Are Sovereign Ratings In The Americas Transitioning Toward Recovery Or Stagnation?
This report does not constitute a rating action
Joydeep Mukherji New York +1-212-438-7351
Nicole Schmidt Mexico City +52-55-5081-4412
S&P Global Ratings expects that the recent deterioration of sovereign ratings in the Americas will decelerate in 2022 as economic recovery helps governments stabilize their public finances. However, we have negative outlooks on the ratings of eight regional sovereigns, indicating that further erosion in credit quality is likely.
The Latin American and Caribbean region within the Americas has suffered more from negative social and political developments during the pandemic than many other regions, giving their governments less political power to make difficult economic decisions to stabilize creditworthiness.
Excluding Canada and the U.S., the average credit rating of sovereigns in the Americas has improved slightly over the past six months to 'BB', from close to ‘BB-‘. However, the GDP-weighted average sovereign rating for these countries has stabilized between 'BB' and 'BB+' since June 2020.
The average rating calculation was affected by the withdrawal of our rating on Venezuela (which had been selective default ['SD']) and upgrade of Belize to ‘B-‘ from ‘CCC+’.
Chart 1 | Latin America, Caribbean, And Other Island Nations
Source: S&P Global Ratings.
Sovereign credit quality for the Latin American and Caribbean region has declined over the last seven years (see chart 1). Since the start of the pandemic, we have taken negative rating actions (either an outlook revision or downgrade) on eight out of the 14 sovereigns in the investment-grade category (rated 'BBB-' or above) and on 10 of the 17 sovereigns in the speculative-grade category ('BB+' or below). As a result, the average sovereign rating level in the Americas region has eroded more than in other regions but is slowly stabilizing.
S&P Global Ratings rates 14 of the 31 sovereigns in the Americas investment-grade, the same number since December 2016 (see chart 2). In May 2021, we lowered our rating on Colombia to speculative grade but added our newest sovereign rating in the region, on the Falkland Islands, in the investment-grade category during that same month. (All ratings we refer to in this report are long-term foreign currency ratings.)
The region's highest-rated sovereign is Canada ('AAA'), followed by the U.S. ('AA+'). Among the remaining sovereigns, the highest rated are Bermuda ('A+'), Falkland Islands ('A+'), and Chile ('A'). The lowest rated are Suriname (‘SD’), and Argentina ('CCC+').
The rating categories with the largest number of sovereigns are 'BBB' and ‘B’, with nine entities each, followed by 'BB' with six. The 'BBB' rating category had held the largest number of sovereign ratings in the region since mid-2012.
Chart 2 | Americas Sovereign Rating Distribution
Chart 3 | Americas Outlook Distribution
A negative number indicates a negative outlook. Source: S&P Global Ratings.
Since the start of 2021, we have lowered our long-term foreign currency ratings on Aruba to ‘BBB’ from 'BBB+', Bahamas to 'B+' from 'BB-', Panama to 'BBB' from 'BBB+', Chile to ‘A’ from ‘A+’, and Colombia from ‘BBB-’ to ‘BB+’.
We lowered our rating on Belize to ‘SD’ from ‘CCC+’ in May 2021 and raised it in October 2021 to ‘B-‘. We downgraded Suriname to ‘SD’ in November 2020 and it has not yet emerged with a post-default rating.
In May 2021, the number sovereigns we rate in the Americas increased to 32 from 31 after we assigned ratings to the Falkland Islands. However, we withdrew our ratings on Venezuela in August 2021 (‘SD’), bringing the total back down to 31.
In addition to these rating actions, we revised the outlooks on Bolivia, El Salvador, Panama, Peru, and Trinidad and Tobago to negative from stable. We revised the outlooks on the Dominican Republic and Jamaica to stable from negative.
