Despite Stabilization, The Pandemic Threatens The Recovery
This report does not constitute a rating action
Roberto H Sifon-arevalo New York +1-212-438-7358
Joydeep Mukherji New York +1-212-438 7351
Frank Gill Madrid +34-91-788-7213
Kim Eng Tan Singapore +65-6239-6350
Remy Carasse Paris +33-14-420-6741
Nicole Schmidt Mexico City +52-55-5081-4412
The evolution of the pandemic continues to be the main risk for sovereign ratings.
A more fragile social context and political polarization will limit governments' capacity to implement revenue and spending rebalancing measures.
This year is likely to be one of transition in terms of fiscal consolidation, which, if further delayed, could become a drag on ratings.
Rising global interest rates will pose an additional challenge for emerging markets, more so for those heavy reliant on external funding.
In 2022, we expect the economic recovery to continue to be uneven (see table 1) and highly correlated with the pace of vaccinations and the size of fiscal and monetary stimulus. While well underway in developed sovereigns, recovery is lagging in several emerging markets in Latin America and Africa. For sovereign ratings--which stabilized last year, albeit in many cases at lower levels, after the deterioration in 2020--the evolution of the pandemic continues to be the main risk.
Fiscal consolidation will take longer, and it could become a drag on growth and ratings. While most economies expect to return to pre-COVID-19 output levels by the end of 2021 or in 2022, we forecast that, even in 2023, average general government deficits to GDP will still be above the 2015-2019 average in nearly all regions (see chart 1).
This year is likely to be one of transition in terms of fiscal rebalancing. While sovereigns are unlikely to be able to implement serious revenue-increasing measures or reforms, the overall fiscal picture should stabilize, primarily from the recovery of revenue--as economies reopen--and from the end of temporary expenditures and subsidies that will not be extended.
Table 1 | Real GDP Growth
(%)
2021
2022f
2023f
2024f
World
5.7
4.2
3.7
3.4
U.S.
5.5
3.9
2.7
2.3
Eurozone
5.1
4.4
2.4
1.6
China
8
4.9
4.8
Asia-Pacific
6.7
4.6
4.5
Latin America
6.2
1.9
2.2
f--Forecast. Source: S&P Global Ratings.
Chart 1 | Average General Government Deficit/GDP
EM--Emerging markets. SSA--Sub-Saharan Africa. MENA--Middle East and North Africa. e--Estimate. f--Forecast. Source: S&P Global Ratings.
All sovereigns are entering 2022 in a weaker fiscal position than before the pandemic (see charts 2 and 3). Some have used up a large share of their fiscal buffers and were able to sustain ratings. Others had little to no room for fiscal deterioration and were unable to maintain their pre-pandemic creditworthiness (see chart 4). The larger share, however, is somewhere in the middle of these two groups.
Between January 2020 and September 2021, we downgraded approximately 25% of our rated sovereigns at least once. Sovereigns that cannot stabilize or improve their fiscal positions will likely face downgrade risk over the next 12-18 months. In 2021, this was the case (among others) for Colombia, Chile, Morocco, and Kuwait, which we downgraded.
Default risk also remains high this year. Three sovereigns (Lebanon, Suriname and Zambia) have been in default since 2020. In addition, seven sovereigns remain rated 'CCC+' or 'CCC' (see table 2), two with negative outlooks, amid more difficult financing conditions as funding costs are increasing globally.
Chart 2 | Average Global General Government Debt/GDP And Growth Rate
e--Estimate. Source: S&P Global Ratings.
Chart 3 | Average General Government Debt By Region
Chart 4 | 52 Sovereigns Saw Their Fiscal Assessments Worsen*
*From January 2020 to September 2021. Source: S&P Global Ratings.
The most important risk is the evolution of the pandemic. The surge of the omicron variant has again forced several countries around the world to impose lockdowns of different magnitudes to contain the spread of the virus. While we do not expect the extent and duration of these lockdowns to be like those of 2020, they will nevertheless hurt or delay the recovery of many sovereigns, weighing on governments' balance sheets and already tense social conditions.
