Country risk September 2010: Growth markets on course to overtake old safe havens

IN THE 21st century an extraordinary transformation has taken place in the way business is done. Cross-border transactions and multinational linkages have created truly international organizations. Today there is a growing need to situate the local within the international.

With this in mind, Euromoney has sought to provide its readers with a dynamic and global analysis of the political, social and economic factors that influence the commercial attractiveness of a particular market. We have updated and enhanced the data sources that make up our semi-annual country risk ranking (see methodology). And the new-look results make for interesting reading in the light of the global financial crisis and its aftermath. The technologically driven age we live in has created a seamlessly flat world in which knowledge, resources and ideas are being transported globally at breakneck speeds. Globalization has facilitated this, making foreign direct investment cheaper and more efficient. This process has been coupled with the rapid resurgence of the emerging markets, which are now dominating the geopolitical landscape.

Joyce Chang, head of emerging markets and credit research at JPMorgan, says: "Emerging market sovereigns this year alone have had 10 credit rating upgrades. Developed countries, particularly in Europe, have experienced downgrades and remain on a negative outlook in many cases, such as Ireland, Spain, Greece and Portugal. The last developed country ratings upgrade occurred back in 2007."

Big changes

Uncertainty continues to surround the direction of the global economy. The effects of the sovereign debt crisis are still being felt because of the collapse of the banking sector and consumer spending and the bursting of the real estate bubble. Last September the US fell out of the top-10 safest countries for investment and this year it has been unable to regain that ranking, dropping a further two places since March, when Euromoney last compiled country risk data.

Many western European countries have struggled too thanks to the sovereign debt crisis – UK (down one place) Spain (down 12), Italy (down eight), Portugal (down two). Greece has fallen a staggering 23 places in Euromoney’s country risk report since March. Elsewhere in Europe, Hungary has fallen seven places as its struggles with the IMF and the imposition of a new bank tax have scared investors.

Not surprisingly, the Nordic countries remain safe havens for investment. Eva Molyneux, a political analyst at Maplecroft, says the strength of the Nordic countries lies in a "combination of political stability, institutional strength and longevity". These democracies have a rule-based system that people respect, making for a predictable business environment and giving businesses reliable access to remedies should things go wrong.

In emerging Asia, the two big economies of China and India have fared relatively well. China, now the world’s second-biggest economy, is up seven places and India has risen three places.

Other highlights include Hong Kong and Macau faring better than ever. Hong Kong has found its way into Euromoney’s top 10 of the country risk ratings at number nine and Macau has risen 15 places since March.

In southeast Asia, Thailand’s red shirt anti-government demonstrations, mainly supporters of former prime minister Thaksin Shinawatra, are creating political upheavals. Despite these clashes, Thailand has climbed 17 places after generating GDP growth of 12% during the first half of the year – its highest rate in 15 years. Indonesia rises nine places and Singapore five.

Chile and Brazil are lifting Latin America’s prospects, with Chile rising 22 places, and Brazil moving up nine. Opinions are mixed on the Middle East, with some countries, such as the UAE and Qatar, faring relatively poorly. UAE is down six places and Qatar has dropped out of the top 10.

The riskiest countries for investors remain the ones most affected by high levels of conflict, which include Somalia, the Democratic Republic of Congo, Iraq, Burma, Central African Republic, Chad and Nigeria.

UK and US tumble together

Growing pressure on household finances, rising fears of job insecurity and still-tight lending criteria are creating a slippery slope for the US and UK in Euromoney’s country risk report. The US has dropped four places and the UK one, as worries mount of a double-dip recession.

In July the US had a record slump of 27% in home sales, and the UK has had an 18.5% drop in mortgage lending over the past year. These signs of stagnation are likely to dent consumer confidence. Xavier Denecker, managing director at Coface, says: "We believe the real estate bubble is not yet completely resolved. We see property prices dropping plus an unusual unemployment rate for the US, which will probably lead to household behaviour of saving more than spending."

However, Rob Downey, partner of International Risk Consultants, believes these risks are overblown. "I don’t think debt is the big issue for the US and the UK right now – we can grow out of debt," he says.

Andrea Keenan, country risk group department at A.M. Best Co., says: "With the US and UK, given that they’re both triple A-rated and both have reserve currencies, they do not have as much impact on each other as they do on developing countries."

She adds: "Even in an economic crisis there is a large consumer base in these countries that sustains a minimal level of growth."

Escalating risk of Greece

Europe’s biggest fall since Euromoney’s country rankings in March is Greece, which fell 23 places from 33rd to 56th. Greece’s woes show no signs of diminishing despite receiving a €110 billion aid package from the EU and IMF in May in return for reining in its fiscal deficit.

