Fitch Report 2013 July

8/22/2019 Fitch Report 2013 July

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Sovereigns

www.fitchratings.com 8 July 2013

Global

2013 Mid-Year Sovereign Review and OutlookFed Exit Fears Adds to Challenges for Emerging Markets

Special Report

Global Sovereign Credit Drivers

Eurozone Crisis Not Over: The intensity of the eurozone crisis continued to subside in H113,

despite recession, record unemployment, uncertainty following Italian elections and the bail-out

in Cyprus, which led to bank failure, capital controls and a domestic debt default (based on

Fitch Ratings distressed debt exchangecriteria). Fitchs long standing view is that a resolution

of the crisis will require country-level fiscal and structural adjustment, greater progress towards

a banking union and a broad-based economic recovery across the currency union.

Global Growth to Strengthen: We expect global growth to gradually pick up pace in H213

and 2014-2015 as the US gathers steam and the eurozone approaches a cyclical turning point.Our latest forecasts for world GDP growth are 2.4% in 2013, 3.1% in 2014% and 3.2% in 2015

(weighted at market exchange rates). However we have cut growth forecasts for many

emerging markets (EM) owing to strains from spill-overs from advanced countries and China,

more difficult policy trade-offs, a declining impact from credit growth and structural bottlenecks.

Fed Exit Casts Shadow: The US Federal Reserves forward guidance on the timing of

tapering quantitative easing (QE) and raising interest rates precipitated a broad market sell-off

and increased volatility since the middle of May, even though the comments should not have

been a great surprise and reflect more upbeat US growth prospects. Fitch does not expect the

first rate hike until mid-2015, and only then if the US economic recovery is secure. Nonetheless,

the uncertain process of the Feds exit is likely to generate periodic bouts of market volatility.

No Broad EM Crisis: EM bonds, currencies and equities were hit disproportionately hard by

the market reappraisal of US monetary policy, despite prior concerns over excessive capital

inflows and strong exchange rates. Fitch does not anticipate widespread EM credit distress

owing to a secular improvement in credit fundamentals, which reduces risks from tighter global

liquidity, higher interest rates and FX risk. However, the Fed move adds to worries over slowing

EM growth, Chinas financial stability, softer commodity prices and a series of political shocks.

Some EMs More Vulnerable: Prospective Fed tightening raises risks facing weaker EM, such

as those with large external financing needs (current account deficits and maturing external

debts) and low foreign reserves, high levels of leverage, vulnerable debt structures (foreign

currency, short maturity and non-resident creditors), those that have seen strong inflows of hot

money and bank credit growth, or have weak policy frameworks or credit fundamentals.

Sovereign Rating Actions and Outlook

Outlook Negative: Sovereign ratings are under pressure from the eurozone crisis, high public

and private sector debt, weak banking sectors, a testing growth and policy environment and

individual political and credit events. In H113 there were 13 notches of downgrades of Foreign-

Currency ratings, compared with 10 notches of upgrades; as well as two sovereign defaults:

Cyprus (Local-Currency rating) and Jamaica. The ratio of Negative Outlooks to Positive

Outlooks is a bit under 3:1, signalling that further downgrades are likely.

EM Upward Trend Stalls: H113 saw six EM upgrades: Lithuania, Mexico, Thailand, Jamaica,

Philippines and Uruguay - the latter two to investment grade. Three-quarters of the J.P.MorganEMBI is now rated investment grade by Fitch, up from one-third in 2008. But there were

downgrades for Egypt, Jamaica (by four notches) and South Africa, as well as China (Local

Currency rating). EM Negative Outlooks now outnumber Positives by 12 to seven.

Figure 1

20%

73%

7%

0

20

40

60

80

100

Positive Stable Negative

Global Sovereign Rating

Outlooks(%)

As at End-June 2013

Source: Fitch

Related Research

Sovereign Data Comparator (June 2013)

Global Economic Outlook (June 2013)

Ageing Costs: The Second Fiscal Crisis(January 2013)

Banking Union's Impact on Sovereigns(June 2013)

Why Sovereigns Can Default on LocalCurrency Debt (May 2013)

Analysts

Ed Parker+44 20 3530 [email protected]

Robert Shearman+44 20 3530 [email protected]
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2013 Mid-Year Sovereign Review and OutlookJuly 2013

2

Global Economic Update

Fitch expects the global economy to strengthen gradually in H213 and 2014-2015 as the US

gathers steam and the eurozone approaches a cyclical turning point (see Global Economic

Outlook, June 2013 in related research). Its latest forecasts for world GDP growth are 2.4% in

2013, 3.1% in 2014% and 3.2% in 2015 (weighted at market exchange rates).

