| Reviews & Outlooks |    3774 VIEWS  |
| Reviews & Outlooks | |
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Wednesday, November 13, 2019
/12:01 PM / By Moody's Investors Service / Header Image
Credit:
Our outlook for sovereign creditworthiness in 2020 is
negative, reflecting our expectations for the fundamental conditions that will
drive sovereign credit over the next 12-18 months. A disruptive and
unpredictable domestic political and geopolitical environment is exacerbating
the gradual slowdown in trend GDP growth, aggravating longstanding structural
bottlenecks and increasing the risk of economic or financial shocks.
The starkest manifestation of the impact of
geopolitical tensions is the disruption to trade, mainly resulting from the
standoff between the US (Aaa stable) and China (A1 stable). The antagonistic
political environment is also weakening global and national institutions,
lowering the shock-absorption capacity of sovereigns with high debt burdens and
low fiscal buffers.
Overall, the global environment is becoming less
predictable for the 142 sovereigns we rate, encompassing $63.2 trillion in debt
outstanding. Event risk is rising, raising the spectre of reversals in capital
flows that would crystallize vulnerabilities facing the weakest sovereigns.
2019 Overview
Domestic political and geopolitical instability, and
in particular its detrimental impact on policy-making and in some cases growth,
informed some of our key rating and outlook changes in 2019 across all regions
as well as our research commentaries during the year. Our map of global
hotspots (see Exhibit 2) identifies the sovereigns that will be at the centre
of our monitoring efforts in 2020.
In Europe and Central Asia, the negative
outlook change for the UK (Aa2 negative) was driven by the continued decline in
institutional strength resulting from the ongoing uncertainty surrounding the
UK's exit from the European Union (Aaa stable). The downgrade of Turkey (B1
negative), after two earlier downgrades in 2018, reflected the continued
erosion in the government's institutional strength and policy effectiveness.
However, Russia (Baa3 stable) was upgraded back into investment grade given its
strengthened fiscal and external debt positions, which bolster its resilience
to external shocks.
In Latin America and the Caribbean, the
negative outlook change for Mexico (A3 negative) was the result of the
government's increasingly unpredictable policy-making and the growing dependence
of PEMEX, the state-owned oil company, on government support. Argentina's (Caa2
RUR-) default, which was the result of weak institutions, unpredictable
politics and rapidly diminishing fiscal strength, drove the three-notch
downgrade and ongoing review for further downgrade.
In Asia Pacific, we changed the outlook on Hong
Kong (Aa2 negative) to negative to reflect the rising risk that ongoing
protests are eroding government and policy effectiveness and damaging the
territory's attractiveness as a trade and financial hub. The negative outlook
change for India (Baa2 negative) reflects the rising risk that economic growth
will remain lower than it was in the past, partly due to lower government and
policy effectiveness, leading to a gradual rise in the government's already
high debt burden.
Sovereigns in the Middle East and Africa recorded the majority of negative rating actions in 2019. The negative outlook change for South Africa (Baa3 negative) reflected the risk that the government will not reverse the deterioration in its finances and growth prospects, largely due to social and political obstacles to reform efforts. The weakening of Oman's (Ba1 negative) external and fiscal accounts linked to a high reliance on the oil and gas sector led to its downgrade into speculative grade. Lebanon's (Caa2 RUR-) dwindling external financing options, growing fiscal imbalances and policy paralysis resulted in two downgrades in 2019. However, Egypt (B2 stable) was upgraded further to fiscal and economic reforms that will support its fiscal metrics and GDP growth.
Increasingly antagonistic political environment is undermining trend
growth, weakening global and national institutions, and reducing resilience to
shocks
The
increasingly confrontational domestic and global political environment has
evolved from a catalyst for tail risks to a driver of lower growth and
heightened risks of shocks. In many advanced economies and some emerging
markets (EMs), influential "populist" movements have emerged in recent years,
either from the political fringe or from within established parties, often in
reaction to years of stagnant incomes and rising income inequality. Many reject
policy orthodoxy and multilateralism, aiming to disrupt the established
consensus or to supplant it. Often, the policies espoused create frictions felt
beyond a country's borders, with domestic political risk morphing into
geopolitical risk. Heightened domestic and geopolitical friction undermines
policy predictability and effectiveness and, with it, institutional strength - particularly as growth slows. Escalating global and regional trade tensions
increase the risk of financial or economic shocks, and the weakening of
multilateral institutions dents policymakers' ability to deal with those
shocks.