We maintain stable outlooks on most of the long-term ratings on sovereigns in the Americas. We currently have no positive outlooks on any sovereigns, while we have negative outlooks on eight (Bolivia, Costa Rica, Curacao, El Salvador, Mexico, Panama, Peru, and Trinidad and Tobago). Investment-grade sovereigns with stable outlooks are Aruba, Bermuda, Canada, Chile, Falkland Islands, Montserrat, Turks and Caicos, the U.S., and Uruguay.
Table 1 | Americas Sovereign Rating Trends And Weaknesses
*Deterioration since June 2021. §Improvement since June 2021. Source: S&P Global Ratings.
Table 2 | Americas Economic Outlook
GG--General government. CAR--Current account receipts. Source: S&P Global Ratings.
The negative rating actions over the last two years in Latin America and the Caribbean reflect the impact of the pandemic, preexisting weaknesses in the economy, and sometimes inadequate policy response that have eroded the pillars of sovereign ratings, in both investment grade and speculative grade. The trajectory of ratings in the region in 2022 will depend on the ability of political leaders to implement effective policies to promote social stability, sustain economic growth, and stabilize recently weakened public finances.
Failure to address structural weaknesses could lead to economic stagnation and a worse financial profile in the coming years, with negative implications for ratings. Conversely, steps to build a more effective social contract (including better social programs reaching the around 50% of the labor force in the informal sector) could create favorable political conditions for economic and fiscal policies that raise trend GDP growth and strengthen sovereign creditworthiness.
The Latin American and Caribbean region inherits a worse social and political legacy from the pandemic than many other regions, which limits political capital for governments to make difficult economic decisions. The region has experienced an immense setback in education due to school closures and rising poverty, which have led to less instruction and more dropouts. Two years of school disruptions, combined with health and social problems, will leave a legacy, especially among the poor, even as the economy recovers. Social problems have also contributed to large migration outflows from countries in Central America, the Andes, and from Mexico. Hence, a sustainable economic recovery depends on addressing immediate social needs as much as on good economic policies.
A common challenge for all countries is achieving sustainable economic growth. Much of the region has had very low (or even negative) growth in per capita GDP over the past decade (and only slightly better performance if the pandemic years are excluded) (see chart 4). We expect GDP growth will fall from around 6% in 2021 toward 2% in 2022-2024, lower than in other emerging market regions.
Chart 4 | Low Economic Growth
The recent combination of economic recession, higher public spending, and weak tax revenues led to a sharp rise in government debt throughout the region (see chart 5).
Chart 5 | Net General Government Debt To GDP
The risk embedded in the higher debt burden was partly mitigated by low interest rates, the prior growth of domestic capital markets, and the credibility of monetary policy in many countries (such as Chile, Peru, Colombia, Brazil, and Mexico). The ability of sovereigns such as Brazil, Chile, and Mexico to fund most of their debt in local markets has mitigated external risks (see chart 6). Such factors helped several sovereigns to run countercyclical fiscal policies without undermining economic stability or incurring an external crisis.
Chart 6 | General Government Securities Debt As Of Second-Quarter 2021
Nevertheless, the pandemic did weaken public finances. Our weighted average fiscal score (based on a scale of 1 to 6, with 1 as the best score) in Latin America is now 4.5, the second worst among all regions of developed and emerging market countries (and only better than in Sub-Saharan Africa).
The cost of servicing the higher government debt burden will depend on, among other things, the evolution of inflation and global interest rates. The recent rise in inflation across developed and emerging market countries is likely to force regional central banks to keep raising their own rates or run the risk of capital outflows and currency depreciation. Tighter monetary policy will further constrain fiscal flexibility in many countries by raising the share of government revenues that go towards servicing debt (see chart 7).
Chart 7 | General Government Interest To General Government Revenue
Different countries in the region face different fiscal, debt, and political challenges, and the appropriate policy response differs accordingly. For example, the pattern of fiscal adjustment may differ for countries that have more scope to raise tax revenues (such as Mexico, Guatemala, and Panama) than those with less scope (such as Brazil and Argentina). However, all would benefit from creating a credible economic strategy based upon a fiscal anchor, manageable debt burden, and some capacity to make policy adjustments if funding costs rise more than expected.