Figure 2Main Projections(Annual averages) 2011 2012 2013f 2014f 2015f

GDP growth (%)USA 1.8 2.2 1.9 2.8 3.0Eurozone 1.6 -0.6 -0.6 0.9 1.3Japan -0.6 2.0 1.8 1.5 1.2Emerging Asia 8.0 7.0 6.9 7.0 6.7Emerging Europe 5.0 2.5 2.3 3.2 3.5Middle East & Africa 5.8 4.9 3.9 4.6 4.8Latin America 4.3 2.7 2.9 3.5 3.7World 3.2 2.5 2.4 3.1 3.2Memo

BRICs 7.0 5.5 5.6 6.0 5.8All emerging markets 6.4 5.0 4.8 5.2 5.2Major advanced economies 1.3 1.0 0.9 1.9 2.0Interest ratesUS federal funds 0.25 0.25 0.25 0.25 0.50ECB refinancing 1.25 0.88 0.50 0.50 0.50Bank of Japan repo 0.05 0.05 0.10 0.10 0.10Bank of Eng. Repo 0.50 0.50 0.50 0.50 0.50Oil (Brent USDpb) 111 112 105 100 100

Regional aggregates on 2011 GDP weights at market exchange ratesSource: Fitch

For the major advanced economies (MAE), Fitch forecasts weak growth of just 0.9% in 2013

before accelerating to 1.9% in 2014 and 2.0% in 2015.

EM growth will continue to far outstrip the pace in MAEs and strengthen from 4.8% in 2013 to

5.2% in 2014-2015. However, several large EMs are experiencing strains from spill-overs from

advanced economies and China, difficult policy trade-offs, a declining impact from credit growth

and structural bottlenecks.

2012-2013 will see the second weakest BRICs' growth (after 2009) since the Russian crisis in

1998 and Fitch has cut its 2013-2014 growth forecasts for all four of the BRIC nations. It

forecasts China will grow by 7.5% in 2013 (down from 8.0% in the March GEO) and 2014,

followed by 7% in 2015. We have also revised down our growth forecasts for India, Brazil and

Russia in total by 0.8pp, 1.1pp and 1.7pp for 2013 and 2014, respectively.

Figure 3 Figure 4

-5

-3

-1

1

3

5

7

9

2005 2007 2009 2011 2013f 2015f

US Eurozone

EM World(%)

Global Growth Forecasts

Source: Fitch

90

110

130

150

170

190

2007 2009 2011 2013f

US Eurozone

EM World

India China

(Index)

Global GDP PathsLevel of real GDP, 2007 = 100

Source: Fitch

Related Criteria

Sovereign Rating Criteria (August 2012)

Distressed Debt Exchange (August 2012)
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Fed Exit Adds to Challenges for Emerging Markets

Bernankes Comments Trigger Global Market Sell-Off

Volatility has soared since the middle of May as the market focused on the timing and impact of

the US Federal Reserves exit from the current unprecedented levels of QE and historically low

interest rates, heightening concerns over the fallout from eventual monetary tightening. Thissection looks at the market reaction and implications for sovereign creditworthiness of EMs,

which have been in the eye of the storm.

The market reassessment and sell-off was triggered by Fed Chairman Ben Bernankes

testimony to the Joint Economic Committee of the US Congress on May 22, 2013. Since then

global bond yields have climbed, spreads on perceived risky assets have widened, equity

markets have dropped and the CBOE volatility index (VIX) has increased sharply (Figures 5, 6

and 7).

Figure 6 Figure 7

0

1

2

3

4

5

6

7

Jan 13 Feb 13 Apr 13 Jun 13

Italian 10-yearGerman 10-year

EMBIG composite

US 10-year

(bp)

Sovereign Bond Yields Rise

Source: J.P.Morgan, Datastream and Fitch

70

80

90

100

110

120


MSCI World ($) MSCI EM ($)

(Jan 2013 = 100%)

EM Equities Underperform

Source: MSCI and Datastream

Other major central banks that manage the worlds other reserve currencies, including the ECB

and Bank of England, have indicated that monetary tightening is distant, while the Bank of

Japan plans to continue expanding its balance sheet aggressively. Nevertheless, it is US

monetary policy that has the greatest impact on global interest rates and risk appetite because

of the role of the US dollar as the pre-eminent reserve currency and main denomination for

foreign-currency borrowing, as well as the size of the US capital markets.

Bernanke clarified the Feds exit strategy after the Federal Open Market Committee meeting on

19 June. The Fed expects to:

Taper the monthly pace of QE asset purchase from the current rate of USD85bn later this

year;

End QE when the US unemployment rate falls to around 7% (from 7.6% in May 2013),which it anticipates in mid-2014;

Only (though not necessarily) raise the Federal Funds policy interest rate from 0%-0.25%

when unemployment falls to 6.5% (assuming inflation and inflation expectations remain

well-anchored), which it does not expect until mid-2015, and then raise rates only

gradually.

Policy is not pre-determined, but will depend on economic data. The Fed economic

forecasts for growth are more optimistic than the consensus, implying a risk that monetary

tightening could be later than the Fed currently anticipates.

Some market reaction to the Feds comments on its exit strategy was natural.

Forward-looking markets respond to a shift in expectations about monetary policy by

repositioning and recalibrating portfolios and asset prices, particularly as US Treasuries

are the worlds main benchmark risk-free asset.

Figure 8

51%

19%

6%

24%

0

20

40

60

A B C D

What Explains Market Rally

and Growth Dichotomy?A. Irrational exhuberance

B. Economic recovery to follow

C. Easing in tail risks

D. QE and low bond yields

Audience response, Fitch conference

11 June 2013

Source: Fitch

(%)

Figure 5

10

12

14

16

18

20

22


(Index)

Source: CBOE

VIX Signals Return ofMarket Fear

CBOE Volatility Index (VIX)

Figure 9

44%37%

19%

0

20

40

60

A B C

How Will the Fed's Exit

Play Out?A. Timely and smooth, no threat to

economic recovery

B. Too slow: leading to inflation and

asset bubbles

C. Sharp rise in bond yields and market

volatility

Audience response, Fitch conference

11 June 2013

Source: Fitch

(%)


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4

The precedent of 1994, when US and global bond yields spiked after the timing and speed

of Fed tightening caught the market off-guard, is widely discussed (though the 2004

tightening was much smoother). By comparison, bond re-pricing in 2013 looks just a

murmur, so far (Figures 11and 12).

