Sovereign Debt Growth, Debt-Servicing Costs Continue to Rise in Sub-Saharan Africa

Low commodities prices for exporters and an ongoing reliance by some sovereigns in sub-Saharan Africa on infrastructure investment to drive GDP growth have and will continue to increase sovereign debt levels and debt servicing costs this year and next.

“SSA remains one of the fastest growing regions in the world,” said Jan Friederich, senior director of sovereigns at Fitch (Hong Kong) Limited in a new report. “However, while debt-funded infrastructure investment will help remove constraints on long-term growth, its benefits may not fully materialize until governance and business environments improve. As such, its near-term impact on sovereign debt ratios will be negative.”

Fitch-rated sub-Saharan African sovereigns’ general government debt/GDP ratio grew to 49.7% in 2015 from 30.2% in 2011, while the rating agency’s country-by-country fiscal projections anticipate the median ratio will continue increasing to 51.4% this year and 53.3% in 2017. Mozambique has the largest debt/GDP ratio at 60% from 2012 to 2017, while Nigeria has the smallest at 3.7%. Most sub-Saharan African sovereigns started from fairly low levels of debt after restructurings and debt forgiveness in 2000.

“As well as rising debt, potential Fed tightening, dollar appreciation and volatile capital flows may lead to tighter financing conditions,” Friederich said. “Some capex budgets have been cut, but without revisions to overall expenditure frameworks for 2016 and 2017, debt ratios are unlikely to fall.”

A third of sub-Saharan African 18 countries are on Fitch’s negative outlook and there are not positive outlooks. Repeated fiscal deficits and escalating external deficits are factors that could result in negative rating actions, particularly in countries that already have high debt levels and moderate liquidity buffers, Fitch analysts noted.

- Nicholas Stern, editorial associate

Latin American Manufacturing Sector to Contract this Year, Sluggish Next Year

An array of troubling economic conditions—from poor infrastructure bottlenecks to rising labor costs to an anemic global economy—are aligning to limit foreign trade of manufactured exports as a primary contributor to Latin American growth in the near-term.

While manufacturing exports have increased in value terms over the last decade in Latin American countries, factors such as wage increases, tax hikes and appreciating currencies following the commodities boom that peaked in 2014 kept the manufacturing sector more exposed to international competition, according to a new Coface report on Latin American manufacturing. Local output was scrapped to allow imports to meet growing domestic demand. “Countries in Latin America seemed unable to compete with low-income countries for the production of unsophisticated goods, or with advanced countries for high value products and technological services,” according to Patricia Krause, LATAM region economist with credit insurer Coface.

Yet the currency devaluation—along with reduced prices and increased competitiveness—in many Latin American countries since 2014 has not been met with a concomitant rise in manufacturing revenues, suggesting changes in exchange rates have had a limited influence, Krause said.

“Overall, countries failed to take the advantage of the past commodity bonanza, to implement the reforms they needed,” she said. “Serious challenges now remain, but government revenues have shrunk.”

Now, these countries’ manufacturing sectors are facing obstacles to future growth. Without a reduction in labor costs, price competitiveness evaporates, Coface economists said. The ongoing weak global economy will naturally reduce demand for manufactured goods. As corruption scandals continue to plague the region, the prospects for infrastructure improvement remain dim. Meanwhile, a growing sentiment toward protectionist policies is likely to weaken the prospects of trade agreements going forward.

Coface predicts the overall impact will be that Latin American GDP growth will shrink by 0.5% this year, and see a small rebound of 1.7% in 2017.

- Nicholas Stern, editorial associate

Agriculture Slows Moroccan Growth, Payment Periods Grow

Thanks in part to declining output in the agricultural sector, the Moroccan economy should experience slow growth during the rest of the year, as payment periods in all sectors lengthen.

The nation’s GDP should expand about 2% this year, following 2015’s nearly 4.5% growth rate, according to a report by credit insurer Coface. The country’s agricultural sector fell 12.1% during the second quarter as poor weather conditions created a 70% drop in cereal production, while its manufacturing and extractive industries grew in the second quarter by 3.2% and the service sector, 2%.

In a Coface survey of Moroccan companies, about 30% said payments came in 30 to 60 days from invoice issuance, down from 24% in 2015, while the number of companies with payment periods greater than 90 days increased, said Sofia Tozy, Middle East and North American economist with the credit insurer. The majority in the retail and building and construction sectors see payment periods in excess of 90 days, with the latter experiencing the most notable deterioration. The trade and retailing sector saw a 23% increase in the number of companies that said their average payment periods were more than 120 days. Business services is one of the few sectors that saw improvement in their payment periods during the second quarter.

