M&A Corner: Sovereign risk in Central and Eastern Europe

For anyone who has anything to do with business in Central Europe, it is important to know the risk associated with your country, and also where this fits in by comparison to other countries in the region.

There are numerous reasons for this, starting with the fact that country risk underpins the risk associated with your company. The interest rate that your company pays for bank debt is at a premium to the interest payable on your country’s sovereign debt. If your country becomes riskier, it also means that it becomes more difficult and expensive for your company to borrow.

Ultimately, how financial markets assess your country’s risk is a reflection of on your country’s fiscal management. It is particularly interesting to follow how your country is doing in relation to your neighbors, and to follow and understand the trends.

There are three rating agencies that are considered the most important rating agencies in the world, whose job it is to assess sovereign (as well as corporate) debt: Fitch Ratings, Standard & Poor’s, and Moody’s (not listed in any order of importance).

The chart at the top summarises the current ratings of Central European countries. As the table shows, Austria is the best rated country in Central Europe. Without taking Greece into consideration, Hungary is the only major EU country that is not rated investment grade among Central European countries.

Turkey is in a very interesting situation. Fitch Ratings upgraded Turkish bonds from junk to the lowest investment grade (BBB-) as of November 5, thanks to Turkey’s stable economic growth and decline in current account deficit.

For most countries, obtaining an investment grade from two or more of the above rating agencies is the crucial threshold for having easy access to global capital markets; many funds and other investors are precluded from investing otherwise.

Investment grade is a rating that indicates that country or corporate bonds have a relatively low risk of default, suitable for pension funds and other institutions. The lowest grades considered as investment grade are BBB- on the Fitch and S&P scales, and Baa3 in Moody’s case. Credit ratings for bonds below these ratings are considered low credit quality, and are commonly referred to as “junk” bonds.

As the graph below shows, country risk impacts directly on borrowing rates.

The chart above shows that bond yields have been generally declining through Central Europe during the course of 2012. This is extremely positive, and bodes well for overall borrowing costs in the region.

There is a high degree of onus on governments to manage fiscal and monetary policy and obtain confidence of rating agencies, as this may have a dramatic effect on government borrowing costs, and sustainability of deficits.

It also impacts directly on private borrowing: extensive government borrowing may squeeze capital availability to the private sector, and irresponsible economic management by Government may also drive up borrowing costs for the private sector.

While many businessmen might prefer to ignore what government is doing, it is important for your business to understand and monitor sovereign risk.



Les Nemethy and Mustafa Emin

Les Nemethy is CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on mergers & acquisitions. He is the author of Business Exit Planning, published by John Wiley & Sons, available on Amazon, and Успешно излизане от бизнеса, published by Klasika I Stil Publishing House in Bulgaria. Mustafa Emin is pursuing his masters in science degree from Bocconi University and is an intern with Euro-Phoenix.