QE, low interest rates and the search for yield appear to have distorted the normalrelationship between economic fundamentals and asset price valuations. That was the

majority view of the audience polled at Fitchs Global Banking Conference in London on 11

June 2013 (Figures 8 and 9).

Figure 11 Figure 12

0

1

2

34

5

6

7

8

9

Jun 92 Aug 93 Oct 94 Dec 95

10-year treasury

Fed funds target rate

2-year treasury(bp)

Fed Exit: 1994 And All That

Source: Datastream

01234

56789


10-year treasury

Fed funds target rate

2-year treasury(bp)

Fed Exit: 2013

Source: Datastream

However, in some ways, the scale and incidence of the market reaction looks strange.

The Fed is still loosening monetary policy and does not anticipate tightening policy until

2015, and then only if the economic recovery is sufficiently strong. The ending of QE1 and

QE2 did not create such an adverse reaction as the comments on ending QE3.

The comments should not have been that big a surprise. QE and near zero interest ratescannot continue forever. The guidance on raising rates was the same as the Fed gave in

January 2013.

Historically low interest rates and QE are a symptom of the profound sickness of the

economies and financial systems of MAE. The Feds comments about its exit strategy

reflect greater confidence that the worlds largest economy is returning to health. That

implies an improvement in fundamentals, which should be good news for risky assets.

Figure 13 Figure 14

0

10

20

30

40

Jan 07 Aug 08 Mar 10 Oct 11 Jun 13

ECB BoJ Fed

(% GDP)

Central Bank Balance Sheets (1)Assets as % of 2008 GDP

Source: Central Banks, datastream and Fitch

0

1

2

3

4

5

6

78

9

2006 2007 2008 2009 2010 2011 2012

Fed ECB BoJ BoE(USDtrn)

Source: McKinsey & Company

Central Bank Balance Sheets (2)

Fitch expects the prolonged and uncertain process of central bank exit from unprecedented QE

and historically low interest rates to be orderly in that it is not anticipating a financial crisis, but itstill expects it to generate periodic bouts of market volatility.

Figure 10

1

2

3

4


EZ US UK

(%)

Source: Fitch

Inflation Epxectations

5Y forward 5Y break even inflation


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5

Emerging Markets in the Firing Line

EM have been hit disproportionately hard in the global market correction, in a manner

reminiscent of the pre-global financial crisis era.

While a market correction is no surprise, the scale of the EM underperformance is puzzling in

some respects, particularly as the Feds move may hold some benefits for EM.

In terms of credit fundamentals, in general, EM look less exposed to tighter global liquidity

and higher interest rates than many MAE (see section below).

EM financial markets have under-performed DM year to date, suggesting less QE-induced

excess to retrace (Figure 7 above).

Barely a few weeks ago, many EM policymakers and market commentators were

concerned that EMs were facing excessive capital inflows, too strong upward pressure on

exchange rates and in some cases having to set policy interest rates that were too low for

domestic inflationary conditions. This led Brazilian finance minister Guido Mantega to coin

the phrase currency wars and prompted some countries to introduce macro prudential

policy measures and even capital controls. Although the EM growth outlook has

subsequently eased (see Global Economic Outlook), it is hard to reconcile the consistency

of such concerns.

The Feds early move may in the long term be better for EMs by taking some froth from the

top of the market, slowing the pace of hot money capital inflows, easing the pace of credit

growth and preventing a misallocation of risk that would store up greater problems down

the line.

Stronger US growth, weaker EM exchange rates and a reduction in the dichotomy between

EM and MAE economic conditions and hence less conflict in monetary policy should be

positive for EMs.

Figure 16

-1,000-800-600-400-200

0200400600800

1,0001,200

2005 2006 2007 2008 2009 2010 2011 2012e 2013f 2014f

FDI, net Portfolio equity, net

Banks, net Other private, net

Official sector, net Private outflows + errors & omissions(USDbn)

Source: IIF

Emerging Market Capital Flows

How Vulnerable Are EMs to the Feds Exit?

The timing of the Feds commentary was unfortunate for EMs as it coincided with and

magnified pre-existing concerns. These include the marked downward revision to GDP growth

outturns and forecasts for many of the large EMs (see Global Economic Outlook), risks

associated with the Chinese financial sector, a decline in commodity prices and a series of

political shocks including in Turkey, Brazil and Egypt. This also fits with the stalling in upward

momentum in EM sovereign ratings (see Sovereign Credit and Rating Outlook).

