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Credit outlook: Is Asia-Pacific immune to challenges in the US and the eurozone?

Michael Petit, Asia-Pacific head of corporate and government ratings at Standard & Poor's, outlines the rating agency's views on credit in the region.

Recent events, including the continuing weakening of Europe’s creditworthiness and the downgrade of the US sovereign rating, point to an increasingly uncertain and challenging environment ahead.

Standard & Poor’s believes there is no immediate ratings impact in the Asia-Pacific region but, in the medium term, challenges include moderating global growth potential, rising funding costs in offshore markets and a reduction of capital flows. Mitigating factors for the region include robust domestic and intra-regional demand supporting a still-positive economic growth outlook, together with generally strong domestic saving rates and healthy household and corporate sectors.

What is your near-term outlook for Asia-Pacific sovereign ratings?
For the moment, the generally stable outlooks for Asia-Pacific sovereigns (with the exception of New Zealand, Japan, Vietnam and the Cook Islands) is supported by sound domestic demand, relatively healthy corporate and household sectors, plentiful external liquidity and high domestic savings rates. Our baseline assumption of no likely abrupt dislocations in developed economies’ financial and real economies underpins this opinion, which is based on our publicly available sovereign ratings criteria (see below).

Investors are concerned about the global economy. What are the risks factors for the region’s sovereigns?
The potential longer-term consequences of a weaker financing environment, slower economic growth and higher risk aversion are negative factors for Asia-Pacific sovereign ratings.

However, given the interconnectivity of the global markets, an unexpectedly sharp disruption in developed world financial markets could lead to a picture that differs from that of our base case. If the US and European economies contract or experience delayed recoveries, export-dependent economies with large exposures to the US and/or Europe would feel pronounced economic impacts. There is little reason to believe things would be very different this time. US and Western Europe remain significant markets for Asia-Pacific exports, even if their importance has declined during the past couple of years. Specifically Thailand, Taiwan, Korea, Malaysia, the Philippines, Japan, Australia and New Zealand are likely to experience export-driven slowdowns either through weaker demand or lower export prices, or both.

What about corporate and infrastructure ratings?
In the near term, we believe that corporate and infrastructure companies should continue to benefit from a still-positive economic outlook for the region and strong domestic saving rates. However, in the medium term, any prolonged market disruption could result in heightened refinancing risks, especially for highly leveraged entities seeking to roll over debt or access new funding. Having said that, a large number of infrastructure companies, utility companies and Chinese property developers have been taking active forward measures in their debt scheduling.

Other risks include significantly weaker US demand that could dampen sentiment worldwide and hence place strong pressures on the profitability of large exporters from China, Korea, Japan, Singapore and Hong Kong. The corporate sector would also need to contend with fluctuations in exchange rates and sharp movements in input costs, ie higher spreads and commodity price movements, and potential disruptions in the G3 debt capital markets and ensuing difficulties in securing financing.

What are the risks for financial institutions in the region?
Financial institutions currently benefit from generally sound financial profiles. We also expect depositor confidence to be maintained, which should sustain the retail deposit base that is the mainstay of funding for the region’s banks. A rise in spreads would marginally raise the funding costs of banks that have some dependence on offshore funding markets.

However, a sharp market reaction in the region — especially if there is reduction or reversal in capital inflows from the US and Europe — could affect a broader swathe of banks and insurers through declines in the market values of their investment assets (due to mark-to-market accounting) and pressure on their capital market-dependent income. The credit quality of banks’ corporate loan books, especially in the export sectors, could come under some pressure if financing costs rise simultaneously with declining revenue. The overall near-term impact could dent the sector’s profitability, but it is unlikely that it would inflict damage to balance sheets.

Which Asian economies are most vulnerable to the challenging environment ahead?
If economic and financial market conditions weaken significantly below our expectations, the pressures are likely to be greater on economies that are more externally dependent and where governments are in weaker fiscal positions. Economies where exports are an important source of growth could see larger declines in headline GDP growth. In Japan, where the fiscal position is a key weakness, the government is unlikely to provide strong fiscal stimulus without a further deterioration of its balance sheet. This could weaken its creditworthiness further.

Economies that rely on international funding are also more exposed as financial market uncertainties could cause their sources of funds to dry up. Economies that run current account deficits are likely to be most affected, so there could be some adjustment pressures on Australia and New Zealand, which are likely to see prices of their commodity exports fall in a global slowdown and international funding for their banks dry up. Also, like Japan, their government balance sheets have also recently suffered as a result of damage arising from natural disasters although they remain relatively strong. Nevertheless, their high-income and relatively flexible economies — together with their flexible exchange-rate regimes — should limit the near-term damage to their sovereign credit ratings.

Lower income economies that depend on external funding — including Vietnam, Pakistan, Mongolia and Sri Lanka — could experience greater pressures on their sovereign creditworthiness. These sovereign ratings could deteriorate more significantly without external support from the international financial institutions.

What is Standard & Poor’s outlook for the US sovereign rating?
The outlook for the US sovereign rating is negative which means that there is a one-in-three chance that we may further downgrade the US in the coming six to 24 months. Our downside scenario assumes a slower pace of economic growth and the incomplete implementation of the agreement reached between Congress and the administration earlier this month, resulting in a higher general government debt trajectory than outlined in our base case. Conversely, in an upside scenario that leads to fiscal consolidation measures beyond the minimum mandated, the rating could stabilise at AA+.


To obtain a copy of Standard & Poor’s sovereign rating criteria, please click here.

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