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Ratings On Emerging Market Local Governments Take The Hardest Hit In The First Half Of 2020

S&P Global Ratings believes that stable outlooks on ratings on non-U.S. LRGs will continue to account for a high proportion of the sector's total outlooks during 2020, but the number of negative outlooks has increased sharply during the first half of the year. As of June 19, 2020, we rate around 300 LRGs outside of the U.S. (see chart 1), and almost 20% have negative outlooks on their ratings.

Chart 1

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Rating Changes In The First Half Of The Year

During the first six months, we didn't upgrade any LRG (see chart 2) and downgraded 18 (6% of total rated LRGs), all of which were already at low rating categories. We also revised outlooks to negative on 25 entities and to stable from positive on eight, indicating more challenging economic and fiscal conditions. These rating actions are partly in line with our expectations at the end of last year (see "Rising Sovereign And Fiscal Risks Could Impair Ratings On Local And Regional Governments Outside The U.S.", published on Nov. 18, 2019). This is because we were observing a negative bias on LRG ratings for 2020. However, economic crisis due to measures to contain COVID-19, scarce financial support to local governments in some countries, the collapse of oil prices, and sovereign negative rating changes weakened LRGs' credit quality more rapidly than we initially expected. Now, less than 5% of LRGs have positive outlooks.

In some cases, we observe that rating actions at the sovereign level keep affecting LRG ratings and outlooks. For example, in Japan (an outlook revision to stable from positive) prompted us to take the same action on the City of Osaka, Prefecture of Aichi, and Tokyo Metropolitan Government. Mexico's downgrade with a negative outlook led us to revise to the outlook on the states of Queretaro, Guanajuato, and Aguascalientes to negative as well. The outlook revision on Colombia to negative also led us to change the outlook on District of Bogota. In all these cases, we don't believe that LRGs could be rated above their respective sovereign. Additionally, the impact of the pandemic, economic woes, and expenditure pressures caused downgrades of subnational governments in India, Brazil, China, Mexico, Israel, Spain, and Argentina.

Chart 2

image

With the exception of the state of Kerala in India, which we downgraded to 'BB-' from 'BB' and the state of Guerrero in Mexico to 'mxBBB-' from 'mxBBB', the majority of downgrades occurred among Argentine LRGs. We took negative rating actions on the following Argentine entities between January and June 19, 2020: the city of Buenos Aires, and the provinces of Buenos Aires, La Rioja, Mendoza, Entre Rios, Rio Negro, Neuquen, Salta, Cordoba, and Jujuy. These provincial governments have announced debt restructurings over the past few weeks. That's why we have lowered ratings to 'CCC', 'CC', or 'SD' on these provinces. We estimate that their total debt restructuring would likely surpass $10 billion in 2020, assuming that it will be completed this year. The obstacles in the sovereign's attempt to complete its own debt restructuring has been has prevented advance in the provincial debt restructuring.

Ratings Remain Mostly At Investment Grade

LRG ratings at investment-grade level (above 'BBB-') represent 79% of the sector's total rated LRGs, and the remainder is in the speculative-grade territory (see chart 3). In other words, as of June 19, 2020, 232 entities--out of 293 that we rate--are in the investment-grade area. The largest investment grade category among the sector entities is 'AA', representing 40% of total ratings, followed by 'A' and 'BBB' (15% each), and finally 'AAA' (almost 10%). Among speculative-grade local governments, the 'BB' category continues to be the largest one (13%). We currently rate some LRGs in Brazil and Argentina at 'SD'.

LRGs in the 'BB' category have continued to fall into the 'B' category, while the latter shrinks because the 'CCC' category increased 2.6 times during the first six months of 2020. Subnational governments at the highest rating categories have shown resilience during the public health crisis, and we expect them to manage the fiscal impact for the rest of 2020.

  • The 'AAA' rated LRGs are in the following investment-grade countries: Canada (9), followed by Sweden (8), Switzerland (4), and Australia and Germany (3 each). No changes from last year.
  • Local governments rated in the 'AA' category are in the following countries: Canada (30), New Zealand (23 compared with 20 last year), Sweden (16), France (11 compared with 14 last year), Switzerland (10 compared with 8 last year), Austria (7), Germany (5), and Australia (4).
  • The 'A' rated entities are found mostly in the following countries: China (15), Spain (7), Canada (7), Japan (3), and France (1 compared with 2 last year).
  • In the 'BBB' category, subnational governments are mostly distributed among the following countries: China (15), Mexico (8), Italy (6 compared with 4 last year), Bulgaria (3), Russia (3) and Spain (4).
  • Most of the speculative-grade local governments are in Mexico, Brazil, and India.

