Sovereign-risk analysts are by nature a pretty sober bunch, paid to assess the many things that might go wrong in the world. But despite a daunting list of dangers threatening the global economy -- rising U.S. interest rates, high oil prices, instability in the Middle East, the threat of terrorism -- analysts seem to be throwing caution to the wind. In their view the outlook has never been better.
Optimism reigns supreme among participants in the latest installment of Institutional Investor's exclusive Country Credit survey. The average creditworthiness rating of 173 countries stands at 45.1 on a scale of zero to 100, according to the dozens of sovereign-risk analysts, economists and portfolio managers surveyed. That is up a full point from September 2005 and represents the fifth consecutive increase in our semiannual survey. The average rating, moreover, is now at its highest level since the early 1980s, long before dozens of low-rated countries were added to the survey.
The continued improvement in this risk measure is decidedly broad-based. In the past six months, 100 countries are up 1.0 point or more, the amount considered statistically significant, and only 24 fall by that much. These kinds of results parallel what's going on at the bond rating agencies, where upgrades are being handed out at about twice the rate of downgrades.
Reflecting the breadth of the upward movement, Western Europe achieves its highest regional rating ever and the Middle East does its best since the first survey 27 years ago; North America and Latin America have their highest scores since the early 1980s; and Eastern Europe wins its highest rating since the fall of communism. Even Africa is at the top of its decidedly modest range.
What's going on here? In a word, growth. Economic expansion has trumped everything from high oil prices to political discord, according to Christine Shields, head of country risk at Royal Bank of Scotland in London. "Last year was a year of strong performance almost everywhere, despite high oil prices," she says. "The U.S. grew by 3.5 percent; you would never have predicted that at the beginning of last year."
Higher commodities prices also benefit countries whose economies depend heavily on raw-materials exports, notes Gregor Eder, a senior economist at Dresdner Bank in Frankfurt. "This has resulted in substantial increases in foreign exchange reserves," he says. "Forex liquidity, which is one of our main ingredients in evaluating country risk, has improved substantially."
The strong ratings reflect more than just a favorable macroeconomic environment. Sound policies, including notable budgetary discipline that continued in many developing countries, also deserve credit. "There is much more astute fiscal and debt management, particularly in Brazil and Mexico," says Shields. That fact lessens the risk that economic shocks will reverberate through the global financial system, she adds.
Meanwhile, the supposedly dire effects of rising interest rates and high oil prices haven't materialized. Indeed, oil tends to have a mostly positive impact, benefiting producer countries but not having a detrimental effect on importers.
Certainly, that's the case in the two regions chalking up the biggest gains since September: Eastern Europe/Central Asia and Latin America/Caribbean. Both rise 2.3 points. To be sure, each region has a couple of oil producers that fare well: In Eastern Europe/Central Asia, Kazakstan climbs 3.6 points and Russia rises 3.1 points; in Latin America/Caribbean, Venezuela jumps 5.1 points and Mexico gains 2.7 points. But in the rest of Eastern Europe/Central Asia, where oil is as scarce as a low-cholesterol meal, 22 countries rise at least 1.0 point. Only one falls by at least that amount -- Belarus, a nation whose leader, President Alyaksandr Lukashenka, has been accused by the U.S. and the European Union of stifling political opponents and muzzling the media ahead of the March 19 presidential election.
The afterglow of Ukraine's Orange Revolution boosts that country's rating 4.1 points, to 46.5; that's up 13.7 points from two years earlier. An assortment of other Eastern European countries at various stages of the EU accession process also fare well. "They simply have good economic growth prospects," says Franz Schardax, a senior fund manager at Capital Invest in Vienna, who adds, "The recovery in Western Europe should be quite helpful."
The countries composing the former Yugoslavia continue to bounce back. Serbia-Montenegro, for example, shoots up 6.6 points -- it's up 11.4 points over the past year -- taking it from No. 105 to No. 87 in the survey. The EU agreed in October to open negotiations on an association agreement with the country that would put it on the path to eventual membership. Macedonia, which was made a candidate for EU membership in December, is up 5.4 points, and Bosnia & Herzegovina gains 1.8 points.
"This region has made great progress with respect to European integration," Schardax says. "The Kosovo problem, of course, is not fully resolved, but the peaceful development in this region is now much more secure than it used to be. Also, their macroeconomic policies are very good -- especially Serbia, which has tight fiscal policies. There are political risks, but the policies they are following at present are very encouraging."
