The shock resulting from the lockdown measures taken to stop the spread of coronavirus is once again dominating the global risk picture, causing analysts to downgrade key economic factors in second quarter of 2020 and reassess the fiscal implications of the extraordinary state support provided in conjunction with liquidity injections from central banks.
Two factors in particular are affected: the economic outlook-GNP variable, which is downgraded in 127 of the 174 countries since the previous survey was undertaken in Q1 2020, and the employment/unemployment indicator, marked down in 118.
In total 79 countries have seen their total risk scores downgraded since Q1, with sharp falls occurring once again for Argentina and Lebanon, reflecting their ongoing debt-servicing problems, as well as Iran, Iraq, Libya, Syria, and Yemen, which were all high-risk options to begin with.
Czech Republic, Mexico and Sri Lanka are also notable among countries with higher risk profiles, along with a great many sovereign borrowers across sub-Saharan Africa with commodity exposures, tightened access to finance, domestic political problems and a rising tide of foreign debt.
The United States continues to descend into populist turmoil with Donald Trump, seemingly aware of his declining popularity, targeting his base through xenophobic appeals both foreign and domestic
- Dan Graeber, GERM Report
It has been a torrid time too for emerging and frontier markets, with increased risk now facing investors in Brazil, Chile, India, Indonesia, Nigeria and Peru, although not in Russia, Cambodia or Vietnam, which are all rising in the survey.
Among the 81 countries showing improved safety are a preponderance of island nations that are clearly able to offer better protection against coronavirus, namely Bermuda, Dominican Republic, Fiji, Haiti, Jamaica, the Maldives and, impressively, Taiwan.
Also safer are Greece, Kazakhstan, Montenegro, Morocco and Paraguay according to the survey’s multifactor metrics. Switzerland, meanwhile, remains the safest country worldwide, ahead of Singapore and the Nordic nations, which all possess comparatively stronger macro-fiscal fundamentals, more stable currencies, low corruption and other advantages.
Euromoney’s unique ‘crowd-sourcing’ risk survey is a responsive guide to changing perceptions of participating analysts in both the financial and non-financial sectors, focusing on a range of key economic, political, and structural factors affecting investor returns.
The survey is conducted quarterly among several hundred economists and other experts, with the results compiled and aggregated, along with a measure of capital access and sovereign debt statistics, to provide total risk scores and rankings.
US downgraded
Normally low-risk advanced industrialized nations have been sent reeling by the coronavirus shock, although in the US there are also political connotations with the presidential elections in November fast approaching.
“The United States continues to descend into populist turmoil with Donald Trump, seemingly aware of his declining popularity, targeting his base through xenophobic appeals both foreign and domestic,” says survey contributor Dan Graeber, geopolitical analyst and founder of the GERM Report.
“There remains a growing disconnect, meanwhile, between the economy, as presented in news headlines, and the economy as presented on the ground.
“US hiring, according to the latest federal report, showed an uptick, prompting a wave of exuberance from the president’s Twitter feed. The data points, however, ended before the dramatic rise in coronavirus cases in the US south.
“The Federal Reserve Bank of Atlanta revised its forecast for GDP upward on the latest jobs data, though its estimate for a 35.2% contraction in the second quarter is nothing to celebrate and economists are worried about what happens when federal stimulus runs out at the end of July.”
This concern is borne out in the survey with the US risk score dropping even further in Q2 2020 to extend a longer-term declining trend.
US economic risk has increased mainly due to a downwardly revised score for the employment/unemployment indicator, as well as the fact that all six political risk indicators are lower. This means the US is down four places in the global risk rankings so far this year, at 21st, putting the country between Iceland and Israel in terms of comparative risk metrics.
Canada has also succumbed to downgrades in Q2 2020. The country is “flattening the curve” as far as coronavirus is concerned, says Graber about Canada, but its economy continues to face downward pressure.
“Relying in part on the vast oil reserves in Alberta, a lingering low price for crude oil means companies have little revenue left over for drilling. Fitch Ratings at the end of June said the coronavirus pandemic, coupled with low global oil demand, increased the likelihood for a severe recession in 2020.
“Canada’s GDP is expected to contract by 7.1% this year and growth prospects further out are limited.”
