Global Sovereign Rating Outlook Improves, but High Debt Lingers-Fitch

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(This Statement was made by Fitch Ratings on Wednesday July 12, 2017)

The global sovereign credit cycle reached an inflection point at the end of last year and has turned less negative in 2017, says Fitch Ratings in its mid-year Sovereign Review and Outlook.

As of end-June, there were 17 sovereigns on Negative Outlook and nine on Positive Outlook, a significant change from end-2016 – a record year for sovereign downgrades – when the Negative: Positive ratio was 26:5.

“Factors that support the improvement in sovereign credit fundamentals include a synchronised pick-up in world GDP growth forecast for 2017 and 2018, a recovery in cross-border trade volumes, the stabilisation of commodity prices, albeit at a lower level, and a global macroeconomic policy backdrop that remains broadly accommodative,” said James McCormack, Global Head of Sovereign and Supranational Ratings at Fitch

“The biggest constraint on ratings is high and still-rising government debt levels, evident in both developed and emerging markets, leaving sovereigns exposed to a change in the global interest rate environment,” McCormack added.

The most notable improvement in emerging market sovereign credit profiles is in external finances. The median emerging market current account deficit is forecast to improve slightly to 2.9% of GDP this year versus 3.3% in 2016, and, on the back of strong capital inflows, foreign exchange reserves (excluding China) are projected to increase by about USD110 billion, the most since 2012.

Unlike the 2013 “taper tantrum”, there has been no sign of disruption to emerging market capital flows associated with the Federal Reserve tightening, and Fitch does not expect any such disruption in the immediate term. A notable difference between 2013 and 2017 is the direction of change of 10-year US Treasury yields, which moved higher in 2013 and are currently on a slow downward trajectory. An eventual reversal in US yields, which is expected by Fitch as the relationship between real yields and real GDP growth normalises, would represent a risk to emerging markets’ external funding conditions.

In developed markets, the rating outlook trend has turned positive, based largely on country-specific developments rather than any common cross-regional improvement in sovereign creditworthiness. The European political environment is more settled than at the start of the year, and the short-term outlook is more benign, as existential questions surrounding the eurozone have become less urgent.

Even so, higher-than-usual policy uncertainty remains in developed markets. It is still unclear whether Europe’s political setting can deliver the much-needed structural reforms to support growth, Brexit negotiations have started and represent a material risk to the UK and – to a lesser degree – remaining EU member states, and changes to US tax and trade policies remain uncertain, as do the implications for US trade partners.

Despite clear upward global growth momentum, most sovereigns are forecast to see deteriorations in their primary fiscal balances (balances excluding interest rates) in 2017 following four consecutive years of general improvements. This is attributed largely to waning political support for additional fiscal tightening in developed markets, and policymakers in a number of emerging market sovereigns still struggling to cope with the downward adjustment in commodity prices. The upshot is that more than one-in-five sovereigns will reach their highest level of government debt as a share of GDP this year (using the period 2000-2017 as the basis of comparison), and 40% will have done so since 2015.

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