CAIRO: Fitch Ratings said that downside risks for the world economy have increased markedly since the summer and that emerging market economies would be unable to remain decoupled in the event of a sharp slowdown in advanced economies, Fitch Ratings said in a statement to the press.
This is one of the conclusions of Fitch’s latest six-monthly Sovereign Review.
Global economic and financial conditions have worsened considerably since the summer. The global credit squeeze and increasing likelihood that the slowdown in US domestic demand will broaden beyond housing and result in below-trend growth and rising unemployment in advanced economies in 2008.
Tighter credit conditions will impinge on economies where housing markets have been buoyant and household leverage has increased rapidly, raising the chances of a synchronized housing market correction as flagged in the June Sovereign Review. Growth in the UK, Spain and Ireland will be most affected.
The financial market turbulence witnessed since early August amounts to no less than a disorderly tightening of global liquidity. Ongoing pressures in global interbank money markets are diminishing the scope for monetary policy easing measures to support growth, and the balance sheet shocks faced by banks make it likely they will seek to rein in credit growth.
Emerging market assets have fared relatively well amid a global re-pricing of risk and flight to safety by investors. Sovereign spreads have remained low, equity markets strong and local fixed-income markets steady.
This financial decoupling partly reflects the strengthening of sovereign credit fundamentals in recent years, which in turn is reflected in continued net sovereign rating upgrades through 2007. But the notion that emerging market economies can decouple from advanced economies and remain immune to US recession risks is far-fetched.
Trade linkages to advanced economies have become more powerful over time and the correlation of emerging market exports with US imports is strong.
High commodity prices are helping many emerging markets but they are also contributing to growing inflation challenges. The onus on emerging market central banks to ensure stable inflation expectations is greater than in advanced economies where inflation-targeting is more credible and food prices are less important.
Policy mistakes could lead to volatility in local bond markets, where foreign investment has been supported by the expectation of continued currency appreciation against the US dollar.
Emerging market sovereigns as a whole are less exposed to global liquidity shocks than in the past but a sustained deterioration in market conditions will be testing and will bring differences in external vulnerabilities into stark relief, the company said.
Countries in emerging Europe where large external financing requirements had been easily funded in a climate of strong risk appetite are most exposed and the region’s rating dynamics have shifted. While external vulnerabilities largely reflect private-sector behavior, heavy external borrowing by the private sector can render the balance of payments and hence macroeconomic stability much more vulnerable to external shocks.
Moreover, during episodes of economic and financial distress, the government may assume all, or some, of the private sector’s external liabilities as a means of restoring economic confidence and stability.
Recent developments in Kazakhstan (BBB/Negative) testify to the importance of private external borrowing for sovereign risk.
The Sovereign Review December 2007 is available on the agency’s website www.fitchratings.com