Japan and Europe in the doldrums
Japan has fallen five places in the risk rankings to 39th and is now pitched between the UAE and Spain. There are downgrades to key economic indicators reflecting a raft of poor output, sales and confidence readings, the postponement of the Tokyo Olympics and rising unemployment.
Political factors including institutional risk, the regulatory and policymaking environment and government stability are also revised lower, with the country embroiled in deteriorating diplomatic and trade relations with South Korea and the governing party beset by low approval ratings following a series of scandals.
Belgium, France, Germany, Italy, the Netherlands and Sweden have all succumbed to a further rise in investor risk as their economies are weakened and fiscal pressures intensify due to the Covid-19 crisis.
The OECD is predicting steep falls in GDP and sharply raised unemployment rates this year for all G10 members, with France, Italy and the UK worst affected. The UK’s risk score has stabilized in the survey, buoyed in part by political stability, but it is still down substantially this year, with the prospect of failing to reach an agreement for a Brexit trade deal an additional risk factor.
Internationally, Beijing’s credibility has hit a new low given widespread criticism to its response to the initial outbreak of Covid-19 and the ongoing backlash against some aspects of the Belt and Road Initiative
- Daniel Wagner, Country Risk Solutions
Independent sovereign risk expert Norbert Gaillard believes more in a W-shaped than a V or U-shaped recovery for the global economy, noting that after the economic shock: “There is the increased risk of a financial shock, despite the proactive policies implemented by central banks, driven by a surge in non-performing loans in emerging countries and possibly in the US if coronavirus cases still go up in July.
“Such a financial crisis would spread to European banks and depress ECR ratings again.”
Gaillard goes on to state that the Covid-19 pandemic has exacerbated inequality within and between European countries, which will have various consequences.
“A country like Spain will be especially affected. Given the structurally high level of the unemployment rate there, I do not expect the general government fiscal balance to return to its 2019 level (of -2.8% of GDP) in the next three years,” he says.
He also sees the informal economy growing in most countries, especially in southern Europe.
“This will undermine the capacity of governments to levy taxes efficiently. Accordingly, I have already downgraded the government finances, and regulatory and policy environment sub-ratings for the five top European economies. I have also downgraded the corruption sub-rating for several of them.”
In Germany, he says, the government is now convinced that solidarity between EU members is needed.
“We don’t know yet how such solidarity will materialize. The European Investment Bank and/or the European Stability Mechanism may play a key role. The creation of Eurobonds is another option. In any case, this new framework will support the ECR ratings of EU members in the medium term and make the euro more resilient than expected,” says Gaillard.
He also sees the Covid-19 crisis serving as a catalyst.
“The arrogant behaviour of Chinese authorities has led the European Commission and some European governments (such as France and Germany) to attempt to regain some form of sovereignty.
“Some multinational firms will relocate jobs in Europe, others could revise their partnerships with Chinese firms. Next, the EC seems determined to fight against foreign subsidies which skirt EU market rules. This new paradigm must be scrutinized carefully because it could contribute to ‘re-industrializing’ Europe and boost ECR ratings in the medium term as well as mark the end of the populist momentum.”
Two sides to China’s story
China, which has managed to combat the disease and reopen its economy, has seen some improvement in this latest survey, although its risk score remains below the level prevailing at the end of last year.
Effective quarantining and economic stimulus are supporting recovery prospects, with China one of the rare exceptions that may still see GDP grow in real terms this year, albeit weakly, bolstered by improving industrial sector prospects and domestic demand.
In response, forecasts for bank and currency stability, and government finances have begun to improve.
Survey contributor Friedrich Wu, a professor at Nanyang Technological University, acknowledges the improvement to China’s economic outlook since April.
“Both the IMF and Asian Development Bank have revised upward China’s GDP outlook for 2020 to 1.0% to 1.5% growth, with May-June figures showing that manufacturing activity, retail/auto sales, and real estate transactions in China had all shot up, indicating a general recovery in private consumption,” he says.
Still, China’s score is worse than last year, weighed down by foreign policy issues relating to the situation in Hong Kong and worsening relations with the US and UK.
Daniel Wagner, chief executive of Country Risk Solutions, is certainly pessimistic, believing the political and economic climate will deteriorate in China for the foreseeable future.