Market volatility creates its own problems and can feed on itself. Losses can trigger fund

redemptions and forced selling. J.P.Morgan estimates that outflows from EM bond flows

totalled USD12bn in the five weeks since May 23, 20131

. Sharp exchange-rate depreciationswill raise inflation (at least in the short term) and reduce local purchasing power, which could

1EM Fixed Income Flows Weekly, Trang Nguyen, 27 June 2013

Figure 15

-1 1 3 5 7 9 11 13

IndiaSouth

AustraliaBrazil

TurkeyMexico

ThailandPoland

PhilippinesRussia

ColombiaS. Korea

SerbiaTunisia

IndonesiaEuro

EgyptHungary

China

Exchange Rate

DepreciationsVersus USD 1 May to 26 June 2013

Source: Datastream (%)

Figure 17

0

2

4

6

8

2006

2007

2008

2009

2010

2011

2012

2

013f

LatamE. EuropeMiddle East & AfricaEM Asia ex-ChinaChina(USDtrn)

Source: IMF and Fitch

EM Foreign Exchange

Reserves


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6

increase political pressures. Fluctuations in interest rates, credit availability and asset prices, as

well as uncertainty, may deter investment.

Nevertheless, Fitch does not anticipate a widespread wave of EM crises. An improvement in

credit fundamentals over the past decade should make EMs more resilient to this type of global

liquidity shock than in past.

Record foreign-exchange reserves provide many countries with substantial buffers to

cushion the pressures on balance of payments and currencies, and capacity to maintain

foreign-currency payments (Figure 17).

Many EMs have flexible exchange-rate regimes that can take some of the strain from

volatile capital flows, provide countries with more scope for setting interest rates to suit

domestic conditions and may support growth through gains in competitiveness.

A greater share of EM sovereign debt is in local rather than foreign currency compared

with the past, reducing the vulnerability of balance sheets to exchange-rate depreciation.

Fitch estimated that 84% of EM government debt was denominated in local currency at

end-2012, up from 74% at end-2005, while the EM median for the share in local currencywas 50%, up from 40%. Therefore creditors many of them non-residents - rather than EM

borrowers will take a share of the losses from recent currency sell-offs.

Many EMs have lengthened the maturity of debt, reducing their fiscal financing

requirements. Fitch estimates that the (un-weighted) EM average for the amount of

government debt maturing declined to 5.6% of GDP in 2013, from 8.6% in 2005.

Government debt-to-GDP ratios remain moderate in the majority of countries and well

below the average in DM (Figure 18).

The prevalence of countries with high rates of inflation has declined. The (un-weighted)

average consumer price inflation rate for the nearly 70 Fitch-rated EMs was 5.2% in 2012,

down from 10.8% in 2001, although the reduction in the median to 4.5% from 5.2% wasless pronounced.

Most EMs showed impressive resilience in coming through the stresses of the global

financial and eurozone crises.

In some respects, however, EM vulnerabilities have increased in the past few years:

Private sector leverage has risen over the past decade. Fitch estimates that aggregate EM

bank credit to the private sector increased to 86% of GDP at end-2012, from 66% at end-

2008, even excluding the shadow banking sector in China. Nevertheless, EM bank credit

remains well below levels in DMs (Figure 19).

Current account surpluses have declined steadily since the mid-2000s and particularly

since the global financial crisis as DM economies have deleveraged, raised savings rates

and reduced their import growth. Fitch estimates that the aggregate current account of

Fitch-rated EMs will be in balance this year, compared with an aggregate surplus of 4.5%

of GDP in 2006. Excluding China, Russia and the GCC, it estimates a current account

deficit of over 2% of GDP (Figure 20).

The proportion of general government debt held by non-resident creditors has increased

markedly over the past decade, to high levels in some countries (Figure 21). Foreign

creditors are often quicker to sell than domestic creditors, potentially exacerbating bond

and exchange rate market volatility, and/or pressure of foreign exchange reserves.

The outlook for growth has weakened, reducing in some cases the political and policy

flexibility to react to adverse shocks.

Which EMs Are Most Vulnerable to a Potentially Turbulent Fed Exit?

Some EMs are more exposed than others to volatile capital flows and higher interest rates if

the Feds exit from ultra-loose monetary policy proves to be bumpy.

Figure 18

0

20

40

60

80

100

2005 2007 2009 2011 2013f

DM excl Japan

EM(% GDP)

Source: Fitch

Moderate EM Public Debt

Burden

Figure 19

406080

100120140160180

2005 2007 2009 2011 2013f

DM EM

(% GDP)


Bank Credit to Private

Sector

Figure 20

-5

-3

-1

1

3

5

2005 2007 2009 2011 2013f

EM aggregate

EM ex-China

EM ex-China, GCC and Russia

EM median(% GDP)


Deteriorating Current

Accounts


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7

The most vulnerable will be EMs with large external financing requirements (current account

deficits and maturing external debts), low foreign reserve buffers, high levels of leverage,

vulnerable debt structures (foreign currency, short maturity and non-resident creditors), those

that have seen strong inflows of hot money and recent bank credit growth, and those with weak

policy macroeconomic frameworks or weaker fundamentals as signalled by low ratings.

Figure 21 shows how the largest 15 and selected other EMs fare on 11 indicators, which

capture some of the potential vulnerabilities related to external finances, public finances and

banking sectors with an emphasis on liquidity and funding exposures.

Countries with at least three indicators that show up as red on the heat-map signalling risky or

stretched levels include: Hungary, Jamaica, Lebanon, Mongolia, Turkey and Ukraine.

Countries with at least two red indicators include: China (both related to the banking sector),

Indonesia, Poland, Egypt (both related to public finances), Sri Lanka and Dominican Republic

(both relate to external finances).