Greece’s security forces have warned of social unrest as the government implements painful cuts and higher taxes. These include public-sector pay freezes, VAT rises, a higher retirement age, and laws making it easier to lay off company workers.

Denecker at Coface says: "Greece has not mastered its public finances for many years. They were deceptive in their public accounts when they joined the euro as these accounts had been optically improved. This explains why even Angela Merkel was at first reluctant to help Greece."

For a western European country Greece also has huge benefits programmes, with no efficient means of collecting tax. Downey at IRC, says: "Many people say that these governments such as Greece’s went overboard in their safety nets. These are arithmetic problems that might be resolved by cutting some benefits and extending the retirement age a few years for example. The imbalances caused by bad arithmetic can be cured by more refined arithmetic."

Maplecroft’s Molyneux says that Greece, when compared with similar developed countries, is rated as "high risk" on Maplecroft’s business integrity and corruption index. "We recorded high levels of political as well as police corruption alongside a general climate of impunity for corruption. The judiciary is also subject to influence and corruption on occasion."

Greece has experienced an asymmetric shock relative to the rest of Europe. Molyneux says: "Many European countries are being lumped together with Greece unjustly. Greece is in another category as its sovereign debt-to-GDP ratio is much worse, with Italy being a somewhat close second. Certainly there are similarities but these countries do not have as poor a fiscal situation as Greece."

After Greece, the most vulnerable country in western Europe is Spain, which dropped 12 places. Five of its banks failed the EU bank stress tests in July, more than any other country in the EU. Portugal fell two places as a large budget and trade deficit, combined with a shortage of savings, has raised questions about its ability to service its debt. Portugal’s prime minister, José Sócrates, has had to break his election promise and raise taxes. Italy dropped eight places, with its finances in a precarious state after its economy contracted by 5% of GDP last year, and a recent slump in its manufacturing industry.

France has dropped six places since March and Germany’s ranking has fallen by two places. France’s biggest economic worry is its budget deficit, which stands at 8% of GDP, more than twice the maximum agreed for members of the EU. Germany is confounding critics. In the second quarter its economy grew at its fastest pace since reunification in 1990 as output soared 9%. A recovery in global demand, as well as a decline in the euro against the dollar, is making German goods more competitive.

Hungary falls

Hungary has fallen seven places in Euromoney’s country risk report since March 2010. Mandy Kirby, a principal analyst at Maplecroft, says: "Investor confidence in Hungary’s government wavered as a result of unguarded comments by officials comparing Hungary’s fiscal situation to debt-ridden Greece. This brought concerns over public financing to the fore – essentially Hungary’s fiscal position had been worsening for some time but had not received as much attention outside of the region."

The IMF has taken a tough stance by suspending talks on its €20 billion rescue package agreed in 2008. Kirby says: "The postponement of the review was seen as a negative outcome by investors in the light of concerns over the size of Hungary’s foreign-denominated debt, which built up when the currency was stronger and interest rate differentials were greater."

The economy is barely growing, with the country’s central bank being blamed for keeping interest rates too high – among the highest in Europe. The government is proposing a special levy on financial institutions as part of measures to meet the financing gap but has drawn criticism from the IMF and EU that this will be a drag on economic recovery.

Kirby says: "The Hungarian government was not keen to commit to reducing its budget deficit to under 3% in 2011, which was promised by the former government that was elected out of office in April. The new Fidesz government has said it will meet commitments to a 3.8% budget deficit in 2010. However, Fidesz has a record of populist measures that might tempt it into spending more in 2011."

Asia climbs

Hong Kong rises into the top 10 of Euromoney’s country risk rankings to reach ninth place. Commercially vibrant and with one of the world’s busiest ports, Hong Kong is still proving itself to be a strong financial centre. Bob Broadfoot, managing director at Political & Economic Risk Consultancy, says: "There’s greater faith in the institutional strength of Chinese banks – all of a sudden they don’t look weak compared with western banks. China’s looking strong and Hong Kong is a beneficiary of this."

He adds: "A few years ago people thought Shanghai would replace Hong Kong but this simply is not going to happen. Hong Kong is not defending itself in manufacturing terms, but its financial sectors and professional sectors are supporting it well."

