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Credit FAQ: Sovereign Ratings And The Effects Of The COVID-19 Pandemic

(Editor's Note: We have republished this article on April 17, 2020, to update chart 1 to reflect some of the latest stimulus measures announced.)

As the COVID-19 pandemic continues, the world's economies are battling the financial and economic effects of the disease, which have brought most markets around the world to an almost complete standstill.

This unprecedented set of circumstances is testing the capacity of governments around the world to provide the support needed for the private sector through this time of severe shock. In this context, governments of all sizes and with different capabilities have embarked on what is likely to be the largest monetary and fiscal stimulus since the end of World War II. Below, S&P Global Ratings answers questions on the possible impact on sovereign ratings as we incorporate the effects of the pandemic, their policy responses, and their capacity to recover.

Frequently Asked Questions

What is S&P Global Ratings' approach to sovereign ratings in the context of the COVID-19 pandemic and the impact it's having on the financial health of governments around the world?

Our criteria-based analysis, based on our sovereign ratings methodology and our analytical judgment, remains the same, as does the process by which we assign ratings and maintain surveillance.

A situation like this, however, presents unique conditions. A global economic downturn of this magnitude will affect economic growth, fiscal balances, debt burdens, the health of the financial sector, and the access to external liquidity of many sovereigns with different credit characteristics. By any calculation, it is safe to say that after the pandemic is over, the overall financial health of most governments around the world will be weaker than before. At first glance, these negative dynamics could lead to the conclusion that such shocks must lower sovereign ratings across the board.

However, our analysis takes a variety of factors into consideration apart from "headline" items. First, we assume that whereas the downturn of the global economy will be severe--probably the worst since the Great Depression--we also believe, at least at this stage, the downturn will not be prolonged. Economic recovery, under our base-case scenario, should start in late 2020, picking up pace in 2021.

Our sovereign criteria are designed to allow ratings to withstand short-term fluctuations within different economic cycles. The analytical judgment we use in evaluating the different characteristics of each sovereign, including its room to maneuver and the policy flexibility it possesses to defend the economy, is an important factor in our analysis of such fluctuations. Our quantitative analysis is based on ranges for the different variables that influence the rating, and many of the ranges deliberately overlap. This is designed to allow us to differentiate between transitory fluctuations and underlying trends, and not to be confined to a strict quantitative outcome.

The financial health, economic structure, and resilience of sovereigns before COVID-19 sets the background for us to incorporate the effects of the pandemic. In this context, it is important to distinguish between the short- and long-term implications of the new developments. Some sovereigns that have greater capacity to effectively use their substantial monetary and fiscal flexibility will likely be able to cushion the impact of the pandemic in the short term and postpone or alleviate its potential long-term impact. These are, in general, advanced economies in the upper end of the sovereign ratings spectrum, where we are not likely to see many immediate downgrades during the first waves of the pandemic. Among these sovereigns (see table 1), we find, for example, the U.S. (long-term foreign currency rating 'AA+'), Germany ('AAA'), and France ('AA'). We affirmed our ratings and maintained stable outlooks for these sovereigns on April 2 and 3, incorporating our assumptions for economic contraction and substantial fiscal stimulus announced by those governments (see chart 1). Over the long term, depending how they manage the consequences of the pandemic, we might see rating actions involving higher-rated sovereigns.

Table 1

Sovereigns At The Upper End Of The Ratings Spectrum
Rating actions since the beginning of the COVID-19 pandemic
Current long-term foreign currency rating/Outlook Previous long-term foreign currency rating/Outlook
Ratings affirmed
U.S. AA+/Stable AA+/Stable
Germany AAA/Stable AAA/Stable
France AA/Stable AA/Stable
Belgium AA/Stable AA/Stable
Qatar AA-/Stable AA-/Stable
Abu Dhabi AA/Stable AA/Stable
Rating or outlook changes
Australia AAA/Negative AAA/Stable
Kuwait AA-/Stable AA/Stable
Ratings as of April 16.

Chart 1

image

Several other sovereigns were very exposed to volatility in financial markets because of their pre-pandemic financial and other vulnerabilities. These sovereigns are typically lower rated. Many of them have a narrow economic base and, in some cases, are highly dependent on commodity prices, which were hurt by the demand shock the pandemic created. They depend heavily on accessing international markets to meet their financing requirements. This group of sovereigns, with limited policy flexibility, is most vulnerable to adverse rating actions in the short term. We've taken some recent negative rating actions within this group, including actions on Argentina and Ecuador as both governments recently announced suspension of debt payments (see table 2).