Countries with several yellow indicators of lesser potential stress (and in some cases one red)include: Argentina, South Africa, Romania, Vietnam, Tunisia, Ghana, Serbia and El Salvador.

Fitch acknowledges that such an exercise is purely illustrative and not a substitute for country

specific credit analysis. The results can be sensitive to the selection of different indicators and

threshold rates, and there may be significant country-specific factors that mitigate risks related

to some indicator levels. Fitch has used the same threshold levels for every country rather than

trying to tailor them to account for special factors. For example the IMF Flexible Credit Lines of

Colombia, Mexico and Poland mitigate some external financing risks.


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Figure 21Emerging Market Heat-map of Vulnerability to Drop in Capital Inflows

External finances Public finances Banks

Current acc.

+ net FDI

(% GDP)

Gross ext.financing needs

(% FX reserves)

Liquidity

ratiob

(%)

Netexternal

debt

(% GDP)

Gen. govt

balance

(% of GDP)

Gen. govt

debt

maturities

(% GDP)

Foreign

currency

gen. govt debt

(% total)

Non-resident

holdings of

govt debt

(% total)

Bank credit topriv. sector

real growth

(%)

Bank credit to

priv. sector

(% GDP)

Loan to deposit

ratio

(%)

2013 2013 2013 2012 2013 2013 2012 2012 (2008-12) 2012 2012

China 3.9 -4.3 688.4 -43.6 -2.0 2.3 0.4 n.a. 16.0 134.3 75.8Brazil -1.2 31.1 201.3 2.0 -3.5 8.8 2.3 17.6 12.7 66.3 141.4Russia 1.3 5.7 408.8 -18.6 -0.4 1.2 2.8 19.4 6.8 51.5 106.4

India -3.2 37.0 166.1 2.2 -8.0 5.3 5.9 6.7 9.5 51.3 79.8Mexico 0.5 19.7 107.7 1.8 -2.3 4.5 5.7 33.2 7.6 26.5 92.2Indonesia -1.9 61.7 98.6 10.4 -2.4 2.1 11.0 54.6 16.9 33.1 84.0Turkey -5.4 89.4 79.5 22.5 -2.2 9.1 13.4 29.6 16.3 50.7 110.0Saudi Arabia 14.2 -12.7 1,882.4 -94.8 6.2 1.3 0.0 n.a. 6.4 61.2 75.4Poland -1.1 95.6 52.8 43.6 -3.9 5.5 19.3 52.8 9.6 54.1 106.1Argentina 0.4 18.5 114.9 -14.2 -3.9 5.9 20.7 31.8 11.2 17.0 70.4South Africa -4.6 51.7 133.1 7.9 -4.6 5.6 3.3 32.0 -1.1 142.2 92.3Venezuela 4.8 -15.9 121.3 -41.5 -3.8 1.7 14.7 n.a. 4.8 24.6 52.0Colombia -0.5 55.0 191.8 0.3 -1.6 3.1 11.3 27.7 10.6 47.9 103.3Thailand 1.0 6.2 260.5 -38.5 -3.3 4.8 6.4 10.3 8.7 139.4 96.3Malaysia 4.3 5.9 136.6 -31.6 -3.5 7.4 1.8 28.8 7.8 119.6 78.7Egypt -1.3 52.6 361.7 -0.2 -13.1 28.0 12.2 12.4 -4.0 28.2 47.5Nigeria 8.1 -34.3 705.4 -9.7 0.0 5.4 2.9 n.a. 6.8 20.3 71.5Philippines 2.3 0.2 420.4 -10.6 -0.9 6.7 19.3 n.a. 7.8 31.8 65.8Ukraine -4.1 161.1 56.1 1.0 -5.3 4.9 18.0 37.7 -0.6 55.8 137.0Romania -2.3 75.1 96.3 38.6 -2.6 9.3 20.9 47.9 7.4 43.0 114.5Vietnam 7.1 -13.1 238.7 14.0 -6.3 4.9 24.4 n.a. 10.0 95.1 97.1Hungary 3.1 26.3 113.4 70.3 -2.7 17.8 30.0 67.7 -3.8 54.4 124.5Sri Lanka -3.7 80.7 72.5 38.1 -6.1 16.8 36.7 n.a. 6.2 31.4 87.4Dominican Rep. -0.6 138.4 75.3 18.1 -2.8 2.9 23.3 n.a. 6.4 23.0 75.4Tunisia -4.8 61.9 134.5 26.6 -6.7 3.7 27.8 n.a. 7.3 77.7 127.7Lebanon -9.0 21.5 201.2 -86.7 -9.3 20.9 59.0 n.a. 10.3 87.3 37.5

Ghana -1.5 113.7 130.0 21.1 -10.2 5.8 33.1 n.a. 14.0 17.0 73.0Serbia -3.6 76.2 153.0 32.7 -4.5 12.6 34.5 n.a. 7.9 49.2 129.0El Salvador -3.4 108.4 96.2 25.7 -3.7 4.0 52.8 n.a. -1.2 39.6 97.0Jamaica -5.7 117.1 125.6 72.5 -0.6 7.1 72.4 n.a. -1.6 28.5 83.8Mongolia 7.9 111.9 212.1 69.2 -3.1 1.7 40.3 n.a. 16.2 54.7 104.8

Notes Largest 15 and selected other EM. Selection of indicators and red and amber thresholds levels is for illustration. See text for health warningsbFitch liquidity ratio is the ratio of the stock of international reserves including gold plus banks external assets at the p revious end-year to liquid external liabilities are defined as scheduled external debt service in the current

year, plus the stock of short-term external debt and all non-resident holdings of marketable medium- and long-term local-currency debt at previous end-yearSource: IMF and Fitch


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Sovereigns


9

Sovereign Credit and Rating Outlook

Global sovereign ratings remain under downward pressure owing to the eurozone crisis, high

public and private sector debt levels, weak banking sectors, a difficult growth and economic

policy environment and individual EM political and other credit developments. There have been

13 notches of foreign-currency rating downgrades spread across eight countries so far in 2013,

compared with ten notches of upgrades (covering eight countries).

