From the CEO
Several of the key metrics we monitor in our risk models for both the International Country Risk Guide (ICRG) and Political Risk Services (PRS) Country Reports are a government’s budget balances and foreign debt as a percentage of a country’s GDP. We also look at debt servicing costs as a function of exports of goods and services, along with foreign exchange cover to months of imports.
Foreign denominated bonds can be risky to service and to repay if the borrower has insufficient or dwindling foreign currency earnings, and/or if the debt is contracted on a short-term basis – the latter is especially worrisome in the event capital exits the market in a hurry during a downturn or financial crisis.
In order to plug the budget gaps, an increasing number of bond issuances have occurred in emerging markets and a range of others planned in the near future. Indeed, emerging markets are on a path to raise a record sum on the international capital markets this year.
As an aside, in his seminal work, The Volatility Machine, Michael Pettis applied the principles of corporate finance and the notion of capital structure to emerging markets’ balance sheets in an effort to better understand the history of financial crises. Pettis’ work continues to have relevance in today’s context of increased borrowing by emerging market sovereigns in the face of slow global growth and relatively depressed commodity prices.
Mexico, Qatar and Argentina have issued notes valued at $90 billion so far in 2016, with an increasing number of these issuances denominated in US dollars and the euro.
In Argentina’s case, the country is planning to tap the eurobond market again about six months after it sold a $16.5 billion dollar bond, the largest ever issue from a developing economy, which marked its return to the international debt market after being shut out for the past 15 years.
Russia returned to the global bond market in May with a $1.75 billion bond (it was the first issuance since the US and the EU passed sanctions against Moscow over the annexation of Crimea and the ongoing conflict with Ukraine), and plans to raise an additional $1.25 billion in dollar bonds.
As continued expectations that the US Federal Reserve will remain cautious about raising rates anytime soon, which keeps dollar borrowing low and the ability for emerging markets to refinance their credits relatively easy, it’s not surprising that inflows into emerging market bonds have surpassed other risky assets since the earlier part of the summer, with investors pouring over $16 billion since the UK voted for Brexit.
From our perspective, the countries that appear to have the more favorable fundamentals for borrowing (which include manageable budget deficits, reasonable current account balances, and sufficient foreign exchange reserves) include Russia, Indonesia and Colombia. Clients of ICRG are encouraged to consult Tables 10, 11, 12 and 15 for relevant data and comparisons across ICRG’s 140 country universe).
Turning to the IMF’s regular use of our data in its research and working papers, several new studies are worthy of note. First, the Fund’s Africa Department used our country risk data in a study that sheds light on financial development in Sub-Saharan Africa.
Another study employed our financial risk metrics to show that frontier markets are becoming similar to emerging markets in terms of capital flows dynamics (e.g., inflows, outflows, integration into the international financial marketplace).
Our Research Spotlight series on social media (LinkedIn, Facebook, Twitter) this month featured Professor Campbell Harvey of the Duke University’s Fuqua School of Business. Professor Harvey is a long-time user of ICRG and PRS Country Reports, with some of his earlier work using our data being profiled in Barron’s.
Professor Harvey is also Research Associate of the National Bureau of Economic Research in Cambridge, Massachusetts, and is President of the American Finance Association in 2016. In addition to serving on the faculties of the Stockholm School of Economics, the Helsinki School of Economics, and the Booth School of Business at the University of Chicago, Campbell has also been a visiting scholar at the Board of Governors of the Federal Reserve System.
Moreover, Harvey has received seven Graham and Dodd Awards/Scrolls for excellence in financial writing from the CFA Institute, and published over 125 scholarly articles on topics spanning investment finance, impact of political risk, emerging markets, corporate finance, behavioral finance, financial econometrics and computer science.
The professor has used The PRS Group’s data for decades, citing its value in terms of (1) its long data series; (2) its availability on a monthly basis; and (3) its separation of political, economic and financial risk which, within these categories, can be disaggregated further.
Significantly, Campbell finds that ICRG’s indices are predictive. In a paper recently published in the Journal of International Business Studies called “Political Risk Spreads”, Campbell found that there is a significant ability of The PRS Group’s political risk indicator to predict realized political risk events (where the research method measured realized risk events with textual-based news searches), which allowed the study to address the related issue: how much of a country’s sovereign bond yield is due to political risk?
Moving to ICRG’s ratings in September, some of the more significant changes to political risk profiles include Libya, Romania and Croatia.
Libya’s profile improved as an ISIS headquarters was captured in Sirte, in addition to other tactical setbacks suffered by the organization, and as the risk of “Civil Disorder” eased as the government seems more firmly in place and thus not likely to be removed by strikes or protests. Higher oil production numbers should also help the economy going forward.
Romania is experiencing the fastest economic growth in the EU, with consumer confidence levels edging up. We have lowered the country’s risk as it affects “Investment Profile” and “Internal Conflict” given the improved stability of the regime and growth prospects despite inflation peaking this year.
And in Croatia, the conservative HDZ party prevailed in the parliamentary election earlier this month, gathering 61 of the 151 seats up for grabs. But the party will have to get the support of a centrist party to form a governing coalition, ostensibly the Most (Bridge) party which collected 13 seats. The Social Democratic-led four party alliance garnered 54 seats. The HDZ’s new leader, Andrej Plenkovic, has suggested the new regime will be more “Europe-oriented’ in its overall approach to governing and policy-making.
While the election has improved overall “Government Stability,” Croatia’s risk as it affects “Socioeconomic Conditions” and “Investment Profile” increased as the jobless rate has reached just over 13%, growth is weak, consumer confidence levels are low, and the central bank’s foreign exchange reserves continue to trend downward.
Finally, clients should note that some 47 countries had their political risk profile adjusted in September, affecting just over 60 individual risk metrics.
Thanks for your continued support, and please contact us if we can be of any assistance.