24 Jun 2008
For the past nine months, the emerging markets (EMs) overall have withstood the turmoil in the financial markets and the downturn in the US economy, which led Fitch Ratings group managing director of sovereigns David Riley to say that things were looking "rosy in the emerging markets' gardens". At Fitch Ratings' Emerging Markets 2008 event in London, Riley pointed to the steady improvement in sovereign ratings, with Brazil being the last of the Brazil, Russia, India and China (BRICs) to receive an investment grade rating in May.
But there are some storm clouds ahead, specifically around the threat of inflation. Brian Coulton, head of EMEA sovereigns and global economics, sovereign group, Fitch Ratings, London, said that there were growing concerns regarding inflation in terms of credit and the possible economic impact (see figure below).
Coulton explained that inflation affects credit ratings because:
•High and volatile inflation undermines macroeconomic stability;
•It renders public finances more vulnerable to shocks;
•It reduces sovereign debt tolerance; and
•It creates an elevated risk of exchange rate crises and an elevated risk of banking crises.
Inflation also has an impact on EM local currency (LC) government debt markets: LC investors become more focused on domestic interest rate risk and it becomes harder for governments to sell long-term domestic bonds increasing market risk.
On a positive note, Coulton pointed out that domestic investment will drive the EMs' economies through 2008 and 2009. Most EMs are experiencing consumer spending dynamism. The macro economic picture also seems to be holding up with the commodity price rises and improving income levels. He agreed that the average EM credit rating continues to improve with an upward trend in the level of ratings, but revealed that this picture is changing: in 2008, Fitch oversaw 10 positive rating actions and 10 negative rating actions compared to a ratio of four positive to one negative in 2007.
Coulton likened the monetary policy in the EMs to US/UK policy in the 1970s in terms of the way that EMs responses are lagging today. He said that domestic overheating is starting to affect emerging Europe, while the Gulf Cooperation Council (GCC) monetary conditions and effective exchange rates are going the wrong way. "There has been an increase in soft exchange rate pegs in the last few years. This attracts concern because these pegs have yet to be tested in volatile markets. Plus inflation targets are being blown out of the water - in some cases, the gap is bigger than the target rate," said Coulton (see Figure 2). The top three most vulnerable EMs are Jamaica, Ukraine and Kazakhstan (see Figure 3).
Brazil, on the other hand, is experiencing heady days, particularly since the discovery of new oil deposits. Individuals, followed strongly by lending to SMEs, have led the loan growth in the country. Market turmoil has led to increased domestic demand from the corporate sector, which had been borrowing in international capital markets, leading to loan portfolio diversification. "The outlook in 2008 calls for some moderation," said Peter Shaw, managing director, financial Institutions at Fitch Ratings, "but banks are still predicting growth north of 20%, with resurgent corporate demand supporting this growth. So the outlook for 2008 is good, sustained by continued loan growth; and beyond 2008 - credit costs are key." He pointed out that funding for Brazilian banks is largely Brazilian; foreign investment is less than 10%, although it is still the biggest percentage in Latin America.
China, another of the BRIC nations, is expected to maintain its economic growth at around 10% in 2008/9. There are some problems: corruption within the development model is creating tension; the asset price bubble could generate social discontent; and increasing social inequalities and environment problems could also foster unrest. Overall, the long-term fundamentals are good, according to Frederic Gits, senior director, Tokyo at Fitch Ratings. "The race, or craze, to acquire land bank has weakened the financial structure of many companies. Government intervention is attempting to cool down the overheated property market and restrict speculation. These crises could lead to weaker players going under. The raw material price hike has mainly affected steel industry, airlines, auto manufacturing, refiners, as well as light manufacturing industries. Because China is a net importer of raw materials, Chinese companies are hungry for acquisitions in order to buy up raw material assets."
Gits said that the strong growth in China has lifted the performance of all corporates, even the poorly managed ones, but warned, "Although a rising tide lifts all boats, the problem is when the tide turns."
First published on www.gtnews.com
- Joy Macknight
- I am deputy editor at The Banker, a Financial Times publication. I joined the magazine in August 2015 as transaction banking and technology editor, which remain the beats I cover. Previously I was features editor at Profit & Loss, an FX and derivatives publication and events company. Before that I was editorial director of Treasury Today following a period as editor of gtnews.com. I also worked on Banking Technology, Computer Weekly, and IBM Computer Today. I have a BSc from the University of Victoria, Canada.