Also, if the recovery continues, governments face the delicate task of withdrawing fiscal stimulus without hurting growth in a more fragile and politically polarized social context. In Peru, for example, the pandemic contributed to a very fragmented congress that could make it harder to manage fiscal consolation and, in turn, hurt growth. We revised our rating outlook on Peru to negative in October. More recently, in Kazakhstan, the government's decision to eliminate a fuel subsidy triggered widespread social unrest and violent protests that ended with the government reinstating the subsidy.
Table 2 | Sovereigns In The 'CCC' Category Are Facing Hard Fiscal Conditions
Net GG debt / GDP (%)
CA balance / CAR (%)
GG interests / GG revenues (%)
CCC+
Congo (DR)
13.85
13.94
(9.70)
(9.22)
2.62
2.29
Mozambique
95.30
94.04
(57.56)
(55.28)
13.88
14.37
Congo-Brazzaville
96.40
93.54
(7.56)
(9.23)
6.39
6.40
Argentina
70.11
65.62
(7.38)
(9.97)
5.25
5.35
Angola
84.29
83.26
11.09
5.94
27.51
31.11
CCC
Ethiopia
35.09
34.66
(36.89)
(39.20)
9.97
7.84
Sri Lanka
106.29
107.25
(6.71)
(6.97)
62.38
60.43
GG--General government. CA--Current account. f--Forecast. Green: positive outlook. Blue: stable outlook. Pink: negative outlook. Source: S&P Global Ratings.
In addition, monetary tightening and rising interest rates could complicate governments' attempts to balance growth and fiscal rebalancing. Inflationary pressures are mounting. A combination of supply-chain bottlenecks, labor dislocations, and production facilities that are still not operating or are doing so at reduced capacity are pushing wages and prices higher. Commodities reached their highest prices of the past five years. In response, monetary authorities have started to reduce the massive stimulus put in place to fight the pandemic. Interest rates in advanced economies will start to rise in 2022, while the rate hikes have already started in emerging markets.
The combination of inflation, higher commodity prices -- especially energy -- and measures to counterbalance them could throw a wrench in the recovery. Emerging markets that are net importers of oil could see their current account deficits widen because of higher import bills while foreign currency funding will be more expensive and difficult to access. In addition, persistently high energy prices will likely mean that some of the temporary fiscal measures established during the pandemic could be extended or replaced by new ones, instead of phased out. This would likely weigh on growth and extend rebalancing to future years, which would hurt creditworthiness and ratings.
S&P Global Ratings rates 137 sovereigns globally. Over the last decade, sovereign credit quality has continued to deteriorate, as indicated by a decline in investment-grade sovereign ratings (as a proportion of total sovereign ratings) of four percentage points to 52.6% as of Dec. 31, 2021 (see chart 5). In addition, the average rating is now ‘BBB’, one notch lower than in 2011, a trend that has only accelerated during the pandemic (see chart 6).
Currently, 19 sovereigns have negative outlooks and 10 have positive outlooks. All but one of the negative outlooks (Spain) are in emerging or frontier market economies (see chart 7 and table 3).
Source: S&P Global Ratings.
Data to June 14, 2021. Source: S&P Global Ratings.
Positive
Negative
EMEA
Armenia
Belarus
Congo D.R.
Cyprus
Georgia
Estonia
Kuwait
Greece
Rwanda
Italy
Spain
Oman
Turkey
Serbia
Americas
Bolivia
Costa Rica
Curacao
El Salvador
Mexico
Panama
Peru
Trinidad and Tobago
Taiwan
Indonesia
Vietnam
Malaysia
Papua New Guinea
Developed Europe. As of Dec. 31, 2021, 25 of our 30 rated European developed sovereigns have stable outlooks. This means that many of our ratings are likely to remain at current levels in 2022. However, in contrast with the recent past, four sovereigns--Cyprus, Estonia, Greece, and Italy--have positive outlooks and only one, Spain, remains negative.
Most of the European economies have already seen their nominal GDP returning to 2019 levels. However, fiscal positions have not yet recovered from the pandemic. Government debt in Belgium, Cyprus, France, Greece, Italy, Portugal, Spain, and the U.K. is now above 100% of GDP. In 2022, European governments will face a delicate balancing act: repairing their balance sheets while ensuring strong growth in a still uncertain environment, in tandem with monetary policy decisions.
We think that the capacity to implement pro-growth reforms to capitalize on the support from facilities like the Next Generation EU program will be key for creditworthiness. In turn, failure to address persistent structural weaknesses could strain investment and growth, reversing the somewhat positive ratings momentum.