Table 2

Sovereigns At The Lower End Of The Ratings Spectrum
Rating actions since the beginning of the COVID-19 pandemic
Current long-term foreign currency rating/Outlook Previous long-term foreign currency rating/Outlook
Ratings or outlook Changes
Oman BB-/Negative BB/Negative
Bahrain B+/Stable B+/Positive
Angola CCC+/Stable B-/Negative
Nigeria B-/Stable B/Negative
Ethiopia B/Negative B/Stable
Ecuador SD CCC-/Watch Neg
Argentina SD CCC-/Negative
Cameroon B-/Stable B/Negative
Ratings as of April 16.

Most of the sovereigns rated by S&P Global Ratings reside between these two groups of the least and most vulnerable entities. These sovereigns typically have some room to implement countercyclical monetary and fiscal policies, and enjoy access to local and international financial markets. They also have an economic base, a level of wealth or GDP growth prospects that provide moderate resilience to weather the effects of the pandemic, and allow for a recovery. Our recent rating actions among sovereigns in this group (see table 3) focus on policy responses to the pandemic and the ability of governments and central banks to minimize the negative impact on structural features of the credit rating. These sovereigns have differing capacities to effectively use countercyclical monetary and fiscal policies without weakening economic stability and public finances.

As with all sovereigns, we will differentiate between developments that are likely to be temporary, and may be reversed soon, and developments that produce structural changes that will persist or take longer to reverse. We will assess whether the impact of such developments is consistent with current ratings levels. The sovereigns in this third group are, in general, more likely to experience downgrades during the first waves of the pandemic, compared with highly rated advanced economies, but less likely than countries in the lower end of the ratings spectrum, consistent with our ratings definitions.

Table 3

Sovereigns In The Middle Of The Ratings Spectrum
Rating actions since the beginning of the COVID-19 pandemic
Current long-term foreign currency rating/Outlook Previous long-term foreign currency rating/Outlook
Ratings or outlook Affirmed
Malaysia A-/Stable A-/Stable
Azerbaijan BB+/Stable BB+/Stable
Saudi Arabia A-/Stable A-/Stable
Russia BBB-/Stable BBB-/Stable
Ratings or outlook Changes
Mexico BBB/Negative BBB+/Negative
Colombia BBB-/Negative BBB-/Stable
Thailand BBB+/Stable BBB+/Positive
Brazil BB-/Stable BB-/Positive
Ratings as of April 16.

Finally, there are many unknowns on how the world will look over the medium to long term. Human behavior could change, affecting some sectors of the economy and benefiting or creating others that do not exist today. Governments will have to deal with the consequences of the preventive measures implemented to combat the recession. We witnessed some version of that only a couple of years ago, when central banks started to indicate that it was time to start retreating the monetary stimulus put in place during the global financial crisis of 2008. These and many other issues, as well as the governments' capacity and policy response to adapt to new challenges, will shape the future and the long-term trajectory of our sovereign ratings.

Is the eurozone at risk of a sovereign debt crisis?

In our view, while public debt levels are set to increase rapidly over the next 12 months, the risk of a sovereign debt crisis is low.

The lockdown measures introduced by European governments last month to fight COVID-19 have pushed the eurozone into a recession, we believe one that could exceed that of the 2008-2009 global financial crisis. In an effort to prevent the economic standstill from destroying productive human and physical capital, eurozone governments, like their peers in the U.S. and U.K., are providing fiscal stimulus--ranging from 7% of GDP in Italy to 32% of GDP in Germany. Under these programs, nearly every eurozone government is temporarily contributing to paying workers' salaries, deferring corporate tax payments and social security contributions, frontloading social benefits, and guaranteeing private obligations on the assumption that later this year economic activity will normalize. The cost of this intervention, in terms of rising public debt, will be high, but the apparent alternative is severe long-term damage to their economies.

After the global financial crisis, the eurozone implemented a series of reforms that should help manage the current challenge, as long as it remains temporary. In 2012, the European Council established the European Stability Mechanism (ESM), an emergency lending facility available to member states in financial distress. That same year, member states put in place the single supervisory mechanism, the first step toward a banking union. Also that year, European Central Bank (ECB) President Mario Draghi promised the "euro is irreversible" and committed the ECB to purchase the bonds of any member state that enters into a macroeconomic stability program funded by the ESM under the Outright Monetary Transactions Program.

