Weaknesses in the major advanced economies – dominated by the continuing euro zone crisis and the looming threat of the US fiscal cliff – are exerting a negative influence on global sovereign credit quality, Fitch Ratings says in its latest bi-annual global Sovereign Review and Outlook report.
While emerging market (EM) economies are proving more resilient, their continuing exposure to the MAEs, combined with their own vulnerabilities, is constraining the upward rating momentum of EM sovereigns, Fitch said.
The report says that the ratings of seven of the world’s 10 largest economies are currently on Negative Outlook, including three major ‘AAA’-rated sovereigns – the US, the UK and France, highlighting the strained credit quality of the countries underpinning the global economy. Fitch expects to resolve these three Negative Outlooks in 2013, against a challenging backdrop, with the euro zone back in recession and a US recovery not expected to gain traction until the latter part of 2013.
The euro zone crisis has entered a period of relative calm, influenced heavily by the announcement of the European Central Bank’s (ECB) “Outright Monetary Transactions” (OMT) programme in early September.
“(ECB President) Mario Draghi’s policy initiative has effectively addressed near term liquidity risks for troubled euro zone sovereigns, buying time for the necessary but painful adjustments required to secure solvency,” Fitch said.
“However, notwithstanding some progress on banking union at last week’s EU summit, significant challenges still confront policy-makers, both in terms of moving towards greater fiscal and financial risk sharing and in breaking the negative feedback loop between sovereigns and their banking systems.”
Fitch said that it was concerned that the current easing of market pressure on sovereign bond yields – combined with the specifics of 2013’s electoral calendar, including Italian and German general elections – could induce complacency and slow policy momentum to a crawl. More positively, the recent Troika agreement to provide additional debt service relief measures in order to secure Greek sovereign debt sustainability reflected a concerted commitment to avoid a Greek exit and supported Fitch’s view that a euro zone break-up will be avoided, the ratings agency said.
“Fitch has identified the US fiscal cliff as the single biggest, near-term threat to the world economy, given its potential to tip the US into an unnecessary and avoidable recession, with negative implications for global growth.”
However, the agency’s base case expectation is that a compromise will be reached to avoid the $600 billion of tax increases and spending cuts due to come into effect on January 1 2013. “Fitch still anticipates a material fiscal tightening of 1.5 per cent in the US economy in 2013, but this falls well short of the five per cent implied by the fiscal cliff,” the agency said.
“If the negotiations on the fiscal cliff and raising the debt ceiling extend into 2013 and appear likely to be prolonged with adverse implications for the economy and financial stability, the US sovereign rating could be subject to review, potentially leading to a negative rating action.”
The crisis took a further heavy toll on ratings in 2012, as Fitch downgraded six euro zone sovereigns by a total of 19 notches (15 excluding Greece), although the vast majority of the downgrades occurred in H112, indicating an easing of tail risks in the second half of the year following the OMT announcement.
Spain was particularly hard hit by two multi-notch downgrades, taking its rating to ‘BBB’. In March, Greece set a record 199 billion euro sovereign default, the first in an advanced economy as classified by the IMF in the modern era. In May, Fitch also downgraded Japan, the world’s second largest debtor, to ‘A+’/Negative.
Ten developed market countries are on Negative Outlook and none on Positive Outlook, although – in one more positive development – the Outlook on Ireland’s ‘BBB+’ rating was revised to Stable in November, representing the first positive rating action Fitch has taken on a euro zone peripheral sovereign since the crisis began, reflecting Ireland’s progress with its fiscal consolidation, external adjustment and economic recovery, as well as its improved financing options, the agency said.
“Global growth outturns are undershooting expectations and risks remain skewed to the downside,” Fitch said.
The contraction in the eurozone and Japan, as well as weaker growth in Brazil and India in Q312, highlights the underlying weaknesses and risks still facing the global economy, the agency said.
Fitch anticipates fragile global growth in 2013, with the major advanced economies in particular likely to record only a marginal improvement year-on-year as the weak recovery from the 2008 financial crisis continues.
For the major advanced economies, Fitch forecasts economic growth of 0.9 per cent in 2012, followed by 1.2 per cent in 2013 and 1.9 per cent in 2014. Global growth is forecast at two per cent in 2012, 2.4 per cent in 2013 and 2.9 per cent in 2014.
EM economies are continuing to show relative resilience to tough global conditions and to outperform so-called advanced countries, Fitch said.
“Although the overall medium-term trend is one of moderating growth, Fitch expects that the major EM economies, particularly China (‘A+’/Stable), India (‘BBB-‘/Negative) and Brazil (‘BBB’/Stable), will regain momentum in 2013, with GDP growing by eight per cent, seven per cent (to March 2014) and four per cent, respectively,” Fitch said.
“However, this will fall some way short of recent multi-year peaks, and reflects the combination of weak import demand from the major advanced economies and domestic vulnerabilities reflected in tighter policy settings and the need to address longer term structural issues, such as China’s rebalancing towards higher domestic consumption and lower investment to generate growth,” Fitch said.
Upward momentum in EM sovereign ratings has slowed, the agency said.
There have been six EM sovereign upgrades so far in 2012, following 18 in 2011 and 13 in 2010, although all six occurred in H2, again indicating an improved trajectory since the first half of the year. The balance of Negative Outlooks to Positive for EM sovereigns now stands at 2:1, representing a clear deterioration from the December 2011 ratio of 1:1. However, bucking the general weakening trend were significant upgrades for Turkey – to ‘BBB-‘/Stable from ‘BB+’ – and Korea to ‘AA-‘/Stable from ‘A+’, Fitch said.
(Photo: Gilles Letar)