Europe long ago lost its ability to drive global economic growth, but it is threatening to put on the brakes.
The euro zone’s long-running debt crisis continues to weigh on the region’s credit rating, and those of the bloc’s major trading partners. Western Europe’s rating falls by 1.8 points in Institutional Investor’s latest Country Credit survey, and the average global rating declines by a similar amount from the level that prevailed in September.
“Overall, sovereign balance sheets are still in pretty bad disrepair,” says Carl Ross, a managing director for investments at Oppenheimer & Co. in Atlanta, “and while there has been a lot of talk, there has not been a lot of progress.”
A total of 108 countries see their ratings fall by 1 point or more, the amount considered statistically significant, while only 22 countries rise by that amount. The current average global rating of 44.1 is the same as it was in September 2005, and well below the recent high of 47.0 reached in September 2008. (Countries are rated on a scale of 0 to 100.)
Western Europe’s debt woes torpedo ratings in neighboring Eastern Europe, and Africa and Asia suffer significant declines. Average ratings in the Middle East fall for different reasons, mostly geopolitical ones, and Latin America also declines, on balance — but the few solid gains in the ranking are concentrated in those two regions. The two drivers of the global economy, China and the U.S., also decline, although by less-than-average amounts.
Although country risk raters responded to the latest survey before European governments and the International Monetary Fund agreed to a fresh €130 billion ($170 billion) bailout for Greece late last month, that development did little to lift hopes for the country and the euro area. Doubts persist about Athens’s ability to meet the budget targets in the rescue program and avoid a default (Standard & Poor’s Corp. declared Greece to be in selective default late last month). The crisis continues to exert a heavy economic toll. Greek output plunged by 6.8 percent in 2011, aggravating the country’s debt burden. Much of the euro zone economy shifted into reverse in the fourth quarter, and the IMF and many private forecasters are predicting a technical recession for much of the region this year.
After three years of dithering, the conversation about Europe is moving from learned explanations about why the currency union cannot be dissolved to musings about how a country could exit the euro. “Maybe we won’t end up with 17 countries in our currency union,” says Annette Cappelmann, an economist at Landesbank Berlin.
Greece falls another 7.6 points, to 19.6. That’s the second-largest decline in the ranking — Cyprus drops 7.8 points, clearly buffeted by its neighbor’s economic troubles, and Laos tumbles by 7.6 points. Greece now ranks in 151st place in the survey, just below Malawi and East Timor. It stood at No. 27 in March 2007.
Other European countries caught up in the debt crisis also experience large declines, with Italy plummeting by 5.9 points, Portugal tumbling 3.4 points and Spain dropping 2.6 points. What used to be described as a problem of the periphery has infected the euro area’s heartland, as evidenced by S&P’s move in January to downgrade nine European countries along with the bloc’s rescue vehicle, the European Financial Stability Facility. France, which lost its triple-A rating from S&P, falls 2.7 points; while Germany, the euro area’s strongest economy and ultimate credit backstop, drops by 2.8 points.
The overall rating for Western Europe falls to 76.1. That’s 14.9 points below where it stood five years ago. The region used to rank neck-and-neck with North America; now it stands 15.1 points below North America’s 91.2, and also lags the 84.0 average rating tallied by the half-dozen most industrialized countries in the Asia-Pacific region.
The survey does offer two hopeful signs in Western Europe. Ireland climbs 2.9 points and Iceland moves up 0.6 point, suggesting that both economies are on the mend and that markets can forgive. The countries now rank 68th and 71st, respectively, on the list. Contrarian investors like Franklin Templeton Investment’s Michael Hasenstab — who manages the Templeton Global Bond Fund — have reportedly been snapping up Irish debt, which has risen more than 35 percent since the middle of last year. As for Iceland, whose 7.7 point climb over the past year is the largest gain of any country, “they still have debt problems, but the economy is more or less doing all right,” says Cappelmann. “They have adapted very quickly, which Greece has not been able to do.”
Still, there is growing concern that Europe’s fundamental problems are self-reinforcing. Portugal, which has embraced austerity, is seeing its debt-to-GDP ratio worsen because the economy is shrinking faster than its stock of debt.
The debt crisis is also forcing European banks to deleverage, notwithstanding the massive supply of cheap credit that the European Central Bank is pumping into the sector, analysts note. A number of multinational corporations are said to be turning to global banks based in North America and Asia, believing those institutions will be more willing and able to accommodate their needs. “We see home country bias,” says one credit analyst at a U.S. asset manager. European banks “would rather sell their best assets in Brazil and keep their worst assets in Europe.” The region needs a vigorous banking system to buy its government bonds, to finance its private sector growth and to generate overseas earnings for the service-oriented Western European economy.
When asked which of the 179 countries in the survey are likely to exhibit higher credit risk in the next 12 months, survey participants name European countries as the top five: Italy, Greece, Portugal, Spain and France. Some 51.6 percent of respondents think Italy will exhibit higher risk, while 38.7 percent say the same for Greece, Portugal and Spain.
Participants also signal little confidence in the latest bailout program. Fully 95 percent of respondents said Greece is “likely” or “highly likely” to default on its debts over the next two years. The comparable numbers are 49.2 percent for Portugal, 27.3 percent for Hungary, 22.4 percent for Ireland and 19 percent for Italy.
Western Europe’s difficulties have reverberated through the economies of Eastern Europe and Central Asia. The region’s average rating is down 2.3 points, the largest decline of any region in the survey. Notable decliners include Romania (–3.8 points), Slovenia (–2.9 points), Czech Republic (–2.3 points) and Poland (–1.8 points). Even the Baltics, which had shown strength recently, have reversed course, with Estonia down 3.7 points, Latvia off 1.6 points and Lithuania down 2.7 points. Altogether, 22 countries in the region fall by 1 point or more while only one — mineral-rich Kazakhstan — rises by that amount.