There were also two recordings of a comparative rarity: sovereign defaults in Jamaica and

Cyprus (local-currency IDR) only the tenth and eleventh Fitch-rated sovereign defaults since

we initiated sovereign rating coverage in the mid-1990s.

Figure 22 Figure 23

-30

-20

-10

0

10

20

DM

E'zone

DM

Other

EM

Asia

EM

LatAm

EM

MEA

EM Eur

2010 2011

2012 2013 ytd(Index of actions)

Outlook change = +/ 1

Upgrade/downgrade = +2/ 2

Source: Fitch

Sovereign Rating Actions by

Region

0% 20% 40% 60% 80% 100%

DM

EM Asia

EM Europe

EM LatAm

EM MEA

Stable Negative Positive

Sovereign Rating Outlooks

Note: based on rating Outlooks/Watches on all

sovereigns (FC and LC LT IDRs)

Source: Fitch

The ratio of Negative Outlooks/Watches to Positive Outlooks/Watches is a bit under 3:1,

signalling that sovereign creditworthiness as a whole is deteriorating and further downgrades

are likely (see Figures 22 and 23).

The trend of convergence in DM and EM ratings is continuing, with the majority (five out of

eight countries) of the foreign-currency downgrades year-to-date taking place in DM and most

of the upgrades (six out of eight countries) in EM countries. The balance of DM and EM

Outlooks suggests this trend will continue in 2013 and 2014.

Figure 24

Jan 97 Feb 00 Mar 13 Apr 13 May 13 Jun 13

DM EM - Asia EM - Eur EM - LatAm

EM - MENA EM - SSA EM - GCC

Simple Avg Long-Term FC IDRBy region

Source: Fitch

AA

BBB

BB+

BB-

B

A+

A-

Developed Market Ratings Remain Under Downward Pressure

The eurozone crisis and related economic, fiscal, political and financial trends is driving

negative rating actions, though the pace has eased. Overall, ten DMs (seven in the eurozone)

are on Negative Outlook and none on Positive Outlook.

In H113 Fitch downgraded three eurozone sovereign Foreign-Currency IDRs by a total of five

notches: Cyprus (by three notches to B-/Negative, and its Local-Currency IDR by seven

notches to RD), Italy (BBB+/Negative) and Slovenia (BBB+/Negative), as well as the UK


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10

(AA+/Stable) and Bermuda (AA/Negative). There were two DM upgrades: Greece (B/Stable)

and Iceland (BBB/Stable), demonstrating the potential for crisis-hit countries to regain some

lost rating ground as they start to recover.

Figure 25

0

2

4

6

8

10

12

Jan13

Apr13

Jul13

Oct13

Jan13

Apr13

Jul13

Oct13

Jan13

Apr13

Jul13

Oct13

Jan13

Apr13

Jul13

Oct13

Jan13

Apr13

Jul13

Oct13

Jan13

Apr13

Jul13

Oct13

Jan13

Apr13

Jul13

Oct13

Jan13

Apr13

Jul13

Oct13

Upgrades (trailing 12M sum) Downgrades (trailing 12M sum)

Positive outlooks at month-end Negative outlooks at month-end

Sovereign Rating Trends - Developed Markets

(No.)

Source: Fitch

The easing in the intensity of the eurozone crisis, particularly since ECB president Mario

Draghis Whatever it takes speech in July 2012, has led to a slowdown in the pace of negative

rating actions. The net four rating notches of downgrades in H113 compares with 18 (across

seven countries) in 2012, of which 16 were in the first half of the year. The Greek upgrade this

year was the first of a eurozone sovereign since the start of the crisis.

Cyprus became the second eurozone country after Greece to default on its sovereign debt in

June 2013 when under the terms of an exchange, domestic law bonds with a total nominal

value of EUR1bn that were due to expire within the EU-IMF programme period (2013-Q116)

were replaced by new bonds with the same coupon rates but with the maturity dates of the new

securities extended to outside the programme period. This transaction constitutes a Distressed

Debt Exchange (DDE) under Fitch's criteria, as the maturity extension at existing coupon rates

represents a material reduction in terms for bondholders.

Previously, Fitch downgraded Cyprus ratings from BB/Negative to B/Negative in January

2013 and then to B/Negative in June for the Foreign-Currency IDR and CCC for the local

currency. The country faces a deep recession; uncertainty about the medium-term outlook and

restructuring of the financial sector; high implementation risks on the EU-IMF programme; and

a marked rise in the public debt to GDP ratio above the peak of 126% by 2015 assumed under

the programme.

