Sovereign Credit Risk Analysis - Credit and Finance Risk Analysis

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Sovereign Credit Risk Analysis

International Comparison Program, World Bank Group

Global Competitiveness Report 2008-09, World Economic Forum

Doing Business Guide, World Bank Group

Euro Area Economic and Financial Data, European Central Bank

Tankan Corporate Survey, Bank of Japan

Economic Indicators, Statistische Bundesamt Deutschland

The World Bank indicates that global GDP contracted by 2.2% in 2009 (the original forecast in March 2009 was 1.7%), the first decline in world output on record. The agency also forecasts that global GDP is expected to grow 2.7% during 2010, and 3.2% in 2011.
go.worldbank.org/RWLJPPA0D0

The EU has publicly indicated that the EU economy contracted by 4.1% during 2009, and GDP growth is forecasted at 0.70% in 2010. The ratio of national debt to GDP has increased to 80.0% (compared to 60.0% in 2007; the low is 66% in The Netherlands and the high is 125% in Greece). Government deficit across the EU averages 6.7% of GDP, which is in excess of the 3.0% mandated by EU guidelines.

In February 2009, Moody's Investors Service rated the United States and the United Kingdom Aaa Stable Outlook but further categorized them as part of a "Resilient" group as both nation's "ratings are being tested due to a shock to their growth model and large contingent liabilities" as they "also face considerable challenges to their debt positions as they loosen fiscal policy to fight recession." Standard & Poor's Ratings Services also indicate a continued AAA long-term and A-1+ short-term sovereign credit ratings on the U.S. government. U.S. government debt (Treasury bills, notes, and bonds) have usually been considered the benchmark of safety (risk free rate of return) for sovereign issued financial instruments. However, within the Triple-A category Moody's actually created a superior "Resistant" (to downgrade) category, which consists of Germany, France, Switzerland, Austria, Australia, Canada, Denmark, Finland, Luxembourg, Netherlands, Norway, Sweden, Singapore, and New Zealand. Spain and Ireland were termed as "Vulnerable".

Sovereign Analysis

In some ways, a nation is subject to the same economic and financial forces that affect a corporation:

Interest Rates: if interest rates are high, and people are worried about their jobs, then national consumption spending declines.

Government Finance:
: A deficit or budget deficit is the gap between a government's revenue and expenses (expenses are greater than revenue) when the government prepares the annual budget projections.; The national debt of a government is the total amount of deficits added together year after year.; Both figures are measured in terms of annual Gross Domestic Product (GDP) as deficit to GDP and debt to GDP.; It is not uncommon for a government to have an annual deficit and a national debt however it is desirable that both are amounts that are considered "acceptable" or "servicable" in terms of GDP.; The government's treasury department must issue debt on a constant basis in order to service the pending deficit and the outstanding debt, which is held by both the citizens and corporations residing / domiciled within the nation and by foreign investors outside the nation.

Currency: if the value of the currency is depreciating then the cost imports become more expensive and outstanding borrowings also become more expensive.

There are three kinds of exchange rates: pegged, floating and fixed. The U.S., Japan and the Euro have floating rates; Hong Kong and Argentina have fixed rates. Under floating rates, monetary policy is set by a central bank and the exchange rate is allowed to float on autopilot. With a fixed-rate regime, a currency board fixes the exchange rate, and monetary policy automatically adjusts. If the current-account deficit shoots up, money supply automatically tightens to cool the economy and move the current account back toward a balance. It works like the old gold standard, only with reserves in U.S. dollars, rather than in gold.

The important point to remember is that both floating- and fixed-rate regimes are free-market mechanisms in which there cannot be conflicts between exchange-rate and monetary policies. That's why balance-of-payments crises don't occur with these systems.

With pegs, the central bank sets both exchange rate and monetary policies. There's no way for market forces to automatically adjust the economy toward equilibrium.

Inevitably, pegged rates result in fundamental contradictions between the exchange rate and the domestic money supply. When the contradictions start to appear, the speculators show up. This was the case with Mexico in 1994, and Thailand and other Southeast Asian countries the late 1990s.

The contradiction in Southeast Asia was this: Their pegged exchange rate policies required high interest rates to defend the pegs; on the other hand, the high interest rates sucked in hot money, which kept their economies booming and their current accounts large. The speculators knew something had to give, and something did.

A country's trade weighted exchange rate is an average of its bilateral rates with its trading partners, weighted by the amount it trades with each of them. The measure captures the effect of currency changes on the competitiveness of a country's exports: the higher the rate, the costlier they are.

European Union Article III-76 mandates that government deficits may not exceed 3% of GDP. If the excessive deficit continues then the EU may impose an order that the offending nation increase taxation or decrease spending. If the offending nation fails to comply then the EU may impose a fine on the nation.

