Credit fundamentals in emerging market sovereigns have deteriorated markedly over the past seven months, according to an unusually literary* report released on Monday by Standard & Poor’s.
The report – titled “The Race is Run; the Runner Spent” – notes S&P has downgraded 10 of its universe of 43 emerging market sovereigns in the last six months, including one default. The rating agency also “worsened the outlook without a downgrade” on another ten; nearly half the group now has a negative outlook, compared with less than a fifth in late September.
From the note, emphasis FT Alphaville’s:
We opened the last report card with the lead “the trend of improving credit fundamentals in emerging market sovereigns that has prevailed since 2003 appears to have run its course.” The course is run and the runner spent, but we don’t think he’s dead. This is not like the story of Pheidippides, who ran from a battlefield near the town of Marathon to Athens in 490 B.C., announced to his fellow citizens that the battle had been won, and then collapsed and died.
…
Since Sept. 15, 2008, the data closure date of our last emerging market sovereign report card, we lowered the ratings on Argentina, Bulgaria, Dominican Republic, Ecuador (twice), Hungary (twice), Jamaica, Pakistan (twice), Russia, Sri Lanka, and Ukraine (twice). Although each downgrade was motivated by factors specific to the government concerned, some common factors prevailed. The marked economic downturn in the major economies and the rise in investor risk aversion depressed emerging market exports and sharply raised external funding costs.
Worsening external liquidity indicators and rising external rollover risk contributed to the downgrades of Argentina, Bulgaria, Dominican Republic, Ecuador, Hungary, Jamaica, Pakistan, and Sri Lanka. A deteriorating political environment was a factor for others: Argentina (which seized control of its private-sector pension scheme), Ecuador (which declared some of its external commercial debt illegitimate), and Pakistan and Ukraine (which suffered from policy paralysis due to problems within the ruling coalitions). Some had problems with their financial systems, such as Hungary and Ukraine. Some had fiscal outturns, which combined with other factors were no longer consistent with their rating, such as Argentina and Dominican Republic.
In the midst of these negative rating actions, one government bucked the trend. The Slovak Republic was the only emerging market sovereign we upgraded during the period. It joined the EMU and has avoided many of the pitfalls that trouble its Eastern European neighbors. In addition, Pakistan, after being downgraded twice in short succession, had its rating raised one notch to ‘CCC+’ after it obtained an IMF program.
All in all, it was a rough six months
Despite the downgrades and outlook adjustments, the distribution of S&P’s emerging market sovereign ratings has remained relatively stable, since:
Not only were most of the downgrades of a single notch in the past six months, also all but the two downgrades of Ecuador and the second downgrade of Pakistan and Ukraine were within their rating categories. As a result, the distribution of our emerging market sovereign ratings hasn’t changed much since the upgrade of Brazil in April 2008 and Peru to investment grade in July 2008
The percentage of investment-grade emerging market sovereigns to the total number of rated emerging market sovereigns remained at 42% from Sept. 15, 2008, to March 31, 2009. The ratings of these emerging market sovereigns are fairly well distributed among the four categories that range from ‘A’ to ‘B’.
Nonetheless, the outlook for the coming quarters is less than rosy. S&P forecasts that more than half of its rated emerging market sovereigns will record negative real GDP per capita growth for 2009, and that “the fiscal balances of all but a handful will worsen.”
S&P’s analysts “don’t see much rating upside for the near term for emerging market sovereigns,” although they expect any downgrades to be modest.
In other words, we expect that most will survive the Marathon to Athens run, but a few won’t. Downside risks to credit quality predominate for the asset class, but we don’t foresee a wholesale erosion of credit quality for emerging market sovereign borrowers as a group.
Still, this is another indication that the decoupling theory was more like a myth.
(*by rating agency standards)
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