Fitch’s take on Asia-Pacific sovereign credit outlook

Resilience in global uncertainty and strengthening emerging Asia ratings momentum

Fitch Ratings recently published the ‘Asia-Pacific Sovereign Outlook,’ summarising its views on sovereign credit trends in the region.

Emerging Asia’s sovereign credit-worthiness is supported by strong or improving public and external finances, as well as relatively strong medium-term growth prospects for most countries. These factors supported the assignment of a Positive Outlook to Korea’s ‘A+’ rating on 7 November 2011, and Indonesia’s upgrade to ‘BBB-’ on 15 December 2011.

Emerging Asia’s growth prospects remain relatively favourable, though the region is not immune from problems elsewhere in the world. Fitch has cut its forecast for Emerging Asia’s 2012 growth to 6.8% for 2012, from 7.4% in June, reflecting both the deterioration in the outlook for the world economy and the lagged impact of policy tightening in some countries, including the region’s two giants, China and India.

“High-income Asia” exhibits more mixed credit trends. Australia joined Singapore among the ranks of ‘AAA’ sovereigns on 28 November 2011, while long-standing concerns over external indebtedness saw New Zealand downgraded to ‘AA’/Stable from ‘AA+’/Negative on 29 September 2011.

Hong Kong was affirmed ‘AA+’/Stable, while Japan’s ‘AA’ Foreign-Currency and ‘AA-’ Local-Currency IDRs remain on Negative Outlook on Fitch’s concerns over medium-term government debt dynamics. Here is the full report

Asian economies not immune: Fitch has cut its forecast for emerging Asia’s 2012 growth to 6.8% for 2012, from 7.4% estimated in June 2011. This reflects both the deterioration in the outlook for the world economy and the lagged impact of policy tightening in some countries, including the region’s two giants, China and India. Emerging Asia’s resilience provides some support for high-income Asian countries relative to other advanced economies, although weak domestic demand and a strong currency make for anaemic growth prospects in Japan.

Policy flexibility: Many emerging Asian economies’ prospects are bolstered by scope for a domestic policy response to any deterioration in global economic outlook. China and India are exceptions. Although China’s explicit public indebtedness is low and fiscal stimulus may be feasible if needed, the country’s banking system is still working through the consequences of the credit-led stimulus of 2009-2010 and may struggle to repeat the effort. India is constrained by negative real interest rates and the high public deficit and debt burden.

Strong/stronger external finances: Strong and/or improving external balance sheets buffer most of emerging Asia from ongoing volatility in global investor risk appetite. India and Sri Lanka are the only Fitch-rated emerging Asian countries to run deficits on “basic balance” (the current account plus net foreign direct investment). This structural weakness may help explain why the Indian rupee fell to a record low against the US dollar in December 2011, while Sri Lanka devalued its currency in November.

Bank credit worries emerging: While many advanced economies “de-lever”, the speed of credit growth and rising asset prices has led to Asia-Pacific harbouring four of the world’s nine highest-risk financial systems according to Fitch’s macro-prudential risk framework.

Hong Kong and China were joined by Indonesia and Sri Lanka in the December 2011 assessment, although Vietnam dropped out as credit growth eased.

Political risk: Political risk weighs on several ratings in the region. Fitch will carefully monitor events on the Korean peninsula following the death of Kim Jong-Il on 17 December 2011.

The agency does not view the North Korean ruler’s death as a negative rating trigger in itself, but an escalation in tensions could affect not just Korea but also the broader region and potentially the world economy. Separately, Fitch does not believe that Thailand’s peaceful elections and orderly handover of power in July 2011 have fully resolved tensions in Thai society.

Emerging Asia positive momentum: The positive rating trends for emerging Asian countries strengthened in H211, supported by strong or improving public and external finances and relatively strong medium-term growth prospects for most countries. These factors supported Fitch Ratings’ revision of the Outlook on Korea’s ‘A+’ rating to Positive on 7 November, and its upgrade of Indonesia to ‘BBB−’ on 15 December.

High-income Asian diversity: High-income Asia has more mixed credit trends. Australia joined Singapore among the ranks of ‘AAA’ sovereigns on 28 November 2011, while long-standing concerns about external indebtedness caused New Zealand to be downgraded to ‘AA’/Stable from ‘AA+’/Negative on 29 September. Fitch affirmed Hong Kong at ‘AA+’/Stable, while Japan’s ‘AA’ Foreign-Currency and ‘AA−’ Local-Currency IDRs remain on Negative Outlook due to the agency’s concerns about medium-term government debt dynamics.