Italy was downgraded in March following the inconclusive election results in February, which

heightened political uncertainty and created a less-conducive environment for structural

reforms; the risk of a more protracted and deeper recession; and the resultant adverse impact

on the headline budget deficit and upward revision in Fitchs projection that gross general

government debt will peak in 2013 at close to 130% of GDP. The Slovenia downgrade also

reflected deterioration in the economic and fiscal outlook and upward revisions to GGGD ratio,

partly related to costs from cleaning up the banking sector.

The downgrade of the UK's sovereign ratings primarily reflected a weaker economic and fiscal

outlook. Fitch now forecasts that GGGD will peak at 101% of GDP in 2015-2016 and will only

gradually decline from 2017-2018.

In May, Fitch upgraded Greece to B/ Stable from CCC, owing to reductions in twin budget

and current account deficits, improvements in competiveness, progress in bank recapitalisation,increased ownership of the EU-IMF economic adjustment programme, lower political and

Grexit risks, and a moderation in the projected peak public debt/GDP ratio following extensive


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Sovereigns


11

private and public sector sovereign debt restructuring2. The upgrade of Iceland was its second

in successive years, after it regained investment grade in 2012.

Emerging Market Upward Movement on Hold

The strong net upward momentum in EM sovereign ratings since 2010 appears to have slowed

as many face more challenging growth conditions, difficult policy trade-offs and politicalpressures. The balance of EM Outlooks has also turned negative, with 12 on Negative and

seven on Positive, while 47 are Stable. Fitch expects future EM rating changes to be driven

more by country-specific factors than global macro trends.

In H113, the balance of EM upgrades and downgrades were skewed slightly to the upside.

There were six EM upgrades: Lithuania (BBB+/Stable), Mexico (BBB+/Stable), Philippines

(BBB/Stable), Thailand (BBB+/Stable) and Uruguay (BBB/Stable), as well as the technical

upgrade of Jamaica (three notches to CCC on the completion of its distressed debt exchange).

This compares with three EM foreign-currency downgrades: Egypt, Jamaica (by four notches to

RD) and South Africa (Local-Currency rating by two notches).

Figure 27

0

5

10

15

20

25

Jan13

May13

Sep13

Jan13

May13

Sep13

Jan13

May13

Sep13

Jan13

May13

Sep13

Jan13

May13

Sep13

Jan13

May13

Sep13

Jan13

May13

Upgrades (trailing 12M sum) Downgrades (trailing 12M sum)

Positive outlooks at month-end Negative outlooks at month-end

Sovereign Rating Trends - Emerging Markets

(No.)

Source: Fitch

In addition, Fitch downgraded Chinas Local-Currency rating to A+/Stable from AA/Negative

in April, mainly reflecting an increase in risks to financial stability from the rapid growth of credit

and size of the banking and shadow-banking sectors, as well as the increased indebtedness of

local governments3.

Figure 28 Figure 29

Jan 00 Sep 02 May 05 Jan 08 Sep 10 May 13

Rating index Rating

Source: Fitch LTFC IDRs, Fitch estimates, JP Morgan

EMBIG Weighted Average RatingWeight in JPM EMBI global index

B+

BB-

BB

BB+

BBB-

BBB

0%

20%

40%

60%

80%

100%

Dec95

Jul97

Feb99

Sep00

Apr13

Nov13

Jun13

Jan13

Aug13

Mar13

Oct13

May13

Inv. grade BB B CCC/D

Source: Fitch LTFC IDRs, Fitch estimates, JP Morgan

EMBIG Mkt Cap. by Rating

CategoryJPM EMBI global index

2 Fitch Upgrades Greece to 'B'; Outlook Stable, May 2013.3 Fitch Affirms China's FC IDR at 'A+'; Downgrades LC IDR to 'A+', April 2013.

Figure 26Investment GradeGraduates

Country DateCurrentrating

Philippines Mar 13 BBBUruguay Mar 13 BBBTurkey Nov 12 BBBIndonesia Dec 11 BBBColombia Jun 11 BBBAzerbaijan May 10 BBBPanama Mar 10 BBBBrazil May 08 BBBPeru Apr 08 BBBFC IDRs, since 2008

Romania (Jul 11) and Latvia (Mar 11)regained IG lost during crisisSource: Fitch


12/16

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12

The default by Jamaica in February was its second in recent years (after February 2010). Fitch

viewed the domestic debt exchange as a DDE, as it adversely impacted the original contractual

terms of domestic bondholders.

The upgrades of Philippines and Uruguay made them the latest in a succession of EMs to

graduate to investment grade in the past five years, including large bellwethers such as Brazil,Indonesia and Turkey (Figure 26). As a result, three-quarters of the JP Morgan Emerging

Market Bond Index (EMBI) Global is rated investment grade by Fitch, up from just over one-

third five years ago (figure 29). This underlines our view that EM debt has become a more

stable and resilient asset class.

Fitch started sovereign rating coverage of Paraguay in January, assigning a rating of BB4,

and of Macao in May, assigning a rating of AA5.

4Republic of Paraguay, Full Rating Report, March 2013.

5Macao, Full Rating Report, May 2013.


