New COVID Strain Thwarts An Earlier Recovery
This report does not constitute a rating action
KimEng Tan Singapore +65-6239-6350
Andrew Wood Singapore +65-6239-6315
YeeFarn Phua Singapore +65-6239-6341
Anthony Walker Melbourne +61-3-9631-2019
Martin J Foo Melbourne +61-3-9631-2016
Rain Yin Singapore +65-6239-6342
Rebecca Hrvatin Melbourne +61-3-9631-2123
Ruchika Malhotra Singapore +65-6239-6362
Rating Outlook And Trends
Asia-Pacific sovereign ratings are demonstrating resilience amid health crises, disrupted supply chains, geopolitical strains, and weak economies. S&P Global Ratings expects most of the ratings to remain unchanged over the next one to two years, even as COVID-19 continues to weigh on government and corporate balance sheets.
The ratings are mostly in the investment grade (see chart 1). The average Asia-Pacific sovereign rating, lying between 'BBB' and 'BBB+', had weakened further in the second half of 2021. Our downgrade on Fiji in September 2021 moved this average rating closer to 'BBB'.
Fifteen of the 21 sovereign ratings in Asia-Pacific have stable outlooks as of Dec. 31, 2021 (see chart 3). Four have negative outlooks (Indonesia, Sri Lanka, Papua New Guinea, and Malaysia). The ratings on Taiwan and Vietnam have a positive outlook, partly because of their better-performing economies.
Chart 1 | Asia-Pacific Sovereign Ratings Trends Have Stabilized Despite Ongoing COVID Effects
Source: S&P Global Ratings.
In the second half of 2021, we took two negative sovereign rating actions in the region. First, we downgraded Fiji to 'B+' because we believe the country's protracted economic recovery has elevated budgetary strains. The freeze in international travel since the onset of COVID-19 has hit Fiji's economy hard.
In late August 2021, we revised the outlook on the Sri Lanka long-term rating to negative from stable. The outlook revision was in keeping with our view that the government faced increasingly challenging external financing prospects. Persistent high fiscal deficits would continue to add to funding pressure. In our view, funding from existing sources is unlikely to be enough to cover financing needs. High costs also limit commercial funding options.
Chart 2 | Asia-Pacific Sovereign Rating History
Note: The rating history is an average of the foreign currency rating adjusted for positive or negative outlooks. Bangladesh was first rated in April 2010. Cambodia was withdrawn in September 2014. Source: S&P Global Ratings.
We view the Sri Lanka government's access to external financing to be increasingly dependent on favorable business, economic, and financial conditions. As the sovereign credit metrics worsened further, we revised the Sri Lanka long-term rating to 'CCC' from 'CCC+' in January 2022. The outlook is negative.
Chart 3 | Asia-Pacific Ratings Outlooks Are Overwhelmingly Stable
The omicron variant that emerged in late 2021 dashed hopes of a rebound in international travel. Until the virus began spreading fast in December 2021, international travel had shown signs of coming back in parts of Asia-Pacific. Foreign arrivals in Sri Lanka and Thailand--where tourism is a key industry--picked up sharply in the final two months of the year (see chart 4). The recovery in arrivals reflected increased confidence in these countries in managing the pandemic as vaccination rates rose.
However, the surge in new infections in many countries has put a recovery of visitor arrivals into doubt. If arrival numbers stall for a long time, tourism-dependent economies will find sovereign credit pressures hard to shake.
Chart 4 | Tourism-Focused Economies Are Experiencing An Uptick In Visitors
Source: CEIC.
The omicron variant has also focused attention on COVID management strategies, especially in China. Many Asia-Pacific regions have achieved high vaccination rates (see chart 5), so most patients will not fall seriously sick. Even so, the fast-spreading virus could still overwhelm hospitals simply because it infects so many. Should COVID cases overwhelm healthcare systems, this could force some governments to impose strict social distancing restrictions.
Chart 5 | High Vaccination Rates Will Support Recoveries
Number of people fully vaccinated per 100, as of January 2022. Source: Our World In Data.
The economies most at risk of being affected by new COVID restrictions could be those where hospital capacities are smallest relative to their populations. In much of Asia-Pacific, hospital beds (adjusted for population size) are fewer than in many European countries (see chart 6). Consequently, healthcare resources could be stretched at lower levels of infections. This may necessitate stronger social distancing restrictions from governments.
Chart 6 | Robustness Of Heath Care Systems Influences Likelihood Of Lockdowns
Hospital beds per 1,000 people. Source: World Bank (latest year available for each economy in 2015-2019)
Increasing attention is being focused on China where the government continues its strict zero-COVID policy. The policy has been beneficial for Chinese economic growth and allowed many citizens to live near-normal lives. The much more contagious omicron variant, however, has seen infections break out in several places in the country simultaneously.
