Sovereign Outlook Stable; Fitch Rating says emerging Asia to grow faster than emerging global


Credit Rating Agency Fitch, just reported that most emerging Asia sovereign are stable, and that emerging Asia, is expected to grow at a faster pace than emerging global average.

  • Fitch says:

Fitch expects emerging Asia’s macroeconomic performance as a region to outperform global peers. Emerging Asia is projected to remain the fastest-growing global region, with growth of six per cent to 6.5% a year until 2014. Even excluding still fast-growing China (constituting 48% of emerging Asia’s overall GDP), the rest of the region is expected to grow five per cent in 2012, picking up to 5.5% in 2013 and six per cent in 2014, outpacing global emerging markets as a whole. Inflation for the whole region is expected to average 3.7% a year in 2012-2014, close to the 2001-2011 average of 3.6% and below the average for all emerging markets of 4.8% a year.

  • The role of Credit Agency, such a Fitch:

Credit rating agencies are meant to provide global investors with an informed analysis of the risk associated with debt securities. These securities include government bonds, corporate bonds, CDs (certificates of deposit), municipal bonds, preferred stock, and collateralized securities, such as CDOs (collateralized debt obligations) and mortgage-backed securities. The riskiness of investing in these securities is determined by the likelihood that the debt issuer–be it a corporation, bank-created entity, sovereign nation, or local government–will fail to make timely interest payments on the debt.

  • Criticism of Credit Rating Agency:

However, the “Big Three” global credit rating agencies–U.S.-based Standard and Poor’s, Moody’s, and Fitch Ratings–have been under intense scrutiny since the 2007-2009 global financial crisis.

They were initially criticized for their favorable pre-crisis ratings of insolvent financial institutions like Lehman Brothers, as well as risky mortgage-related securities that contributed to the collapse of the U.S. housing market. But since 2010, the agencies have focused on U.S. and European sovereign debt. That resulted in S&P’s unprecedented downgrade of the United States’ long-held triple-A rating in early August 2011, initially prompting a global sell-off and market volatility not seen since December 2008.

  • Observing Impacts the Observed:

Since the spring of 2010, one or more of the Big Three relegated Greece, Portugal, and Ireland to “junk” status–a move that many EU officials say has accelerated a burgeoning eurozone sovereign debt crisis. In January 2012, amid continued eurozone instability, S&P downgraded nine eurozone countries, stripping France and Austria of their triple-A ratings.

Both the United States and Europe have taken steps to regulate the three main rating agencies and ensure more transparency and competitiveness. In July 2010, the United States enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act, which created an Office of Credit Ratings at the Securities and Exchange Commission to hold rating agencies accountable and protect investors and businesses. In early 2011, the EU established an independent authority known as the European Securities and Markets Authority (ESMA), tasked with regulating the activities of rating agencies relative to EU standards.

The following, is what Fitch ratings said in its report ‘2013 outlook: “Emerging Asia Sovereigns.”

Outlook for majority of emerging Asian sovereigns stable – Fitch

Emerging Asia’s economic outlook has weakened since the September Global Economic Outlook. Growth forecasts were revised down for the more trade-driven economies of Korea and Taiwan amid a weaker global outlook. Consumption in Korea and Taiwan is also facing headwinds from high household indebtedness. Fitch has revised down forecasts for Indonesia and Sri Lanka in expectation of tighter policy settings to avoid overheating. The agency shaved China’s growth forecast for 2013 by 0.2 percentage points (pp) on signs that stimulus measures announced in summer 2012 are feeding through to investment more slowly and on a smaller scale than expected in September.

Malaysia and Philippines bucked the trend with upward revisions for 2013. High investment, led by public sector firms, is supporting domestic demand in Malaysia. Domestic demand in the Philippines is also strong, buoyed by consumption and strong remittance inflows and higher government budget disbursements. The government’s PPP scheme is also starting to take off, supporting the outlook for investment. Mongolia’s growth forecast was revised up significantly to average 14.5% each year in 2013-2014 as large natural resource projects move towards the commercial production stage. Mongolia’s Gross Domestic Product (GDP) is still projected to be only 0.1% of the emerging Asian total by 2014, so its impact on the aggregates is minimal.

The region has yet to decouple, as final demand from the high-income economies remains crucially important. A rising proportion of the region’s trade is with itself, but to some extent this reflects regional integration of supply chains just three years after the completion of a free trade deal between Association of South-East Asian Nations (ASEAN) and China, as well as similar deals with India and Korea, in 2010. A simple correlation of emerging Asian exports with retail sales in major trading partners suggests final demand from the high-income economies remains the main driver of regional export performance.