Some of the gains in Latin America/Caribbean, meanwhile, appear to be the triumph of hope over experience. Argentina surges 8.2 points, the second-biggest gain in the latest survey, and is up 14.5 points since a year ago. That is by far the biggest one-year gain of any country, enough to move Argentina from No. 137 in the March 2005 ranking to No. 115 last September to No. 91 in this edition of the survey. The message from bankers is clear: All is forgiven less than five years after Buenos Aires defaulted on $95 billion in bond debt and less than one year after bondholders accepted 35 cents on the dollar in a restructuring. "We see considerable improvement in the overall macroeconomic situation," says Dresdner Bank's Eder. "We have seen strong economic growth for quite a while now."
Similarly, the Dominican Republic leads the survey with a 9.0-point six-month rise -- a strong resurgence after its financial crisis. Argentina and the Dominican Republic are joined by three other Latin nations -- Venezuela, Peru and Uruguay -- in the list of the top-ten gainers in the survey. All told, 20 of the 27 Latin countries are up by at least 1.0 point; only three countries, all minor players, see their ratings decline by at least that amount.
Anita Gray, an economist at Standard Chartered Bank in London, says the broad-based Latin surge "is no surprise. They have benefited from the commodities boom, low global interest rates and deep global liquidity levels." But what about the leftward drift in Latin politics? In the past few years, seven populist leaders have taken power in Latin America, and crucial elections are to be held in Peru, Mexico and Brazil later this year.
This generation of leftists is different, one New York banker says. "Even when left-of-center candidates win, they tend to be much more of a Lula than a Chávez," he says, referring to presidents Luiz Inácio Lula da Silva of Brazil and Hugo Chávez of Venezuela. To be sure, the December election in Bolivia produced a victory for Evo Morales, whom the New York banker calls "a baby Chávez," but elsewhere, he says, even when the political rhetoric is fiery, "there has been a shift in these countries to pursue sound technocratic approaches to policy. This avoids capital flight, and that is extremely beneficial in terms of longer-term, faster growth.
"Brazil and Mexico have both demonstrated extremely good policy discipline, and their external vulnerability has fallen dramatically," the banker says. "They have both got elections looming, and they are still being reasonably disciplined in their policy attitudes. And that's a real break with the past."
But another banker in New York, dismayed by the era of good feeling in the Latin world, says: "If you are a hedge fund -- if your business is buying short-term Argentinean paper -- then, yes, there are opportunities. But if that is not your business, I would take a different view. There are still major problems to be overcome. It astonishes me how short the market's memory is."
Our survey, however, finds that the amnesia is not total. When asked to rate the importance of various attributes in determining creditworthiness, survey respondents give Latin America's debt profile 7.5 points on a scale of 1 to 10, the highest rating of any attribute in the survey. Still, that is down from 7.7 points six months ago, and one New York banker says there is much more hope that Latin countries "will grow their way out of debt."
One thing the Latin and Eastern European run-ups suggest is that oil is not the only kingmaker: Its rising cost neither automatically hurts many oil importers nor helps traditional oil producers. For example, Bahrain, Kuwait, Qatar and Saudi Arabia rise modestly since September, even as the United Arab Emirates and Oman are off by small amounts.
Standard Chartered's Gray says it is possible that the major oil producers "have maxed out in terms of the amount by which their scores can increase." Whatever their bank accounts, she adds, sheer political risk still clouds the Middle East, which is awash in liquidity. The question is what they will do with the money. Will it be reform and economic development -- or yachts? Because of this concern, the ratings of Bahrain, Oman and Saudi Arabia have fallen below the likes of Latvia, Mexico and Thailand. Marginal oil producers fare better: Algeria climbs 2.7 points, and Libya rises 3.2. "Libya and Algeria are second-round beneficiaries of higher oil prices," RBS's Shields explains.
Although the Middle East's oil producers remain becalmed, politics moves other countries in the region. Israel is up 2.1 points, reflecting survey responses that were completed after Ariel Sharon withdrew the country's forces and settlements from the Gaza Strip but before he was incapacitated by a stroke. Political factors also drive down the ratings of Iran, Iraq, Syria and Yemen, but the region's average rises 0.6 point, to 52.0. That's 2.2 points higher than a year ago, and it represents one of the highest ratings the region has ever attained in the survey.
Expectations of continued growth also bring modest but broadly based gains in Western Europe and North America. In Europe any concern about the failure of the EU constitution has faded, Capital Invest's Schardax says, and, more important, "there is an economic recovery under way." Every country in Western Europe advances, with 14 up 1.0 point or more. In North America strong commodity prices push Canada's rating 1.4 points higher, and the U.S. gains 1.0 point on stronger-than-expected economic growth. Did someone say "enormous continuing deficits"? Not to worry -- China is financing them.