Still, “Cash flow forecasts remain stable for a number of companies, regardless of delay,” Coface analysts said. “This could mean that companies are taking into account the payment behavior of their clients and making provisions for possible delays in their cash flow forecasts.”

- Nicholas Stern, editorial associate

Trade Risks from Policies under the Next US Administration Most Likely to Impact Europe, UK

Regardless of the winner in the U.S. presidential election in November, the next administration’s trade policies will most likely affect European companies, especially those in export-focused sectors like manufacturing, machinery and transportation goods.

"The next U.S. administration's stance on some existing and prospective trading relations will strongly indicate its willingness to enter into new international trade agreements, a key consideration for European, and in particular UK-based companies as Britain prepares to exit the EU," says Richard Morawetz, a Moody's Investors Service group credit officer for the Corporate Finance Group and author of a new Moody’s report. "That said, we believe that there would be an incentive for both countries to maintain strong trade links, although the U.K. is more reliant on the U.S. for trade than vice versa."

The European automobile and manufacturing sectors have the most exposure to U.S. trade policies, while European and Middle Eastern companies working in the U.S. healthcare market could experience new pricing pressures arise with the uncertain survival of the Affordable Care Act under new leadership, Moody’s analysts said. On the other hand, both presidential candidates’ support of increasing infrastructure spending could bode well for European firms that supply cement and ready-mixed concrete to the US construction sector.

A continuation of the status quo to a “gradual retrenchment from trade and investment ties and curbs on immigration” account for the general range of policies under the future president, said Marie Diron, senior vice president/manager of the Sovereign Risk Group at Moody's Investors Service Singapore. Under a new administration, Asian economies—including Malaysia, Taiwan and Korea—that export high value-added manufacturing products to the U.S. carry more vulnerability to policies that discourage foreign sourcing of business activities, she said.

If the United States decided to strengthen immigration rules, remittances to Asia could decline. However, the Philippines and Vietnam, which have the largest remittance receipts from the U.S. in comparison to the size of their economies, have current account balance surpluses that likely would buffer such negative impacts, Diron said.

Remittances and trade in the Middle East and North Africa could also be affected, though the effects probably would be limited to countries such as Lebanon and Jordan, according to Mathias Angonin, an analyst in Moody's Investors Service Middle East Limited Sovereign Risk Group. "Outcomes could range from lower access to the U.S. for MENA countries' non-oil exports, to curbs on aid to and immigration from Levant countries," he said.

- Nicholas Stern, editorial associate

Auto Manufacturers Face Growing Risks as Governments, Consumers Seek to Reduce Emissions

The automotive manufacturing industry worldwide faces increased credit risks amidst shifting and more rigorous environmental standards and increasing demand for vehicles that run on alternative fuel sources.

“Given that the auto industry is one of the most significant emitters of greenhouse gases, there is a clear need for the industry to improve emissions-reducing technologies and adapt to the broadening emergence of AFVs [alternative fuel vehicles],” said Brian Cahill, a Moody's Investors Service managing director.

“We believe that major auto manufacturers face material risks, which are transmitted through four channels: rising policy pressure, with stricter emissions-reducing regulatory targets a likely outcome; increasing pressure on margins and cash flows; changing consumer preferences; and disruptive technological shocks,” said Motoki Yanase, a vice president with Moody's Corporate Finance Group and lead analyst for the automotive sector in Japan.

As manufacturers’ research and development, as well as capital spending, grows in the search to reduce emissions, and as new competitors emerge to meet these environmental challenges, their financial risk will increase, the Moody’s analysts said. Consumers’ preferences and governmental policies to incentivize the production of vehicles that emit less will also drive future sales.

Auto manufacturers also need to look out for unpredictable take-up risks driven by technological shocks. Producing alternative fuel vehicles requires changes to manufacturing processes, as well as increased coordination with auto-parts suppliers, Moody’s said. “Auto manufacturers without a well-developed technology strategy and ability to rapidly retool, or those with long product life cycles, will fare the worst as the need for manufacturing flexibility and speed-to-market rises.”

- Nicholas Stern, editorial associate

Builder Confidence for New, Single-family Homes Grew in September

Builder confidence for newly built, single-family houses surged in September, jumping six points to 65 from the August reading for the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI). The September reading represents a high point for the index not seen since October 2015.

