Mixed trends In Asia-Pacific sovereign ratings in 2009 and 2010
Asia-Pacific sovereign ratings have fared well compared with other regions. That said, we've seen two downgrades (Fiji Islands; Thailand--local currency rating) and six sovereign ratings had their outlooks revised to negative in 2009, three of which remained on negative by the end of the year--Cook Islands, India, and Taiwan. In January 2010, we also revised our outlook on Japan's ratings to negative. In addition, the outlook for Vietnam and Thailand remained negative since 2008. On the other hand, and thanks largely to support from the International Monetary Fund, Pakistan was upgraded to a still-low 'B-', while Mongolia's outlook was revised to stable and Sri Lanka's to positive. Two Asia-Pacific sovereigns are currently on positive outlooks -- Sri Lanka and Indonesia. Nine out of 21 rated sovereigns remained at the same rating level and with stable outlooks throughout the crisis. One common theme for many Asia-Pacific sovereign governments is the influence of recent and ongoing political developments on their creditworthiness.
Some countries face fiscal challenges
Looking into 2010, we can identify a number of countries in the region with important fiscal challenges--Japan, India, Taiwan and, to some extent, Vietnam. These sovereigns display higher debt burdens than similarly rated peers (See chart 1). Their ratings may come under pressure unless policymakers overcome structural fiscal issues and take tough measures in consolidating finances in the medium term while not stifling economic growth.
Japan's recently elected Democratic Party of Japan (DPJ) government faces a number of daunting challenges, including deflation, aging population, and high government debt burden. It does, however, benefit from a strong net external asset position and low interest rate environment of deep domestic markets, making its debt less costly, at least for the time being.
India's economy continues to grow, and domestic markets have so far been able to absorb additional government debt (including through increasing the statutory liquidity ratio--the proportion of deposits banks have to hold in approved government securities). Sri Lanka's fiscal position is a key credit constraint, but more immediate concerns on external liquidity have recently abated. The rating is now on the improving trend from a relatively low level. Malaysia has proposed an ambitious budget for next fiscal year, which would cut the deficit significantly and could be a supportive credit factor. But the devil is in the detail --i mplementation.
The government in Taiwan has supported the economic recovery with a package of stimulus measures. However, this comes at a cost -- adding to existing structural revenue imbalances. In the Cook Islands, a rising debt burden and high infrastructure development needs will challenge the government's commitment to disciplined and affordable spending.
Vietnam appeared to have achieved healthy economic growth and lower inflation in 2009. However, its trade deficit remains relatively large and inflationary expectation high. This has put pressure on the currency, leading the government to devalue the dong in November 2009. Maintaining economic and financial stability will be key to restoring the policy credibility lost in the volatility of the past few years. A serious misstep could cause an economic shock that will have significant negative implications for the sovereign ratings.
Sovereign borrowing trends: Is there a convergence of risks?
Given the expectation that sovereigns will remain active borrowers in domestic and international markets in 2010, it is not surprising that markets are looking at sovereign risks more closely in terms of sustainability of growing debt burdens and potential re-benchmarking of risks between emerging and developed sovereigns.
In Asia-Pacific, Australia, New Zealand, and Japan (collectively called JANZ) are good representatives of high-income, highly rated sovereigns, while China is one of the most highly rated emerging market governments. The ratings on China are currently only two notches away from Japan's and the gap may narrow. At the same time, important differences between China and JANZ economies, financial systems and capital markets remain. Some key differences include: lower risk of policy reversals in JANZ, more balanced economic structures and higher income levels, sound banking systems and deeper financial markets, and fully convertible international currencies.
Comparisons between JANZ and lower-rated emerging market sovereigns, such as Indonesia, Philippines, Vietnam, result in even more stark contrasts. Among other things, the lower-rated sovereigns have low-income economies, narrow tax bases, structural impediments to growth, shallow domestic capital markets, limited track record of effective policy formulation and implementation, sometimes combined with external vulnerability. As a result, these economies' ability to adjust to sudden shocks and absorb additional liabilities is limited. Some emerging market sovereigns might have fared better than their developed peers in the current downturn. But, unlike JANZ, their ability and willingness to service debt in a timely manner can deteriorate rapidly, and the sustainability of their creditworthiness cannot be assured over the long term.
In our view, the ascent of emerging market sovereigns to higher levels of creditworthiness will be gradual and will depend on the pace of economic and institutional reforms, as well as demographic and geopolitical dynamics. Meanwhile, we expect developed sovereigns with wealthy flexible economies and deep domestic markets will continue to be able to sustain higher debt burdens than their emerging market peers, as their track records have proven.
The author of this article, Elena Okorotchenko, is a senior director of sovereign & public finance ratings for Asia at Standard & Poor's Ratings Services.
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