The negative trend in sovereign rating Outlooks in the year to date emphasizes the challenges faced by emerging market (EM) issuers dependent on oil and gas exports, Fitch Ratings says in a new report.
Negative outlooks in Russia and Brazil result in ratings pressure on financial institutions and select sovereign-owned entities. Financial institutions and corporations have weaker rating mixes than five years ago, partly reflecting enduring challenges from the global financial crisis.
The negative trend in rating Outlooks for sovereigns during 1H16 was the most pronounced since 2011 and encompassed both developed market (DM) and EM issuers, indicating that sovereign ratings are on track for a record number of downgrades this year. At 30 June, there were 22 sovereigns on Negative Outlook and only six on Positive Outlook. The former include major economies such as the UK, Japan, Brazil and Russia as well as Saudi Arabia.
Current sovereign rating pressures focus on emerging markets, many of which face continued fiscal and external sector adjustments to lower commodity prices, even though prices recovered somewhat recently. In advanced economies, persistently high government debt is the most common rating constraint as fiscal consolidation has slowed. The UK’s vote to exit the EU adds a primary risk in Europe.
Negative rating actions on sovereigns can have knock-on effects in other sectors, particularly financial institutions and corporates. Some sovereign downgrades have placed downward pressure on bank ratings, especially in countries where banks are rated on the assumption of sovereign support. Negative Outlooks for banks in Brazil, Russia and the Gulf Cooperation Countries reflect negative sovereign Outlooks and/or weaker operating environments.
Outlooks for banks in the EU, where sovereign support now rarely drives ratings, are increasingly diverging. They are turning negative for Italy as recapitalization pressures increase from high non-performing loans. Belgium, France, Ireland and Spain bank Outlooks are turning positive as banks work through legacy issues and improve capitalisation. Low DM interest rates have kept impairment charges low but pressure profitability.
The rating profile of Fitch’s portfolios is weaker today than in 3Q11 – the last time sovereign rating Outlooks took a sharp negative turn. Today, only 35% of sovereigns are rated in the ‘A’ or above category, compared with 38% in 3Q11. The trend has been similar for financial institutions and corporates: to 42% from 46%, and to 20% from 22% respectively over the same period. Only the insurance sector has bucked the trend, with 74% of ratings currently at ‘A’ or higher, up from 60% five years ago.