Current Account Deficit: difference between how much a nation saves and how much it invests; (coupled with): measure of a nation's international transactions; when the outflow of international transactions is higher than revenues generated by international transactions, the shortfall is made up through borrowed funds. Includes not only trade but tourism, investments, services, brokerage fees, international phone tolls, and money sent by immigrants back home to another nation. If the money coming into a nation goes into productive investment, then the nation will have the wherewithal to pay back foreign debt. If it is used for consumer goods/lifestyles, the national deficit will continue to increase.

Merchandise Trade Deficit: when the purchase of imports into the country exceed the sale of exports going to other nations.

Economic Factors:: Monetary Reserves; Balance of Trade; GDP Growth; Industry Diversification; Economic Infrastructure; Economic Trends (Output, Demand and Job Creation); Foreign Exchange Creation; Stability of Banking System; Access to Capital Markets; Consumer Prices; Inflation; Economic Growth; Domestic Budget

Political Factors:: Stability of Government (Lehman Brothers / Eurasia Group Stability Index); Political Infrastructure; Legal System; Military; Government Succession; Independence of Monetary Policy; Fiscal Policies; Currency Restrictions; Tariffs, Quotas

Social Factors:: Business Customs; Income Distribution; Religion; Racial issues; Welfare System; Accounting Practices

Economic Indicators:: Exports/Imports: called the coverage ratio, indicator of economy's rate of growth.; Current Account Deficit/Exports: short-term measure of possible balance of payments difficulties.; Total External Debt/exports: long-term indicator of country's liquidity.; Interest Payments/Exports: indicator of debt burden, reflects carrying costs of the external economy.; International Reserves/Imports: measure of short-term liquidity.; Indistrial-production: an increase indicates that the economy is growing.

United Nations Human Development Index (HDI)

The United Nations Development Program anually publishes the Human Development Report, which includes the Human Development Index (HDI) that examines such factors as a nation's income distribution, standard of living (measured by purchasing power parity, PPP, income), health, education, equality, child mortality and life expectancy. hdr.undp.org/en/reports/global/hdr2007-2008/

The 2007 / 2008 HDI (reviews data from 2005): 1. Iceland; 2. Norway; 3. Australia; 4. Canada; 5. Ireland; 6. Sweden; 7. Switzerland; 8. Japan; 9. Netherlands; 10. France

Regional and Supranational Organizations

These groups exist primarily to coordinate economic policies between nations.

Group of 3 (G3) comprises Japan, European Union and the United States.

Group of 5 (G5) comprises France, Germany, Japan, United Kingdom and the United States.

Group of Seven (G7) comprises the United States, Japan, Germany, France, Italy, Canada and the United Kingdom, and grew out of the 1985 Plaza Accord.

Group of 8 (G8) comprises Canada, France, Germany, Italy, Japan, Russia, United Kingdom and the United States.

Group of Ten (G10) comprises Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States, who work together to coordinate economic, monetary and financial policies. Observers include the Bank for International Settlements (BIS), European Union (EU), International Monetary Fund (IMF), and the Organisation for Economic Co-operation and Development (OECD).

Group of 11 (G11), also known as the Cartegena Group, comprises Argentina, Bolivia, Brazil, Chile, Colombia, Dominican Republic, Ecuador, Mexico, Peru, Uruguay, Venezuela.

Group of 20 (G20), comprises Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, United Kingdom, United States, the European Union and the Bretton Woods Institutions.

Group of 24 (G24), comprises Algeria, Argentina, Brazil, Colombia, Democratic Republic of the Congo, Côte d'Ivoire, Egypt, Ethiopia, Gabon, Ghana, Guatemala, India, Islamic Republic of Iran, Lebanon, Mexico, Nigeria, Pakistan, Peru, Philippines, Serbia and Montenegro*, Sri Lanka, Syrian Arab Republic, Trinidad and Tobago, Venezuela.

