October 18, 2016 / 10:02 AM / a year ago

Fitch: Terms of Trade Weighing on EM Sovereign Ratings

(The following statement was released by the rating agency) Link to Fitch Ratings' Report: Terms of Trade Weigh on EM Sovereign Ratings here LONDON, October 18 (Fitch) Fitch Ratings says in a new report that shifts in the terms of trade (the ratio of export prices to import prices) can have a profound effect on economies and sovereign ratings. Emerging markets have been hard hit by the dramatic fall in commodity prices since mid-2014 as they are net exporters of commodities. This has been the single most important factor behind the wave of 13 EM sovereign rating downgrades in 2015 and a record 18 in 2016, a combined two-thirds of which were major commodity exporters. A decline in the terms of trade can lead to a fall in growth and GDP per capita, deterioration in current account and budget balances, a rise in public debt or a drawdown in assets, and a decline in foreign exchange reserves and/or exchange rates. Countries lacking fiscal and external buffers may have to make pro-cyclical spending cuts to narrow twin deficits. In severe cases, a rise in borrowing costs, loss of capital market access, asset price falls, worsening bank asset quality and political stresses can add to challenges. Overall, Fitch estimates that EM terms of trade have declined by 20% over 2014-2016, based on adjusted UNCTAD and IMF data. The EM regions that have seen the greatest declines are the Middle East & North Africa (MENA), the Commonwealth of Independent States, sub-Saharan Africa (SSA) and Latin America. In contrast, China has gained, helping to cushion the impact of its growth slowdown on living standards. Shifts in the terms of trade are strongly correlated with sovereign rating actions by Fitch, by region and for EMs as a whole, as demonstrated by the relationship between indices of the terms of trade and Fitch's Sovereign Credit Index (SCI) of average ratings. The relationship is strongest for the main commodity exporting regions: SSA, MENA and Latin America. EM sovereign ratings are still on a downtrend, even though commodity prices started falling in mid-2014 and appear to have passed their trough. Ratings for commodity exporters build in some tolerance for price shocks, particularly where buffers are large. Critically, sovereign rating actions also take account of the size and effectiveness of a country's policy response to terms of trade shocks. The drop in oil prices proved larger and longer than expected when the cycle first turned. The full impact can take time to feed through to credit metrics, as countries initially draw on reserves and financing options, and due to lags and informal buffers in the economy. The impact of oil prices on budgets is non-linear and so proved much more challenging when they dropped further to USD35/b in 1Q16. Many countries are still running substantial twin deficits at current oil prices and thus still experiencing rising public and external debt ratios. Sixteen EM sovereigns are on Negative Outlook, of which half are heavily dependent on commodity exports, signalling that further downgrades are likely. Fitch's forecast assumption is for only a gradual increase in Brent oil prices, from an average of USD42/b in 2016 to USD45/b in 2017, USD55/b in 2018 and USD65/b by 2019. Nevertheless, if commodity prices slowly recover, this should start to feed through to stronger economic performance. The strong historical relationship between the terms of trade and EM sovereign ratings suggests the outlook should then start to brighten. The report, "Terms of Trade Weigh on EM Sovereign Ratings", is available on www.fitchratings.com or by clicking the link above. Contact: Ed Parker Managing Director +44 20 3530 1176 Fitch Ratings Limited 30 North Colonnade London, E14 5GN James McCormack Managing Director +44 20 73530 1286 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. 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