In March 2015, the ECB launched quantitative easing, including purchases of eligible governments' debt, to help the ECB meet its inflation objective and support economic growth in the eurozone. And last month, the ECB increased net public and private asset purchases to 9.3% of eurozone GDP for 2020, including via the creation of a new purchase program (the Pandemic Emergency Purchase Programme), besides specific measures supporting the capital and liquidity position of eurozone banks. In effect, the ECB is backstopping in very favorable terms the financing that governments require to support their national economies. Nearly all the new sovereign debt created will be held by European monetary authorities rather than in the market.

Even before COVID-19, eurozone growth had been significantly less than that of U.S. More than anything else, Europe's weak track record on growth reflects a combination of aging populations and a high propensity of the private sector to save rather than spend. Nearly every major eurozone economy is producing more than it's investing and consuming, resulting in vast current account surpluses that are reinvested abroad or deposited in low-yielding assets domestically. At $240 billion, Germany's current account surplus is the largest, in absolute terms, in the world--nearly 50% bigger than Japan's. Italy operates the world's eighth-highest current account surplus at $56 billion. Since year-end 2009, in most member states, levels of private debt have declined even faster than public debt has increased. In Italy and Spain, private debt has declined by 47 percentage points (ppts) of GDP and 134 ppts of GDP, respectively, over the last decade (see chart 2).

Chart 2

image

One side effect of the savings glut and low growth equilibrium in Europe has also been negative nominal as well as real interest rates, with the ECB decision of June 2014 to cut its deposit rate to less than zero. Negative rates are particularly unpopular in those member states where savings rates are high. But the ECB's policy has enabled eurozone governments to refinance themselves at rates that are both below expected nominal economic growth and below the average cost of their historical debt stock (see chart 3). We calculate that Spain is refinancing itself at 0.15% at present compared with an average cost on its debt of 2.1%, while Italy is refinancing itself at about 1% compared with an average cost of debt of 2.6%. This implies that even if their stock of debt increased by 15 ppts this year, interest expenditure to GDP will continue to fall. At the least, benign financing conditions give governments time to markedly improve their debt profile, including extending the average maturity of their outstanding debt.

Chart 3

image

While we believe even higher public debt levels are sustainable in economies where private debt continues to decline, the current policy settings are not optimal. Most of our ratings on eurozone member states are well below where they were before the global financial crisis. Relative to per capita GDP levels, our eurozone sovereign ratings are on average the lowest sovereign ratings S&P Global Ratings has issued globally. The eurozone appears hampered, compared with the U.S. and U.K., by lack of a central fiscal capacity capable of handling economic shocks to its labor markets, as seems to be the case with the pandemic. Indeed, the absence of private and public cross-border risk sharing--and the vigorous disagreements around mutualizing debt issuance--appears to place the eurozone at a disadvantage compared with older monetary areas such as the U.S. and the U.K., which issue common risk-free instruments.

The decision to mutualize risk is ultimately a political one, and the next 12 months should continue to see a lively debate on the benefits of mutualization versus individual member state responsibility. Depending on member states' individual circumstances and the specific shocks that COVID-19 and its consequences will impose over the medium term on large economic sectors such as tourism, transport, and manufacturing, we could lower eurozone sovereign ratings further over the next few years. On the other hand, a strong economic recovery and an effective policy response in the area of risk sharing or other alternatives would, under our sovereign credit rating methodology, likely benefit sovereign ratings within the Economic and Monetary Union.

How has S&P Global Ratings applied its approach to countries in the Americas?

The diversity of the Americas region means the pandemic will leave a greater or lesser negative legacy, depending on the country and on how governments respond.

The likely differential impact on creditworthiness in the Americas is shown by various rating actions that we have recently taken. We may see more negative rating actions in 2020 among speculative-grade sovereigns (rated 'BB+' and below) than among investment-grade sovereigns. We have already affirmed some ratings and lowered others among investment-grade countries. Our rating actions among speculative-grade countries show a similar pattern.

For example, we affirmed the 'AA+/A-1+' sovereign ratings on the U.S. despite expectations of a substantial increase in its fiscal deficit and debt burden. The affirmation reflects our view that the wealth, resilience, and diversity of its economy; its institutional strengths; its extensive economic policy flexibility; and its unique status as the issuer of the world's leading reserve currency provide sufficient capacity to recover from the recent shock with limited impact on creditworthiness.

