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Emerging market downgrades likely to gather pace says S&P

[LONDON] Emerging market sovereign downgrades are likely to gather pace Standard and Poor's warned on Wednesday, having already hit the fastest rate this year since the height of the financial crisis.

Nine of the top 20 emerging market economies have negative outlooks on their S&P ratings and a new report from the firm said 'contingent liabilities' - costs of bailing out state-owned firms or damaged banks in a crisis - could add to the strains.

"We currently do not anticipate a Government Related Entity (GRE) debt crisis comparable to Dubai World in 2009; however, the rapid surge in GRE debt and EM credit growth more broadly poses new potential risks to EM sovereign ratings," S&P said.

Emerging market economies accounted for almost half of the growth in global debt between 2007-2014 and nearly half of that in terms of gross issuance came from government-related firms.

At the end of last year some 170 GREs had US$783 billion worth of outstanding bonds with a quarter of that concentrated in just five firms; Mexico's Pemex, Brazil's Petrobras, PDVSA in Venezuela, Gazprom in Russia and Korea's Export-Import Bank.

"Contingent liabilities crystalizing on a government's balance sheet have so far not played an important role in the negative ratings trajectory of EM sovereigns. This is not to say that they do not matter," S&P said.

"On the contrary, they do - and they materialize rather frequently. In fact, a new IMF contingent liabilities database covering 80 countries has identified 91 episodes of financial sector crises between 1990 and 2014, leading to a call on public funds to, on average, of 9.7 per cent of GDP."

Despite the concentration of debt in the big Latin American and Russian state-controlled oil firms, by far the largest proportion of GRE debt was in China where it adds up to almost 120 per cent of the country's annual economic output.

Brazil is next at just over 20 per cent, S&P calculated, followed by Mexico and Russia which each have about 20 per cent.

The report said contingent liability issues rarely lead to downgrades on their own. However, they often trigger or stack on top of other economic problems and can be tricky to estimate because governments may not implicitly promise support.

"Contingent liabilities will then weigh on already-stressed public finances, a slowing economy, and sagging confidence." Therefore with so many countries already on downgrade warnings, the run of ratings cuts was likely to keep going.

"This pronounced negative bias (in rating outlooks) suggests that the gradual slide of EM sovereign ratings is not only likely to continue, but to gather pace," S&P said.


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