Nonetheless, the importance of Asian domestic demand is rising. The region’s aggregate current account surplus has fallen to an estimated 2.4% of GDP for 2012, against an average 4.2% a year in 2002-2008. The picture is mixed across the region. Four of eight sovereigns with available data for quarterly real GDP by expenditure had faster growth of domestic demand than of GDP in the four quarters to end-September 2012, including China on Fitch’s estimate. Every country saw retail sales grow faster than exports with the exception of Taiwan, underscoring the burden of high household debt in that economy.

The robustness of domestic demand in Malaysia and Thailand relative to overall GDP growth is particularly striking. The public sector has played an important role in stoking demand in both economies. There are risks arising from a build-up of sovereign contingent liabilities in both cases. From a ratings perspective, these risks weigh more on Malaysia’s credit profile given the scale of public investment and borrowing by public corporations and other public bodies there. Federal government guaranteed debt rose to 15.2% of Malaysia’s GDP (four-quarter-rolling) by end-September 2012, from 12.2% at end-2010.

  • Majority of stable outlooks

Nine of 11 emerging Asian sovereigns are on Stable Outlook, despite the region’s favourable macroeconomic prospects. The two exceptions are significant – China and India. Fitch revised the Outlooks on India’s ‘BBB−’ IDRs to Negative in June 2012. China’s Local Currency IDR of ‘AA−’ is on Negative Outlook, affirmed in April 2012, with the Foreign Currency IDR of ‘A+’ on Stable Outlook.

The balance of Stable Outlooks in the region should be seen in the context of recent positive rating actions. The only rating change in the region, since the June Sovereign Review and Outlook was Fitch’s upgrade of Korea to ‘AA−’/Stable from ‘A+’/Positive in September. Over the past decade, the region has tracked the broader improvement in emerging-market sovereign creditworthiness, and has narrowed the gap with the average for high-income sovereigns to five notches, from eight in the wake of the Asian crisis in 1998.

Positive rating momentum has eased. A common theme for many countries is that the pace of sovereign balance sheet improvement, which was one factor driving positive actions, has stalled.

China’s weight in the regional weighted average, and the strong rise in Chinese local government indebtedness as part of the stimulus in 2009-2010, obscures developments in other countries. Excluding China, the general government debt to GDP ratio dropped a weighted-average 7.4 pp in 2000-2011, but is projected to fall only a further one pp in 2012-2014. Sovereign external balance sheets have stopped strengthening amid a slowdown in foreign reserves’ accumulation and, for some countries, greater recourse to foreign borrowing. Net public external debt as a percentage of current external receipts is projected to rise four pp in 2012-2014, after falling 35pp in 2000-2011.

The persistence of global economic and financial uncertainty underscores the importance of buffers for sovereign creditworthiness, in terms of the strength of sovereigns’ own balance sheets and scope for policy flexibility to absorb and offset shocks. In terms of indebtedness, Indonesia is in the strongest position as it has a debt/GDP ratio below the median for its peer range and the ratio is projected to fall on current forecasts, giving scope for a fiscal policy response if growth slowed sharply.

Debt ratios are projected to fall slightly in India and Sri Lanka, but those sovereigns’ high public indebtedness gives limited scope for further fiscal easing if shocks materialize. India’s real policy interest rate is already low as inflation has remained stubbornly high at 7.5% (Year-on-Year) YoY in October, not far below the 12-month average of 7.8%. Sri Lanka couples limited fiscal flexibility, thanks to its high debt, with an already strongly negative real policy rate, suggesting limited scope for a policy response if a shock occurs.

  • Market access & refinancing risk grow

Emerging Asian sovereigns demonstrated their strong ability to access global capital markets in H212. Sri Lanka issued a US$ 1 billion 10-year sovereign bond in July. Indonesia issued a US$ 1 billion Sukuk and Philippines issued a US$ 0.8 billion equivalent global peso note in November. In December, Mongolia issued US$ 1.5 billion in two tranches under a global medium-term note programme with US$ 5 billion ceiling.

Market access can however be a double-edged sword. If funding conditions deteriorate, sovereigns could find refinancing their obligations becomes challenging. Monetary easing from advanced-economy central banks seems unlikely to be unwound imminently with the US Fed’s October statement that “Exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.”

Investor perceptions of emerging market risk might shift even if global liquidity remains abundant. Spreads on emerging market debt have tracked broader measures of market risk appetite. Investor preferences might shift in response to some asymmetric EM-focused shock. Fitch’s December Global Economic Outlook explored the ramifications of one possible such shock – a sharp slowdown in China (a so-called hard landing). Modelling suggests that emerging Asian sovereigns may see some of the sharpest growth slowdowns in such a scenario, which could affect their funding conditions.

Ratings will balance the benefit of proven market access against the risks of rapid growth in foreign-currency denominated public debt. At the regional level, FC-denominated debt is projected to decline as a ratio of current external receipts. However, it is projected to remain above 100% for Sri Lanka and to remain above the end-2011 level for Mongolia. This factor is likely to weigh on these sovereigns’ ratings.