Eastern Europe’s “export markets are highly dependent on the economies on the Western side,” says Christian DiClementi, an associate economist at AllianceBernstein in New York. Oppenheimer’s Ross also points out that Eastern Europeans are heavily indebted to Western European banks, and a banking retrenchment “will affect these countries in terms of massive credit crunches.”
The economic uncertainties are reinforced by concerns about the commitment to democracy in Ukraine (–5.4 points) and Hungary (–5.2 points), whose debt was downgraded to junk status by S&P and Moody’s Investors Service late last year. Russia edges up by 0.4 point, though, despite mass protests in recent weeks against the Putin regime.
Western Europe might not matter so much if the U.S. and China were holding up strongly, but that’s not the case. The U.S. rating falls 1.1 points, even though its economy has shown signs of accelerating growth. The country inches up one place, to 11th, overtaking Denmark. “The U.S. has shown itself to be pretty dysfunctional in terms of the political process,” says one British risk analyst. “The episode we had last year with the debt ceiling and the rating downgrade gave people pause.”
As concerns China, which holds steady in the ranking at No. 23, the long-awaited downturn in its growth rate seems to be at hand, but that may be more of a problem for others than for China itself. “Exports are slowing down considerably,” says John Sharma, an economist at National Australia Bank in Melbourne, “but it has huge foreign exchange reserves, and it can always prime the pump, so that limits the damage.” Signs of slowing Chinese demand are holding back the more industrialized countries in Asia. Japan sees its credit rating fall by 1.9 points, while Taiwan drops 2.9 points. In spite of their wealth in resources, even Australia and New Zealand decline, by 0.9 point and 1.1 points, respectively.
Emerging Asia is hurting even more, with Bangladesh down 3.9 points, the Philippines off 1.5 points and Vietnam losing 3.1 points. “People feel Chinese demand for commodities is softening,” explains David Masse, senior credit analyst at GE Asset Management in Stamford, Connecticut. Flood-battered Thailand falls 1.2 points.
The one bright spot among Asia’s emerging markets is Indonesia, which climbs 1.6 points. The country grew by 6.5 percent last year, foreign direct investment rose 20 percent, and Moody’s and Fitch Ratings both raised Indonesia to investment grade around the turn of the year. “They’ve improved their balances, and the economy is largely domestically focused and not as dependent on trade as some of the other Asian countries,” says NAB’s Sharma.
Latin America offers echoes of Asia’s decline. The region is down 1.6 points overall, as 18 countries drop by 1 point or more, but seven rise. Indeed, much of the limited good news in the ranking is concentrated in this region: Brazil (up 1.4 points), Colombia (2.2 points), Panama (1.7 points), Paraguay (2.2 points) and Peru (1.0 point) show significant gains. “We see a preference for what people call low-beta sovereigns, which are not as volatile and not as connected to Europe, and the largest countries in Latin America fall into that category,” says Masse. Six of the ten largest rating gains over the past year are in Latin or Central American countries, and the region’s aggregate rating is higher now than it was in March 2007. Most notably, Brazil’s rating has risen from 58.2 five years ago to 70.9 this time, which has boosted the country’s standing from 60th to 35th in the ranking.
In contrast to the mixed results in Latin America, Sub-Saharan Africa, whose regional rating falls 1.6 points, offers an undiluted expression of global stagnation. While 29 of the 49 countries in that region fall by 1 point or more, only one rises by more than 1 point: Tiny Eritrea is up 2.3 points, but it’s not exactly a bellwether. All of the major countries drop, some by a lot: South Africa is down 5.4 points, Gabon, 6.6 points; Nigeria, 5.2 points; Angola, 4.5 points; and Ethiopia, 3.6 points. Economists have specific political concerns about several countries, particularly South Africa and Nigeria, but all the heady talk about the benefits of political reform and tide of Chinese investments has been supplanted by flat demand for Africa’s commodities.
Only the Middle East is driven by a truly different dynamic. The region’s rating falls only 0.6 point. While eight of the 19 countries fall by more than 1 point, seven rise by at least that much. The reasons for these patterns “are obvious,” says DiClementi of AllianceBernstein: The gainers are oil producers, such as Qatar (up 2.3 points), United Arab Emirates (2.7 points), and Kuwait and Oman (1.0 point each). The losers are at the center of the Arab Spring. The biggest country faces the biggest question marks: Egypt is down 6.0 points. Other focal points of political uncertainty also fall, including Bahrain (–1.9 points), Iran (–2.2 points), Lebanon (–3.2 points), Morocco (–1.4 points), Syria (–2.5 points) and Tunisia (–2.0 points).
When asked which countries are most likely to experience regime change over the next couple of years, economists put Syria first, with 95.5 percent saying it is “somewhat” or “highly” likely, followed by Yemen (89.1 percent), Lebanon (67.4 percent), Iran (64.6 percent) and Algeria (56.8 percent). Some 62.8 percent of respondents see regime change as a positive for the creditworthiness of Syria and 60.5 percent for Libya. For most other Middle Eastern countries, opinion is sharply split over whether regime change would be a positive or negative.
The preoccupation with Europe looks likely to continue, even if some analysts take heart from recent efforts to contain the debt crisis. “It will take another year, but things are getting better,” says Landesbank Berlin’s Cappelmann. “There are some exceptions, like Greece, but we are quite optimistic concerning the rest, and we have already seen quite a bit of progress.”
For Oppenheimer’s Ross, however, talk of an end to the crisis — even the beginning of the end — is premature. Invoking a baseball metaphor, he says, “I don’t feel like we’re in the eighth or ninth inning. It feels more like the fourth or fifth.” • •