Indeed, China seems to be taking on a role the U.S. has long had: the unmoved mover whose own rating may not change much but whose economic fortunes affect others. China rises 1.6 points since September as its economic juggernaut keeps rolling. Recent revisions of government statistics indicate that the country's growth rate and level of output are higher than previously believed, but China's creditworthiness is held back by ongoing concerns about its banking system. Indeed, when asked to rate the importance of various factors in shaping China's rating, the stability of the banking system leads the way, scoring 7.3 points on a scale of 1 to 10.
Nonetheless, China's relentless growth plays a major role in boosting Hong Kong's rating 2.7 points and Taiwan's 1.5. Japan does not benefit, however: The country's rating remains unchanged despite rising exports to China, a continued economic recovery and a bull market in Japanese stocks. There is still concern about debt and, more essential, the country's inability to effect fundamental change, says one New York banker.
India also turns in a surprisingly tepid result, rising only 0.5 point. The economy is growing, and foreign investors have been feeling more welcome than in the past. In December, for example, Intel Capital, the venture capital arm of the giant chip maker, unveiled a $250 million fund to invest in Indian high tech. Despite India's good growth, many analysts see the country's prospects constrained by an antiquated infrastructure, an even more antiquated tax system and a potential shortage of well-trained talent for hire. Elsewhere in Asia-Pacific/South & East, the news is mainly good. Ten of the 23 countries are up by 1.0 point or more.
Once again, Africa/Sub-Saharan fails to participate fully in the global optimism. Its regional rating rises 0.4 point, to 23.3, and although that is the highest level since 1999, the level has not changed much in almost two decades. Overall, 19 of the 47 countries gain 1.0 point or more and ten fall by at least that amount. The gainers generally were boosted by strong commodities prices, and the decliners largely suffered from political unrest or uncertainty. Despite the uneven results, Gray says Africa is turning a corner.
"It has benefited hugely from debt relief," she says, citing debt forgiveness programs agreed to by the Group of Eight nations and the International Monetary Fund. "This frees up a huge amount of funds that can be spent on development and on upgrading infrastructure. The big question is whether they can spend the money wisely."
All in all, the array of good news around the globe produces a fifth straight rise in global average creditworthiness, but what are the chances for a sixth increase? Gray believes the improvement is likely to slow. "The rate-hike cycle in the U.S. is nearing an end, but emerging markets, particularly in Asia, are still going through higher interest rates. And with this comes slower growth," she says. By next year, she predicts, ratings increases "will be modest, and we will see scores stabilizing."
Shields is a bit more optimistic. Although the increases in U.S. interest rates are still working through the system, those rates will start coming down by the start of next year, and Latin American elections will be over. To be sure, the prices of oil and other commodities are unlikely to continue rising, she adds: "We must be close to a peak, so windfall earnings are not going to be there anymore." For most countries, she says, "things might be a little easier," and that suggests that those who rate creditworthiness might continue being optimistic.
Brazil: On the rise, unless it falls
When asked to predict which nations would rise the most and which would decline over the next year, our country credit survey respondents put five countries on both of their top-ten lists: Argentina, Brazil, Mexico, Russia and Turkey. The country with the greatest number of mentions on both lists was Brazil: Fully 22.5 percent of respondents expect its score to rise, whereas 17.6 percent expect it to fall.
That dichotomy is not unusual for a nation critics say is perpetually the country of the future. Dwarfing its neighbors geographically, demographically and economically, and endowed with generous natural resources, Brazil has enormous potential. For decades, however, it has danced an economic and political samba in which every two steps forward have seemed to be followed by one step back.
With presidential and congressional elections scheduled for October, some analysts fear a reversion to the Brazilian mean of costly political promises guaranteed to damage the nation's finances. But this time not everyone is worried.
"Some remember what happened last time, when there was preelection turbulence and the International Monetary Fund stepped in, but I would say the situation is completely different,'' says Gregor Eder, a senior economist at Dresdner Bank in Frankfurt. The rhetoric may be fiery, but the policies are moderate in Brazil, and increasingly so elsewhere in Latin America, he contends. Regardless of the election outcome, Brazil will continue to benefit from strong commodity prices, Eder adds.
This time the elections may not result in economic turmoil after all. -- H.D.S.
Associate Editor Donovan Hervig compiled the statistics for this feature.
