A welter of sovereign downgrades reached record levels in the second quarter of 2016. But early signs of rating downgrade abatement in the third quarter of 2016 suggest the worst may be over for commodity-related sovereign downgrades.
This is according to the latest Sovereign Risk Review by IHS Markit that compares and assesses every sovereign nation worldwide across ratings agencies and fills in the industry’s long-neglected market space of short-term sovereign credit risk.
Between June and August 2016, sovereign risk rating downgrades exceeded upgrades by 24 to 16. Africa again had the most downgrades while Turkey and Mongolia also became downgrade hot spots.
“For Turkey, the main concern raters have is with the weakening of institutions and the rule of law in the post-coup purge,” says Jan Randolph, director of sovereign risk at IHS Global Insight. “The purge removed several thousand technocrats from government institutions and court systems. Replacing this number of civil servants with qualified employees will be a nearly impossible task.”
Mongolia, once the darling of inward investors in emerging markets, is one of the worst hit by the commodities downturn. “With still weak global demand for commodities, especially from neighbouring China, strained relations with investors, and large debt repayments due during the next few years, Mongolia finds itself in a very difficult situation.”
Ratings trends to watch in 2017 include:
* Brexit: The two major EU powers, Germany and France, have made it repeatedly clear that free movement of people is indivisible with the free movement of goods, capital and services in the single market. Any loss of UK access to the EU’s core single markets (that is, a ‘hard BREXIT’) could materially undermine the UK’s medium term growth prospects, add pressure to UK fiscal account and ultimately lead the UK sovereign downgrade.
* Finally, some good news for Russia, Brazil and South Africa: The commodity price drop has taken its toll on a number of countries. Russia, Brazil and South Africa are likely to return to some very modest growth in 2017 after a few years of negative or low growth.
“These three countries adopted relatively early and painful remedial policy measures to protect their bottom line in foreign exchange reserves,” Randolph says. “Between these reforms and the stabilised commodity prices, we are likely to finally see some very modest growth for Russia, Brazil and South Africa in 2017.”
For other energy and commodity exporters, times are more uncertain and difficult, according to the IHS Global Insight report. “For Nigeria and Angola, much will depend on how efficiently they implement painful, yet necessary, remedial policy measures against the external adjustment in an era of lower oil for longer,” Randolph says.
* New debt to be norm in Gulf Cooperation Council (GCC): Growth in the GCC has been better than others, but financial pressures from lower oil have had an impact. “Fiscal accounts for the GCC have been strained and we are likely to see greater issuance of debt in these countries to fill the deficit gaps emerging,” Randolph says. “Saudi Arabia could see some tumultuous economic policy changes provoked by the lower oil price era and the emerging challenge from renewable energies.”
* Reform, necessary to survive: Many emerging market sovereign ratings have withstood or even benefitted from the commodity crash the last two years. “The emerging markets that succeeded in the past two years were the ones that extracted growth from within,” Randolph said. “In order for others to grow like India and the Philippines, well-designed reform policies will have to be made. However, this again may face political hurdles. Nevertheless, next year may be the year we see reforms and subsequent Cinderella stories.”