However, we lowered the ratings on other investment-grade sovereigns, like Mexico (foreign currency long-term rating lowered to 'BBB') and Trinidad and Tobago (to 'BBB-'), and revised the outlook on Colombia ('BBB-') to negative. These negative actions reflect our view that the combination of external shocks and preexisting vulnerabilities and weaknesses in the economy would erode the pillars that sustain those ratings (or increase the risk of such weakening, in the case of Colombia). We also lowered the rating on Curacao ('BBB') based on our view of greater institutional and governance risks, and the impact of the pandemic on tourism earnings and GDP growth.

Similar to the pattern among investment-grade sovereigns, we have affirmed some speculative-grade ratings and lowered others. We affirmed our rating on Costa Rica ('B+') and maintained a negative outlook based on our view that our current assessment already reflects vulnerabilities in public finances, a weak external position, and the likely policy response. In contrast, we revised the outlook on The Bahamas ('BB+') to negative from stable based on our view of the risks of a downgrade because of the economic shock and the sovereign's growing debt burden. The impact of the pandemic led us to revise the outlook on Brazil ('BB-') to stable from positive, reflecting our updated fiscal and economic expectations, and our assumption of slower-than-expected progress to pass and implement meaningful legislation to reduce structural fiscal vulnerabilities and to raise medium-term GDP growth prospects.

The pandemic exacerbated already substantial fiscal and financial stress in low-rated sovereigns like Suriname, Ecuador, and Argentina. As a result, we lowered our rating on Suriname to 'CCC+' and assigned a negative outlook, reflecting the impact of low oil prices and ongoing economic deterioration amid policy uncertainty before national elections due later this year. The economic and social cost of the pandemic contributed to Ecuador's recent decision to seek debt restructuring, and led us to lower our rating on March 25 to 'CC-' and place it on CreditWatch with negative implications. We since downgraded Ecuador to 'SD' (selective default) on April 13.

Similarly, the pandemic exacerbated Argentina's already stressed fiscal needs and resources, leading the government to reconfigure its financial planning and budgetary priorities. We lowered our foreign currency rating on Argentina to 'SD' following the government's decision to postpone payment of U.S.-dollar-denominated principal and interest on local-law debt to at least 2021, or when deemed feasible by the government. We view this unilateral extension as tantamount to default under our criteria.

Are Asia-Pacific sovereigns that announced sizable support packages more likely to see pressures on their ratings as a result?

Higher-rated governments in Asia-Pacific--including Australia, Japan, Hong Kong, and Singapore--have announced sizable support packages to cushion the shock of the COVID-19 pandemic on their economies. In comparison, sovereigns with lower ratings have responded with less spending.

Policy decisions in the current environment involve balancing the damage to the balance sheets of governments, businesses, and households. The minimum overall balance sheet damage is determined by the country's ability to contain the outbreak within its borders. Large stimulus packages could weaken fiscal support for sovereign ratings. However, well-implemented measures could help maintain social cohesiveness in a difficult period and position businesses to rebound quickly once the pandemic eases. In turn, these conditions will help the process of budgetary repair to begin earlier.

Nevertheless, some sovereigns are seeing near-term rating pressures as a result. Structural fiscal performances are unlikely to be affected by the outbreak, and we expect large deficits in the current and next fiscal years to be temporary in most cases. Still--unlike Hong Kong, Japan, and Singapore--we see the increase in the debt burden over the next two years as having a material negative impact on the sovereign credit support for Australia (AAA/Negative/A-1+). We revised our outlook on the long-term ratings to negative from stable on April 7 to reflect this.

For some Asia-Pacific sovereigns--such as Pakistan, Sri Lanka, and India--fiscal or other constraints do not allow them to roll out large stimulus measures. This limits the short-term pressures on fiscal support for the ratings. However, if the pandemic is prolonged, this could build up social dissatisfaction that could increase political instability. At the same time, the balance sheet damage suffered by businesses and households could weigh on the subsequent economic and fiscal recovery. Rating pressures on these sovereigns may still mount over time.

This report does not constitute a rating action.

Primary Credit Analyst:Roberto H Sifon-arevalo, New York (1) 212-438-7358;
roberto.sifon-arevalo@spglobal.com
Secondary Contacts:Joydeep Mukherji, New York (1) 212-438-7351;
joydeep.mukherji@spglobal.com
Frank Gill, Madrid (34) 91-788-7213;
frank.gill@spglobal.com
KimEng Tan, Singapore (65) 6239-6350;
kimeng.tan@spglobal.com

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