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Moody's Market Signals Sovereign Risk Report Summary

Core Content

This report by Moody's Capital Markets Research provides an analysis of the changes in sovereign default risk measures for various emerging markets (EMs) and developed markets (DMs) over the past year, focusing on how different economic challenges have impacted these risk indicators. The report categorizes countries based on the types of challenges they face and evaluates their Sovereign EDF (Expected Default Frequency) measures, CDS (Credit Default Swap) implied ratings, Bond implied ratings, and Senior ratings.

Main Points

Emerging Markets

• Countries with Economic Growth Challenges:

  • China, Brazil, Russia: These countries have experienced an increase in default risk measures, but the magnitude is relatively smaller compared to other groups.
  • China saw a +1 bps increase in its one-year annualized Sovereign EDF measure, from 0.04% a year ago to 0.05%.
  • Russia had a -1 bps change in its Sovereign EDF, remaining stable around 0.12%.

• Countries with Large Current Account Deficits and High Currency Risk:

  • Turkey, South Africa, Thailand, Indonesia, Chile, Peru: These countries experienced a +84% year-over-year increase in their average five-year Sovereign EDF measure.
  • Turkey saw a +29% increase in its one-year annualized EDF, rising from 0.17% to 0.22%.
  • South Africa, Thailand, Indonesia, Chile, Peru also had notable increases in their EDF measures.
  • Turkey also saw a +15% increase in its bond yield spread and a +235 bp rise in its five-year CDS spread.

• Countries with Currency Crisis:

  • Argentina, Ukraine, Venezuela: These countries face significant currency instability and high inflation.
  • Argentina has the highest probability of default with an EDF of 10.63% as of February 17, 2014.
  • Venezuela has an EDF of 6.01% and is also highly vulnerable due to structural issues.

• Countries with Fragile Banking Systems:

  • Hungary, Romania, Bulgaria: These countries have shown improvement in their EDF measures.
  • Hungary experienced a -18 bps decrease in its one-year EDF, from 0.36% to 0.18%.
  • Romania and Bulgaria had -11 bps and -1 bps changes, respectively, in their EDF measures.

• Mexico:

  • Mexico was an exception, with its Sovereign EDF improving from 0.7% to 0.5%.
  • Moody's upgraded Mexico's sovereign rating to A3 in February 2013 due to structural reforms and a strengthened fiscal outlook.

Developed Markets

• Europe:

  • Austria, Belgium, Czech Republic, Estonia, Finland, Germany, Iceland, Ireland, Latvia, Lithuania, Malta, Netherlands, Norway, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, Switzerland, Ukraine:
    • Most European countries showed a decrease in their Sovereign EDF measures, indicating a reduction in default risk.
    • Cyprus and Greece had significant increases in EDF, with Cyprus at 0.94% and Greece at 0.72%.
    • Greece had a +2 change in its Senior Rating, from Caa3 to Caa3, and its Bond Implied-Rating improved from C to Caa3.
    • Italy had a -20 bps decrease in its one-year EDF, from 0.31% to 0.11%.

• Asia-Pacific:

  • Australia, Hong Kong, Indonesia, Japan, Korea, Malaysia, New Zealand, Philippines, Singapore, Sri Lanka, Taiwan, Vietnam:
    • Australia, Hong Kong, Japan, Korea, Malaysia, New Zealand, Singapore had minimal changes or improvements in their EDF measures.
    • Indonesia showed a +7 bps increase in its one-year EDF, from 0.08% to 0.15%.
    • Sri Lanka had a +22 bps increase in its one-year EDF, from 0.19% to 0.41%.
    • Philippines had a +3 bps increase in its one-year EDF, from 0.03% to 0.06%.
    • Vietnam had a +7 bps increase in its one-year EDF, from 0.08% to 0.15%.

• Other Developed Markets:

  • Japan had a -9 bps decrease in its one-year EDF, from 0.11% to 0.02%.
  • Korea had a -1 bps decrease in its one-year EDF, from 0.04% to 0.03%.
  • Malta had a -15 bps decrease in its one-year EDF, from 0.31% to 0.16%.

Key Information

• The report highlights that emerging markets are facing a variety of challenges that have increased their sovereign default risk measures.
• Mexico is a notable exception, with significant improvements in its EDF and rating due to structural reforms and fiscal stability.
• Argentina and Venezuela continue to have the highest default risk among the 84 sovereign entities analyzed, with EDF measures of 10.63% and 6.01%, respectively.
• The US Federal Reserve's tapering of quantitative easing has had a negative impact on countries that relied heavily on foreign capital inflows, such as Turkey and South Africa.
• Countries with lower current account deficits and higher hard currency reserves appear to be less vulnerable to the impact of Fed tapering.
• CDS and Bond Implied-Ratings are used to assess the market's perception of credit risk and are compared with Senior Ratings provided by Moody's Investors Service.

Summary

The report underscores the increased sovereign default risk in emerging markets due to economic challenges, currency crises, and structural issues. While some countries, like Mexico, have shown resilience and improvement, others, such as Argentina and Venezuela, remain highly vulnerable. Developed markets, particularly in Europe, have generally seen a decrease in default risk, although a few countries like Greece and Cyprus have experienced significant increases. The US Federal Reserve's monetary policy changes have influenced the credit risk of several EMs, with those reliant on foreign capital being more affected. Overall, the report serves as a critical analysis of how market signals reflect sovereign risk, offering insights into the financial stability of different regions.