Sovereign Defaults Set to Hit Record in 2020


Thursday, May 14, 2020 / 05:45 AM / By Fitch Ratings / Header Image Credit: Investopedia

Further sovereign defaults are probable in 2020 as the coronavirus pandemic and collapse in oil prices exacerbate underlying credit weaknesses, Fitch Ratings says. Argentina, Ecuador and Lebanon already have defaulted on sovereign debt in 2020, equalling the record high of three defaults by Fitch-rated sovereigns in 2017.

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The sovereigns most exposed to the coronavirus and oil price shock are those with generally weak credit fundamentals, such as high government debt and weak policy credibility; and those reliant on commodity exports or tourism, or with large external financing requirements, foreign-currency debt, prior hot-money inflows and low foreign-exchange reserve buffers.

There is strong downward pressure on ratings. In only the first four months of 2020, there were a record number of sovereign downgrades of 29 (of which eight have been within the 'CCC/CC/C/RD' range). There was a sharp change in Outlooks to a net negative balance of 28 (despite the downgrades) from four at end-2019, the joint highest ever. This amplifies the longer-term trend of declining average emerging-market ratings. Some 29% of all sovereign ratings are now in the 'B/C/D' categories.

Fitch rates five sovereigns at 'CCC' or below (excluding those in default): Gabon, Mozambique, Republic of Congo and Suriname at 'CCC' and Zambia at 'CC'. We also rate El Salvador, Iraq and Sri Lanka at 'B-' with a Negative Outlook. The rating definitions of 'CCC' ("substantial credit risk: default is a real possibility") and 'CC' ("very high levels of credit risk: default of some kind appears probable") and historical experience imply a likelihood of further defaults in 2020. The average annual default rate over 1995-2019 for 'CCC/CC/C' sovereigns was 26.5% and the cumulative five-year default rate was 38.5%.

These default rates include sovereigns rated at 'CCC/CC/C' post-default. Only five sovereigns downgraded to or originally assigned a 'CCC+' or lower rating have avoided a default. For sovereigns that default, the median time to default from entering the 'CCC/CC/C' range is just seven months, compared with 40 months for 'B' range sovereigns.

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Sovereign defaults are relatively rare. Fitch has recorded just 23 defaults of rated sovereign across 14 countries since it started its sovereign coverage in the mid-1990s. However, there has been a marked increase in defaults since 2016.

Sovereign defaults are multifaceted and reflect idiosyncratic as well as common factors. They can reflect ability and willingness to pay; solvency and liquidity; predominant macroeconomic, external financing and fiscal drivers; and/or governance, political or banking sector developments; abrupt shocks or slow-burn trends. The small sample size of sovereign defaults impedes the ability to conduct robust statistically significant analysis of their causes.

Nevertheless, trends in a few key indicators show that medians for Fitch-rated defaults for GDP growth and governance decline sharply pre-default, while budget deficits widen and government debt rises sharply to high levels.

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