From the CEO – July 2018

Dear Clients,

Christopher McKee, PhD
Chief Executive

The release of second quarter American GDP growth was one of the more significant market and economic events as PRS wrapped up its monthly data, ratings and forecasts. As our data are showing, the growth figure has some not entirely inconsequential implications for emerging market credits and sovereign risk overall.

Gross domestic product rose at an annual rate of 4.1%, up 2.2% during the first three months of the year, making the strongest growth figure since 2014. The rise was broad-based but fueled in particular by consumer spending and exports.  There is talk that the US economy could grow 3% this year, which would make it the first in almost a decade.  Not too surprising, the release of the GDP number forced the major American indices higher, while the greenback dipped slightly and treasuries rose.

To be sure, while the quarterly growth does not appear to be the result of ‘one-off’ factors, some suggest that the figure represents the ‘high-water’ mark for the economy in 2018, with a moderate deceleration as the year winds down.  PRS thinks this is likely the case, too, but the more immediate concern for us is the impact the growing American economy has on the risks many of our clients face in emerging and frontier markets.

The growth numbers arrived at a time when the future path of interest rates in the US is being debated. President Trump has said that he is ‘not thrilled’ about further rate increases, but the GDP numbers really underscore the likelihood of a September rate hike and quite possibly one in December.  The 4.1% rate of growth during the second quarter represents an average of 2.9% over the past four quarters, which is a more accurate reading of the strength of the underlying economy. It is close to the central bank’s 2018 growth forecast of 2.8% and should help keep employment growth sufficient to maintain downward pressure on the jobless rate.

Concerns about various trade wars brewing globally do suggest the Fed might need to shift to a more dovish phase. The number of larger firms that have made clear the impact of higher tariffs on their earnings is growing, with the US auto sector being but one. Yet the Fed would probably look more at the effect of higher trade costs on growth rather than inflation – which it would see as temporary – when it comes to shifting its monetary stance.

Higher rates, a stronger dollar, and slumping emerging market currencies have made life complicated for emerging and frontier market players, particularly for those that have borrowed heavily in greenbacks, as they have seen their debt repayment burdens rise.  Indeed, new data from the Bank of International Settlements finds that USD credit to emerging markets has risen to $3.7 trillion in dollar-denominated securities – an increase of 16% over the past year.

This makes for a tricky future, which some have suggested harkens back to the Asian financial crisis of the late 1990s. Then, fueled by relatively loose liquidity, firms defaulted on billions of dollars of liabilities as currencies in the region collapsed following the devaluation of the Thai baht.  Heavy dollar denominated debt became problematic when revenues are in local currencies.

Some firms in China have already defaulted on dollar notes this year and PRS suspects that firms in Latin America may also follow suit.

On the sovereign side, a number of countries PRS covers carry significant external debt loads and debt servicing costs, including Lebanon, Lithuania, Venezuela (no surprise), Brazil, and Angola.

Clients are advised to consult the appropriate tables in The International Country Risk Guide for a complete picture of external debt exposure and servicing costs to the 140 countries covered each month.

Turning to our ratings for July, some changes are notable.  Cyprus’ risk profile has been deteriorating largely on the back of falling consumer confidence levels and their impact on the support for the government. Finland has also seen some backtracking as consumer confidence levels there are also trailing off, and the opposition Social Democratic Party is gaining in support following the difficulties the government has had in implementing its health care reforms.

Additionally, Iraq continues to spiral downward as protests in Basra – the country’s main oil hub – spread to other cities, such as Amrah, Nasiriyah and Samawa.

A number of people have been killed in clashes with security forces since the flare up began several weeks back.  Discontent runs high at the moment over joblessness, a lack of electricity and less-than-sanitary water conditions.  The demonstrations have targeted the offices of such oil facilities as the West Qurna 2 and Zubair oil fields.

As I mentioned in an interview with CNBC on the protests and the potential impact on oil prices, there could be minor operational disruptions to the flow of oil if the protests gather pace. But the security around oil installations and supply routes is relatively robust, and the protesters themselves are not well organized.

In a related fashion, PRS’ coverage in the press continues to be robust as we have been called upon to comment on the violence in Nicaragua and the fate of the Ortega regime (, the Mexican elections and the way forward for that country (, the liquidity issue affecting Lebanese bonds (, and the recent election in Pakistan (

On the latter, we were correct is predicting a win for Imran Khan and his Pakistan Tehreek-e-Insaf (PTI) as well as the problems that the new leader would face in cobbling together a viable governing coalition.  Now some opposition party leaders are calling for fresh elections given concerns that the vote was ‘rigged.’   The vote was marred by violence and such policy goals as eradicating corruption – important as they are for business and investment – will likely be put on the backburner as the new government attempts to consolidate power.

ICRG’s July risk ratings were significant in number, as the risk profiles of some 60 countries were adjusted, affecting some 75 individual political risk metrics.

Thanks for your continued support, and please contact us if we can be of any assistance.

Christopher McKee, PhD
Chief Executive


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