, particularly in Asia, in the context of reduced global trade and the commodity price shock. And the ability to achieve reform targets, and to instill confidence amongst investors that those targets will be achieved will determine which sovereigns are most exposed to those broader threats.

Over the course of 2015, roughly a quarter of rated sovereigns have experienced some form of rating action, with 41 actions to the ratings and/or outlooks of the 129 sovereigns we rate. Western Europe (including all euro area member states) has seen the greatest activity. The actions taken in 2015 have been biased to the downside, with 15 positive actions and 26 negative ones. The pattern has differed somewhat between regions, with the small number of actions in Asia Pacific mostly positive, those in Sub-Saharan Africa and the Commonwealth of Independent States (CIS) negative, and those elsewhere broadly balanced.

As a result of these actions, 75 per cent (97/129) of rated sovereigns now carry a stable outlook, a slight decline from almost 80 per cent towards the end of 2014. At the same time, the proportion of sovereigns with negative outlook has increased to 17 per cent (22/129), up from 13 per cent this time last year. Only eight per cent (10/129) of sovereigns have positive outlooks, almost level with last year’s seven per cent. The overall picture is consistent with our forecast 12 months ago of a continued albeit halting global recovery that is vulnerable to shocks.

Looking ahead to 2016, our credit outlook for global sovereigns is stable overall, but risks are tilted to the downside. Looking at whether sovereigns’ rating trajectories are upwards or downwards, we see no clear balance one way or the other – except perhaps in the CIS, which has experienced more negative rating actions than any other region. However, if we look beyond our base case, negative scenarios are more likely to materialise than positive ones: the risk distribution is balanced to the downside and we see more scope for negative surprises than for positive ones.

This somewhat more pessimistic view is consistent with the slightly lower proportion of sovereigns that have a stable outlook (75 per cent) going into 2016, compared with almost 80 per cent towards the end of last year, and with the larger share of negative outlooks than a year ago. Not all sovereigns’ credit profiles are vulnerable to a slowdown in global growth and worsening terms of trade. Those with more diverse economies that generate above peer growth and are able to recover quickly, and those that have or are making durable improvements to their balance sheets retain the policy space to manage a period of weaker growth and revenue inflows without material damage to public sector balance sheets.

Falling demand for Latin America’s commodities exports and lower foreign direct investment (though not from China) in the region’s dominant extractive industries have undermined growth prospects. As elsewhere, the credit impact depends on economic diversity, institutional capacity and the strength of each government’s balance sheet. However, we expect fiscal and external buffers to allow Latin America sovereigns to weather the storm.