Jan. 14 2019 — As of Dec. 31, 2018, S&P Global Ratings rates 133 sovereigns globally (see chart 1), and the overall credit quality of these still remains a full notch below the pre-2008 global financial crisis level, at a 'BBB-' average, or 'A+' if weighted by GDP. That said, the overall outlook balance (positive versus negative outlooks) is at positive six, continuing a process of slow improvement in the ratings that started in November 2017.
This trend is more notable in Eastern Europe, where we see the highest concentration of positive outlooks globally because of a steady growth performance and improved fiscal outcomes, particularly of smaller and more flexible economies. In the Americas, on the other hand, sovereign credit quality has deteriorated since its peak nearly five years ago, and the ratings outlook balance is negative two. In the rest of the regions, the outlooks are slightly tilted to the positive.
The year 2019 brings several and difficult challenges for sovereigns. As the developed world normalizes its economic trajectory and the monetary stimulus of the last decades fades away, a complicated political landscape in both developed and developing economies restricts the room to maneuver of politicians. Protectionism and populism are on the rise, threatening to derail the weak recovery on global growth. If these conditions worsen over the upcoming year, and the policy reaction is not timely and appropriate, pressures can start building again in the asset class.
Sovereign securities remain the most important asset class globally in terms of borrowing (see "Sovereign Debt 2018: Global Borrowing To Remain Steady At US$7.4 Trillion," published on Feb. 22, 2018). Close to 54% of all rated sovereigns are investment grade ('BBB-' or above). This is a slight increase from the all-time low observed midyear 2017 (see chart 2), when the ratio stood at 51%. The historically low ratio in the past few years is due not only to new sovereign ratings, which tend to be in lower rating categories, but also to some "fallen angel" sovereigns, which we downgraded over the last three years from investment grade to speculative grade, such as Brazil, South Africa, and Oman.
Throughout the past decade, sovereigns rated in the 'B' category have made up the single-largest cohort, currently 41, up from 29 five years ago.
At the other end of the spectrum, the number of 'AAA' rated sovereigns has declined to 11, from an all-time high of 19 in June 2011, mostly because of downgrades in the eurozone. But downgrades in other regions over the last few years have also contributed to the shrinking group of 'AAA' rated sovereigns--the last ones being Hong Kong to 'AA+' in September 2017, and the U.K. to 'AA' in June 2016 following the Brexit referendum. The share of 'AAA' ratings in the total universe of rated sovereigns has gradually dropped to 8% today from more than 16% before the global financial crisis. All 'AAA' rated sovereign have a stable outlook, and no 'AA+' or 'AA' rated sovereign has a positive outlook, which could indicate that, over the longer term, the share of 'AAA' rated sovereigns is not likely to increase.
The eroding credit quality of rated sovereigns goes some way to explain the mild decline we have seen in the unweighted average sovereign rating, as governments across the world have had to inject fiscal resources to cope with the different waves of shocks over the last decade. Since mid-2008, sovereign downgrades have generally outnumbered upgrades (see chart 3; for further details see "Sovereign Ratings History," published monthly). However, this trend has reversed in the second half of 2018, and, as of Dec. 31, 2018, upgrades outnumbered downgrades by three, on a rolling-12-month basis.
Another reason for the decline in the unweighted average rating is that most of the new sovereign ratings we have assigned have been to countries in emerging or frontier markets and have been in the lower rating categories. For example, our new ratings on Sub-Saharan African sovereigns have predominantly been in the 'B' category.
Also, sovereigns with larger and wealthier economies, and therefore higher ratings, have experienced a deteriorating trend. The downgrade of the U.S. in August 2011 clearly stands out (see chart 4), because it is the world's largest economy, as do the downgrades of several eurozone sovereigns, includingFrance, Italy, and Spain in January 2012, as well as the U.K. in June 2016 and China in September 2017.
2019 Outlook: Balance Remains Cautiously Positive
Currently, we have six more positive outlooks than negative, up from three one year ago and considerably up from the -24 at midyear 2017 (see chart 5). The number of negative outlooks is the lowest in over a decade, and the marginally positive outlook balance suggests that globally we have reached the trough of average sovereign ratings. Our rating outlooks are intended to indicate our view of the potential direction of a long-term credit rating, typically over six months to two years for investment-grade ratings ('BBB-' and higher) and six months to one year for speculative-grade ratings ('BB+' and lower). A positive or negative outlook is intended to designate at least a one-in-three likelihood of a rating change in the indicated direction.
