Sovereign creditworthiness has risen modestly, and there’s much to be modest about.
Consider the economy. Stanley Fischer, the vice chair of the U.S. Federal Reserve Board, noted in a recent speech in Stockholm that economic activity around the world has been “disappointing.” As he pointed out, again and again economists and policymakers “have had to explain from midyear on why the global growth rate has been lower than predicted as little as two quarters back.”
That pattern seems likely to persist, many analysts say. “I can’t look anywhere and say they are a shoo-in for growth and prosperity,” says Jon Alterman, senior vice president and Zbigniew Brzezinski Chair in Global Security and Geostrategy at the Center for Strategic and International Studies in Washington. “It feels like countries are poised for growth, but I don’t see anybody for whom it’s guaranteed or strongly likely.”
That tepid outlook is reflected in our latest Country Credit survey, Institutional Investor’s exclusive semiannual ranking of global creditworthiness. The average sovereign credit rating edges up to 44.8 on a scale of zero to 100, according to economists and risk analysts surveyed, up 0.6 points over the past six months and up just 0.2 points from a year earlier.
The U.S. economy is “finally gaining traction,” says David Dollar, a senior fellow at the Brookings Institution in Washington and former U.S. Treasury official. But, he adds, “things have only improved a little bit in Europe and Japan, and the developing world is a mixed bag. You can see why survey participants are not excited.”
Indeed, just as the U.S. growth rate seemed to be accelerating smartly this summer, news came from Europe that Germany’s growth had stalled in the second quarter and Italy had slipped back into recession. China, which has increasingly played the role of global locomotive in recent years, “has reached the middle-income country stage, where you can’t grow at 10 percent — no one has ever done that,” says Dollar. So 7 percent is the new 10 percent.
The economy isn’t the only drag on ratings. Geopolitical developments have put a notable damper on the outlook in some regions.
In Eastern Europe, President Vladimir Putin seems intent on expanding Russia’s influence, judging by the country’s annexation of Crimea and its support for separatists in eastern Ukraine. Many analysts fear a decline in trade and investment in the region, as the European Union and the U.S. have imposed economic sanctions on Russia, drawing retaliation from the Kremlin reminiscent of the tit-for-tat exchanges of the cold war.
In the Middle East the perpetual Israeli-Palestinian conflict has heated up, and much of the rest of the region is, often literally, aflame, with the forces of the Islamic State of Iraq and Syria spreading terror in both countries and beyond. The tensions hadn’t led to an oil price spike as of August, but Alterman worries about “the resurgence of terrorist threats in the West as jihadists in Syria and Iraq go back to their countries of origin.”
In Asia, China has been flexing its political muscles, leading to shadow boxing with Japan, the Philippines and Vietnam, among others, as it seeks to define its geopolitical role.
All of these tensions have combined to hold back improvements in creditworthiness in many parts of the globe even as concerns about outright economic disasters in Western Europe and elsewhere have eased.
A few countries post strong gains. Myanmar’s rating jumps 8.5 points, the second-biggest increase in the survey and a sharp turnabout from its 7.6-point drop in March. The rise reflects growing faith that the country will surmount its ethnic tensions and remain the poster child for foreign investment. Elsewhere, however, rating gains are numerous but mostly small.
The U.S.’s rating rises 1.4 points, to 93.0, pushing the country up one place in the ranking, to sixth. Many respondents agree that U.S. economic growth is gathering strength. Asked when the Federal Reserve and its chair, Janet Yellen, will make the first rate hike — presumably signalling vibrant growth — 32.1 percent of respondents say the tightening will happen during the first half of 2015 and 49.4 percent pick the second half. Six months ago the comparable figures were 25.5 percent and 34.0 percent, respectively.
Nonetheless, the political stalemate between the Obama administration and the Republican-controlled House of Representatives remains unresolved, says Matthias Kreie, a country analyst at Nord/LB in Hannover, Germany. Although the U.S. fiscal situation has improved greatly, he adds, “the U.S. would not meet the criteria to join the EU.”
There are small rating increases all around in Western Europe, with countries once deemed the most troubled scoring the biggest gains. Greece rises 8.1 points, the fourth-largest gain in the survey, and sizable improvements are posted by Portugal (up 4.8 points), Spain (+4.4), Ireland (+3.5) and Italy (+1.9). The survey was conducted before the collapse of Portugal’s Banco Espírito Santo in August.
