What is the `Tree of Truth’?
According to RBS, it is a Binary Recursive Tree Approach aimed at selecting explanatory variables and critical threshold levels that best discriminate between sovereign debt crisis and non-sovereign debt crisis states.
In basic terms it’s a flow chart, showing which countries in Central Eastern Europe, the Middle East and Africa, the bank (using criteria from a 2005 IMF working paper by Nouriel Roubini and Paulo Manasse) thinks are potentially vulnerable to a sovereign debt crisis.
And RBS has just updated its Tree of Truth chart for 2010.
The result is below, click to enlarge.
If you want to compare and contrast with the 2009 version, created in June, the chart is here.
We can tell you that the model identified 14 economies at risk in 2010, compared with 13 for 2009. In the words of RBS’s CEEMEA specialists Tim Ash, Imran Ahmad and David Petit-Colin, that means that “… despite the general improvement in global sentiment, the analysis suggests a more lasting impact from problems faced by the global economy over the past year or so.”
Specifically, Hungary, having dropped off the list of vulnerable credits in CEEMEA in 2009, re-enters in 2010, along with Romania. Having added some new states to the model mix for 2010, RBS also identifies Bahrain, Iceland, Lebanon and the UAE as crisis-prone this year.
The majority of at-risk states are still, however, within emerging Europe.
Here are some select excerpts:
* The results are broadly in line with current market risk perceptions as in recent years Emerging Europe has generally suffered from wide current account deficits and excessive foreign borrowing and hence large external financing requirements/relative to FX reserve positions. Rigid exchange rate regimes, predominant through the region, add an extra vulnerability, suggesting a very hard landing for these economies, with pass thru to banking sectors via rising [nonperforming loans].
* None of the major EM economies in Asia and Latin America surveyed appear vulnerable to crisis as per the IMF definition/methodology. The latter two regions’ much better external financing positions, particularly reflect the maintenance of current account surpluses and relatively light external debt burden while the accumulation of healthy stocks of FX reserves during the “good years” provide an added degree of insulation.
* The analysis clearly has its limits as it only reveals “ability to pay”. As recent debt crises (e.g. Argentina and Ecuador) in Latin America and perhaps even Dubai in CEEMEA, in particular, have shown, “willingness to pay” is also critically important, but difficult to model. Countries could perhaps use the “cover” of the global crisis to manage their external liabilities lower by restructuring liabilities.
Full paper in the usual place.
(H/T the FT’s Chris Flood)