x Abu Dhabi, UAESunday 23 July 2017

Interesting time to play rating game

Concerns about Europe's ability to recover from the lingering debt crisis have hit Spain hard. In the Middle East, countries with oil may fare better than those without, but predicting what happens next is a challenge.

Trevor Cullinan, the director of sovereign ratings at S&P's, says growth in the Middle East will be weak compared with previous years. (Antonie Robertson / The National)
Trevor Cullinan, the director of sovereign ratings at S&P's, says growth in the Middle East will be weak compared with previous years. (Antonie Robertson / The National)

Agencies have lowered their credit assessment of Spain on concerns over Europe's ability to recover from the lingering debt crisis. In the Middle East, countries with oil may fare better than those without. Predicting what happens next is complex but exciting, Tom Arnold writes

Spain's slide into recession last week was the latest reality check to anyone still clinging to hopes of an easing in the euro-zone crisis.

It came just days after Standard & Poor's, one of the three big ratings agencies along with Moody's Investors Service and Fitch Ratings, lowered its ranking on the country by two notches, citing more obstacles ahead for the fourth-biggest economy in the single currency bloc.

"In the European region we expect continued weakness in growth and similarly in the Middle East there's also likely to be weakness compared to previous years," says Trevor Cullinan, the director of sovereign ratings at S&P.

During the past few years of the global economic slowdown, ratings agencies have done their job as harbingers of doom, flagging risks for investors in financial markets.

Governments of a number of nations, including the United States for the first time in the country's history, have watched their ratings being cut. And more could follow, according to Mr Cullinan, who was speaking at S&P's Capital IQ event in Dubai last week.

q So how would you assess the health of the global economy?

a There's potentially going to be some pick-up this year depending on which region you're in. In … Europe, we expect continued weakness in growth and similarly in the Middle East there's also likely to be weakness compared to previous years. In terms of the downgrades last year, we had a significant number in the Middle East and Europe. Last year, we downgraded 20 per cent of rated sovereigns and upgraded nearly 15 per cent. At the moment, 28 per cent of rated sovereigns are on a 'negative' outlook. A negative outlook means there's a one in three likelihood we will lower the ratings, which suggests there is potential for further deterioration in sovereign ratings [nations debt].

From the global financial crisis of 2008 to the euro-zone turmoil and the Arab Spring, the past few years have kept ratings agencies very busy. How do keep track of dramatic changes in the global economy?

There have been a significant number of developments over the past few years which have made this an interesting and exciting time. We have offices around the world. Analysts in those offices are dedicated to each country, company and region. They will be staying abreast of the changing political and economic scene in those regions. We have access to government officials in those countries and the private sector, so we are well informed.

S&P's downgrade of the US from its "AAA" rating last year triggered instability in global markets. The stripping of France's top credit rating created further turmoil this year. Given the uncertainty in the global economy and the major shifts in the balance of power taking place, how likely is it that more countries will lose their top ratings in the near future?

I wouldn't agree our ratings action was responsible for creating turbulence. Our ratings are one opinion and there [are] plenty of other opinions out there agreeing or disagreeing with us. The actions taken on the US and France were significant, however. We still have 14 "AAA"-rated sovereigns and three of those are on a negative outlook. They are Finland, Luxembourg and the Netherlands. Of the most highly-rated sovereigns where we see an extremely strong capacity to meet financial commitments, three of the 14 could potentially be downgraded within the next one to two years.

In Europe, there is a backlash building against austerity measures agreed by governments to tackle high national debt. From a ratings perspective, do cutbacks to spending generally improve a country's rating?

It's more complex than that. We are not just focused on fiscal austerity. Too much austerity will lead to weaker public consumption and potentially have a negative impact on growth. As well as some fiscal profligacy in the euro-zone periphery, a major issue in the crisis has been diverging competitiveness and widening current account deficits. We think there needs to be a dual approach. Reducing large fiscal imbalances would [help] sovereign ratings, but would be much more likely to be successful if accompanied by measures supporting growth. We have seen this in Spain, where we are encouraged that as well as aiming to reduce the general government deficit, they are reforming their labour markets. However, we lowered the ratings on Spain to "BBB plus" as we still think that more needs to be done. In our view, there will be weaker growth than the government expects, potential further deterioration in fiscal imbalances and the potential the government will need to provide further support to the banking system.

Is the euro zone the weak spot in the global economy?

I wouldn't necessarily agree it was the obvious weak spot. If you look at ratings, the average in the euro zone is "A plus", which is still high. It's true there has been a deterioration since 2008 [the financial crisis]. Ratings peaked in 2004 and there has been a deterioration since then. We still have a negative outlook on euro-zone sovereigns and there's a potential they could be downgraded further. We also have a negative outlook on the US. Our outlook period covers the next two years. But we also have negative outlooks and much lower ratings in other regions of the world. In the Middle East and North Africa, the average is in the "A minus/BBB plus" category but there is a significant split between Mena [Middle East and North Africa] countries with oil wealth and those without. Those with hydrocarbon wealth are closer to "A plus" and those without are closer to 'non-investment' grade.

Turning to the Middle East and North Africa, how would you assess impact of the Arab Spring on the strength of economies in this region?

Yes, there has been a general impact on the region because of the unrest but some have been more affected than others. In Egypt, the transition has been much more fraught, and had an impact on foreign currency reserves, foreign direct investment inflows and tourism. Last year we lowered the rating on Egypt, Bahrain and Tunisia. On the 13 sovereigns we rate in the region we have negative outlooks on Bahrain, Egypt, Jordan, Oman and Tunisia. There's potential for further downgrades on those five. The other eight sovereigns we rate have "stable" outlooks including Abu Dhabi and Ras Al Khaimah. In general we are not expecting any change, but for the five I've listed there's potential that political development and the impact it has on fiscal and external indicators could mean a further deterioration.

What is the biggest risk for the region? Is it geopolitical tensions surrounding Iran or is it the euro-zone debt crisis?

It's difficult to weigh two such multi-faceted risks against one another. We take into account geopolitical risks wherever we have ratings. On Iran, as long as the worst-case scenario of armed conflict remains unfulfilled and shipping volumes are not significantly affected, the main impact of rising geopolitical risks in the region would be higher oil prices. This would actually benefit the oil exporting economies of the GCC [such as the UAE]. In the worst-case scenario, where low-level provocation inadvertently escalated into armed conflict between Iran and the US and its allies, political as well as financial risks would likely rise significantly in the region. We also think the euro-zone crisis does have an impact on the region, it's hard to quantify how much. A substantial amount of exports go to the euro zone but a substantial amount also go to Asia as well, so the diversification should help. We note that apart from in Bahrain, GCC banks' dependence on wholesale funding is relatively low and so deleveraging by European banks should not have such a significant impact on the region.

tarnold@thenational.ae

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