Concerns are increasing that the policy may see economic costs outweigh benefits, particularly as new and more contagious COVID variants arrive. Apart from the hit on Chinese growth, widespread strict social distancing rules may also create serious supply-chain disruptions that affect countries across the world. Many analysts question whether China can maintain its strong economic growth as it continues to battle the pandemic in this way. A pronounced slowdown of the Chinese economy could have a significant effect on its trade partners in Asia-Pacific.
More observers also question how China will emerge from its zero-COVID policy. Most countries have gone down the road of living with the disease, even if the omicron surge has forced some into temporary retreat. With its population largely never infected by COVID, China could experience a large, prolonged surge in the number of infections if it opened its borders and eased domestic restrictions. Pressures on the Chinese health care system will mount.
This suggests the country will stick with the policy for a while. China is more likely to ease its strict COVID policy if a highly effective vaccine were found, a very effective cure were developed, or if it significantly expanded its healthcare capacity.
U.S.-China relations pose another threat to regional sovereign credit metrics. This is an important political year for the U.S. (where the mid-term elections will be held near the end of 2022) and for China (which holds it 20th Party Congress late in 2022). Any disagreement between the two countries risks serious escalation since both governments will have less room for compromise. The risk could be exacerbated if the U.S. remains distracted by developments in Eastern Europe and the Middle East well into the new year.
Chart 7 | Sequence Of Events: North Korean Weapon Tests In 2022
Source: Various news media.
At the same time, tensions on the Korean peninsula have returned. The Democratic People's Republic of Korea (North Korean) regime was focused on keeping COVID-19 out of the country in the past two years. Now, it appears to be ratcheting up old conflicts.
In late 2021 and early 2022, the country conducted several high-profile missile tests (see chart 7). Possibly, with both China and the U.S. preoccupied with key political events in 2022, the North Korean regime sees a chance that it could get some of the economic sanctions on the country removed. More provocative and destabilizing actions may come in the new year.
The higher inflation seen in some advanced economies don't appear to have swayed price trends in Asia-Pacific yet (see chart 8). Outside Sri Lanka and Pakistan, where the central banks had raised policy interest rates, consumer price inflation was not abnormally high late in 2021. Modest inflation has even allowed China to bring down interest rates marginally, as a policy-induced slowdown in the country's real estate sector weighed on economic growth.
Chart 8 | Consumer Inflation Not Yet A Serious Issue For Most Asia-Pacific Governments
Year-on-year growth in consumer price index. Source: CEIC.
Nevertheless, some Asia-Pacific central banks have tightened policies to hold down inflation expectations. This includes the Reserve Bank of New Zealand and the Monetary Authority of Singapore, as well as the previously discussed actions of the central banks of Sri Lanka and Pakistan. The Bank of Korea also lifted its policy rate, although its actions also reflected concerns over rapid household credit growth and rising real estate prices. Less-intense inflationary pressures in much of Asia-Pacific suggest forced increases in policy interest won't derail regional economic recovery by themselves.
For Pakistan and Sri Lanka, however, higher inflation intensified already-significant credit strains, crimping policy flexibility. Despite challenges in obtaining new financing, the Sri Lankan government introduced a US$1.2 billion relief package targeted at public sector employees and low-income households. This helped to offset the rising cost of living but added to the size of the already-large fiscal deficit.
Pakistan recently passed a budget that ended some sales-tax exemptions to obtain more financial support from the International Monetary Fund. However, this move has ignited significant political pressures as it adds to consumer prices.
Elsewhere in Asia-Pacific, where concerns about domestic inflation are not as serious, the potential for greater increases in international interest rates may affect some sovereigns. Borrowers in economies that rely on external financing could see financing costs rise further. In places such as Indonesia, rate moves that surprise on the upside may hold back economic growth. Stronger export performance and a comparatively favorable policy environment should shield Indonesia from significant financial disruptions arising from capital outflows.
Table 1 | Asia-Pacific Sovereign Rating Score Snapshot
*Deterioration since June 2021. §Improvement since June 2021. Source: S&P Global Ratings.
The recent rapid spread of the omicron variant highlights the inherent uncertainties of the pandemic as well as the importance and benefits of vaccines. The risk of new, more severe variants displacing omicron and evading existing immunity cannot be ruled out. But our current base case assumes that existing vaccines can continue to provide significant protection against severe illness. Furthermore, many governments, businesses, and households around the world are tailoring policies to limit the adverse economic impact of recurring COVID-19 waves. Consequently, we don't expect a repeat of the sharp global economic contraction of second-quarter 2020. Meanwhile, we continue to assess how well each issuer adapts to new waves in its geography or industry.
Table 2 | Asia-Pacific Economic Outlook
f--Forecast. GG--General government. CAR-- Current account receipts. Source: S&P Global Ratings.