Group of 77 (G77), comprises the Islamic State of Afghanistan, Algeria, Angola, Antigua and Barbuda, Argentina, The Bahamas, Bahrain, Bangladesh, Barbados, Belize, Benin, Bhutan, Bolivia, Bosnia and Herzegovina, Botswana, Brazil, Brunei Darussalem, Burkina Faso, Burundi, Cambodia, Cameroon, Cape Verde, Central African Republic, Chad, Chile, China, Colombia, Comoros, Democratic Republic of the Congo, Republic of the Congo, Costa Rica, Côte d'Ivoire, Cuba, Cyprus, Djibouti, Dominica, Dominican Republic, Ecuador, Egypt, El Salvador, Equatorial Guinea, Ethiopia, Fiji, Gabon, The Gambia, Ghana, Grenada, Guatemala, Guinea, Guinea-Bissau, Guyana, Haiti, Honduras, India, Indonesia, Islamic Republic of Iran, Iraq, Jamaica, Jordan, Kenya, Democratic People's Republic of Korea, Republic of Korea, Kuwait, Lao People's Democratic Republic, Lebanon, Lesotho, Liberia, Libya, Madagascar, Malawi, Malaysia, Maldives, Mali, Malta, Marshall Islands, Mauritania, Mauritius, Federated States of Micronesia, Mongolia, Morocco, Mozambique, Myanmar, Namibia, Nepal, Nicaragua, Niger, Nigeria, Oman, Pakistan, Panama, Papua New Guinea, Paraguay, Peru, Philippines, Qatar, Romania, Rwanda, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Samoa, São Tomé and Príncipe, Saudi Arabia, Senegal, Serbia and Montenegro, Seychelles, Sierra Leone, Singapore, Solomon Islands, Somalia, South Africa, Sri Lanka, Sudan, Suriname, Swaziland, Syrian Arab Republic, Tanzania, Thailand, Togo, Tonga, Trinidad and Tobago, Tunisia, Uganda, United Arab Emirates, Uruguay, Vanuatu, Venezuela, Vietnam, Republic of Yemen, Zambia, Zimbabwe; Palestine Liberation Organization (PLO).

The EU expanded to 25 nations on May 1, 2004, adding the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, Slovenia, Cyprus (greek area) and Malta to Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden and the United Kingdom.

The twenty-one Asian Pacific Economic Cooperation (APEC) countries comprises Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, South Korea, Taiwan, Thailand, United States, and Vietnam.

The ten Association of Southeast Asian Nations (ASEAN) members comprises Brunei, Burma, Cambodia, Indonesia, Laos, Malaysia, Philippines, Singapore, Thailand, and Vietnam.

The NEA3 comprises Hong Kong, South Korea and Taiwan.

The SEA4 comprises Indonesia, Malaysia, the Philippines and Thailand.

The SEA5 comprises Indonesia, Malaysia, the Philippines, Singapore and Thailand.

The Asia 9 comprises Indonesia, Malaysia, the Philippines, Thailand, Singapore, South Korea, Taiwan, China and India.

BRIC: Brazil, Russia, India and China.

The Paris Club are governement lenders (creditors) who have renegotiated / restructured sovereign debt.

The London Club are commercial bank lenders (creditors) who have renegotiated / restructured sovereign debt.

The International Monetaty Fund (IMF) was designed to manage the balance of payments relationship between nations.

Sovereign Wealth Funds

A number of nations who have earned substantial foreign currency reserves either through either commodities sales or current-account surpluses through trade operate Soveriegn Wealth Funds. There is concern about the fund making investments in strategic businesses in foreign nations as the fund managers ultimately answer to a foreign government (they are not managed by intermediary asset managers). The concern is over national security such that there may be some sort of political motivation for the investment becuase it may provide a foreign government with the ability to exercise influence over business sectors, activities and decisions that are in the national interest of the fund but not in the national interest of the nation where the asset(s) are domiciled. Secondly, there is the complaint that there is insufficient disclosure from the funds regarding their management, operations and investment guidelines.

Sovereign Wealth Funds:: Australia: Australia Future Fund; Canada: Alberta Heritage Fund, managed by Alberta Investment Management (AIM); China: China Development Bank (CDB); Kazakhstan: Kazakhstan National Fund; Korea: Korea Investment Corporation (KIC); Kuwait: Kuwait Investment Authority (KIA); Mayaysia: Khazanah Nasional; Norway: Government Pension Fund-Global (Statens pensjonsfond - Utland), managed by Norges Bank Investment Management (NBIM); Qatar: Qatar Investment Authority (QIA); Russia: Stabilization Fund of the Russian Federation; Saudi Arabia: Several funds under the control of the Saudi Arabian Monetary Agency (SAMA); Singapore: Government of Singapore Investment Corporation (GIC); Singapore: Temasek Holdings; Sultanate of Brunei: Brunei Investment Agency (BIA); UAE: Abu Dhabi Investments Authority (ADIA) - In November 2007, the ADIA agreed to invest $7.5 Billion for a 4.9% interest in Citigroup.; UAE: Abu Dhabi Mubadala Development; UAE: Dubai International Capital - owns interests in Sony Corp., European Aeronautic Defence & Space Co. (EADS), Daimler AG and HSBC Holdings Plc.; UAE: Emirates Investment Authority

National pension funds usually invest in local currency assets but are increasingly investing outside of the nation: NPS (South Korea), Superannuation Fund (New Zealand), GPIF (Japan)