The lack of a credible policy framework is most apparent in Argentina, which currently lacks access to international capital markets. Since emerging from default on its commercial debt in September 2020, the Argentine government has failed to create a coherent economic strategy to control inflation, stabilize the exchange rate, restore GDP growth, and regain access to external financial markets.
Political polarization in countries such Peru and Ecuador has raised uncertainty about future economic policies. The pandemic reduced support for traditional political leaders and contributed to a narrow election victory last year by leftist president Pedro Castillo, whose political party has a small presence in the highly fragmented Congress. Subsequently, political and policy uncertainty has hurt investor confidence and threatens to damage Peru’s GDP growth prospects, fiscal and debt metrics, and potentially lead to a downgrade. Similarly, Ecuadorian President Guillermo Lasso faces strong opposition in Congress, where his own political party has a minor presence, making it difficult to advance with various reforms in conjunction with the IMF. In other countries, such as Bolivia, Nicaragua, and El Salvador, political divisions continue to hurt private-sector investment and constrain GDP growth prospects.
We have a negative outlook on our ratings on Mexico despite political stability and relatively stable government finances. The outlook reflects the risk of a downgrade due to either more pronounced contingent liabilities for the sovereign associated with managing complex fiscal challenges at Petróleos Mexicanos (PEMEX) and Comision Federal de Electricidad (CFE), or from uncertainties in the business climate that would keep economic growth subdued.
Our ratings on Mexico are constrained by a poor GDP growth record, partly reflecting disagreements on economic policies between the government and much of the private sector.
Prolonged poor economic performance also underlies our negative outlook on Trinidad and Tobago, whose per capita GDP was almost 20% lower in 2021 than it was a decade earlier. Further increases in the government’s debt burden or the country’s external debt metrics, or a failure to recover economic resilience, could result in a downgrade.
National elections in Brazil, Colombia, and Costa Rica this year add uncertainty about future policies. The combination of political pressure to extend social programs and court rulings on unpaid debts led Brazil to modify its fiscal legislation to accommodate higher government spending in 2022.
Fiscal slippage and high inflation (reaching 10% last year, well above the central bank’s target range) have weakened Brazil’s GDP growth prospects, posing serious challenges for the next administration. Brazil’s average per capita GDP growth has been -0.9% annually during 2014-2021, illustrating the country’s structural weaknesses.
Social pressures in Colombia, as shown by massive public protests in 2021, could trigger important political and economic policy changes following its upcoming national elections, potentially resulting in new leadership distinct from the country’s traditional political parties. The winner of national elections in Costa Rica will face the challenge of negotiating new terms with the IMF to obtain funding and political support for managing a difficult fiscal panorama, including a high sovereign debt burden.
In Chile, the recently elected center-left administration of President Gabriel Boric has ambitious plans to increase the provision of social services. A new constitution, now being drafted by a special assembly, will affect Chile's economy and policies. The new elected leadership and constitution may lead to substantial long-term changes that have an impact on public finances and GDP growth prospects.
The wealth, institutional effectiveness, monetary flexibility, deep domestic capital markets, and other credit strengths of Canada and the U.S. allowed them to maintain their high sovereign credit ratings during the pandemic despite a sharp increase in government debt in both countries (see chart 5). Both undertook robust countercyclical fiscal and monetary policies to manage the pandemic and recession. Nevertheless, both have benefited from falling interest costs (interest rates on their sovereign debt remain below precrisis levels despite a recent increase) that give more fiscal scope to reduce their budget deficits and stabilize their sovereign debt burden along with economic recovery (see chart 6). The experience of the two advanced countries compared with their lower-rated neighbors in the Americas shows the importance of structural characteristics, qualitative and quantitative, that mitigate the otherwise negative rating impact of higher sovereign debt.
