S&P Just Demolished One Big Distinction Between Emerging and Developed Markets
On Wednesday, S&P Global Inc. dropped a bombshell on the sovereign-credit ratings community.
Sounding the alarm over the rise of populism in Europe and the U.S., the credit agency said key historic drivers of the creditworthiness of advanced economies over their emerging-market counterparts — the strength of institutions and quality of policy making — can no longer be taken for granted.
That represents a potential game-changer for a slew of developed markets, which have historically enjoyed uplifts in their ratings simply by virtue of the strength of their political architecture relative to emerging markets.
"We believe it may no longer be possible to separate advanced economies from emerging markets by describing their political systems as displaying superior levels of stability, effectiveness, and predictability of policy making and political institutions," wrote Moritz Kraemer, chief sovereign ratings officer, in a 2017 outlook report entitled "A Spotlight On Rising Political Risks."
In other words, S&P is gearing up for the prospect of regressive convergence: advanced economies becoming more like emerging markets with weaker political systems.
"We believe that political and institutional uncertainties are on the rise in so-called emerging and advanced economies alike," Kraemer added.
"This represents a big shift in views," says Richard Segal, emerging market analyst at Manulife Asset Management Ltd. "One of the main arguments for higher ratings for developed markets relative to emerging markets has been institutional quality. If that differential — the quality of institutions between the two groups — is narrowing, so might the differential between their credit ratings."
The report cites, among other things, the policy uncertainty associated with U.S. President-elect Donald Trump's victory (which clouds the credit outlook for the AA+ rated economy) and the U.K., where the firm says a hard Brexit outcome now looks more likely, threatening full-scale access to export goods and services in the world's largest-trading bloc.
It also mentions political risks in a clutch of emerging markets from South Africa to Turkey to Brazil, as well as the euro-area — the Italian referendum and the upcoming French presidential elections come to mind — that may destabilize sovereign ratings across the region.
"It's relatively unusual for credit analysts to make forward-looking political judgement in advanced economies, rather than awaiting policy outcomes," Segal adds. "However, it recognizes how challenging the current global political climate is."
To be sure, sovereign-credit ratings between countries have slowly converged over the past decade. Emerging markets played catch-up with their developed countries thanks to strengthening policy frameworks and growth rates. Meanwhile, a wave of sovereign downgrades swept the euro-area in 2012, in light of the Greek debt crisis — the largest sovereign default of all time despite the country's advanced-economy classification by the OECD.
What's more, the lowering of credit ratings on the U.S. in 2011 and the U.K. this year threw into sharp relief rising institutional risks in the West.
In the wake of the global crisis and the euro-area sovereign debt debacle, the three big ratings agencies have revisited their methodologies, focusing on making them more transparent, and sharpening quantitative inputs, such as monetary policy regimes, and financial cycles.
Now, the S&P report suggests there may be a more intensive focus on institutional effectiveness, one of its five rating factors after economic prospects, external liquidity and investment position, fiscal performance, and monetary flexibility.
"We see two broad trends of rising political risks," Kraemer concluded. "The first relates to the fear among some parts of society that they are falling behind, prompting their support of more protectionist and nationalistic parties. The second may be the result of complacency, as a benign external environment has permitted a refocusing on a domestic and more ideological agenda, subordinating the attention on economic management."