The tight inventory of new and existing homes, steady job creation and low interest rates are leading to demand and builders’ confidence for new construction, NAHB analysts said this morning. This enthusiasm could be dampened by labor shortages and constrained building lots, but the association expects to see positive growth in the index to carry into 2017.

The three components used in the HMI index rose in September, NAHB said. Current sales expectations increased six points to 71; sales expectations for the next six months jumped five points to 71; and the index measuring traffic of prospective buyers rose four points to 48. Likewise, the three-month moving averages by region either gained or stayed flat. The West increased four points to 73; the Northeast and South saw a point gain to 42 and 64, respectively; and the Midwest stayed unchanged at 55.

- Nicholas Stern, editorial associate

Construction Input Prices Down in August and Potentially for Near Future

Nonresidential and overall construction input prices fell in August along with declining oil prices—good news for an industry facing higher labor costs.
In August, nonresidential construction input prices dropped 0.2% from the prior month and 1.7%, year-over-year, according to the Bureau of Labor Statistics Producer Price Index.
“With industry labor costs now rising aggressively and the subcontracting community generally busy, falling input prices help to moderate growth in total construction costs, allowing more projects to move forward and industry backlog to remain stable,” said Associated Builders and Contractors (ABC) Chief Economist Anirban Basu.
A weak global economy and strong dollar are among the top reasons for reduced input prices, Basu said. Also, U.S. interest rates should increase more rapidly than in other nations, making the case for an even stronger dollar and, therefore, ongoing soft input prices. “While falling energy prices would negatively impact a number of regional economies across the U.S., the overall impact could be neutral to positive with respect to the durability of the current nonresidential construction cycle,” he said.
- Nicholas Stern, editorial associate

Oil and Gas Sector Downturn Could Reach Historic Proportions

Whether it’s the number of bankruptcies or the recovery rates for creditors that serve the oil and gas sector, the industry may be facing a downturn not seen since the telecoms sector collapse in the early 2000s.

"The jump in oil and gas defaults that was driven by slumping commodity prices, was primarily responsible for the increase in the overall U.S. default rate in 2015 and continues to fuel it in 2016," said David Keisman, senior vice president at Moody's Investors Service. "When all the data is in, including 2016 bankruptcies, it may very well turn out that this oil and gas industry crisis has created a segment-wide bust of historic proportions."

Moody’s recorded 17 oil and gas bankruptcies in 2015, including 15 from the exploration and production (E&P) segment, one from oilfield services and another from drilling, the ratings agency found. This year, bankruptcies in E&P have accelerated at twice the rate, year-to-date, than they did for all of 2015. To compare the industry to the telecom sector’s troubles, Moody’s found 43 company bankruptcies in that industry from 2001 to 2003.

Firm-wide recover rates for E&P bankruptcies are also troubling: In 2015, the average was just 21%, less than half the historical average of 58.6% for all E&P bankruptcies filed prior to 2015 and the overall historic average of 50.8% for all types of corporations that filed for bankruptcy from 1987 to 2015, Moody’s said. Reserve-based loans recovered, on average, 81%, well below the 98% recovered in previous energy E&P bankruptcies from 1987 to 2014. High yield bonds recovered some 6% compared to the low 30% range in prior E&P bankruptcies. Further, more than half of the E&P companies that completed distressed exchanges to ward away bankruptcies wound up filing for Chapter 11 protection within a year.

- Nicholas Stern, editorial associate

The Liquidity Stress on Speculative-Grade Asian Companies Grew in August

Indonesian and Chinese industrial sectors helped worsen Moody’s Investors Service’s Asian Liquidity Stress Index (Asian LSI) in August.

The index, which measures the percentage of high-yield companies with the weakest speculative grade liquidity scores of SGL-4 and increases when their liquidity deteriorates, increased to 33.9% in August from 32.5% in July. Moody's rated 115 speculative-grade nonfinancial businesses in Asia, excepting Japan and Australia, with a total debt of $59.1 billion.

"The Asian LSI weakened further in August as both the Indonesian and Chinese industrials sub-indices hit all-time highs at 30% and 52%, respectively," said Brian Grieser, a Moody's vice president and senior analyst. "Furthermore, the Asian LSI remains at elevated levels due to weak corporate liquidity profiles across the region. Property, oil and gas, and metals and mining sectors, which account for over 50.0% of the SGL-4 scores, continue to pressure the Asian LSI.”