Emerging Asia: Macroeconomic outlook

Fitch has cut its forecast for emerging Asia’s growth in 2012 to 6.8% from 7.4% in the Sovereign Review and Outlook published on 30 June 2011 and available at www.fitchratings.com (see under Related Research for the December 2011 edition).

The reduction partly reflects weakening in the outlook for the advanced economies since June. It is also partly driven by the impact of policy tightening in a number of Asian countries in response to stubbornly high inflation, including China (58% of the region’s GDP in 2011) and India (a further 15%).

Despite the slowdown, the projection for regional annual average inflation of 5.9% for 2011 exceeds the 5.6% expected in June, while the 2012 inflation forecast is 4.9%, up from 4.7% in June.

Impact of global weakening

Fitch expects the emerging Asia region as a whole to have a current account surplus of 1.7% for 2012, down from 2.2% for 2011 and 3.5% in 2010. This indicates that foreign demand remains an important if diminishing source of growth in the region. Emerging Asia excluding China (EAEC) sent 20% of its exports to the eurozone in the year to July 2011, against 21% to the US. China sent 14.5% of its exports to the eurozone and 17.3% to the US.

As Figure 2 shows, year-on-year export growth for both EAEC and China tends to lag behind sentiment in the two major advanced economies by six months to a year. More timely aggregate export data are indicating slowdowns in export growth relative to 2010 in China, Korea, Malaysia, Taiwan and Thailand, with outright contraction of 18% yoy in the Philippines.

Real interest rates have risen for the region in aggregate, including for China and India, although overall the region’s authorities have not allowed exchange rates to strengthen markedly. Nevertheless, the pace of reserves accumulation slowed in Q311, testifying to decreased risk appetite among investors. Both China and India face a combination of slowing activity and stubbornly high inflation, underlining the risks that can arise from allowing inflation to rise above desired ranges. Fitch has revised down its forecast for China’s growth to 8.2% for 2012, from 8.5% in June. The official PMI sank to 49 in November, below the break-even 50 level and the weakest result since February 2009, indicating weakening activity. Fitch has revised its forecast for India’s growth in the financial year to March 2013 to 7.5%, from 8.2%, as inflation and monetary tightening are weighing on investment. The Reserve Bank of India raised its key policy rate by 2.25% over 2011 to 8.5%, although this still left the rate negative in real terms against headline wholesale price inflation of 9.1% in November. Moreover, the Indian rupee weakened to an all-time low against the US dollar of around 52 in November 2011. If sustained this level could give a further upward kick to inflation in 2012 and complicate policy management still further.

Fitch sharply revised down its forecast for Thailand to 2.8% in 2011 from 4% in the June Sovereign Review and Outlook due to the impact of heavy flooding in October. Manufacturing output fell 36% yoy in that month, the worst drop on record. Prospects remain uncertain as recovery from the disruption continues, although further downside risks to growth in 2011 arising from flooding disruption would be likely to be offset by a rebound in 2012 as the situation is restored.

Emerging Asia: Positive rating momentum strengthens

Emerging Asia’s positive sovereign ratings momentum increased in H211 with the revision of the Outlook on Korea’s Long-Term Foreign-Currency IDR to Positive on 7 November. The Outlook revision reflected Fitch’s assessment that strengthening sovereign and external finances are exerting upward pressure on the ratings.

The agency estimates that Korea faces relatively heavy external debt maturities in 2012 (US$ 66 b), while the export-oriented economy faces risks from the global environment. Nevertheless, Fitch’s expectation is that Korea will surmount these challenges and that the rating will be upgraded within the agency’s standard outlook horizon of 12 to 24 months.

The Outlook on the Local-Currency IDR of ‘AA’ remains Stable, as Fitch does not consider that an upgrade of the rating from this high level would be warranted even if the Foreign-Currency IDR were upgraded. The death of the North Korean leader Kim Jong-Il on 17 December 2011 highlights the continued relevance of political and security risk associated with the North. An escalation in tension could be negative for the South’s ratings, although Fitch does not expect this outcome at present.

