Fitch: Global Sovereign Downgrades Set for a Record Year

LAGOS, Nigeria, Capital Markets in Africa: Fitch Ratings-London-07 July 2016: Sovereign credit ratings are on track for a record number of downgrades in 2016, driven by the impact of lower commodity prices in emerging market economies, Fitch Ratings says in its latest bi-annual Sovereign Review and Outlook. There were 15 downgrades in 1H16 compared with the previous annual high of 20 in 2011, and 22 ratings are on Negative Outlook, suggesting this year’s final total is likely to exceed that of 2011.

Lower commodity prices continue to be the single most important factor responsible for downward sovereign ratings momentum. Seven of the 10 most commodity-dependent sovereigns rated by Fitch have been downgraded in 2016 or are on Negative Outlook. All are in emerging markets.

The partial recovery in commodity prices in 1H16 has led to improved market sentiment towards emerging markets, but not necessarily to improvements in sovereign credit fundamentals. Public and external finances in a number of commodity-exporting countries are not yet aligned with the new structurally-lower price environment.

The Middle East and Africa region accounts for more than half of the negative rating actions in 1H16 and 10 of the 22 Negative Outlooks assigned currently. Unlike 2011, when the previous record-number of sovereign downgrades was concentrated in investment-grade sovereigns, this year’s ratings deterioration is led by speculative-grade credits. As of end-June, the ratings of more than one in three sovereigns in the ‘B’ and ‘BB’ categories had a Negative Outlook.

From a regional perspective, the significance of the UK’s pending exit from the EU is difficult to overstate. The short-term economic impact of the vote to leave the EU will be decidedly negative in the UK, leading us to downgrade the UK’s rating to AA and assign a Negative Outlook on 27 June. We revised our GDP growth forecasts lower for 2016-2018, and project a corresponding deterioration in the fiscal balance and consequent rise in government debt as a share of GDP. There is considerable uncertainty over the political outlook, and no agreement as yet on when the country should trigger Article 50 of the Treaty on European Union, the formal mechanism for EU withdrawal.

Fitch believes that developments in the UK make it more probable that populist or Eurosceptic movements find greater support elsewhere in the EU, providing added impetus for political fragmentation and polarisation trends that became evident in the aftermath of the eurozone crisis. A referendum in Italy in October on constitutional reform will be another test of populist pressures and could trigger political instability.

Europe’s political backdrop could have negative implications for sovereign ratings, as fiscal consolidation may drop further down the list of policy priorities. An easing of fiscal policy in the eurozone has already been evident, prompted by the shift of focus to issues surrounding migration and security, and austerity fatigue. In addition, the fiscal space made available by lower interest rates is not being used to bring fiscal deficits down. Several eurozone sovereigns have comparatively high government debt levels, which are likely to remain effective rating constraints.

Markets reacted positively in 1H16 to accelerated Chinese credit growth and other signs of activity picking up in response to policy easing, but volatility is likely to persist as long as Chinese policymakers send mixed signals with respect to addressing the country’s corporate debt problem. Fitch expects higher US interest rates and a stronger US dollar to result in renewed downward pressure on the renminbi later this year, with possible regional implications.

In the US, Fitch recently revised down its US GDP growth forecasts, but we still expect the Federal Reserve to raise policy rates by year-end. Latin America is headed for its second consecutive year of contractions as it faces subdued commodity prices, weak external demand (notably China, relative to previous growth rates) and tighter external financing conditions. Larger government deficits and tepid growth combined with currency depreciations are contributing to rising government debt.