Plunging stock markets and volatile currencies in January and early February reflected growing fears of a global slowdown, if not outright recession, according to many analysts and investors. Country risk analysts apparently didn’t get the memo. The average rating in Institutional Investor’s latest semiannual Country Credit survey increases by 0.6 point from September, to 44.7 on a scale of zero to 100.
Two main factors drove the increase:
A reassessment of troubled euro zone countries, led by Greece. The beleaguered nation is far from out of the woods, yet Athens did strike a third debt restructuring agreement in August. Its rating jumps 5.6 points, one of the larger gains in this survey, but that is just a fraction of the ground the country has lost over the past six years. Greece vaults 19 places, to 126th place, leaving it sandwiched between Libya and Pakistan. Other peripheral European Union economies post strong gains, including Ireland (+3.4 points), Italy (+1.3) and Spain (+1.0), while non–EU member Iceland gains 3.9 points.
A more generalized round of upgrades for dozens of countries in Latin America, Central Europe and Africa, even though the prices and volume of their commodities exports have faltered. By contrast, among the top 20 countries in the survey, only South Korea posts a gain of more than a point — the amount considered statistically significant — whereas Canada (–1.5) and Finland (–1.7) suffer significant falls. Most other top-ranked countries show relatively little change.
Given the clouds gathering over the global economy, the ratings increases surprise some analysts. “These people sure must have been in a good mood when they were surveyed,” says Vincent Deluard, a Europe strategist at Ned Davis Research, based in Venice, Florida.
In January the World Bank lowered its global growth forecast for 2016, from 3.3 percent to 2.9 percent. The European Commission, the executive arm of the EU, trimmed its projections by a tenth of a point, predicting that the 28-nation bloc would grow by 1.9 percent this year, while the euro zone would expand by 1.7 percent. The European Central Bank cut its key deposit rate further into negative territory in December, even as the U.S. Federal Reserve raised rates off the zero bound for the first time since 2008.
So what explains the broad-based gains in European ratings? “There are some modestly improved economic numbers coming out,” says Victoria Marklew, head of country risk management at the Northern Trust Co. in Chicago. “You’ve had successful internal devaluations in quite a few of these countries. Ireland is out of the woods, there are fundamental improvements in Spain, and even Italy has managed to avoid disaster.” As for Greece, she says the market view is “it has not crashed, so therefore I can stop worrying about it.” But, she adds, that “doesn’t mean it won’t come around again. Markets have just turned to other things.”
A similar phenomenon explains Ukraine’s 1.1 point rise. “It’s slipped out of the headlines; people are not paying attention to it anymore,” says a risk manager for a German bank, who spoke on condition of anonymity.
Elsewhere, China (+0.1) holds steady despite the drumbeat of negativity provoked by the country’s sliding stock market and weakening renminbi.
Beneath the stock market’s twists and turns, the economy is undergoing a significant transition. Like an assortment of Asian tigers before it, China has reached a level of per capita income that inevitably requires its growth rate to drop from the 10 to 12 percent level to something on the order of 5 to 7 percent. “As long as you don’t have a full-blown hard landing in China, the rest of APEC should weather the storm,” says Marklew, referring to the 21-nation Asia-Pacific Economic Cooperation forum.
For many emerging-markets economies in Asia and around the world, the consequences of China’s slowdown have begun to pale compared with the effects of tighter U.S. monetary policy on global capital flows. The Institute for International Finance calculates that emerging markets suffered a net capital outflow of $735 billion in 2015, the first time that emerging markets have had net outflows since 1988.
Moreover, the Bank for International Settlements warns that although some advanced economies have reduced leverage since the 2008–’09 financial crisis, debt has continued to build up in many emerging economies. Hyun Song Shin, head of research at the BIS, notes that the indebtedness of companies in emerging markets as a percentage of GDP has overtaken that of companies in developed markets, while the profitability of emerging-markets companies has fallen below that of developed-markets companies for the first time. Further strengthening of the dollar could have a deflationary effect on the global economy as export-driven nations pursue competitive currency devaluations to bolster their exports, some analysts warn.
To be sure, amid the generally rising tide of ratings, some countries suffer major losses because of specific economic and political problems. Brazil, where recession and a political corruption scandal seem to worsen by the day, drops 6.2 points, one of the biggest declines in the survey, whereas Venezuela, which devalued the bolivar by nearly 70 percent against the dollar in early February, falls 2.7 points. Some 56 percent of respondents think Brazil will present even higher risks in six months, while 31.7 percent fear the same for Venezuela. Rounding out the top four decliners, 43.9 percent think Russia will be riskier, and 34.1 percent fear the same for Turkey. Plummeting oil prices push the formerly unassailable Saudi Arabia down 2.3 points.
But those declines are more than offset by positive feelings. A notable case is Argentina, where recently elected President Mauricio Macri is trying to restore the country’s access to international markets and promote growth-oriented reforms. The country’s rating advances by 3.6 points.
Survey participants don’t deny that “the ability to pay has been reduced for the emerging markets,” as Deluard of Ned Davis Research puts it. But as Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott in Philadelphia, says, one result of this development is that “bond prices have improved.” He invokes an old bond market adage, “There’s no such thing as a bad bond, only bad pricing,” and notes that spreads on many emerging-markets bonds have widened, creating what some see as an attractive risk-return play.
Will the confidence last? Northern Trust’s Marklew says the answer may be found in China — not only in its economy but perhaps in its zodiac. The lunar year that began in February is the Year of the Monkey, and the element is fire. That means, things “could be extremely volatile, but they could end up either glorious or terrible,” she says.
