Coronavirus to Weaken Sovereign Fiscal Positions; Track Record Matters


Wednesday, March 18,  2020 /01:17 PM / By Fitch Ratings / Header Image Credit: Fitch Ratings


The economic impact of the coronavirus combined with the associated policy responses is likely to result in a higher-than-average number of sovereign rating actions in 2020, and a more pronounced downward bias in sovereign rating changes than in any year since the aftermath of the global financial crisis in 2009, Fitch Ratings says. Sovereigns' fiscal records will be one component of our assessment of the credit impact of supplementary fiscal measures. The intent will be to evaluate whether temporary - and in many cases, urgent - fiscal measures introduced to counter the impact of the coronavirus will have public finance implications that last through the medium term.


Global economic policymakers face an unprecedented combination of challenges including a health crisis, economic disruption, severe financial market dislocation, changes in investor sentiment, exchange-rate volatility and a commodity price shock. One of the primary economic consequences for regions and countries affected by coronavirus is 'sudden stops' in activities.


Traditional macroeconomic policies will have limited effects on curtailments motivated by health concerns, but can have a role in softening the consequent impact on household and corporate income streams, preventing a more marked and extended economic decline. Fitch expects that, over time, fiscal policy responses will come to match those already underway on the monetary side, at least in terms of the number of countries engaged.


The relationship between changes in fiscal positions and changes in sovereign ratings is well-established. Fitch measures and compares sovereign public finances by considering fiscal balances relative to GDP, government debt stocks relative to GDP, interest payments as a share of government revenue and shares of government debt denominated in foreign currency. We create individual sovereign scores on this basis. The sum of the changes in these scores is strongly correlated with global sovereign rating changes, implying that a period of fiscal weakness ahead will be accompanied by sovereign rating downgrades.


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In the current environment, Fitch will continue to assess fiscal initiatives in terms of their medium-term effect on credit fundamentals. In developed market (DM) sovereigns, automatic stabilisers associated with a slowdown in economic growth or a recession are inherently cyclical, and thus of less rating influence. Instead, our focus will be on supplementary measures including much-needed support to households, businesses and economic sectors hit hardest by the economic decline.


With the probability of a large number of supplementary fiscal measures being adopted across a wide range of DMs, judgements on whether such measures should affect ratings will be guided in part by sovereigns' records of fiscal consolidation during more favourable economic times.


Automatic stabilisers are a less common feature of emerging-market (EM) public finances, as social safety nets are typically less developed. Fiscal performance is still affected by economic cycles, however, with revenue strongly influenced by GDP growth. Fitch will apply the same analytical framework in assessing specific coronavirus countermeasures that are intended to be temporary, in judging whether they will affect medium-term fiscal performance.


EM fiscal conditions are often subject to an additional set of cyclical variations, such as changes in commodity prices, exchange rates and global funding conditions. All of these factors are currently evident, and will also be part of our ongoing sovereign rating review processes. They make EM public finances more volatile, both in terms of revenues and expenditures, and that too is expected in the period ahead.

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