Number of Downgraded Sovereigns Set to Eclipse 2011 Lows

The likely onward march of lower commodity prices despite a partial recovery in the first half of the year will continue to take its toll on the sovereign credit ratings of emerging market nations for the second half of the year.

In its latest bi-annual Sovereign Review and Outlook, Fitch Ratings reports it downgraded 15 nations in the first half of the year, close to the previous annual high of 20 in all of 2011. Considering that 22 ratings are on negative outlook, this year’s total number of downgrades is set to surpass 2011’s peak. But unlike in 2011 when more of the previous record number of sovereign downgrades were focused on investment-grade sovereigns, this year’s ratings fall is concentrated in speculative-grade credits—by the end of June, more than one in three sovereigns in the ‘B’ and ‘BB’ categories had a negative outlook. Further, Fitch’s ratings of seven of the 10 most commodity-dependent sovereigns—all of which are in emerging markets and include Brazil, Russia and Saudi Arabia—have been downgraded in 2016 or are on negative outlook.

“The partial recovery in commodity prices in 1H16 has led to improved market sentiment toward emerging markets, but not necessarily to improvements in sovereign credit fundamentals,” wrote James McCormack, managing director of Fitch Ratings Limited. “Public and external finances in a number of commodity-exporting countries are not yet aligned with the new structurally-lower price environment.”

More than half of Fitch Ratings’ negative marks in the first half of the year and 10 of the 22 negative outlooks are currently assigned to nations in the Middle East and Africa, the ratings firm said. Also, lower commodity prices in Latin America and weak demand from China for these goods, as well as tightening external financing, are set to lead to a second consecutive year of contraction in the region.

In Europe, the current political situation of easing fiscal policy as austerity fatigue sets in and the focus turns to issues of migration and security could negatively impact sovereign ratings; already, lower interest rates are not being used to reign in fiscal deficits as several eurozone sovereigns maintain relatively high government debt levels that serve to constrain more positive ratings, Fitch Ratings said.

Investors have taken positively to China stepping up credit growth in the first half of the year, “but volatility is likely to persist as long as Chinese policymakers send mixed signals with respect to addressing the country's corporate debt problem,” McCormack said.

Fitch’s list of downgraded sovereigns thus far this year include: Bahrain, Brazil, Finland, Nigeria, Saudi Arabia and the U.K. The firm’s list of nations with a negative outlook include: Belgium, Brazil, Costa Rica, Kenya, Japan, Russia and Saudi Arabia.

- Nicholas Stern, editorial associate

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