In this blog, speakers from the ACT webinar 'Forecasting 2020 - credit events to shape the debt markets', Naresh Aggarwal, Associate Director of Policy and Technical at the ACT and Alex Griffiths, Managing Director and Head of EMEA Corporate Ratings at Fitch Ratings answer the quesitons raised by attendees.
Economic activity in China has been decelerating since early 2018, due initially to the impact of the government’s financial de-risking campaign, and more recently as a result of the US-China ‘trade war’. Year-on-year exports have turned slightly negative, with exports to the US down sharply. Retail sales and investment have slowed as well. It is impossible to separate all the underlying drivers, but for context our forecast for China GDP growth in 2020 fell from 6.0% in our June 2019 Global Economic Outlook to 5.7% in our September 2019 GEO. This forecast revision was entirely due to the escalation in the US-China trade war in August.
The recent Phase One agreement to cut some US tariffs and suspend earlier plans to raise US tariffs further is positive. If it is implemented in full it would help keep China’s GDP growth closer to 6% in 2020. However, the effective tariff rate would still be significantly higher than it was before the trade war began however, illustrating that the trade war is far from resolved.
The strengthening of economic policy frameworks has been an important driver of upward movement of CIS ratings in recent years, and this will continue in 2020. The process is most advanced in Russia, where the macro framework is entrenched and has shown resilience in the face of external shocks. The reform agenda in Russia is moving to boosting economic growth and the policy challenge is to deliver faster growth without compromising macro stability gains. However, sanctions risk for Russia will remain high and difficult to anticipate due to the number of geopolitical flashpoints, US domestic politics and the absence of a de-escalation path.
We assume Ukraine and the IMF will agree a new programme that will anchor policy after investors responded favourably to the early actions of the Zelensky administration. Politics, notably vested interests’ strong influence, will weigh on Ukraine’s ability to improve its weak track record with implementing IMF programmes. Similarly, the recently elected Armenian government has committed to a meaningful reform programme. Uzbekistan is also implementing widespread and rapid reforms and in 2020 will continue to face the challenge of balancing structural gains with policy coordination issues that have contributed to rapid credit growth and a high current account deficit. Elsewhere, the IMF programme will anchor policy in Georgia while it adjusts to the Russian flight ban, while policy credibility in Kazakhstan may be tested in the context of recent deviation from fiscal rules and the evolving role of the former president.
Chinese authorities have set an annual sales target of 2 million units for electric vehicles (EVs) in 2020. This compares to our expectation for total Chinese auto sales of around 21.6 million in 2019. We think the 2020 target is likely to be a stretch, as subsidy cuts earlier this year led to the year-on-year declines in monthly sales. But we expect EV sales to resume steady growth in 2020. Foreign brands are also likely to gain share in the Chinese EV market, which is currently dominated by domestic brands, as they sacrifice profitability for volume in response to China’s tightening fuel-efficiency requirements.
The regulation of emissions and the cost of producing carbon dioxide are becoming an increasingly important factor for the corporate sector, and have contributed to the negative outlook we have on some sectors for the year ahead.
More stringent European emissions targets for auto manufacturers have the potential to severely disrupt demand for new vehicles and manufacturers’ profitability in 2020 at the start of a phase-in period. Manufacturers need to increase electric vehicle sales to avoid penalties under the new rules, but margins on these vehicles are lower and the adoption rate is uncertain.
New regulations on sulphur oxide emissions will push up operating costs or capex for shipping companies due to the choice of buying more expensive low-sulphur fuels or installing scrubbers to reduce emissions. The significant rise in carbon prices under the EU Emissions Trading System is also affecting costs and investment decisions in the steel sector and among utilities.
More generally, we believe the gap between government’s pledges on emissions and the actions they have taken increases the risk of a rapid increase in the scope of climate regulation.
European countries have different degrees of fiscal space. Highly indebted sovereigns have limited room for manoeuvre, while countries with more fiscal space appear reluctant to use it. We therefore expect only modest fiscal loosening in the eurozone in 2020.
We do not yet sense that a large German fiscal easing package is likely in the near term, despite an intensifying policy debate. The German slowdown is due to weakness in external demand, while domestic demand remains solid and some sectors (particularly construction), are operating very close to full capacity. Against this backdrop, the German authorities appear reluctant to launch a large fiscal stimulus package and abandon the “Schwarze Null” central government balanced budget rule. Among other eurozone countries with more fiscal space, the Netherlands has announced a modest fiscal stimulus plan.
UK companies are generally significantly more exposed to Brexit risks as the EU represents a much bigger proportion of cross-border trade for the UK than the UK does for the rest of the EU. The long-term introduction of tariffs and non-tariff barriers, or the shorter-term border disruptions that could come with a hard Brexit, would all therefore affect the UK corporate sector more significantly than the EU.
The regulatory environment and trade relationships with third-parties will also be unaffected in the EU, but are subject to change in the UK, creating uncertainty and the potential for new costs. Of course, while the overall impact will clearly be higher in the UK, there are likely to be European companies that are disproportionately affected. For example this could be because they have significant exports to the UK or are reliant on UK suppliers as part of a just-in-time supply chain.
BBB issuance growth reflects many factors, but central to the trend is the fact that very low interest rates and spread compression have significantly reduced the borrowing-cost advantage of a higher investment grade rating. This has helped make issuers comfortable with operating at the higher leverage levels associated with the BBB category.
Many companies have taken advantage of cheap debt to buy growth through M&A activity, as organic growth has been harder to achieve in a relatively weak economic environment. Others have used debt to bolster returns to shareholders.
Our recent CLO stress test found investment-grade CLO note ratings would remain broadly resilient to leveraged loan recovery falls by 20%-50%, a significant shock when considering both average and peak historical default rates and the stresses the agency applies in its rating analysis.
More details of the stress test, and how it differs from our base case, can be found here.
