As economies in the world try to find a firmer footing in a fragile recovery in 2010, sovereign creditworthiness has come under more intense scrutiny. These are the questions we often hear from investors:
- Can sovereign governments shoulder the growing weight of debts accumulated as a result of unprecedented fiscal stimulus measures?
- Is there a re-benchmarking of sovereign risk going on? Is the gap in default risk of emerging and developed sovereigns closing?
- How can one properly factor in the likelihood of government support to state-owned enterprises (SOEs) and resulting contingent liabilities?
Base-case scenario: Global recovery and a complicated policy environment
The strong fiscal and monetary support from governments around the world appears to have helped avert a double-dip recession (See table 1 for key economic indicators). Asia-Pacific sovereigns have -- with few exceptions -- weathered the crisis better than their peers in other regions. The base-case economic scenario underlying Standard & Poor's sovereign ratings is a gradual global recovery. Still, the economic revival remains a fragile affair and its sustenance depends on governments timing well the withdrawal of policy support. Investor sentiment often changes suddenly. We cannot rule out another round of dislocations in western financial markets that would make investors risk averse again and spread volatility to markets in Asia-Pacific. This could complicate funding options for governments that are still expected to be active issuers during 2010.
Asia-Pacific Economic Outlook
|Real GDP Growth||Consumer Price Inflation||General Government Balance||Current Account Balance|
|Papua New Guinea||5.0||4.0||6.1||6.5||(4.1)||(1.4)||(7.8)||(6.5)|
|Source: Standard & Poor's; e -- estimates; f -- forecasts|
Monetary and fiscal stimuli have not been without negative consequences. Policy-spurred liquidity and credit growth are feared to have contributed to new asset bubbles and bad loans. Sizeable government subsidies and investments -- often debt financed -- have led to overcapacity in some sectors, price distortions in others, and soaring government debt burdens.
Asia's sovereigns have also shown significant support to their GREs in the past 18 months, often to avoid wider systemic problems. With the GREs borrowing more -- often on behalf of the government or for government-specified programmes -- and government stimulus often channelled through the domestic banking systems, the level of contingent liabilities has increased, in our view.
At the same time, structural imbalances contributing to the global recession remain largely unresolved. Countries with large current account deficits are now looking to increase exports. In countries with current account surpluses, rebalancing from export-led to domestic-driven growth has become an important priority for policymakers. However, moves to stem currency appreciation are slowing progress in global rebalancing. They also risk triggering capital and trade protectionism measures that could harm economic growth.
All this speaks to a complicated policymaking environment for the next few years. For rebalancing to occur, the major economies have to identify new sources of medium-term economic growth. Many governments are under pressure to find ways to reduce public debt over the medium term. Monetary authorities face the risks of resurging inflation and asset bubbles as economic activity picks up.
A few factors help determine which Asia-Pacific sovereigns can deal with these challenges successfully and sustain additional debts without a detrimental impact on their creditworthiness. Chief among the factors are: (1) the sovereigns' projected debt and structural deficit levels relative to peers; (2) the flexibility and wealth of domestic economies, the speed of economic recovery, and thus any additional stimulus needed on the way out; (3) their ability to formulate and implement effective policy responses--a credible medium-term plan for fiscal consolidation could be one key component; and (4) any additional idiosyncratic issues affecting their creditworthiness--political, economic, external, etc.
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.
|Asia-Pacific Sovereign Ratings|
|Papua New Guinea||B+/Stable/B|
|* As of February. 2, 2010; FC -- Foreign currency|
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.