“Politically, Beijing’s crackdown on free speech and internet freedom continues, with anyone who is vocal in their dissent against the Chinese Communist Party becoming a target for political persecution,” he says.
“Internationally, Beijing’s credibility has hit a new low given widespread criticism to its response to the initial outbreak of Covid-19 and the ongoing backlash against some aspects of the Belt and Road Initiative.
“Economically, GDP growth had been projected to be just 2.5% for 2020, compared with 6.1% for 2019, the result of Covid-19 and a dramatic reduction in cross-border trade and investment. Even that now looks uncertain, with some analysts suggesting that GDP growth may even be negative for the year. Either way, it is likely to be the worst economic performance for half a century.”
Mixed picture for EMs
Not all countries are seen as bigger risks. Russia for instance has shown further improvement, reflecting the fact the country is comparatively resilient to external shocks, with oil prices coming off their lows and with constitutional backing for Vladimir Putin’s reforms supporting government stability and the rouble.
By contrast countries that are struggling to control Covid-19, facing more severe economic shocks and with initial recoveries levelling off, have seen their risk scores worsen, putting their currency stability at risk.
ABN Amro economists taking part in the survey believe that in the coming months emerging market currencies will suffer again.
The recovery in economic data is mostly factored in they argue in a recent research note. Investor sentiment will deteriorate and fundamentals appear weak for many countries, including commodity prices and the US-China tensions.
Brazil is struggling with deep recession and the tax and administrative reforms required to manage its fiscal concerns are delayed, threatening the Brazilian real. In the latest survey Brazil has plummeted 14 places in the global risk rankings and 24 places overall since the end of last year.
Indonesia is another big faller, down 13 places in the second quarter and a whopping 28 overall, highlighting similar uncertainty for the rupiah. Other big fallers include Mexico, India and a large swathe of sub-Saharan Africa’s indebted sovereigns reeling from the commodity shock and constrained access to financing.
Africa on the brink
Although South Africa’s multi-year downgrades have now stabilized, other bond issuers on the continent are becoming riskier. These include Ethiopia, Kenya, Namibia and Tanzania, as well as oil producers Cameroon, Gabon and Nigeria, as economies struggle for trade, tourism and investment in the aftermath of the pandemic.
Independent economist Jawhara Kanu says Ethiopia’s risk performance measures might seem strong thanks to continued major investments by the government, good management of the Covid-19 outbreak, the fact that vulnerable industries such as Ethiopian airlines have been kept afloat and the country’s growing importance as a regional player. However, a deeper look at the country’s political economy reveals an underlying fragility.
“One layer to this fragility is the endless racial fractions between the different ethnicities and also between the state’s forces and protesters across the country. This translated in the recent security crackdown which caused the death of at least 235 people and a total internet blackout across the country,” says Kanu.
“Another layer is the dispute with Egypt over the Grand Ethiopian Renaissance Dam that not only gives room for increased lobbying and external meddling in the country’s internal issues, but it also allows the government room to enlarge its authority under the cover of national security.”
In Nigeria, Rafiq Raji, chief economist with Macroafricaintel says the economy could contract by anywhere between 3% and 10% in 2020.
“A five-week lockdown to curtail the spread of the coronavirus stopped what was still a fragile recovery in its tracks. A recession is almost certain, with likely contractions in Q2 and Q3, though some sectors of the economy will recover faster than others,” he says.
“Banks are already beginning to restructure loans, as non-performing ones increase rapidly. As many firms were not able to do much business during the lockdown period and are still trying to put their affairs in order, many do not have the cash flow to service their loans.”
There are a myriad of challenges that persist such as the dramatic decline in oil prices, a frail regulatory environment and prevailing insecurity
Bank stability is certainly among the economic factors downgraded in the survey.
Raji also states that oil prices, although currently above the key $40 a barrel level, are not a cause for optimism because the government is forced to cap production below its budget targets to comply with OPEC cuts. Also, rising public debt is a cause for concern with high debt servicing costs relative to revenue raising alarm bells.
“With continued devaluation of the naira expected for the remainder of the year on likely lower hard currency inflows and eager foreign portfolio investors looking to exit their naira exposures, there is much to be cautious about in regard to Nigeria,” says Raji.
