ECR survey results Q3 2016: China, Italy, Nigeria mar stabilizing global outlook

Sink or swim time for global investors as the clock ticks down on Italy’s decision day on December 4

In total, 73 of the 186 countries in Euromoney’s country risk survey became riskier (their risk scores fell) in July to September, as a combination of political, economic and structural risk factors weighed on the prospects of a vast array of sovereign borrowers, which are still struggling to convince the experts taking part.

Topping the list is Italy, which has shed more than three points, and has lost 30 in all since 2007, plummeting 10 places in the global risk rankings since June, to 51st, questioning the country’s investment-grade credit ratings.

The financial markets are braced for instability on December 4 when a referendum on prime minister Matteo Renzi’s political reforms could spark early elections if Italian voters reject the bill, plunging Europe potentially into another crisis if a Eurosceptic coalition were to be formed.

The suspect health of Italian and Portuguese banks is an added factor to concern eurozone investors as low profitability, rising non-performing loans (NPLs) and the demands to uphold new capitalization levels strain their ability to lend.

Poland’s political risks are, meanwhile, producing conflict with the European Union, creating tax uncertainty for corporate investors, and raising the possibility of missing the 2017 budget deficit target, all of which is signalling a credit rating downgrade is overdue.

In the UK, downgraded economic forecasts and an abandoned fiscal surplus target highlight the uncertainty spilling over from the Brexit referendum putting pound-sterling in a spin, with the UK’s debt burden casting a dark shadow and investors requiring greater certainty about the new trading relationships.

The downgraded risk scores for Italy, the UK, and also for Germany and the US precipitated by their prospective national elections means the G10 score has fallen more than any other investor region in Q3 2016, explaining the outflow of funds from low-yielding assets that are not guaranteeing low levels of risk (second column of chart):

However, a mixed picture is forming, in which many other regions have become less risky. Even in the G10, Canada has become safer.

So, too, has the Netherlands with its vastly improved fiscal record and the fact a copycat referendum to leave the EU seems unlikely, with none of the political parties willing to cooperate with Geert Wilders’ anti-EU Party for Freedom, which is leading in the opinion polls for the elections due in March.

There are 75 countries in all, spread around the world, with higher risk scores since June – implying they are safer.

Among them are Argentina, Bulgaria, Cyprus, Iceland, Romania and Senegal, all tracking higher in the rankings to provide investors with a broad range of portfolio options.

Prospects for the larger emerging markets are similarly diverging, despite the poor performance of the Brics and Mints so far this year.

More than 400 economists and other experts taking part in the survey are asked to rate 15 economic, political and structural indicators, which are then added to values for capital access, credit ratings and debt indicators, and are aggregated each quarter to provide a total risk score.

The latest results show Brazil, China, Turkey and, to a lesser extent, India becoming riskier in Q3 2016. China is seemingly managing its economic slowdown successfully, but the debt stock has risen to 250% of GDP and NPLs are rising in the banking system.

Nigeria, too, is still suffering from the fallout of the oil-price crash, which is showing up in recession, high inflation and a foreign-exchange crisis made worse by the government meddling with capital controls starving the corporate sector of liquidity.

The crisis is still enveloping other oil producers, too, from Azerbaijan and Kazakhstan (weighing on prospects for the CIS), to Angola and Gabon – similarly for sub-Saharan Africa (SSA) – but not the Gulf producers. They are insulated from the shock by their huge sovereign wealth and are even a little safer now the price of oil has gone back above $50 per barrel, thanks to Opec support.

Survey experts are showing greater faith in Saudi Arabia in particular, despite its short-term failings, since it approved a diversification programme, and elsewhere Argentina is racing back, benefiting from improved capital access.

Indonesia and Mexico are, meanwhile, blazing a trail with their ameliorating risk scores.

South Africa and Russia have also earned a reprieve, but it remains to be seen if either country will suddenly become safe havens for yield-hungry investors still fleeing the ultra-low and negative rates of industrialized sovereign bond placings, given their hugely depressed scores and vulnerability to setbacks.

The same is true of others posting mini-rebounds, including Armenia, Montenegro, Kenya and Ukraine, many of which it must be considered still have low scores, symbolizing high risk.

Indeed, there is still the sense of nervous anticipation, as investors brace themselves for the Italian referendum and the heavy electoral calendar in Europe next year, taking in parliamentary votes in the Netherlands (in March), France (April/May) and Germany (later in the year), all preceded by the battle for the White House on November 8.

Tomas Kinmonth, fixed income strategist with ABN Amro, identifies a number of factors that are sustaining global risk, including China’s debt build-up, which he says will not trigger an externally driven liquidity crisis, but “adds to the risks in the banking system and to future growth prospects”.

US Federal Reserve policy, he says, could “turn sentiment in markets, and emerging markets in particular”.

However, it is Italy he considers “the proximate risk”, with the possibility of elections being held before 2018 being won by Beppe Grillo’s populist Five Star Movement, despite Renzi seemingly backtracking on his pledge to resign if his reform bill does not gain public approval.

In Asia – apart from the fact China, Malaysia and Taiwan are becoming riskier – others including Indonesia, Japan, South Korea and Thailand have either improved or stabilized since June.

Concerns for regional trade, debt growth and South China Sea tensions are mitigated by capital inflows steadying currencies, and sustained strong growth prospects averaging more than 5% in real terms in 2016-17, according to the IMF’s latest World Economic Outlook projections.

Benefiting from political stability and their positive business-friendly regimes, Myanmar and Vietnam have become safer, in contrast to other frontier markets such as Cambodia and Mongolia becoming riskier owing to political tensions, softer economic growth, and fiscal and balance-of-payments problems.

The situation across much of South America remains in flux due to the commodity crunch, Brazil’s acute problems and the seemingly never-ending downward spiral in Venezuela, where the economic crisis is delivering hyperinflation, goods shortages and the prospect of debt default amid heightened political conflict.

Compare that to Argentina, where the government is getting to grips with its problems in a market-friendly orthodox manner, introducing a new competition law and embarking on deficit reduction, with the central bank adopting inflation-targeting.

The country is still a medium-to-high risk, but is now up to 96th in Euromoney’s global rankings.

Chile, Mexico and Peru have improved this month, benefiting from a small rebound in commodity prices, and Caribbean investors should note the improvement in all countries there, except Barbados, which has seen the recovery slip, putting the focus back on its fiscal deficit.

The risks of investing across the Middle East and North Africa region have stabilized with oil and gas producers coping with the oil shock and eyeing a small rebound in market prices that will avoid sovereign wealth depletion.

However, the familiar theme is one of heightened political and social instability risk caused by the regional conflicts that are still weighing on scores for Egypt, Libya, Iraq, Syria and Yemen.

Political tensions and fiscal problems have also led to downgraded scores for Jordan, Lebanon, Tunisia and Oman – the Gulf state which is most exposed to the oil crisis.

Risk scores for oil producers across SSA, including Angola, Congo Republic, Gabon and Nigeria, have fallen further as the economic effects of the crisis manifest in lower incomes, less foreign exchange and worsening fiscal deficits.

Poorer, more unstable countries with political problems have also become riskier, but for a large proportion of the region’s comparatively safe borrowers their risk scores have increased – among them are Botswana, Cameroon, Cote d’Ivoire, Ghana, Namibia and Senegal. 

To view the methodology and follow the changing risk trends more closely in the coming months, go to: www.euromoneycountryrisk.com.

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