The
increasingly antagonistic global political environment is exacerbating the
slowdown in global growth, especially among the more trade-oriented economies.
Across the G-20, we estimate that growth has fallen to 2.6% in 2019 from 3% in
2018. While recovery from weak or negative growth in a number of EMs will
sustain that level overall in 2020, global growth will remain below trend and
any recovery will be shallow and fragile. The slowdown partly reflects cyclical
factors, partly structural drivers, including demographic trends. But the
adverse impact of the increasingly antagonistic global political environment,
particularly on global trade and investment, has been pervasive and will likely
remain so. While the starkest example is clearly the trade war between the US
and China, distracting and, in some cases, growth-diminishing tensions have
also risen in the Gulf, between Japan (A1 stable) and Korea (Aa2 stable), India
and Pakistan (B3 negative), the US and the EU, and the EU and the UK (see
Exhibit 2 on previous page). The first-order direct effect of these tensions - for example, the impact of tariff increases on trade volumes (see Exhibits 3
and 4) - is not always severe. However, the second-order impact on investment
and capital flows via confidence channels is likely to damage both near- and
medium-term growth prospects across all regions.
In an
unpredictable environment, growth and credit risks are tilted to the downside.
There are few silver linings, and a rising risk of more negative outcomes.
Unpredictable politics create an unpredictable economic and financial
environment, prone to volatility in financial and commodities markets and sharp
shifts in sentiment. That unpredictability, and the difficulty in envisaging
positive shocks, are key drivers for the negative outlook for the sector. The
two largest trading economies - the US and China - are slowing down and
seemingly locked in an unwinnable trade war, with repercussions for other
countries. Those embedded in global supply chains that rely on trade for growth - such as Hong Kong, Singapore (Aaa stable), Ireland (A2 stable), Vietnam (Ba3
RUR-), Belgium (Aa3 stable), the Czech Republic (Aa3 stable) and Malaysia (A3
stable) - face a slowdown in economic activity (see Exhibit 5 on the next
page). Those with large current account deficits and most reliant on external
capital - like Lebanon, Mongolia (B3 stable), Tunisia (B2 negative), Pakistan,
Sri Lanka (B2 stable), Argentina, Turkey, and to a lesser extent Indonesia
(Baa2 stable) and South Africa - are most exposed to financing shocks. Recent
years offer ample evidence of the scope for reversals in capital flows, which,
if sustained, can profoundly damage recipient country fundamentals.
Around
the world, an increasingly populist tone is undermining domestic policy
effectiveness, weakening institutional strength and compounding social and
governance risks. The erosion in the geopolitical consensus has been mirrored
by rising domestic political tensions, particularly - though not exclusively - in western democracies. Those tensions, and the unorthodox policies or policy
inertia to which they give rise, have in common their damaging implications for
the effectiveness of policymaking institutions. Our assessments of
institutional strength for global sovereigns have generally deteriorated over
the past five years (see Exhibits 6 and 7 on the next page), and these will
remain under pressure in 2020 and beyond as slowing economic growth will likely
increase social pressures and fuel populist policy agendas. Examples are
varied.
- Among
advanced western economies, the domestic travails and external confrontations
of the Trump administration continue to distract US policymakers from the
longer-term fiscal challenges - comprising widening federal budget deficits, a
rising debt burden and falling debt affordability - facing the country. In the
UK, the predictability and effectiveness of UK economic and fiscal policymaking
has diminished as policymakers struggle to adjust to the inward-looking and
anti-European sentiment that continues to drive the UK towards exiting the EU.
In Italy (Baa3 stable), the rise of populist parties on both sides of the
political spectrum has distracted policymakers from the reforms needed to
address the deep-seated structural impediments to growth. In France (Aa2
positive), the "gilets jaunes" protests have prompted the government to
accelerate tax reductions and implement spending cuts more slowly than
originally planned.
- Throughout Central and Eastern Europe (CEE), increasingly nationalist sentiment
and inward-looking politics in countries like Poland (A2 stable) and Hungary
(Baa3 stable) continue to pose challenges to domestic institutions and,
externally, to the integration and cohesion of the EU. The continued weakening
of Turkey's public institutions and unpredictable policy-making have highlighted
the lack of a clear and credible plan to address the underlying causes of the
country's macro-financial distress.