  • External robustness tested

H212 offers some evidence that emerging Asia’s resilience to external shocks has improved. The region’s external finances are strong. Gross and net external debt ratios are lower than for other EM regions and the external liquidity ratio is higher, reflecting large foreign reserves stockpiles (US$ 4.7 trillion in aggregate end-September 2012, of which China was US$ 3.3 trillion).

Taking the VIX index as an inverse gauge of investor risk appetite, Emerging Asia rode out an upsurge in global investor risk aversion in Q411 without much effect on exchange rates. This was in contrast to other recent such episodes such as in Q210 and Q109. Improved external finances, specifically a reduction in short-term external indebtedness and successful navigation of a period of high external debt service payments, were a key factor in the upgrade of Korea to ‘AA−’ in September 2012.

The uplift to ratings from strengthening external balance sheets will decrease if Fitch’s projections for external finances are realized. The agency expects the region’s aggregate current account surplus and net external creditor position to diminish modestly over the next two years.

  • Macro-prudential risk concerns

Loose monetary and credit policies in emerging Asia carry some downside risk for financial stability. Real policy rates across the region (GDP-weighted average) dipped back towards zero as central banks reverted to easing (while regional inflation eased to three per cent since June). Four regional central banks cut their policy rates in H212 (China, Korea, Philippines and Thailand) while none hiked, although Indonesia tightened its macro-prudential requirements and raised its deposit rate.

Emerging Asia already hosts four of the world’s 12 countries in the highest-risk ‘3’ category of Fitch’s macro-prudential risk assessment framework, China, Mongolia, Indonesia and Sri Lanka (with Hong Kong as a fifth). Real-terms credit growth accelerated across the region to 10% in 2012 from eight per cent in 2011 and is projected to accelerate again to 10.7% in 2013.

Credit growth was below the 12-month average for every country in the region except China (15.9% in October compared with the 15.4% 12-month average for on-balance-sheet credit). Fitch’s Financial Institutions team warns on-balance-sheet credit data for Chinese banks are becoming increasingly unreliable as off-balance-sheet credit channels expand. Timely tightening of monetary conditions across the region as and when demand strengthens would avert a build-up of macro-prudential risks. However, Asian countries that leave policy too loose for too long – possibly out of concern about attracting excessive capital inflows – could find risks building up in the financial sector.

  • Political risk matters

Domestic politics were important for sovereign credit developments in a number of emerging Asian countries in 2012. In both India and Malaysia, Fitch regards national elections in 2014 and 2013 respectively as a material influence on policy-making. The Indian Government has committed itself to fiscal consolidation and has promoted structural reforms, although its ability to implement these ahead of elections will be crucial. Malaysia has so far largely ducked structural fiscal reforms to lessen revenue-side dependence on petroleum-derived receipts.

In China and Indonesia, current or forthcoming leadership changes are affecting prospects for economic reforms that would provide the foundation for future sustainable growth. In China’s case, rebalancing the economy away from investment towards consumption will be a significant challenge and implies wide-ranging changes in the country’s political economy. In Indonesia’s case, Fitch is concerned that leading politicians will be more focused on the presidential elections of 2014 than on pushing through structural reforms and delivering needed improvements in public infrastructure. However, such concerns, if they materialize, would be unlikely to weigh on Indonesia’s economic performance or ratings over the next two years.

Political stability remains a concern in Thailand, which Fitch downgraded to ‘BBB’ in 2009 from ‘BBB+’ primarily on those grounds. Thailand’s economy has proved resilient to recurrent political turbulence including serious protests and bloodshed in Bangkok, and has staged a strong recovery from the flooding of 2011, with 5.2% growth expected for 2012. However, anti-government protests in November 2012 highlight the persistence of deep cleavages in Thailand’s society. A projected rise in public indebtedness, albeit modest, following expansion of welfare programmes and strong growth in public sector wages, as well as capital spending on flood defences also weighs on the credit profile.

In Korea, imminent presidential elections are expected to have less effect on policy or factors relevant for the credit profile. In upgrading Korea in September, Fitch took the view that the broad parameters of economic and financial policy would be unaffected regardless of the outcome of imminent presidential elections on 19 December 2012.

Geopolitical risk is rising in the Asia-Pacific region. It hosts a number of territorial disputes regarding sovereignty over the waters around China and the South China Sea, including notably the Sino-Japanese dispute over the Diaoyu/Senkaku Islands. Tensions over these disputes increased in 2012. China also has a territorial dispute with India, although tensions on this have eased recently. Overall, Fitch does not expect geopolitical risk to drive rating actions in 2013 given the fundamental interests of all parties in peaceful resolution.

Heightened uncertainty on the Korean peninsula caused by the leadership transition in the North did not preclude Fitch from upgrading South Korea, as the agency does not expect an escalation of North/South tensions. However, North-related risk could become more relevant as a constraint should Korea rise further up the rating scale.


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