The index reading in August was higher than the trailing yearly average, but it remained below the record high of 37% reached in December 2008, Moody’s said.

Overall, the number of speculative-grade companies with negative-leaning outlooks fell in August to 45 from 47 in July, the ratings agency said. Likewise, the percentage of negative leaning outlooks dropped to 39.1% in August from 40.2% in July, and remains below August 2008’s peak of 44.8%.

The number of speculative-grade companies with negative-leaning outlooks decreased to 45 in August from 47 in July. Overall, the percentage of negative leaning outlooks declined to 39.1% in August from 40.2% in July, but remains below the peak of 44.8% posted in the fourth quarter of 2008.

- Nicholas Stern, editorial associate

What’s Going on With Weak Residential Construction Spending?

Private residential construction spending has been fairly weak of late—0.3% rise in July’s spending mostly came from increased allocations on home improvements—even as new home sales and single-family homebuilding have been increasing. The situation is made more confusing because residential construction employment also has been on the rise, notedMark Vitner, senior economist with Wells Fargo.

Still, investment in residential construction declined at a 7.7% annual rate during the second quarter and economists’, including those at the Federal Reserve Bank of Atlanta’s GDPNow, expect drops during this quarter by about a 4.8% annualized rate. A closer look at the data reveal that while new single-family homes sales increased 12.4% in July, most of that was attributed to sales of more moderately priced homes between $200,000 and $400,000 in the South, where prices are lower, Vitner said. Sales of starter homes and higher priced dwellings remained mostly flat.

“The shifting mix of home sales may partly explain the recent slide in private residential construction spending,” he said. “New home sales have fallen in many high-priced markets, reflecting less foreign buying and reduced affordability in general. Higher land costs are apparently pushing development back out to the suburbs, where land and building costs tend to be lower.”

New home sales and housing starts climbed in July as builders have seen more interest from buyers and for large tract development, Vitner and other Wells Fargo economists said. Meanwhile, existing home sales have been mixed, as tight inventories—existing home inventories dropped 5.8% in July from a year ago—and keep new buyers looking and sellers worried about finding a new home on the sidelines.

The number of single-family homes under construction jumped 11.6% from a year ago, even as residential construction spending for single-family homes fell for the past four months, Vitner said. This puzzling situation likely represents a shift away from the expensive apartment construction and urban infill that took place following the recovery.

“As rents and home prices have soared in submarkets close to urban centers, single-family development has increasingly been pushed back out into the suburbs,” he said. “Apartment development, while still in full swing in much of the country, also appears to be moving toward lower costs areas. Moreover, builders are increasingly seeking out opportunities to develop townhomes, which meet the needs of those still interested in having an urban lifestyle but at a lower price point than traditional single-family homes.”

- Nicholas Stern, editorial associate

Small Business Credit Conditions Show Pockets of Deterioration

Overall, Experian and Moody’s Analytics Main Street Report for second-quarter 2016 presents a positive outlook for small business credit, provided interest rates don’t increase or economic growth doesn’t decrease. For segments of the United States, however, the news was not as bright.

The quarterly report looks at the financial well-being of small businesses and includes business credit data such as credit balances, delinquency rates and utilization rates as well as macroeconomic information such as employment rates, income retail sales and investments.

“States in the Upper Plains and Mid-Atlantic regions experienced some of the largest increases in small business bankruptcy rates in the country,” while most states—with the exception of Nevada and Oklahoma—in the Southeast and Southwest saw a decline, the report says. Oklahoma’s outlook remains negative because of “the decline in oil prices, which last quarter had a major impact on delinquency rates in the transportation and utility industries,” it notes.

The District of Columbia experienced a broad-based decline in bankruptcy rates across construction, finance and services sectors and showed the most improvement nationwide with a drop of 6 basis points. “DC’s bankruptcy rate is below the national average and likely to remain there as the business climate in the District improves and the federal government’s presence remains a steadying force for businesses,” the report states.

On the other side of the coin, “West Virginia has the distinction of having the highest bankruptcy rate of any other state,” it adds. Bankruptcies in the state rose more quickly than any other state with an increase of 3 basis points. The report credits the increase to its “large exposure to the mining and transportation industries, which have been hammered as the price of coal has declined.”

- Diana Mota, associate editor

For additional coverage of the Experian and Moody’s Analytics Main Street Report, check out this week’s eNews.