Global Sovereign Outlook Buoyed by Short-Term Growth Prospects

4/12/2017/Fitch Ratings

The global sovereign rating outlook is set to be the strongest in seven years based on net positive rating outlooks going into the new year, indicating an end to a multi-year period of downward sovereign rating momentum, says Fitch Ratings. While the balance of rating outlooks is improving with 15% of Fitch’s portfolio on a Positive Rating Watch or Outlook compared with 4% last year, a number of risks continue to face global sovereigns.

“In broad terms, strong short-term economic growth supported by still-accommodative fiscal and monetary policies may not be sustainable in the medium term or compatible with positive rating momentum extending beyond 2018,” said James McCormack, Global Head of Sovereign Ratings at Fitch.

Despite the medium-term risks, developed-market (DM) sovereigns are in the midst of their best rating performance since the global financial crisis. The number on Positive Outlook reached an all-time high in October 2017, at seven, implying an upward bias to rating changes in 2018 including for some of the sovereigns that were worst affected by the eurozone financial crisis.

With eight emerging-market (EM) sovereigns on Positive Outlook and 13 on Negative Outlook, 2018 is set to be the fourth consecutive year in which downgrades outnumber upgrades, albeit by a much smaller margin than in recent years. Most downward rating pressure remains in commodity-exporting economies where a number of EM sovereigns have not yet fully adjusted to the decline in commodity prices that began in 2014, particularly in the Middle East & Africa.

“Monetary policy will be tightened steadily in the US, and easing will end in the eurozone, leading to less favourable global sovereign financing conditions, though the effects are likely to be slow to materialise for many countries. Exchange rate volatility is difficult to predict but more probable with changing monetary policies, raising an important risk for emerging market sovereigns with higher levels of foreign currency borrowing,” added McCormack.

Government debt as a share of GDP is at or near multi-year highs for a large number of sovereigns spanning the entire rating spectrum and across all regions. With higher interest rates, some funding pressures may emerge in the short term and, in the absence of prompt fiscal consolidation, policy flexibility will diminish in the medium term.

Possible changes to US tax and trade policies could have far-reaching global implications. In Europe, it is still not clear whether Brexit negotiations will deliver an agreement, or how an agreement might govern UK-EU trade and other relations, should it materialise.

Elections in several large EMs, the persistence of populist, anti-establishment sentiment primarily in Europe, geopolitical and security flashpoints as well as deteriorating economic and trade relations between some countries all have the potential to unsettle the 2018 outlook, many in unpredictable ways.