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Global credit conditions to remain uneven

Despite stabilising growth, a number of challenges cast a shadow over the prospects for credit worldwide. Rahul Ghosh of Moody's Investors Service discusses the outlook for 2017.

A modest revival in global growth and sustained low interest rates provide a reasonably stable backdrop for global credit.

However, nine years after the global financial crisis, the world economy is still meandering along a path of disappointing growth.

And a number of challenges, including concerns over the efficacy of monetary policy and rising political risks, cast a shadow over the global credit outlook. 

Looking ahead, six broad themes will dominate the global credit narrative in 2017, alongside key sector exposures.

First, G20 global growth will be around 3.0% in 2017 compared to an estimated 2.6% in 2016, as advanced economies show steady growth (Exhibit 1) and a number of emerging markets recover from recent slumps (Exhibit 2).

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This will likely represent a cyclical upturn rather than the start of a broad-based acceleration in global economic activity, as potential growth remains low and near-term growth prospects are uneven at a country level.

Commodity prices, too, will show higher average prices next year, although with limited upside. Stabilising economic growth and commodity prices will support revenues and cash flow for many sectors globally.

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Second, most sectors will retain their access to cheap financing conditions over the next 12 months as interest rates will remain “low for longer”. Monetary policy will remain accommodative in the US, though slightly less so than in recent years. Any increases in interest rates will be gradual and well-signaled by the Federal Reserve.

Ultra-loose monetary policy settings in most other major advanced economies, such as the euro area and Japan, will also persist. That said, low long-term rates are leading to a rapid build-up in debt, as well as increases in underfunding of defined benefit pension plans, leading to credit quality deterioration (Exhibit 3).

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Third, political risk will remain elevated in 2017, representing a potential source of volatility for global financial markets in general and credit markets in particular. Heightened political uncertainty emanating from a busy election schedule in Europe, the start of the UK’s formal withdrawal from the EU, and likely changes in policy direction in the wake of the US presidential vote are likely to affect economic and credit outcomes. Volatility in credit spreads and exchange rates because of political risk may affect the ability of some issuers to borrow or refinance their debt.

Fourth, the recovery in global trade since the 2008-09 global financial crisis has been one of the slowest on record, and global demand is unlikely to improve sufficiently to reignite trade growth in 2017. Furthermore, a rising tide of protectionist sentiment will act as an additional drag over the coming years. Export-oriented sovereigns and corporates are most exposed to a weak global trade recovery, and in particular corporates in manufacturing, logistics, shipping, rail/air freight and trading.

Fifth, the Paris Agreement came into effect in November 2016, representing a key milestone for global climate action. The agreement should accelerate the adoption of greenhouse gas emission policies and tighter energy efficiency standards globally in 2017 and beyond.

Over time, the transition to a low-carbon economy could have material credit implications for rated entities in a number of high-emitting industrial sectors, as well as sovereigns and regional and local governments, globally. However, the election of Donald Trump as US president has added a significant degree of uncertainty not only around the direction and the pace of decarbonisation, but also the participation of the US in the process.

And sixth, technological innovation and disruption will not materially change the way businesses operate in 2017 or even 2018. However, the next two years will see various technological advancements gather momentum in terms of strategy and investments, implementation and the emergence of initial benefits. The pace of technological innovation also has the potential to create a more competitive landscape and disrupt supply chains across a range of industries.

Risks overall remain skewed to the downside, in particular the growing risk of a re-pricing of assets globally, or a loss of confidence in the ability of China to manage its deleveraging and rebalancing process. Positive surprises are less likely. A renewed focus on fiscal expansion via infrastructure spending in advanced economies could provide a short-term boost to global growth, although such a scenario would add to government debt and potentially lead to renewed debt sustainability concerns.

Rahul Ghosh is a vice president and senior credit officer with Moody’s Investors Service and is based in London

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