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Moody's Market Signals Sovereign Risk Report Summary

Core Content

This report from Moody's Capital Markets Research provides an analysis of market-based credit risk measures for various countries, focusing on the impact of the European Central Bank (ECB) rate cut and broader economic conditions on sovereign credit risk. It highlights the mixed signals observed in European and Asia-Pacific markets and discusses the implications of these signals on sovereign debt and economic fundamentals.

Main Points

European Sovereign Credit Risk Measures

• On June 5, 2014, the ECB cut its benchmark interest rate to a record low of 0.15% in response to slowing GDP growth, low inflation, and a weakening manufacturing purchasing managers' index.
• Sovereign EDF™ (Expected Default Frequency), a forward-looking credit risk measure derived from CDS spreads, showed mixed results:
  • Peripheral countries (e.g., Ireland, Latvia, Italy) experienced significant declines in their one-year EDF measures:
    • Ireland: 27% decline
    • Latvia: 26% decline
    • Italy: 25% decline
  • Core countries (e.g., Germany, France) saw minimal changes.
• Bond-implied ratings improved for several countries, while CDS spread-implied ratings remained stable.
• The average bond-implied rating for European countries was Baa1, one notch below the CDS-implied rating and Moody's rating of A3.
• Ukraine had the highest one-year EDF measure among European peers at 1.6%, indicating higher credit risk.

Economic Fundamentals

• Despite a slight decrease in aggregate unemployment in the euro area, it remains high at 11.7%.
• Youth unemployment is more than double the overall rate, at 23.5%.
• Greece and Spain had the highest unemployment rates at 26.5% and 25.1%, respectively.
• Unemployment has risen over the past year, especially in southern peripheral European countries, which continue to face significant challenges.

Government Debt Trends

• Government debt-to-GDP is expected to rise in peripheral European countries this year before gradually declining by 2018.
• Italy has the highest debt-to-GDP ratio in the euro area (excluding Greece), projected to reach 134.5% in 2014 and decline to 124.7% by 2018.
• Portugal is expected to see a slight decrease in its debt-to-GDP ratio from 128.8% in 2013 to 126.7% in 2014.
• The sustainability of these high debt levels is partially due to low interest rates, but could become more challenging if economic growth does not accelerate.

Asia-Pacific Overview

Australia

• Sovereign EDF decreased slightly to 0.01%.
• CDS Implied-Rating improved to A1.
• Bond Implied-Rating remained at Aaa.
• Senior Rating stayed at Aaa.

China

• Sovereign EDF decreased by 1 bps to 0.04%.
• CDS Implied-Rating improved by 1 to Baa2.
• Bond Implied-Rating improved by 1 to A3.
• Senior Rating remained at Aa3.

Hong Kong

• Sovereign EDF remained stable at 0.02%.
• CDS Implied-Rating stayed at A2.
• Bond Implied-Rating was not available.
• Senior Rating remained at Aa1.

Indonesia

• Sovereign EDF decreased by 4 bps to 0.08%.
• CDS Implied-Rating decreased by 1 to Ba1.
• Bond Implied-Rating decreased by 1 to Ba1.
• Senior Rating remained at Baa3.

Japan

• Sovereign EDF decreased by 3 bps to 0.02%.
• CDS Implied-Rating improved by 3 to A1.
• Bond Implied-Rating remained at Aaa.
• Senior Rating remained at Aa3.

Korea

• Sovereign EDF decreased by 2 bps to 0.02%.
• CDS Implied-Rating improved by 1 to Baa3.
• Bond Implied-Rating improved by 3 to A1.
• Senior Rating remained at Aa3.

Malaysia

• Sovereign EDF decreased by 1 bps to 0.04%.
• CDS Implied-Rating decreased by 1 to Baa2.
• Bond Implied-Rating decreased by 1 to Baa2.
• Senior Rating remained at A3.

Philippines

• Sovereign EDF decreased by 1 bps to 0.05%.
• CDS Implied-Rating decreased by 1 to Baa2.
• Bond Implied-Rating decreased by 1 to Baa1.
• Senior Rating remained at Baa3.

Singapore

• Sovereign EDF was not available.
• CDS Implied-Rating was not available.
• Bond Implied-Rating was not available.
• Senior Rating remained at Aaa.

Vietnam

• Sovereign EDF decreased by 2 bps to 0.11%.
• CDS Implied-Rating decreased by 2 to Ba3.
• Bond Implied-Rating remained at Ba2.
• Senior Rating remained at B2.

Key Information

• Sovereign EDF is a forward-looking measure of default risk derived from CDS spreads, adjusted for loss-given default and the market price of risk.
• The ECB's actions are aimed at preventing deflation and stimulating growth, but investor confidence remains low.
• Financial leverage in the most challenged Euro zone countries is likely to remain high.
• Economic fundamentals in many European countries, particularly youth unemployment and government debt, continue to raise concerns.
• Market signals indicate that investors are not fully convinced of the effectiveness of ECB measures in boosting growth.
• Moody's Analytics does not provide investment advisory services, and the research is separate from Moody's Investors Service.

Conclusion

The report underscores the mixed market signals regarding sovereign credit risk in Europe and Asia-Pacific. While peripheral European countries showed improvements in credit risk measures following the ECB rate cut, core countries remained largely unchanged. The sustainability of debt levels and economic growth remain key concerns, particularly in southern Europe. In the Asia-Pacific region, most countries showed stable or slightly improved credit risk indicators, indicating better market confidence.