This assessment is based on a smaple 15 countries in Europe, the Middle East, and Africa (EMEA) and is the result of the Liquidity Vulnerability Index developed by Standard & Poor's Rating Services to assess sovereign debt resilience to adverse market conditions.
At the other end of the spectrum, Russia, Egypt, Ukraine, and the Czech Republic should, in principle, have least to fear from the changing mood in the capital markets. Lithuania, Lebanon, Slovakia, Poland, Hungary, and South Africa currently occupy an intermediate position. The Liquidity Vulnerability Index is part of a report entitled "Which Way Now For EMEA Sovereign Ratings, As The Credit Cycle Turns Sour?" published yesterday.
"We have not, to date, changed any ratings or outlooks due to the tighter financial conditions," Standard & Poor's credit analyst Moritz Kraemer is quoted as saying "Over the past 24 months, however, we have lowered ratings or outlooks for a number of sovereigns in the sample with deteriorating credit fundamentals."
These negative ratings and outlook actions are concentrated in those sovereigns that, according to the Liquidity Vulnerability Index, are most exposed to changes in investor risk appetite. On the other hand, the relatively sheltered group experienced positive rating actions during the maturing credit cycle.
"Our EMEA sovereign ratings have thus been consistent, successfully avoiding cyclicality and indiscriminate and generalized upgrades while the rising liquidity tide had benefited all emerging economies," continued Mr. Kraemer. "Instead, the strong correlation with the Vulnerability Index shows that sovereign rating actions in EMEA have been timely in pointing, in the relevant cases, at the increasing risks as the credit cycle draws to a close."
The Vulnerability Index is a simple indicator, aggregating various quantitative measures usually assumed to be relevant in emerging debt crises: sovereign debt rollover needs as a share of GDP; gross external borrowing requirements as a share of current account receipts; gross external financing requirements net of foreign direct investment inflows as a share of usable official foreign exchange reserves; the share of a current account deficit financed through foreign direct investment; and the real effective exchange rate appreciation in 2007 from the average of the 1990s. The Vulnerability Index is a mere snapshot as it uses exclusively 2007 ratios. If tight liquidity conditions were to extend well beyond the current year, individual sovereigns would be expected to move up or down the scale.
For example, Ukraine is still benefiting from relatively low external imbalances in the region. Ukraine, however, is very susceptible to changes in its volatile terms of trade. If Ukraine's terms of trade deteriorate in 2008 and 2009, external financing needs are bound to go up, increasing Ukraine's vulnerability as time goes by. Conversely, Iceland's hefty external imbalance is expected to shrink, as export capacity comes on stream and high interest rates curb economic demand. As time passes and if global credit conditions continue to be tight, Standard and Poor's will update their vulnerability index as appropriate.
"Placing a country in the vulnerable group is not a predictor of a negative rating action, just as being in the sheltered group is no predictor of a positive action," added Kraemer. "Everything depends on the policy reaction by the authorities. Indeed, Standard & Poor's last week affirmed the ratings and stable outlook on Turkey, despite the country's well above average vulnerability to changes in market sentiment. The affirmation reflects our expectation that the government's policy mix will continue to mitigate Turkey's refinancing risks."
Summary Of The EMEA Emerging Economies' Liquidity Vulnerability Index*
Sovereign (index value; last rating/outlook action {excluding affirmations})
Latvia (+1.3; downgrade)
Iceland (+1.2; downgrade)
Bulgaria (+1.0; upgrade)
Turkey (+0.8; downward outlook revision)
Romania (+0.7; downward outlook revision)
Lithuania (+0.4; downward outlook revision)
Lebanon (+0.3; negative outlook/CreditWatch resolved)
Slovak Republic (+0.1; upgrade)
Poland (+0.0; upgrade)
Hungary (-0.0; upward outlook revision)
South Africa (-0.1; upgrade)
Czech Republic (-0.9; upward outlook revision)
Ukraine (-1.3; downward outlook revision)
Egypt (-1.4; upward outlook revision)
Russia (-2.0; upgrade)
*A higher score indicates greater vulnerability, a lower score less vulnerability.
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