Credit Worries in Europe and EM Countries Offset U.S. Strength
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Credit Worries in Europe and EM Countries Offset U.S. Strength


Our Country Credit survey shows widespread weakness stemming from concerns about the euro area and the health of emerging-markets economies.

Everything old is new again, or so it may seem. Greece’s behavior is once again threatening the euro; the U.S. economy seems to be on a solid if modest growth path amid continuing political bickering; Japan is faltering; financial risk in Eastern Europe is colored by the Soviet Union’s — oops, Russia’s — posture vis-à-vis its neighbors; and the U.K. is gearing up for yet another intense debate about whether or not it wants to be a part of Europe.

For risk analysts, it all adds up to a dicier outlook. The average rating in Institutional Investor’s semiannual Country Credit survey, which asks economists and risk analysts to rank creditworthiness on a scale of zero to 100, falls to 44.1, down 0.7 points from the previous survey, in September. Declines were broadly based, reflecting widespread concerns about the prospects for growth. The results chime with the more sober forecast last month from the International Monetary Fund, which downgraded its projection for global growth this year by 0.3 percentage points, to 3.5 percent.

The survey decline is all the more notable considering that it comes at a time of sharply lower oil prices, which analysts believe should be positive, on balance, for the world economy. “It’s like a global tax cut for energy importers,” says Gabriel Stein, London-based director of asset management services at Oxford Economics in the U.K.

One of the few bright spots is the U.S. The country’s credit rating rises 0.8 points, to 93.8, enabling the country to climb one notch to fifth place among the 179 countries in the survey. With the country moving closer to energy independence and the economy gaining greater momentum lately, there is mounting agreement with Federal Reserve Board chair Janet Yellen that the economic expansion is “solid.” “I’d hardly say the U.S. economy is off to the races,” says John Nugeé, a consultant and former central bank official in the U.K. and Hong Kong, “but the U.S. is the least bad in a pretty poor world.”

The hope is that the U.S. will be the locomotive of old, as a strong dollar leads to a substantial increase in imports. But foreign investors continue to shift funds to the U.S. because “investors’ risk appetites are going down, and the U.S. is perceived as a safe haven,” says Marcel Fratzscher, president of the German Institute for Economic Research in Berlin and an adviser to the German Ministry of Economic Affairs and Energy.

The resurgence of the U.S. economy suggests the Federal Reserve will begin tightening sooner rather than later. Some 94.6 percent of respondents surveyed predict the Fed will start raising interest rates in 2015, with 25.7 percent saying this will happen in the first half of the year and 68.9 percent saying it will begin in the second half. Six months ago, 81.5 percent of respondents saw the Fed tightening in 2015. “When tightening comes, it will suck even more funds out of other countries, particularly the emerging markets,” says an economist at a New York bank.

As the U.S. story grows more positive, however, Western Europe is having flashbacks to 2010. Most survey responses were completed before the January election ushered the left-wing, antiausterity Syriza party into power in Greece; the country’s rating dips 0.8 points, after having surged by 7.3 points in the previous survey.

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After vowing to end the country’s deeply unpopular bailout program, new Prime Minister Alexis Tsipras backed down in late February and tentatively agreed to roll the program over in exchange for some modest concessions from Greece’s euro zone partners. The deal won’t be finalized until the end of April, though, which is plenty of time for things to go wrong. Many Europeans believe that Tsipras’s “bark is worse than his bite. There’s going to be a compromise, there’s going to be a deal,” says Stein, but he adds, “I have a horrible feeling that a game of chicken is being played out, and there’s no assurance it will end well.”

Survey participants also downgrade ratings on France and Italy, by 1.2 and 2.0 points, respectively. In December Fitch Ratings reduced France’s rating from AA+ to AA. Spain’s rating is up in the latest survey because its economy is growing faster than the euro zone average. The U.K., where growth continues at a healthy pace but political uncertainty is rising ahead of the May general election, sees its rating drop by 1.1 points. “There is still a large budget deficit, but on the whole things are looking much better, with stronger growth, stronger domestic demand and higher incomes,” says Stein. “So it seems peculiar to downgrade the U.K.”