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Appendix 1

Figure 30Long-Term Issuer Default Ratings on 30 June 2013

LTFC FC Outlook LTLC LC Outlook Country Ceiling

Western Europe & North AmericaAustria AAA Stable AAA Stable AAABelgium AA Stable AA Stable AAABermuda AA Negative AA Negative AA+Canada AAA Stable AAA Stable AAACyprus B Negative RD - BDenmark AAA Stable AAA Stable AAAFinland AAA Stable AAA Stable AAAFrance AAA Negative AAA Negative AAAGermany AAA Stable AAA Stable AAAGreece B Stable B Stable BIceland BBB Stable BBB+ Stable BBBIreland BBB+ Stable BBB+ Stable AAAItaly BBB+ Negative BBB+ Negative AAALuxembourg AAA Stable AAA Stable AAAMalta A+ Stable A+ Stable AAA

Netherlands AAA Negative AAA Negative AAANorway AAA Stable AAA Stable AAAPortugal BB+ Negative BB+ Negative AAASan Marino BBB+ Negative - - A+Spain BBB Negative BBB Negative AAASweden AAA Stable AAA Stable AAASwitzerland AAA Stable AAA Stable AAAUnited Kingdom AA+ Stable AA+ Stable AAAUnited States AAA Negative AAA Negative AAA

Emerging EuropeArmenia BB Stable BB Stable BBAzerbaijan BBB Stable BBB Stable BBBBulgaria BBB Stable BBB Stable BBB+Croatia BBB Negative BBB Negative BBB+Czech Republic A+ Stable AA Stable AA+

Estonia A+ Stable A+ Stable AAAGeorgia BB Stable BB Stable BBHungary BB+ Stable BBB Stable BBBKazakhstan BBB+ Stable A Stable ALatvia BBB Positive BBB+ Positive ALithuania BBB+ Stable A Stable A+Macedonia BB+ Stable BB+ Stable BBBPoland A Positive A Positive AARomania BBB Stable BBB Stable BBB+Russia BBB Stable BBB Stable BBB+Serbia BB Negative BB Negative BBSlovakia A+ Stable A+ Stable AAASlovenia BBB+ Negative BBB+ Negative AAATurkey BBB Stable BBB Stable BBBUkraine B Negative B Negative B

Asia PacificAustralia AAA Stable AAA Stable AAAChina A+ Stable A+ Stable A+Hong Kong AA+ Stable AA+ Stable AAAIndia BBB Stable BBB Stable BBB-Indonesia BBB Stable BBB Stable BBBJapan A+ Negative A+ Negative AA+Korea AA Stable AA Stable AA+Macao AA Stable AA Stable AA+Malaysia A Stable A Stable AMongolia B+ Stable B+ Stable B+New Zealand AA Stable AA+ Stable AAAPhilippines BBB Stable BBB Stable BBBSingapore AAA Stable AAA Stable AAASri Lanka BB Stable BB Stable BBTaiwan A+ Stable AA Stable AAThailand BBB+ Stable A Stable AVietnam B+ Stable B+ Stable B+


14/16

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14

Long-Term Issuer Default Ratings on 30 June 2013 (Cont.)LTFC FC Outlook LTLC LC Outlook Country Ceiling

Middle East and AfricaAbu Dhabi AA Stable AA Stable AA+Angola BB Positive BB Positive BBBahrain BBB Stable BBB+ Stable BBB+Cameroon B Stable B Stable BBBCape Verde B+ Negative B+ Negative BBEgypt B Negative B Negative BGabon BB Stable BB Stable BBBGhana B+ Negative B+ Negative B+Israel A Stable A+ Stable AAKenya B+ Stable BB Stable BBKuwait AA Stable AA Stable AA+Lebanon B Stable B Stable BLesotho BB Stable BB Stable AMorocco BBB Stable BBB Stable BBBMozambique B Positive B+ Stable BNamibia BBB Stable BBB Stable ANigeria BB Stable BB Stable BBRas Al Khaimah A Stable A Stable AA+Rwanda B Stable B Stable B

Saudi Arabia AA Positive AA Positive AASeychelles B Positive B+ Positive BSouth Africa BBB Stable BBB+ Stable ATunisia BB+ Negative BBB Negative BBBUganda B Stable B Stable BZambia B+ Negative B+ Negative BB

Latin America and CaribbeanArgentina CC - B Negative BAruba BBB Stable BBB Stable ABolivia BB Stable BB Stable BBBrazil BBB Stable BBB Stable BBB+Chile A+ Stable AA Stable AA+Colombia BBB Positive BBB Positive BBBCosta Rica BB+ Stable BB+ Stable BBBDominican Republic B Stable B Stable B+

Ecuador B Positive - - BEl Salvador BB Negative BB Negative BBBGuatemala BB+ Stable BB+ Stable BBBJamaica CCC - CCC - BMexico BBB+ Stable A Stable APanama BBB Stable BBB Stable AParaguay BB Stable BB Stable BBPeru BBB Stable BBB+ Stable BBB+Suriname BB Stable BB Stable BBUruguay BBB Stable BBB Stable BBB+Venezuela B+ Negative B+ Negative B+

Source: Fitch


15/16

Sovereigns


15

Appendix 2: EM Classifications

Fitch has reclassified the following countries from EM to DM in line with the IMFs World

Economic Outlook classification: Korea, Taiwan, Israel, the Czech Republic, Estonia, Slovakia

and Slovenia. It has also classified Macao as a DM. This reclassification is introduced

retrospectively in Fitchs EM and DM aggregate series.


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Sovereigns

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