An economist based in the USA adds that in recent years there has been little improvement to the public financial management systems needed to deliver basic human services in Nigeria, against the backdrop of continued conflict in northern Nigeria and a growing youth ‘bulge’ adding to economic uncertainty.
“There are a myriad of challenges that persist such as the dramatic decline in oil prices, a frail regulatory environment and prevailing insecurity. With the additional layer of global pandemic one could predict that conditions would likely worsen in the short term.”
Nevertheless, she offers some hope for an African renaissance among Nigeria’s challenges, stating that the government is providing some economic relief to citizens affected by the pandemic and that Nigeria is a vibrant and resilient nation, so the recession could be “deep but short”.
Indeed not all countries in the region have become riskier and there are other bigger factors that are likely to give parts of the continent a lift, as Diery Seck, director of the Center for Research on Political Economy, explains: “Significant changes have occurred in creating the west Africa common currency, which will help improve the soundness of monetary and banking policy. Regional integration in west Africa is getting stronger with better prospects of policy harmonization and more vibrant integration through the free trade zone.”
Winners and losers in Asia
Across Asia many countries are weathering the storm and have also been upgraded in the survey. These include Bangladesh, Cambodia, Taiwan and Vietnam, which have taken decisive action to stop Covid-19 from spreading without using full lockdowns and have also benefited from investment as companies relocate to avoid trade tariffs on China.
Still, there are several countries feeling the impact of downgrades to politico-economic factors, these include Indonesia, Malaysia, Sri Lanka, South Korea, Thailand, Hong Kong and Singapore.
Wagner of Country Risk Solutions says Singapore is highly vulnerable to global economic trends and has been hit hard this year.
“The country’s ministry of trade and industry has projected negative GDP growth of between 0.7% and 4.0% this year. That said, the city state has an amazing ability to reinvent itself and stands to gain from a pending exodus of financial firms from Hong Kong. Singapore represents an attractive alternative.”
Nanyang’s Wu says authorities have handled the crisis competently but adds: “It is a regional trading, financial and travel hub. If Singapore reopens its borders too hastily, imported Covid-19 cases might surge and it would have to re-impose a lockdown again, and that would be a setback for the economy and its citizens.”
He is also scathing of radical protesters in Hong Kong saying they are “reaping what they sowed last year.
“From an anti-extradition law movement, they crossed the ‘red line’ to advocate independence to challenge Beijing’s sovereignty rights,” he says.
“Many private businesses and peaceful residents in Hong Kong actually support China’s National Security Law imposed on it, because the law only targets a minority of radicals and will have little impact on normal, day-to-day operations of businesses and lives there.”
Whatever the merits of the law, it has nevertheless increased the risks of investing.
“The imposition of the National Security Law was no surprise given the passage of the law in 2015 by Beijing,” says Wagner.
That law emphasizes that “China must defend its national security interests everywhere” and “affects almost every domain of public life in China.” The law’s mandate covers politics, the military, finance, religion, cyberspace, ideology and religion.
“The law has transformed Hong Kong’s political and economic landscape from being a place where ideas and free speech thrived to a place where people must now live and businesses must function in fear of saying or doing something that may be interpreted as a threat to China’s national security.
“Many international businesses – especially in the financial services sector – may now choose to relocate to countries where that is not a consideration,” he warns.
CEE is split
Central and eastern Europe has fared much better than most regions with upgrades for Bosnia-Hercegovina, Estonia, Hungary, Montenegro and Slovenia occurring both in Q2 and during the first half of the year overall. However, it has also seen some significant downgrades to Bulgaria, Czech Republic, Poland and Romania.
For Poland, Adam Antoniak, senior economist with Bank Pekao, notes the economic impact of the Covid-19 crisis and also a less predictable political landscape playing out in the presidential elections.
“While at the beginning of current parliamentary campaign current president Andrzej Duda was leading the polls, and even had a chance to secure a second term in the first round of the election, in the face of general discontent linked to the pandemic his lead started diminishing over time,” he says.
“In the meantime the opposition Citizen Coalition replaced presidential candidate Ewa Kidawa-Błońska with Rafał Trzaskowski, who managed to gain solid popularity among voters in the first round.
“Now the outcome of the second round is a close call. For the ruling parliamentary majority cooperation with the opposition president could prove more cumbersome, so the political outlook has turned more uncertain.”
