Fitch on Sovereign Outlook, Fed exit adds to challenges for emerging markets
Wednesday, 10 July 2013 00:09
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Fitch Ratings says in its latest bi-annual global Sovereign Review and Outlook report that more testing funding conditions following the US Federal Reserve’s forward guidance on monetary policy, slower growth rates, and lower commodity prices add up to a less favourable economic and credit environment for emerging markets (EM).
The Fed’s comments on the timing of ‘tapering’ quantitative easing and eventually raising of interest rates precipitated a broad market sell-off and increased volatility since the middle of May, even though the comments should not have been a great surprise and reflect more upbeat US growth prospects. Fitch does not expect the first rate hike until mid-2015, and only then if the US economic recovery is secure. Nonetheless, the uncertain process of the Fed’s exit from unprecedentedly loose policy settings is likely to generate periodic bouts of market volatility.
EM bonds, currencies and equities were hit disproportionately hard by the market reappraisal of US monetary policy, despite prior concerns that capital inflows and exchange rates were excessively strong. Fitch does not anticipate widespread EM credit distress owing to a secular improvement in EM credit fundamentals, which reduces risks from tighter global liquidity, higher interest rates and FX risk. However, the Fed move adds to concerns over slowing growth, China’s financial stability, softer commodity prices and a series of political shocks in some EMs.
Prospective Fed tightening will increase risks facing weaker EMs including those with large external financing requirements (current account deficits and maturing external debts) and low foreign reserves, high levels of leverage, vulnerable debt structures (foreign currency, short maturity and non-resident creditors), those that have seen strong inflows of hot money and bank credit growth, or have weak policy macroeconomic frameworks or credit fundamentals
In Europe, the intensity of the eurozone crisis continued to ease in H113, despite recession, record unemployment, uncertainty following the Italian elections and the bail out in Cyprus which led to bank failure, capital controls and a domestic debt default (based on Fitch’s distressed debt exchange criteria). Nevertheless, we do not view the crisis as over. Our long-standing view is that a resolution of the crisis will require on-going country-level fiscal and structural adjustment, greater progress towards a banking union and a broad-based economic recovery across the currency union.
Fitch expects global growth to gradually pick up pace in H213 and 2014-15 as the US gathers steam and the eurozone approaches a cyclical turning point. Our latest forecasts for world GDP growth are 2.4% in 2013, 3.1% in 2014% and 3.2% in 2015 (weighted at market exchange rates). However, we have cut growth forecasts for many EMs due to strains from spill-overs from advanced countries and China, more difficult policy trade-offs; a declining impact from credit growth and structural bottlenecks. The ratio of Negative to Positive Outlooks on sovereign ratings is just under 3:1, signalling that global sovereign ratings remain under downward pressure. This is due to the eurozone crisis, high public and private sector debt levels, weak banking sectors, a testing growth and policy environment and idiosyncratic political and credit events. In H113, there were 13 notches of downgrades of foreign currency ratings, compared with 10 notches of upgrades; as well as two sovereign defaults: Cyprus (local currency IDR) and Jamaica.
The upward trend for EM ratings appears to have stalled. H113 saw six EM upgrades: Lithuania, Mexico, Thailand, Philippines and Uruguay, the latter two to investment grade, and Jamaica from default. Some three-quarters of the J.P. Morgan EMBI is now rated investment grade by Fitch, up from one-third in 2008. However there were downgrades for Egypt, Jamaica (by four notches) and South Africa, as well as China (local currency rating). EM Negative Outlooks now outnumber Positives by 12 to seven.