A continued ratings recovery looks possible in 2019, considering the current positive outlook balance. We remain cautiously optimistic given the dynamics behind the balance and the several issues threatening to derail the economic recovery that began a few years ago. Populism has gained traction in both developing and developed markets, propelling anti-immigration sentiments and economic protectionism like the world has not seen in many decades. The trade war between the U.S. and China, which has begun to affect world growth and has increased volatility in the financial markets, stands as clear sign resulting from these negative dynamics in world politics. Continued uncertainties about Brexit is another example of the political polarization that exists now in many countries in Europe, Asia, and Latin America. In this context, the degrees of freedom for policymakers to react to adverse shocks are limited and may lead to governments trying heterodox policy responses that could exacerbate the problems, putting pressure on or reversing the ratings trends of the last few years. The events in Turkey and Argentina in 2018 are an example of these risks.
Looking at the performance by regions (see chart 6), Europe has seen the strongest improvement of all the regions in its outlook balance, particularly since 2011. Back then, Europe accounted for almost the entire global negative outlook bias--largely because of the eurozone debt crisis. Having overcome the acute phase of the crisis, a vast majority of the European Monetary Union members now carry a stable or positive outlook. As of Dec. 31, 2018, we only had four negative outlooks on the continent, of which one is within the eurozone (Italy).
The positive trend is more notable in Central and Eastern Europe (CEE), where we see the highest concentration of positive outlooks globally--albeit at rating levels that remain below where they were prior to the global financial crisis. CEE economies have experienced a cyclical recovery, particularly over the past two years, reflecting pent-up consumer demand and tightening labor markets, driven by the region's increasing integration into Germany's manufacturing supply chain. As the economic cycle is maturing, we expect moderating growth rates, and, with that, a decrease on the risks of overheating, particularly in the housing and labor markets. Domestic consumption will become a more important source of economic growth, which will weigh on external performance. This, however, does not represent a major concern given the currently strong external position of the region, including current account surpluses in the majority of CEE sovereigns.
In the Americas, sovereign credit quality has deteriorated since its peak nearly five years ago, and the ratings outlook balance is negative two. Although the outlook balance has improved in the past two years, this is primarily due to downgrades from negative outlooks, where the outlook has subsequently been revised to stable. The reasons for this performance vary from country to country, but the common denominator across the region is a deterioration of the political landscape that has delayed an appropriate reaction to adverse factors.
Decelerating world GDP growth, higher U.S. interest rates, and concerns about new barriers to cross-border trade set the background for economic trends in the Americas in 2019. Within the region, the evolution of sovereign ratings will be shaped by sluggish GDP growth and new political developments based on recent and upcoming national elections.
We project the world economy to grow around 3.6% in 2019, similar to its pace in 2018. Emerging market economies are likely to grow just under 5%, more than double the pace of growth in advanced economies (around 2.1%). The Latin America and Caribbean region (excluding Venezuela) is likely to grow only 2.2% in 2019, slower once again than emerging Asia and Sub-Saharan Africa.
In the rest of the regions, the outlooks are quite close to balanced, marginally tilted to the positive.
In Asia-Pacific, we expect most sovereign ratings to remain unchanged as the majority of them carry a stable outlook, except Japan and The Philippines, which are positive. However, continued uncertainty over the U.S.-China trade tensions will continue to threaten investment sentiment in the region, increasing risk aversion.
In this context, the continued concerns over future financial instability in China could renew investor worries about emerging markets more generally, given the importance of the Chinese economy to global demand.
Elsewhere in the Asia-Pacific region, preparing their economies for the possible consequences of the above scenarios may not be the top concern for some policymakers. Many of them face more immediate domestic political concerns in the coming year. India, Indonesia, the Philippines, and Thailand will hold important elections in 2019.
Finally, in the Middle East, the Commonwealth of Independent States (CIS), and Africa region, which we group into one, the small positive balance remains unchanged compared with one year ago, with only a small number of positive or negative outlooks.
Particularly for the Middle East and North African (MENA) sovereigns, we expect growth to remain modest in 2019. Supported by a slower pace of fiscal consolidation, coupled with strong government capital expenditure and positive spillovers from a pickup in oil production, non-oil activity in MENA oil exporters will remain supportive of growth over the medium term. We expect the 1.2 million barrel-per-day oil production cut agreed by OPEC and its oil-producing allies, on Dec. 7 2018, will be mostly borne by Saudi Arabia. We expect economic growth in hydrocarbon exporters to recover to 2.2% in 2018 and 2.4% in 2019, after falling sharply in 2017.
MENA oil importers will continue to outperform their regional hydrocarbon-endowed peers. We expect countries with less wealth to have higher economic growth rates. However, stronger growth also reflects ongoing reforms, strong domestic consumption, and continued external demand. We expect growth to reach about 4% on a weighted-average basis in 2019 and to improve marginally to 4.5% over the remainder of the forecast period.