- In
Latin America, increased social demands against a backdrop of slowing growth
and high income inequality are constraining policymakers' room to adopt reforms
and fiscal measures to support growth and public finances. Chile (A1 stable)
and Ecuador (B3 negative) have seen waves of protests. In Argentina, the
default triggered by the surge in support for the victorious populist candidate
has laid bare once again the weakness of the country's policy-making institutions. In Mexico, the credit implications of the shift in policy
direction under the latest administration remain to be seen, given the contrast
between its conservative fiscal stance and the populist rhetoric.
- In
Africa and the Middle East, geopolitical risks and domestic political tensions
drive policy inertia. The protests that recently erupted in Iraq (Caa1 stable)
and Lebanon threaten government stability in the former and led to the
resignation of the prime minister and government in the latter. In Tunisia, the
elections have handed a defeat to the incumbent government linked to rising
austerity fatigue among voters. In Oman, the political imperative of
maintaining economic and social stability has frustrated efforts to curb
further fiscal deterioration. In Ethiopia (B1 negative), the attempted coup in
Amhara underscores the government's underlying susceptibility to domestic
political risk. These risks are unlikely to dissipate in the run-up to
elections scheduled for 2020 given that the Ethiopian government's reform
agenda risks exacerbating ethnic tensions in some parts of the country. In
South Africa, deep inequalities and resistance from key stakeholders inhibit
policymakers' efforts to stabilize public finances, stimulate investment and
reinvigorate growth.
- In
Asia, policy challenges stem less from rising populist sentiment than from
longstanding structural economic challenges facing policymakers in a less
benign global environment. In India, waning growth both reflects and
exacerbates the vested interests that are barriers to reform and also the
authorities' challenges with effective implementation of their original reform
efforts to broaden the tax base, reduce fiscal deficits, strengthen the
financial system and stimulate investment. In China, policymakers face
increasing challenges as declining global growth and rising geopolitical
tensions expose the challenge inherent in simultaneously maintaining growth,
financial and economic stability and wide-ranging reform efforts. In Sri Lanka,
reforms and most policy decisions are on hold ahead of the presidential and
parliamentary elections which could extend well into mid-2020. So far, the
fiscal policy proposals by the main parties have failed to identify funding for
significant expenditure measures.
Weaker
institutions in turn undermine creditworthiness and resilience to shocks.
Weakening, distracted institutions and confrontational political environments
do not merely heighten susceptibility to shocks, they also undermine
policymakers' capacity to respond to them. At a global level, the erosion in
cohesion evident in the continued weakening of multilateral frameworks such as
the G-20 or the WTO, not to mention the bilateral tensions inherent in multiple
trade or other disputes, suggests that the international community would
struggle to respond cooperatively to an acute confidence shock that required
any meaningful policy coordination. At the domestic level, the capacity for
consensus - in any of the countries listed above and many more - is limited. So
is the capacity for decisive action, given the legislative consequences of
fragmenting social and electoral consensus, with authoritative majority
governments increasingly rare. Policymakers are poorly placed to deal with a
crisis, and the world's domestic and multilateral institutions are the weaker
for it.
Entrenched credit pressures in advanced economies are alleviated by
loose monetary policy, but accumulation of imbalances poses risks
Advanced
economies face a number of long-term structural challenges, in particular from
low productivity and fast-rising demographic pressures. These suggest that
economic growth will remain at historically low levels, and will continue to
decline slowly on average for the foreseeable future. At the same time, public
finances remain strained, weighed down by the debt burdens that are the legacy
of the global financial and European debt crises. The risks associated with
high debt and low growth are currently somewhat masked by historically low
interest rates, which seem likely to persist over the coming years given low
global growth. However, the efficacy of accommodative monetary policy in an
already low interest rate environment remains to be seen, while an even longer
period of low interest rates raises financial stability concerns. While some
governments have taken advantage of low interest rates to lengthen debt
maturities, it also seems likely that the enhanced debt affordability offered
by low interest rates has lowered policymakers' willingness to stand up to
electoral aversion to structural economic and fiscal reforms that may enhance
longer-term growth.