These hikes do not necessarily reflect greater confidence in their economic fundamentals, notes Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott in Philadelphia. Greece, for example, has “been out of the headlines long enough so there is a little more confidence,” he says. “Its debt problems have been addressed with restructuring; addressed, but not resolved.”
The EU remains buoyed by the magic words of European Central Bank president Mario Draghi, who promised two years ago to “do whatever it takes” to save the euro. “When people see that the worst didn’t happen, they feel more confident,” says Nord/LB’s Kreie. When respondents were asked which countries were most likely to exhibit lower credit risk in six months, eight of the top 15 were in Western Europe, the same number as in March. Only two European countries — France and Italy — were in the top 15 of those expected to display higher credit risk, compared with five in the previous survey.
Western Europe’s rating comeback has a significant impact on Eastern Europe. Of course, Russia and Ukraine are down, with the former shedding 3.6 points and dropping nine places, to 47th; the latter falls 2.8 points and drops 15 places, to No. 122. But the Baltic states had a dramatic recovery, with Latvia up 8.4 points, Lithuania rising 4.9 points and Estonia gaining 1.4 points. Still, one British bank economist says, “there is one thing I see as quite critical — their trading ties with Russia.” An East-West trade freeze may catch them in the middle.
In Asia, China’s rating is unchanged, a rarity among major countries. China also has the distinction of being among the top dozen on the lists of both the countries expected to have higher ratings in six months and those expected to have lower ratings. It seems that the hard- and soft-landing camps are evenly balanced.
In any case, China is doing well enough to boost its industrialized neighbors. There are significant gains for Australia (up 1.4 points) and New Zealand (+1.7), as well as Singapore (+1.9) and South Korea (+1.2). “They are pretty heavily dependent on China,” says Dollar, who observes that a giant neighbor growing at a 7 percent pace is still a valuable trading partner. Besides, he adds, “these countries are all well-managed places.” Dollar attributes the increases in Japan (+1.7) and India (+3.4) to faith in government policies, although in the case of India, Dollar says, the new regime of Prime Minister Narendra Modi hasn’t done much so far: “Where’s the beef?”
Overall, the emerging markets of Asia, Latin America and Africa present a mixed bag, with local factors moving some countries up or down, whereas the slow pace of global growth holds back the ratings of many others.
Indeed, there is a growing debate among economists and policymakers as to whether the recent modest pace of economic expansion is a temporary phenomenon or reflects a more fundamental shift to lower growth rates. This kind of “secular stagnation” is a new buzzword among economists.
Many of the signposts are ambiguous. In the U.S., for example, merger and acquisition activity has picked up dramatically. Oleg Melentyev, a credit strategist at Deutsche Bank, argues that M&A waves occur when the economy is moving into its next stage of expansion. But others contend that M&A is just proof that companies can’t find attractive uses for their capital, so they’re buying one another.
Even if the pessimists are wrong, says Martin Barnes, chief economist at BCA Research in Montreal, there’s growing sympathy for the secular stagnation view: “Maybe the global growth rate will be more like 2 percent, not 3,” he says. “It doesn’t sound like a huge difference, but a half a percent, compounded over the years, is quite a lot.” Barnes adds that “the fact that bond yields have been so low — and drifting lower — is one indication that financial markets are telling us that there’s a growth problem.”
But Laura Sarlo, a senior sovereign credit analyst at Loomis, Sayles & Co. in Boston, says it’s not simply a question of high or low growth so much as changing sources. She notes the dismal underlying demographics in the Group of Ten countries — aging and declining populations mean smaller labor forces — and worries about whether they “can be sufficiently offset to ensure stable or high potential growth rates.” The emerging markets, on the other hand, are full of young people, one reason Sarlo says “the relative drivers of global growth are changing steadily over time.”
Besides their growing labor forces, Sarlo says, another reason the ratings of some emerging markets could fare well in the near term is that “the process of less accommodative monetary policy — which we seem to be edging toward — means that emerging markets with better policies and who have used this period of low interest rates effectively will probably fare better. But it will be more of a country-picking kind of world.”
For the industrialized countries, too, it will be a country-picking kind of world, because five-plus years after the Great Recession, as Barnes says, “the world remains a dodgy place.” • •