Thailand has risen a steep 17 places since Euromoney’s country risk report in March. This is in spite of being burdened with decades-old separatist struggles, bloodshed, and a monarchy and military shaping its society and politics. In the background are rising anxieties about the deteriorating health of the king. Broadfoot says: "People were afraid that political backlashes would derail the economy but there is a greater sense that the economy will weather this. Tourists haven’t stayed away, exports are still incoming. Thailand is in line with other countries in this region in growth terms. This may all change though if the king dies."

Singapore has risen five places. Its manufacturing output has increased on average 45% in the first five months of this year and tourists have been attracted by the opening of two new casinos, supported by its government. However, Singapore is still at high risk according to Broadfoot. "Singapore’s growth depends on international investment but this means it is exposed to country risk in other countries which it has no control over. Singapore’s risks come not from their sovereign debt but from their assets."

China’s economy surpassed Japan’s to become the second-largest economy, behind the US, this year. However, China’s per capita income remains a fraction of Japan’s and the People’s Republic still has a long way to go in developing its economy. India, Asia’s third-largest economy, grew by 8.8% in the second quarter of the year, its fastest pace in two years as a result of strong manufacturing output and foreign investment. India is also experiencing a reverse brain drain in which professionals are returning to their homeland from technology hotspots such as Silicon Valley and other developed country hubs to take advantage of India’s growing opportunities.

Latin America’s rising stars

The standout performers in Latin America are Chile and Brazil.

Christopher Garman, head of research for Latin America at Eurasia Group, says: "Brazil and Chile entered the global downturn with significantly lower macroeconomic vulnerabilities, which gave them conditions to implement economic policies that helped them emerge from the downturn."

He adds: "Chile suffered more than its counterparts in the beginning stages of the global downturn given its heavy dependence on commodity exports but it also has the highest rate of savings which puts it in a position to engage in the most aggressive counter-cyclical fiscal policy in the region. Chile’s aggressive measures during the earthquake made this quite evident."

Brazil is benefiting from growth in other countries, notably China, which is now its biggest trading partner. There is also potential for a strong trade relationship between Brazil and India, with Brazil having the natural resources India needs to grow.

Garman says: "Brazil is a heavy commodity exporter but its economy is fairly heterogeneous in so far as it has a mixed export platform, large domestic market, and sound macroeconomic policies. The sum of all three has put the country on a good path for growth."

Downey at IRC says: "Brazil and Chile are twin engines. They have a broadening middle class, strong agricultural sector and are enjoying robust export trade. Being in this hemisphere, people used to joke cruelly, saying that Brazil had a great future which was far off, but the future is now, they are realizing their potential now.’

Middle East gloom

Dubai has dominated headlines out of the Middle East over the past year. Once the beacon of the region, the emirate is still heavily indebted, with its public and quasi-public debt estimated at 140% of GDP. Dubai has received $20 billion in support from Abu Dhabi but it cannot rely on its wealthier neighbour forever. Dubai’s government needs to take more stringent action.

Troubled state investment company Dubai World has begun to restructure its liabilities, with plans to raise as much as $19.4 billion by selling assets over an eight-year period in an attempt to appease creditors.

Anthony Skinner, an analyst at Maplecroft, says: "I would say that Dubai still remains the most risky emirate as it has yet to rebound from the crisis and prove that it can implement a prudent policy with the necessary checks and balances to reduce its overall exposure."

JPMorgan’s Chang says: "Even following the restructuring of Dubai World and the stress in the real estate sector, Middle East sovereign risk suffered only limited damage. Qatar’s credit rating was actually upgraded by Standard & Poor’s to AA in July."

Prospects for global recovery

At times of acute global uncertainty the importance of strong domestic institutions becomes apparent. States fostering sound legal conventions have built strong political and social institutions, encouraging democratic processes that are best equipped to overcome the recent slowdown.

Country Risk Group’s Keenan says: "Country risk looms most in weak societies, poor legal systems, non-transparent governments and legislature in which these factors are most vulnerable to swings in investor sentiment."

According to Vanessa Rossi, a senior research fellow at Chatham House: "The most important drivers of world growth are now access to cashflow to fund economic expansion and the confidence to undertake such investment, with developed countries competing to maintain the most highly skilled workforce to drive forward ideas."

Emerging markets have bounced back faster and more effectively than the developed countries. Additionally, emerging markets’ credit quality has improved significantly in relation to developed markets.

Denecker at Coface says: "Europeans need to come back to balance the big spending. It will take time to reduce the debt as well to come back to strong productivity gains. In the short term this will be difficult as we have to digest the debt we have accumulated."

He adds: "Convergence will go on because it is the only way to have a governance of the global economy, which is so integrated now. The economic nationalism we have seen in the crisis and in the moment of panic is not what will continue."