Chart 3

image

Negative Outlooks Outnumber Positive By A Wide Margin

During the first half of 2020, 13 out of total of 25 outlook revisions went to negative due to health and safety related issues that are part of our Environmental, Social and Governance (ESG) assessments, which have taken a toll on LRGs' fiscal performance. Some outlook changes occurred in some European cities, such as Paris and Rome. Outlooks of other entities that suffered from the COVID-19 measures were the Canary Island in Spain, cities of Vasteras, Orebro, and Vellinge in Sweden, the provinces of Alberta and British Columbia in Canada, and Department of Gironde in France.

Chart 4

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Outlook Balance Across Regions

During the first half of 2020, the highest proportion of positive outlooks on LRGs were located in Asia-Pacific (APAC), followed by Europe, and the Americas excluding the U.S. Positive outlooks on the sector's entities represent 4.8%. The number of LRGs with negative outlooks has increased significantly in the past six months, leading negative balance between the number of positive versus negative outlooks (see chart 5). Out of almost 20% of negative outlooks on LRGs globally, the Americas has the highest proportion (44%), followed by EMEA (38%), and APAC (18%).

Chart 5

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Among subnational governments in the Americas, stable outlooks represent 74% of total, while negative outlooks represent 24% and only 2 LRGs have positive outlooks: the city of Monterrey in Mexico and the Regional Municipality of York in Canada. Argentina and Mexico have the largest number of negative outlooks in the Americas. Canada has only three LRGs with negative outlooks: the provinces of Alberta, British Columbia, and Newfoundland and Labrador The arrival of the COVID-19 pandemic in Canada has depressed provincial economies and wiped out fiscal gains of the past decade, while some provinces such as Alberta took another hit from sharply lower oil prices, widening fiscal deficits. Mexican LRGs will face rising public finance pressures toward the second half of 2020, given the contraction of federal transfers and weakening of their own source revenue as a result of the recession.

The majority of outlooks on local governments in EMEA remain stable. Entities in Sweden and Italy contain the largest number of negative outlooks. In Sweden, the combination of continuing cost pressures and eroding tax revenue stemming from COVID-19 ratchet up budgetary risks. Sweden is the only 'AAA' rated country where we view the trend in the LRGs' institutional framework as weakening. This is due to insufficient central government support mechanisms and LRGs' countermeasures against the pandemic. The outlook revision on Italy's 'BBB' rating to negative on April 24, 2020, cap ratings on domestic LRGs. Countries with fewer negative outlooks in EMEA are Germany, France, Austria, Croatia, Spain, and Russia. Only two entities in the region have positive outlooks: the Autonomous Community of Madrid, given the larger financial assistance from the central government covering budget losses and helping to improve budgetary performance, and the Intercity Saint-Quentin-en-Yvelines (SQY) because it enjoys a very strong economy and liquidity position.

APAC entities have a more balanced distribution of negative and positive outlooks than in other regions in 2020. Nevertheless, we observe that negative outlooks also outpace positive ones. On April 8, 2020, we revised our outlook on Australia to negative from stable, which triggered the same action on the states of Victoria and South Wales, and the Australian Capital Territory. Also, following our outlook on Japan to stable from positive, the same rating actions occurred among three LRGs. Finally, growth remains divergent across China's provinces, so LRGs with weaker economic fundamentals and greater reliance on transfers could face more uncertainties in maintaining growth and healthy budgetary performance over the next few years.

Outlook Distribution

Chart 6

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Although the global LRG sector remains mostly stable—slipping to 76% from 82% of total outlooks--we detect higher risks on the horizon, as indicated in the rising number of negative outlooks across the globe, excluding the U.S. Negative outlooks doubled during the first half of 2020, reaching 19% of total global outlooks from 10% last year. If economic recovery takes longer than expected and fiscal packages result to be insufficient, LRGs would face more challenges to maintain healthy public finances. Financial managements with more capacity to plan and react under stressful conditions could make a difference to ensure fiscal sustainability in the longer term and contribute to sustain credit quality.

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Daniela Brandazza, Mexico City (52) 55-5081-4441;
daniela.brandazza@spglobal.com
Felix Ejgel, London (44) 20-7176-6780;
felix.ejgel@spglobal.com
Research Assistant:Deepanshu Goyal, GURGAON HARYANA

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