Advanced
economies' progress in rebuilding lost fiscal space has been slow, despite a
long period of growth and low interest rates. Overall, progress on reducing
macroeconomic imbalances has been tepid and fragile. While public debt levels
in advanced economies and highly rated EMs have fallen in aggregate from their
peaks (see Exhibit 8), the fall has generally been small. Private-sector
leverage remains stubbornly high in many countries, with the risk that a shock
would push some of this debt onto the government's balance sheet once again
(see Exhibit 9). While the decline in public debt levels reflected a number of
factors, it was driven mostly by cyclical growth. With the global cyclical
rebound running out of steam, much will rest in the coming years on
policymakers' resolve in implementing the painful fiscal reforms that are
generally needed to lower debt levels further still over the longer term,
including cuts in social benefits to curb long-term liabilities.
Reform
fatigue is rising. However, progress on reforms is increasingly patchy. In the
US, recent years have seen little appetite to address longer-term fiscal or
economic (infrastructure-related) challenges. Across Europe, reform momentum
has slowed as electorates have turned against "austerity politics". In Slovakia
(A2 stable), the parliament recently capped the statutory retirement age - which was previously fully indexed to life expectancy - at 65 years, leading to
a marked deterioration in cost projections linked to long-term ageing. In
Germany (Aaa stable), the coalition government's reform efforts have so far
only resulted in very limited tax measures as well as credit negative pension
and labour measures, which actually worsen the economy's flexibility and growth
outlook. Although Germany's pension reform commission has been tasked with
developing proposals for ensuring the longterm sustainability of the pension
system, there seems little appetite for reform.
Reversal
of monetary tightening will alleviate near-term pressures somewhat but is a
symptom of a weak global backdrop. Over the course of 2019, a number of
advanced economy monetary authorities abandoned plans to tighten policy in
favour of cutting or maintaining low rates. That dynamic is expected to
continue through 2020 (see Exhibit 10). Among major advanced economies, the
Federal Reserve has reduced its federal funds rate three times in 2019, citing
factors including the slowing global economy and rising trade tensions. The
peak in effective US policy rates this economic cycle was thus 2.45%, compared
with the 3-4% level commonly expected a few years ago. In other major
economies, the so-called natural rate of interest also appears materially lower
than a year ago. Other things being equal, lower interest rates enhance
sovereign credit quality. In this case, however, the accommodative stance simply
mitigates somewhat a weaker-than-expected economic environment and masks
limited progress in debt reduction.
Loose
monetary conditions support short-term growth, but their longer-term impact is
uncertain and they introduce distortions. The effectiveness of further monetary
accommodation remains to be seen. In principle, the favourable financing
conditions brought about by the monetary stimulus should support stronger
consumption and investment and durable employment creation. In practice,
however, policymakers have little experience of implementing a still looser
monetary stance from already highly accommodative levels. Those that do can
bear witness to the uncertain and sometimes unintended consequences of very
low, or even negative, interest rates, such as the weaker profitability of
banking systems in Japan and the euro area. Persistently low interest rates could
lead to distortions that may hamper long-term growth and create risks, such as
frothy asset prices in financial markets, higher leverage or disincentives for
saving across the broader global economy.
Nevertheless,
advanced economies have benefited from favourable funding conditions brought
about by accommodative monetary policies. Lower-for-longer policy rates have
provided substantial respite to fiscal accounts despite the impact of falling
growth on revenues. Sovereigns around the world, but particularly in advanced
economies, have benefited from lower funding costs (see Exhibit 11) and are
expected to continue to do so throughout 2020. Lower interest costs have helped
narrow fiscal deficits and in a number of cases supported the reversal of
previously rising debt trajectories. Moreover, some sovereigns have taken the
opportunity to lengthen maturities and lock in low interest rates, further
helping to regain some lost fiscal space. However, favourable funding
conditions have undoubtedly also contributed to the diminished pace of reform
in recent years, fostering a degree of complacency which leaves many sovereigns
still highly exposed to future rises in interest rates or, more likely in the
near term, to confidence shocks that increase credit spreads.
Less predictable environment heightens event risk for weakest emerging
market sovereigns
The
increasingly unpredictable global - and in some cases domestic - political
environment has resulted in intermittent and abrupt shifts in risk appetite.
Combined with the slowdown among advanced economies, this risk aversion has
exacerbated the broad slowdown in growth in EMs. In Asia, domestic demand has
generally held up well and inflation has remained subdued, but external demand
has weakened considerably. Elsewhere, softening domestic demand has increased
dependency on external demand and capital flows. Many central banks have been
constrained by the need to sustain inward capital flows and respond to
volatility in international financial markets. A "risk-off" episode, depending
on its severity, could expose financial vulnerabilities accumulated during
years of low interest rates as highly leveraged borrowers struggle to roll over
their debt and as capital flows retrench.