Emerging EMEA. As we start the new year, rating trends in EMEA emerging markets look to be stabilizing. For the region as a whole, we project that 2022 will be the second consecutive year of solid 4% real GDP growth, though this average GDP figure masks disparate outcomes: from -0.7% in Belarus all the way up to 8% in Kuwait. Last year’s sharp rally in oil and other commodity prices has, moreover, facilitated a notable improvement in external performance, given that just under 60% of the sovereigns we rate in emerging EMEA are commodity exporters, with over 25% of them exporting primarily hydrocarbons. While negative outlooks still exceed positive ones, by 6 to 4, the differential between the two has declined from 12 one year ago. Moreover, our positive outlooks are comparatively more recent than our six negatives.
Despite this stabilizing rating trend in much of emerging EMEA, challenges persist, particularly when it comes to public finances. Of the 54 rated sovereigns in emerging EMEA, we project that 28 will put debt to GDP on a downward path by 2024. That still leaves close to half (26) of regional sovereigns with rising debt over the next two years. On the fiscal side, Africa remains a key concern not only for the size of projected government deficits this year, but also for the cost of financing them.
*Rating affirmed, outlook revised. Source: S&P Global Ratings.
U.S. and Canada. The wealth, institutional effectiveness, monetary flexibility, deep domestic capital markets, and other credit strengths of Canada and the U.S. have enabled them to maintain high sovereign credit ratings during the pandemic despite a sharp increase in government debt in both countries.
Latin America and the Caribbean. Sovereign credit quality for the Latin American and Caribbean region has consistently declined over the last seven years. Since the start of the pandemic, we have downgraded 53% of the sovereigns we rate in the Americas. We have taken negative rating actions (either an outlook revision or downgrade) on eight out of the 14 sovereigns in the investment-grade category and on 10 of the 17 sovereigns in the speculative-grade category. As a result, the average sovereign rating in the Americas region has eroded more than in other regions but is slowly stabilizing.
Besides the perennial failure to address structural weaknesses to provide sustainable economic growth, Latin America is facing difficult political conditions that severely limit governments' capacity to take corrective measures and reduce the credibility of their execution.
The lack of a credible policy framework is most apparent in Argentina, which currently does not have access to international capital markets. Political polarization in countries such as Peru and Ecuador has raised uncertainty about future economic policies and about the ability to implement announced policies (such as Ecuador’s agreement with the IMF). Despite political stability and relatively stable public finances, our ratings on Mexico are constrained by a poor growth record, partly reflecting disagreements on economic policies between the government and much of the private sector. National elections in Brazil, Colombia, and Costa Rica this year add further uncertainty about policies. Finally, in Chile, the recently elected center-left administration of President Gabriel Boric has ambitious plans to increase the provision of social services. Chile’s economic policies will be affected by the writing of a new constitution, which a special assembly is now drafting, that may make substantial changes in social and economic policies.
Rating action
We expect most Asia-Pacific sovereign credit ratings to remain unchanged in the next one to two years despite the strain posed by COVID-19. Fifteen Asia-Pacific sovereign ratings have stable outlooks and four have negative outlooks (Indonesia, Sri Lanka, Papua New Guinea, and Malaysia) as of Dec. 31, 2021 (see chart 6). Taiwan and Vietnam have positive outlooks.
Attention is on China where the government continues its strict zero-COVID-19 policy. The much more contagious omicron variant has generated increasing concerns that this policy may see economic costs outweighing benefits with new and more contagious COVID-19 variants. A pronounced slowdown of the Chinese economy could have a significant impact on its trade partners in the Asia-Pacific. In addition, concerns over U.S.-China relations are a threat to regional credit metrics. Considering the busy political calendar this year, with both midterm elections in the U.S. and the 20th Party Congress in China, reaching compromise, in case of serious disagreements, could be more difficult.
The higher inflation in some advanced economies does not appear to have affected prices in Asia-Pacific materially--consumer price inflation was not abnormally high late in 2021. However, the potential for greater increases in global international interest rates may affect some sovereigns. Borrowers in economies that rely on external financing are likely to see rising financing costs. In places like Indonesia, economic growth may be held back if interest rate increases surprise on the upside in the advanced economies.
