Portugal, to be found high up Euromoney Country Risk’s global rankings of 186 sovereigns – in 55th position and in the third of ECR’s five tiered groups, sandwiched between Panama and India (both stable investment grades) on a score of 54.1 points – is a strong candidate to emerge from speculative status.
Legislative elections this October are creating some uncertainty over Portugal’s political direction and policies, plus the gross debt burden topping 130% of GDP last year – falling this year – remains a huge problem.
Nevertheless, the peripheral eurozone state successfully concluded its bailout programme. The economy is growing again, and the general government deficit is on track to slide below 3% of GDP, if not this year, in 2016 if austerity is maintained.
Tier-three sovereigns should in any event all be rated either investment grade or on the cusp of joining. The question is whether any tier-fours can make the leap.
One such sovereign, Hungary, a high-flying 67th, is now on 49 points from a maximum 100:
The country has caused consternation for investors in recent years, with the government following a largely unorthodox approach to policymaking, straining relations with its creditors and trade partners.
Country-risk experts have had little option but to downgrade their scores for institutional risk and other factors, including the regulatory and policymaking environment.
The government has recently changed tack, favouring more orthodox and market-friendly policy prescriptions after stabilizing the situation.
Hungary is also enjoying decent economic growth – 3.6% last year and 3.3% year-on-year in Q1 2015 – with a current-account surplus and falling unemployment bolstering its prospects.
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Gergely Urmossy, |
Gergely Urmossy, chief economist with Erste Bank Hungary, recently told Euromoney: “Hungary’s perception should slowly improve as the government’s commitment to keeping the deficit down using a strict cash-flow-based budget deficit target is credible.” The questions now are not only whether these two sovereigns will be upgraded soon, but also which other countries might follow their lead in the next few years.
ECR approach
Locating the next investment-grade sovereign bond issuer is an important element of investment strategy, but is one that is complicated by conflicting opinions among the rating agencies given the many economic, political and structural factors involved.
ECR’s risk-scoring method is now a well-established alternative to their methodology, not least because of its regular quarterly updates and rankings approach.
More than 400 economists and other country-risk experts are asked to evaluate 15 separate indicators, with all 186 countries placed into five-tiered categories based on their total risk scores, which additionally take into account the credit ratings, debt indicators and capital-access scores.
The survey’s ability to picture the fluid nature of changing risks given long-term trends in risk scores can often unearth interesting anomalies to the main agency ratings. That was the case in 2013 when ECR successfully predicted the Philippines becoming an investment grade.
Pinpointing other candidates
Presently, the majority of the 29 sovereigns contained within tier three of Euromoney’s global risk data table are rated investment grade by one or more of the main agencies – Fitch, Moody’s and Standard and Poor’s (S&P).
Ignoring cash-rich oil and gas producer Brunei (one of several states which are unrated), the few exceptions are, as mentioned, Portugal – rated BB+ (positive), Ba1 (stable) and BB (positive) by Fitch, Moody’s and S&P respectively – alongside Cyprus (B-/B3/B+), two places below in 57th spot still recovering from its bank failures, and Croatia (BB/Ba1/BB), now 64th making it the lowest-ranking tier-three sovereign.
Croatia’s credentials differ from Hungary’s and Portugal’s. The sovereign is treading water in the global hierarchy and is still 34 places below its ranking in 2007. Hungary, despite its recent wobbles, is 68 places higher than it was then, and Portugal is 42 places better off.
The differences among them are rather nuanced. Croatia ranks higher than Hungary and Portugal for bank stability for instance (see chart below).
However, it has weaker credentials than Hungary for its economic growth, employment/unemployment situation, the fiscal finances and particularly government stability. It lags Portugal on most counts, often quite substantially.
Moreover, Croatia’s risks are reflected in five-year credit-default-swap spreads, which are presently 271 basis points, compared with 154bp for Hungary and 181 for Portugal, where a higher value equates to a higher insurance cost against default.
What do the rating agencies say?
The legacy of the global financial crisis is still causing problems for countries with large fiscal imbalances, with the Greek crisis returning to the fore.
Emerging markets and major commodity producers are struggling to retain investors’ faith as capital pours out of countries with large imbalances amid expectations of higher interest rates in the US.
This is keeping, or potentially putting, some sovereign issuers into sub-investment-grade (junk bond) status and raises an important question as to whether there are other stronger propositions for investment grade to be found.
The rating agencies, as ever, do not always agree with each other when attempting to answer this question.
Fitch has just four candidates close to investment grade, rated BB+, which in addition to Hungary and Portugal, include Costa Rica and FYR Macedonia.
The latter has improved in ECR’s survey, but is stable, signalling it is unlikely to be considered for an upgrade any time soon.
Costa Rica, meanwhile, is on review for a downgrade, which seems sensible based on ECR data showing declining score trends on both a short- and long-term trend basis.
That leaves just Hungary and Portugal, with each borrower now on a positive outlook.
S&P upgraded its assessment of Portugal in March to reflect the economic recovery and narrowing fiscal deficit, after having downgraded its opinion the previous May, although it is still two notches below investment grade, contrasting with its ratings from Fitch and Moody’s, which are only one step away.
A decision was also made by S&P to upgrade Hungary in March to BB+ positive.
S&P also has Bulgaria, Indonesia and Turkey on BB+, but all three are already rated investment grade by the other two agencies.
Russia’s rating is more likely to be downgraded than upgraded considering its recent plight – the agencies are still viewing the country cautiously, with Moody’s and S&P now differing from Fitch with their sub-investment grades.
Moody’s, meanwhile, believes Hungary and Portugal are stable credits, one notch below investment grade. The agency has other prospective triple B candidates, but none has strong credentials. Among its top-rated double-B sovereigns are Russia, as mentioned, but with a negative outlook attached.
Others include Costa Rica and Croatia, as well as Guatemala, Morocco and Paraguay.
The latter three are all stable ratings. Guatemala is still too risky, lying 91st in Euromoney’s survey, lagging Morocco and Paraguay in terms of its bank stability, labour market, capital repatriation and government stability risks.
Morocco (72nd) and Paraguay (75th) are real possibilities to emerge from the fold as new investment grades, but only over a long-term perspective if their improving score trends continue.
Other claims for investment grade
There are two investment-grade sovereign borrowers – Romania and Indonesia – above Hungary in tier four, and six below.
Russia, as mentioned, is in danger of losing that status as it continues to fall through the rankings. Of the others, Kazakhstan is the least secure, given its own vulnerability to oil prices, banking-sector frailties and Russia’s problems.
Mauritius, Bulgaria, Morocco and Azerbaijan, on the other hand, appear more secure, with all four climbing sharply through the rankings since 2007.
Splitting this group in two is Costa Rica, but lying just below is Paraguay, one of ECR’s hot tips for investment-grade status over the longer term.
However, Paraguay must continue to make progress in terms of its political risk, as scores for corruption, transparency, institutions and the regulatory and policymaking environment remain very low – below three points out of the 10 allocated in most cases.
Some reforms have been made, but others are required for Paraguay to become a more impressive place for doing business.
Other top tips are Gabon, although it is now struggling with low oil prices.
Georgia, Sri Lanka, Tunisia and Armenia have all risen sharply in ECR’s rankings since 2007 and are ones to watch, but there are still nagging doubts over various aspects of their political, economic and/or structural make-up, meaning the risks remain too high.
At present, then, it seems investors can only look to Hungary and Portugal. In the absence of any further transient shocks, the two European countries are odds on to reclaim their investment grades.
This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.