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The eurozone impact: What’s in store for Asian sovereigns?

Standard & Poor’s Kim Eng Tan discusses the effect of the eurozone debt crisis on Asian sovereigns, and considers the rating outlook for India, China, the Philippines and Indonesia.
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Policy mistakes in the eurozone could further increase the cost of borrowing in Asia
<div style="text-align: left;"> Policy mistakes in the eurozone could further increase the cost of borrowing in Asia </div>

The eurozone’s troubles are, undoubtedly, far from over. Although an immediate Greek exit from the eurozone has been avoided, the economic outlook for the region remains downbeat. On top of this, the European banking industry is perceived to be in fragile health. A significant consequence is that bank deleveraging and weak market sentiment are affecting the cost of borrowing and the availability of funding for all but the most credit-worthy borrowers.

What does the near-term future hold for Asian sovereigns?
The troubles in the eurozone have already hurt Asia; and we see this most clearly in the region’s trade data. Asian exports to many eurozone countries are already in decline, in some cases significantly. The only reason why Asia has been keeping up its overall exports and economic growth is that the US and emerging markets have been supportive. Another consequence of the crisis is that Asian companies are finding it more difficult to finance themselves internationally. Indeed, many companies in the region are financing at higher costs than early last year, and costs are rising even more when they extend borrowings to longer horizons.

In our view, the situation is likely to become a lot worse if policy mistakes are made in the eurozone, triggering a greater loss in investor confidence and sharply lower economic growth across the world. In such a case, we expect the growth impact on Asia will be mitigated by local policy responses. Even so, such policy responses would likely weaken some of the credit metrics for sovereigns in Asia. In turn, we may see a lot more negative ratings actions in this region.

Is the tide turning following the eurozone summit?
Some relief could be in sight. In our opinion, the agreements reached at the summit may help stabilise the eurozone and staunch any further weakening of sovereign creditworthiness. Decisions made at the summit reflect policymakers’ growing recognition that the current crisis is not exclusively a budgetary crisis of excessive public debt and deficits, but that it’s also a balance-of-payments crisis. This has been Standard & Poor’s view for some time, and we see the broadening of the policy response as a positive step. Measures that stabilise cross-border capital flows are now complementing fiscal austerity programs. However, we believe the risks associated with implementing measures are significant, and it is unclear to us whether policymakers will be able to build on the agreements.

Is India heading for a rating downgrade?
In April 2012, Standard & Poor’s placed its BBB- long-term rating on India on a negative outlook. In our assessment, India’s political setting has weakened at a time when the country is facing significant policy challenges. We have seen economic growth slow, and we have also seen oil prices remaining relatively high, even if they have retreated somewhat more recently. These factors have conspired to weaken the external and fiscal metrics that support our credit ratings on India. So far, we haven’t seen any policy actions from the government to reverse these trends. On the contrary, we’ve actually seen some policy reversals that have dented investor confidence. This has slowed foreign investment into India, and we now see a larger chance that India’s long-term growth may be hurt. If we see strong evidence that this is the case, or if fiscal and external metrics materially deteriorate from current levels, then we may lower the sovereign rating below the investment-grade level.

How far away is the Philippines and Indonesia from an investment-grade rating?
The ratings on both sovereigns are within one-notch of investment grade. Very recently, we raised the Philippines foreign-currency rating to BB+ from BB. And in April this year, we affirmed our BB+ rating on Indonesia.

We could raise our rating on the Philippines if it makes material progress in achieving a sustainable structural revenue improvement or further strengthens the public balance sheet, yielding reduced fiscal vulnerability. For Indonesia, we could raise the rating if government reforms reinforce fiscal trends, support foreign direct investment and allow subsidy cuts without reversing recent improvement in inflation.

What’s your baseline economic outlook for China in 2012?
We continue to believe that China’s GDP growth will stay at about 8% in 2012. Despite the recent weakening of some economic indicators, we believe that policy easing will help to support growth. However, we don’t think that policy support for the economy will be as strong as we saw in 2009. To some extent, this is because pockets of strength remain in the Chinese economy. Consumption, for instance, remains relatively strong, and this has to do with the fact that labour market conditions have remained supportive of household spending so far.

However, there are significant risks to Chinese growth this year. For example, there is a continuing risk that eurozone economies may deteriorate a lot more than we expect. This remains a significant concern in the case of China, as well as other sovereigns across the world.

What is Standard & Poor’s view on the China government’s policy tools to address both short- and long-term risks?
Positively, China’s domestic savings are large and the government’s balance sheet remains strong. And we expect that the government, if needed, may get the banks to start lending more again. Nevertheless, we believe that the asset quality of Chinese banks has generally deteriorated compared to pre-2008, partly due to the most recent stimulus package. On the other hand, total bank lending remains a lot lower than the banks’ total deposits; hence, there is still capacity for banks to increase lending if needed. What’s more, the government, with its current level of indebtedness, can still borrow significantly more.

In our view, these factors may help offset some of the near-term weaknesses in the Chinese economy. Longer term, however, it’s less clear. Some of the reforms that are needed to enable strong growth in domestic demand are difficult measures that are opposed by strong political forces. Although we have seen some progress recently in this regard — for example, interest-rate liberalisation has taken place faster than we thought — there’s a lot more that needs to be done.


Kim Eng Tan is senior director of sovereign ratings at Standard & Poor’s Ratings Services

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