Tough conditions await firms that are preparing to do business in emerging markets (EMs) this year, Fitch Ratings has warned, as sovereign nations in that category attempt to cope with a range of daunting challenges.
In particular, the ratings agency has highlighted the combination of higher US interest rates, a stronger US dollar, weak commodity prices, sluggish global trade and heightened political risks as potentially detrimental to EMs’ progress.
As 2015 neared its end, Fitch downgraded the sovereign ratings of both Brazil and South Africa, adding to the list of negative-rating actions for large EMs – which already included Russia, downgraded last January.
That trend marks a stark contrast with EMs’ performance over the previous decade, when they achieved stable to improving ratings. Indeed, Fitch noted, rating prospects are almost the “mirror image” of those for developed markets, with a negative/positive rating outlook ratio of about 2:1.
The agency further stressed that “macroeconomic headwinds are affecting the outlook for corporates and banks in EMs”, with FX volatility posing a threat for many leveraged companies – especially those with foreign-currency debt to refinance.
Amid those headwinds, banks are facing up to the prospect of weakening asset quality, and are vulnerable to diminished sovereign support, which may be inevitable in light of the strain on EM governments’ finances.
However, Fitch pointed out, perhaps the most significant problem is private-sector debt, which “has risen rapidly in key EMs in the last decade, surpassing government debt levels and potentially exposing their economies, financial systems and sovereign credit-worthiness to downside risks”.
In an analysis of seven large EM countries (Brazil, India, Indonesia, Mexico, Russia, South Africa and Turkey), Fitch discovered that wide private-sector debt had risen to an estimated average 77% of GDP by the end of the 2014 financial year – up from just 46% in 2005.
Brazil proved to be the most concerning of those seven countries, hitting the highest level of private debt at 93% of GDP.
According to the agency’s estimates, 24% of private-sector debt for those seven countries is raised externally through bonds and loans. “Foreign financing is less stable,” it said, “and often involves currency risk, amplifying vulnerabilities. Capital flows to EMs reduced sharply during 2015, especially from mutual funds.”
Fitch added that the results of its latest surveys of investors in Europe and the US revealed a “strong aversion” to EM debt, based on concerns over “deteriorating fundamental credit conditions”.
Respondents also said that EM problems currently pose the greatest single threat to US and European credit markets.