Elsewhere in the region, Fitch upgraded Indonesia to ‘BBB−’ on 15 December. The upgrade reflected improvements in the sovereign credit profile including sustained fiscal prudence, strengthened external liquidity, and improved trend economic performance.  Monetary policy management contributed to lower inflation over the year than Fitch expected when it revised the Outlook to Positive in February 2011. Fitch projects GDP growth to average more than 6% a year until 2013 despite a less conducive global economic backdrop. Low public debt and positive real interest rates give the authorities flexibility to respond to any slowdown.

Nevertheless, structural and fundamental weaknesses including a low fiscal revenue take, a low average income level, and deficiencies in physical infrastructure and governance weigh on Indonesia’s sovereign credit profile.

Fitch upgraded Sri Lanka’s Long-Term Foreign-Currency IDR to ‘BB−’ with a Stable Outlook from ‘B+’/Positive in July 2011, reflecting the stabilisation and recovery of the economy under the authorities’ IMF programme and efforts to consolidate the chronic budget deficit.

However, foreign direct investment has been surprisingly slow to recover after the end of the country’s long civil war in 2009, and the authorities devalued the Sri Lankan rupee by 3% in November 2011. Structural reforms to support longer-term growth prospects combined with further fiscal consolidation efforts would increase Sri Lanka’s chances of moving further up the ratings scale. Fitch affirmed Vietnam and Mongolia at ‘B+’ with a Stable Outlook in August and November 2011, respectively. In both cases the agency remains concerned that fiscal policy remains overly loose, contributing to inflationary pressure and leaving the economies poorly placed to respond if global growth weakens sharply or if economies are hit by other shocks. Fiscal issues also featured heavily in Fitch’s affirmation of Malaysia’s Long-Term Foreign-Currency IDR at ‘A−’ in August 2011, as the authorities have yet to draw up and implement a convincing plan to diversify the fiscal revenue base away from dependence on petroleum-derived income.

Fitch revised the Outlook on China’s ‘AA−’ Long-Term Local-Currency IDR to Negative from Stable in April 2011. It affirmed the Long-Term Foreign-Currency IDR at ‘A+’ with a Stable Outlook. The Negative Outlook primarily reflects the agency’s concerns that problems in the banking system will ultimately affect the sovereign credit profile, and about the severity of the terms of the short-run growth/inflation trade-off and the medium-term sustainability of China’s increasingly investment-led growth model.

High-income Asia: Sovereign credit trends mixed

High-income Asia – Australia, Hong Kong, Japan, New Zealand and Singapore – has more mixed sovereign credit trends. Fitch upgraded Australia’s Long-Term Foreign-Currency IDR to ‘AAA’ in November 2011, reflecting the agency’s assessment of the robustness and resilience of the sovereign arising from low government debt and macroeconomic policy flexibility.

Fitch affirmed Hong Kong’s rating at ‘AA+’ in October 2011 due to its long-standing strengths: an exceptionally strong sovereign balance sheet and the supply-side flexibility of its open economy. However, in Fitch’s opinion exposure to risks in the Chinese economy – particularly rising cross-border banking links – weigh on the ratings. The agency affirmed Singapore at ‘AAA’ with a Stable Outlook in April 2011, with the rating supported by a high-income, diversified economy, fiscal surpluses, and the strength of the sovereign and external balance sheets.

In September 2011 Fitch downgraded New Zealand to ‘AA’/Stable from ‘AA+’/Negative due to concerns about the economy’s high external indebtedness and the outlook for the public finances. Although these are unlikely to become a weakness among advanced economies their role as a strength is likely to erode. However, the sovereign’s fundamental strengths, including a high-income economy, and among the strongest public institutions and governance standards globally, continue to warrant a high sovereign credit rating.

Fitch revised the Outlook on Japan’s ‘AA’ Long-Term Foreign-Currency IDR and ‘AA−’ Local-Currency IDR to Negative in May 2011. High and rising public indebtedness and anaemic growth make for adverse debt dynamics, exerting negative pressure on the ratings.

The ratings remain supported by the sovereign’s strong financing flexibility, with yields on the benchmark 10-year government bond remaining only around 1%, stemming in Fitch’s view from the sovereign’s ready access to the deep pool of Japanese private sector savings.

However, longer-term trends including population ageing are slowly eroding this strength. Fitch awaits more clarity from the authorities on their strategy for stabilising the public finances and heading off negative rating pressure.