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A gradually recovering global economy will support continued stable credit quality of the world’s sovereigns in 2015, Moody’s Investors Service said in its annual Global Sovereign Outlook. However, the rating agency sees four risks on the horizon that could interrupt growth and undermine sovereign creditworthiness across the globe.
“While the overall credit outlook for sovereigns around the world is stable for 2015, it is vulnerable to a set of shared risks, albeit to different degrees in different regions. The principal ones are the possibility of confidence shocks from the expected rise in US interest rates, especially in the case of a disorderly market reaction, the impact of lower growth in China and the euro area, the overhang of geopolitical risks, and reform fatigue,” said Alastair Wilson, head of Moody’s Global Sovereign Risk Group.
“On the positive side, global GDP growth is likely to continue at a steady pace in 2015, though at lower levels than before the crisis,” continued Wilson.
A major driver of sovereign creditworthiness will be the expected normalisation of US monetary policy. While higher US growth should imply positive economic conditions for sovereigns across the globe with trade links to the strengthening US economy, normalization poses risks should market participants come to fear that the process will be a disorderly one, Moody’s said. That would pose risks to sovereigns in the euro area and to emerging markets that are highly indebted and reliant on confidence-sensitive capital flows. For example, higher US interest rates could encourage European and international investors to re-balance their portfolios in favour of US debt at the expense of European bonds at a time when yields on European sovereign bonds are at historical lows.
In addition, while Moody’s expects inflation to remain in positive territory on average across the euro area throughout 2015, low real growth and deflationary risks will continue to weigh on sovereign credit profiles in the region. The European Central Bank’s willingness to expand its balance sheet is credit supportive, but its ability to stimulate growth and inflation at the current juncture is limited.
Euro area growth will also likely be linked to global growth, given the continued weakness of domestic demand and dependence on external demand and world trade. Moody’s expects Chinese growth, one of the drivers of global GDP, to be between 6.5% and 7.5% in 2015. But a slower than expected expansion would further undermine global economic prospects. Sub-Saharan Africa could also be negatively affected by a sharper-than-expected slowdown in Chinese demand or further deterioration in commodity prices, resulting from commodity exporters’ significant trade linkages and China’s significant contribution to some African countries’ foreign direct investment. Moody’s also noted that geopolitical risks, such as those posed by the Russia/Ukraine crisis and the turmoil in the Middle East, will continue to pose a threat to investor confidence in the affected countries and neighbouring regions. Nevertheless, barring a significant escalation in tensions that has a broader impact on confidence, capital flows and growth, the rating agency expects that the impact on sovereign creditworthiness will continue to be limited to those governments in closest proximity to each crisis.
Finally, governments across the world have identified structural reforms needed to enhance medium term growth. Their success will be an important medium term credit factor and, more immediately, a driver of investor confidence. At the euro area level, the absence of fundamental reform to address the gaps in fiscal and economic governance that the crisis laid bare also remains an important constraint on sovereign ratings. These governance gaps represent a potential source of risk, should investor sentiment begin to turn more negative in response to other shocks.