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Domestic politics to shape Asia sovereign ratings

Political developments in a few Asia-Pacific countries will become important factors in shaping credit trends in the next few years, says S&P's Kim Eng Tan.
Thailand could be hit by fresh protests
Thailand could be hit by fresh protests

With uncertain economic situation in Europe and Japan, should we prepare for a volatile year for Asia sovereign ratings in 2015?

Despite the recent volatility in global financial and commodity markets, we don’t expect many rating changes this year. The fact that 18 of Standard & Poor’s Ratings’ 21 Asia-Pacific sovereign ratings carry a stable outlook reflects this expectation.

Of the remainder, we have positive outlooks on the sovereign ratings of Fiji and South Korea, as well as a negative outlook on Japan.

Economic uncertainties facing Europe and Japan have risen lately and we believe that Chinese growth will continue to moderate over the next few years. Nevertheless, the US recovery appears to remain on track and falling oil prices carry benefits for this region.

It has relieved pressures on fiscal and external accounts for many in this largely oil-importing region.

It has also allowed some governments - including Indonesia, Malaysia and India - to reform fuel subsidies in their countries. On the whole, developments elsewhere in the world do not exert strong pressures on sovereign ratings in the Asia-Pacific one way or the other.

Are you worried about domestic politics in 2015 and beyond?

Political developments in a few Asia-Pacific sovereigns will become important factors in shaping credit trends in the next few years. New leaders in India and Indonesia have made changes that are welcomed by investors after they came into office in 2014.

In Japan, Prime Minister Shinzo Abe recently won another round of national general elections that gave him a stronger mandate to continue with his economic policies.

Further reforms that improve the investment climate and strengthen fiscal health in India and Indonesia could brighten long-term growth prospects.

In both countries, underinvestment in infrastructure has resulted in constraints on development. Diverting funds from subsidies to public investment and reducing barriers faced by businesses could unlock growth potential and strengthen credit support for these sovereigns.

For India, major reforms are more likely if the ruling party manages to gain more seats in the upper house of parliament. This will need the BJP to win more elections at the sub-national government level over the next year or two.

In Indonesia, the progress of reforms will depend on the government’s ability to overcome the vested interests that stand in the way of bureaucratic streamlining and liberalisation of key domestic industries.

The Thai government has been led by the military since May last year, will the uncertainty over timing of a return to democracy affect the credit standing of Thailand? 

Developments in Thai politics could have implications for the government's credit standing. The May 2014 military coup returned calm to the streets of Bangkok. It has also allowed the bureaucracy to introduce policy changes - including the inheritance tax and property tax - that could raise government revenue and reduce income disparity.

These policies had been held up by the political instability of recent years. Nevertheless, uncertainties over the timing of a return to democracy could lead to growing dissatisfaction with the military-led government.

If this leads to renewed protests, already weakened investor confidence could deteriorate further to weigh on sovereign creditworthiness.

The new president of Sri Lanka is in favour of parliamentary system, how would that affect policymaking in the future and the country’s sovereign rating outlook?

The result of Sri Lanka's recent presidential elections has increased political and policy uncertainties that have the potential to undermine sovereign credit support.

President Maithripala Sirisena's promise to abolish the executive presidential system in favor of a parliamentary system may complicate policymaking, especially in view of the diverse views on policies among the parties that backed his candidacy.

Depending on political developments under the new president and possible changes in fiscal and economic policies, some credit metrics could weaken over the next two to three years.

Policy uncertainty stemmed both from the disparate nature of the coalition that fielded President Sirisena as candidate and his election promises portending significant changes.

Under former President Rajapaksa's tenure, Sri Lanka's executive presidential system was highly centralized, exerting significant control over the key areas of the economy and the military. This allowed moderate progress in economic reforms and fiscal consolidation.

The opposition's coalition parties have not agreed on a common approach to economic policy and, in our view, were mainly united by the desire to unseat Rajapaksa. Policy differences are likely to surface when parliamentary elections are called within the first 100 days of president-elect Sirisena's term, as he had promised.

In the run-up to the elections, President Sirisena also promised to expand subsidies and raise welfare payments, which, in the absence of offsetting revenue gains, would jeopardize Sri Lanka's hard-won progress in reducing its large debt and interest burdens.

Is the recent abolishment of fuel subsidy in Indonesia a credit positive step?

The Indonesian government's recent moves to reform the fuel subsidy regime has lowered risks to fiscal and external balances in the event of a sharp rebound in oil prices. Consequently, these moves carry positive implications for sovereign credit fundamentals.

If further policy changes are made to significantly improve the economic infrastructure and investment climate, the resulting boost to growth prospects could lead to a higher sovereign rating if the external metrics also improve.

Is there downgrade pressure for Japan?

Japanese Prime Minister Abe's electoral victory handed him up to four more years of premiership. Many are looking to more policy changes - especially structural reforms - that could improve economic growth prospects, stabilize public finances, and end deflation decisively.

However, some see a risk that the government's focus on pushing through a historic change in the nation's constitution could distract it from furthering economic reforms. In this scenario, the government's credit support could slip further on continuing downward pressures from structural economic weaknesses and a heavy public debt burden.

We currently rate Japan at AA- with a negative outlook. The negative outlook reflects our view of the still-sizable risk of a slow return to sustained inflation and healthier economic performance.

Following several quarters of strong growth, the economy contracted sharply in the wake of the sales tax hike in April 2014. Economic sentiments could have turned more cautious as a result.

We see at least a one-in-three chance that nominal GDP growth could fail to improve sufficiently to stabilize the general government debt level vis-a-vis GDP in the near future.

We could lower the sovereign ratings on Japan if we believe that this scenario is likely. Conversely, we could revise the outlook back to stable if we expect the economy to sustain healthy growth and the monetary authorities to succeed in achieving their inflation target of 2% annually.

This is possible if investors and businesses are encouraged by the government's implementation of important structural reforms. In this scenario, we expect the general government deficit to shrink sufficiently to stabilize the level of government debt with respect to GDP.

The author of this article is Standard & Poor’s credit analyst Kim Eng Tan, senior director of sovereign ratings.

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