Several of Poland’s political risk indicators are downgraded to reflect this and in Czech Republic similar downgrading has occurred in response to the ongoing fraud probe into prime minister Andrej Babis and the resultant anti-government protests.
Latam struggles with the virus
The outlook for the larger economies in Latin America has been badly hit by the lockdowns required to contain the virus. The impact of the global trade shock on commodity prices has also affected many countries, including copper producers Chile and Peru.
Chile’s political and social stability risks have been increased by a series of civil protests since October in response to the rising cost of living sparked by increases to Santiago’s metro fares, which highlighted the growing inequality in the country.
With Chile now facing an economic crisis, the president under pressure to minimize the hardship it will cause and uncertainty surrounding the implications of a delayed constitutional referendum to be held later in the year, many risk factor scores have deteriorated. These include government stability, institutional risk, and the regulatory and policy environment, alongside GDP, employment and government finances.
Argentina is also looking riskier as the government continues to fight an economic crisis on top of the tricky debt restructuring, as are Mexico and Brazil.
Jessica Roldan, chief economist at Finamex notes the crisis arrived at the wrong time for Mexico with: “Major components of GDP decreasing or slowing down, amid deterioration of business confidence and the lack of a cohesive message of key government participants regarding the ‘rules of the game’ to conduct.
“Already in the midst of the crisis, a timid fiscal policy response focused only on those most vulnerable, left most firms and households alone to cope with the effects of lockdown and social distancing measures, thus increasing the likelihood of observing a slower recovery of employment and productive activities, which undermines the country’s ability to generate sustained growth.”
Roldan also notes the political dimension of the crisis will be tested next year when intermediate and local elections will show how the ruling Morena party is faring.
In Brazil where president Bolsonaro’s authoritarian tendencies, unstable cabinet and apathy towards Amazon rainforest destruction cause concern, the risks have increased substantially.
Raphael Lagnado, risk analyst at Velours International, says Brazil has been greatly affected by the lack of a coordinated response to the outbreak.
“Partisanship has marked policymaking, stoked a political crisis and hampered adherence to social distancing. Brazil’s institutional and macroeconomic foundations remain robust, but the following months will see continuous deterioration in the government’s capacity to act effectively.
“Primary economic risks stem from dwindling GNP (from a forecasted -5.3% in April to -9.1% in June for 2020), sharp but controlled devaluation (R$4.84 against the dollar in mid-March to R$5.35 currently) and, in the medium term, inflation and liquidity issues owing to the extraordinarily low interest rate and possible use of fiscal easing to speed up recovery.”
MENA’s oil producers must adapt
The halving of oil prices is hitting the more vulnerable hydrocarbon exporters in the Middle East, depleting already weak revenue streams that worsen budget deficits and debt burdens. Algeria, Iran, Iraq, Libya and Kuwait are among the countries with deteriorating scores, with Syria, Yemen and Lebanon all facing crises.
The Gulf Cooperation Council (GCC) states are especially vulnerable notes Fadi Haddadin, economist at the Foreign Policy Association.
“The consequence of an over-reliance on energy exports, long understood to be a structural weakness in their economies, has become even more apparent and the situation presents an especially significant challenge to countries whose public finances are in a dire condition, such as Bahrain and Oman.
“The story of oil, along with the pandemic, will also impact labour markets. This could be a moment for recalibration of reliance on foreign workers (especially in the GCC), which could weaken a vibrant consumer base and in turn drastically shift standards of living.
“The oil price collapse will simply make the inevitable occur sooner, laying bare the fact that oil revenue dependency and massive public spending on salaries and social benefits have limits.
“It may also pose institutional/policy risks to the GCC (as a regional organization), in terms of regional economic integration and policy coordination. In other words, the GCC states may become more independent in both fiscal and monetary policymaking.”
It is not all gloom, however. Some countries have seen their scores improve this quarter, including Israel, Jordan, Egypt and not least Morocco, the standout country with an impressive gain.
Although the Moroccan economy will still be hit by the Covid-19 pandemic, highlighted by a further downgrading of the employment/unemployment indicator, the country’s production is extremely well-diversified and analysts tend to expect the country to emerge more quickly from the downturn than other north African borrowers when tourism resumes.
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