Slowing
growth and an unfavourable external environment are shifting many EM
governments' focus away from longerterm challenges towards mitigating
shorter-term pressures. In 2019, growth in the EM G-20 countries will have
further moderated to around 4.3%. While we expect a small pick-up in 2020, this
largely reflects reversals in countries experiencing unusually low growth in
2019, including India and Turkey. Overall, growth will remain below historical
levels, with downside risks. The primary growth engines of many EMs have, to
varying degrees, faded in the years since the global financial crisis. In Latin
America and Sub-Saharan Africa, the benefits of the "commodities supercycle" are a distant memory, leaving just residual exposure to growth shocks in China
(see Exhibit 12). In APAC, as in Central and Eastern Europe, exports and
investment have slumped under threat from the US-China trade war. Many EMs face
structural challenges of rapidly ageing populations or a large influx of young
people into the labour market, technological disruptions such as AI and
robotization (see Exhibit 13), pervasive vested interests and other
institutional constraints, and recurring climate shocks. Progress in addressing
these hurdles has been mixed at best, with few achieving tangible increases in
potential output growth rates.
Political
challenges are also hampering economic and fiscal adjustments. Progress on debt
reduction has been mixed, with material reductions evident in only a handful of
cases and rising debt burdens more common. Domestic and external political
shocks hamper progress on fiscal adjustment and structural reforms, with many
governments' fiscal positions weakening even during the relatively benign
recent period of growth. Latin America recently exemplified the potential for
domestic political events to derail longer-term policy programmes, with
particularly serious political disturbances in Peru (A3 stable), Chile and
Ecuador. In the Levant area, Iraq and Lebanon have experienced similar
political volatility. Domestic political challenges are less acute in other
regions but present nonetheless. Falling growth, sticky or rising debt, and
political disruption leave many EM sovereigns vulnerable to abrupt shifts in
global sentiment or shocks that can undermine macro-financial stability or
jeopardize fiscal sustainability. Investors' sentiment towards a number of
large EM sovereigns has soured, in particular Argentina and Turkey, which are
in the midst of difficult macroeconomic adjustment processes.
EM and
Frontier Market (FM) sovereigns with weak policy credibility face the most
demanding financial market conditions. Financial conditions in many EMs and FMs
are deteriorating, reflecting the stresses facing troubled EM sovereigns (see
Exhibit 14) and FM sovereigns' high exposure to shifts in sentiment. As shown
in our heat map (see Exhibit 16), that picture is not uniform: EM sovereigns
with stronger fiscal profiles have faced more benign financial conditions which
have facilitated improvements to debt profiles. Compared with five years ago,
debt structures have improved for sovereigns like Peru, Romania (Baa3 stable)
and Slovenia (Baa1 positive), which have extended their already long debt
maturity profiles through liability management operations, while Hungary has
seen significant progress in reducing foreign-currency exposure. Others have
been less fortunate. Foreign-currency exposure has increased for the likes of
Turkey and Argentina, which have also seen the largest increase in funding
costs. In the Levant and Africa, spreads remain very high for Lebanon, Zambia
(Caa2 negative), Ghana (B3 stable) and Tunisia, reflecting investors' anticipation of how governments may struggle to manage the upcoming maturity
walls beyond 2021. High spreads build exposure to shocks and in some cases
reflect or anticipate loss of market access.
Most EM and FM sovereigns have limited policy space. Fiscal and monetary policy space is more limited for EM governments than a generally higher level of interest rates and lower level of debt than in advanced economies would suggest, given EMs' vulnerability to reversals of capital flows. Overall, capital flows into EMs have fallen compared with 2017 levels, and will remain under pressure in 2020 and beyond (see Exhibit 15 on the previous page). Net portfolio inflows are decreasing for every region except for Asia where China remains an outsized recipient. Potential triggers for further risk-off episodes include further increases in trade tensions or evidence that the toll of the current tensions will be larger than previously thought, protracted policy uncertainty, as well as worsening growth and fiscal dynamics in higher-debt countries. The scope for supporting growth with fiscal stimulus or lower policy rates is therefore limited. Meanwhile, weaker external finances leave a number of EM and - particularly - FM sovereigns vulnerable to shocks (see Exhibit 17).
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