The U.K. may have been tarred by Europe’s seemingly endless financial crisis. Europeans continue to have faith in European Central Bank president Mario Draghi, who has achieved legendary status for saying the ECB will do “whatever it takes.” The central bank will embark this month on a sizable quantitative easing program, buying €60 billion ($68 billion) a month of government and agency bonds.

Although confidence in Greece has improved, it is still weak. Some 32.9 percent of respondents say it is likely that Greece will default within two years, down from 95 percent in March 2012, and 46.4 percent forecast default within five years, down from 85.5 percent three years ago.

At this point, the fundamental concern is not the specifics of the small Greek economy or the legalities of leaving the euro or the EU, but rather Europe’s continued inability to resolve its Greek tragedy. Many share the view of Pope Francis, who in November became the first pope to address the European Parliament since 1988: “In many quarters we encounter a general impression of weariness and aging, of a Europe which is now a ‘grandmother,’ no longer fertile and vibrant.”

The troubled European financial environment raises serious political concerns, Nugée warns. “There are a lot of elections coming up in Europe; Greece was only the first,” he says. “Much of Europe is at risk of difficult economic times, and when you have difficult times and populist parties, politics becomes extremely unpredictable.”

In Japan Prime Minister Shinzo Abe shot three arrows into the air; they fell to earth, who knows where? Abenomics is not exactly a failure, says one Hong Kong–based risk analyst, but “people were more enthusiastic last year. Now they’re slightly more concerned that it’s not going to work.”

Despite two years of fiscal and monetary stimulus, the economy had two quarters of negative growth last year before expanding at an annualized rate of 2.2 percent in the fourth quarter, well below what many economists had forecast. The stock market has risen, but the declining value of the yen has not really stimulated exports.

The gloom in the industrialized world has cast a pall over most emerging markets. Dozens of countries in Asia, Latin America, Africa and Eastern Europe are marked down because their commodities exports are facing weak demand and lower prices among traditional buyers in the developed economies. China’s slower growth has diminished hopes that it could offset weakness elsewhere. There are, of course, local issues: governments locked out of international capital markets in Venezuela and Argentina (the latter is down 8.1 points, the second-biggest decline in the survey), political corruption in Brazil and Ebola in West Africa. “But it’s mainly commodity prices,” says the New York bank economist.

And then there’s Vladimir Putin’s Russia, which sees its rating drop 4.3 points. Plummeting oil prices have halved government revenues and pummeled the ruble and Russian stocks. The three major ratings agencies have been downgrading Russian debt, with Standard & Poor’s relegating the country to junk status at the end of January. Western sanctions seem to be biting, and prospects for an easing of the situation in Ukraine seem remote, notwithstanding the latest cease-fire. But whatever the economic consequences, many share the view of an Austrian banker who says, “Putin is an old-school KGB man, unschooled in economics and driven by an imperial vision that will not easily be tempered.”

So pity the countries in Eastern and Central Europe. Their neighbors to the West — their best customers — are in the doldrums, and the bear to their east is casting covetous eyes on their independence. Ukraine, which is fighting an insurrection that looks a lot like a Russian invasion, is down 4.9 points, and ratings of other former Warsaw Pact members have also fallen.

Still, there are green shoots of optimism in the emerging markets. “Relative to Europe, pretty much everyone looks attractive,” says the German Institute’s Fratzscher. He believes energy prices will remain low, which “will have a big, positive impact on consumer spending and on investment.” Although a strong dollar will increase emerging-markets exports, it will be burdensome for countries that have borrowed heavily. “Everyone is hoping to have an export-led growth,” says Fratzscher, but not everyone can squeeze through that door. There are already concerns about currency wars. Nonetheless, Fratzscher predicts, “over the medium term, the emerging markets will be doing better.”

“We also see glimmers of macroeconomic stabilization and growth in a number of countries in Europe,” says Victoria Marklew, head of country risk management at Northern Trust Co. in Chicago. “Ireland has turned its economy around, but countries like France and Italy struggle to unleash structural reforms.” When survey participants were asked what countries would have a higher rating in six months, Germany, Spain, Portugal and the U.K. make the top ten list, but three European countries — Greece, France and Italy — are near the top of the list of countries expected to suffer a decline in their rating.

For his part, Fratzscher sees a “substantial risk of stagnation” in Europe. In short, the sick man of Europe remains Europe itself. The question is how well the rest of the world can do if the Continent remains in poor economic health.


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