Sovereign Sector Outlook Revised to Neutral on Ukraine War Impact
The deterioration in global sovereign credit conditions this year relative to our expectations at end-2021 has caused Fitch Ratings to change its global sovereign sector outlook to neutral from improving. The impact of the Ukraine war and consequent sanctions on geopolitical risk, trade and capital flows, and economic growth and inflation will not be resolved in 2H22.
Policy responses are driving the fiscal effects of inflation, making post-Covid-19 pandemic consolidation that was evident last year less certain. Meanwhile the Federal Reserve and most other major central banks will tighten policy much more aggressively than anticipated, adding to funding stresses for emerging markets (EMs) with limited local-currency financing options. Commodity exporters are benefiting from high prices, but EMs that are net commodity importers face high gross external funding needs.
Sector outlooks are a general forward-looking assessment of underlying conditions relative to the prior calendar year. Emerging Europe and sub-Saharan Africa (SSA) are the only regions with deteriorating sovereign sector outlooks, indicating that we now see underlying conditions as being worse than in 2021. Sovereigns in the Commonwealth of Independent States (CIS) are exposed to Russia’s economic contraction, and many sovereigns in central and eastern Europe have insufficient alternative energy sources if Russia ceases gas exports.
Inflation and tighter global financial conditions are further weakening SSA’s macroeconomic prospects, and in many cases, the cost and availability of external financing. The region’s main oil exporters will gain from higher prices, although domestic fuel subsidies limit the fiscal benefit for Nigeria.
In western Europe, weaker GDP growth will slow, but not reverse, fiscal consolidation, while we expect APAC economies generally to continue recovering, albeit more slowly. Both regions’ sector outlooks are now neutral, versus improving at the start of the year. But while much of APAC gains from economic reopening, near-term growth in Greater China will be partly influenced by ‘zero Covid’ policies, and we expect China’s economy to grow just 3.7% this year following lockdowns in 1H22. Our Greater China sector outlook remains neutral.
Our neutral sector outlooks for North America and Latin America are also unchanged. US recession risks have risen, but its financing needs are declining and the strong post-pandemic rebound boosted revenues. Latin America’s economic recovery has remained fairly resilient as the pandemic has receded, allowing economic reopening to continue, while higher commodity prices improve terms-of-trade for some. But measures to cushion households from higher fuel and food prices are reducing the net fiscal benefits for commodity exporters and slowing consolidation elsewhere. Difficult political backdrops continue to complicate efforts to tackle underlying growth and fiscal challenges.
The Middle East and North Africa (MENA) is the only region to maintain its improving sector outlook assigned at end-2021. Oil-exporting sovereigns will register significantly stronger public finances and growth in 2022, although the economic picture will be much more challenging outside the Gulf Cooperation Council. The MENA sector outlook is supported to varying degrees by reform momentum as well as by the more constructive regional political dynamics that emerged last year.
Sector outlooks are distinct from Rating Outlooks. Notwithstanding the effects of the war in Ukraine and higher inflation, the numbers of Positive and Negative Rating Outlooks are almost equal in Fitch’s global sovereign portfolio after the balance was deeply negative during the pandemic. This partly reflects the stabilisation of Outlooks on some sovereigns, including Japan, India and Panama, since end-2021. Downgrades to Ukraine, Belarus and Tunisia have taken their ratings to ‘CCC’, where Fitch does not assign Outlooks to sovereign ratings.
More broadly, with a record-high share of sovereigns rated in the ‘B’ category or lower, additional sovereign defaults are likely as EM commodity importers face tighter global funding conditions.
Source: Fitch Ratings