Rating Outlook And Trends

Since the beginning of the pandemic, S&P Global Ratings operated with the view that governments' strong fiscal response to a one-off event like COVID-19 was adequate. However, we also expect governments to gradually withdraw stimulus in order to put debt burdens on a stable--if not declining--path by 2022 or 2023. Over the next six to nine months, a key factor across the ratings spectrum will be the signals from governments as conditions start to normalize.

As most of the world enters another period of lockdowns as a result of surging COVID-19 cases and the emergence of at least three new strains of the virus, governments continue to be the backstop of the world economy. Despite massive fiscal and monetary support implemented in 2020, more will be needed to support economic activity and the population.

Offering some optimism is that a number of vaccines are starting to be available and promise to effectively combat the virus. That said, the production and distribution of the vaccines is a complicated logistical process, and overall inoculation, while underway, is progressing slowly.

As vaccine rollouts in several countries continue, S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic and its economic effects. Widespread immunization, which certain countries might achieve by midyear, will help pave the way for a return to more normal levels of social and economic activity. We use this assumption about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Within this context, a key factor enabling the financing of fiscal stimulus has been the low and decreasing interest rates. This is particularly true for developed economies but also, to some degree, for many emerging markets.

The sustainability of higher debt burdens will largely depend on the pace of the recovery and the level of real interest rates.

In 2020, the largest share of the sovereign ratings and outlooks affected by the pandemic was in emerging and frontier markets, in countries that rely heavily on one industry or commodity producers. They also have a more limited capacity to undertake the type of countercyclical macroeconomic policies that many sovereigns in the developed world were able to implement.

On the other hand, emerging markets could benefit from a growing number of funds searching for yield, as interest rates in the developed world will likely remain very low or negative for a longer period.

A growing risk for fiscal consolidation is that the political and social space for governments could be limited and the tightening of fiscal policy be delayed beyond our expectations, putting pressures on some ratings and outlooks.

26 Negative Outlooks Versus Only One Positive Outlook Indicate A Complicated Year Ahead

S&P Global Ratings rates 135 sovereigns globally (see charts 1 and 2). During the next six months, the global outlook balance for sovereign ratings is negative, with expected downgrades surpassing upgrades by 25 (see chart 3).

Over the next six months, and as the pandemic continues forcing economies to come in and out of lockdowns, risks will remain high and might even grow further.

Chart 1

Chart 2

Chart 3

Regional Outlooks

• Trends among sovereigns in Latin America and Africa indicate that pressures to the downside will remain during the next six to eight months.
• Asia-Pacific (APAC) is the region with the most constructive outlook for sovereign ratings in 2021. Most of the sovereign ratings have stable outlooks, though the number of negative outlooks increased to four in 2020 from none in 2019.
• Ratings on the eurozone sovereigns remain mostly stable on the back of the extraordinary support provided by the European Central Bank and, going forward, on the recently agreed upon EU recovery fund.

Chart 4

Europe, the Middle East, and Africa (EMEA)

Developed Europe.  Most of the outlooks on the 30 European developed sovereigns we rate are stable, while one outlook is negative (Spain).

Following the 2020 COVID-19 recession, sovereign creditworthiness among developed European sovereigns will depend on the pace of economic recovery, which, in turn, depends on the evolution of the pandemic. As governments continue to provide large fiscal support, we project that government debt will increase, on average, by close to 20% of GDP for the larger sovereigns this year, and by 14 percentage points of GDP for the euro area.

While the virus is still rampant in Europe, we do not expect the effects of the second and third rounds of lockdowns to be as severe as the first wave. Businesses have learned to operate in this new environment, better health and safety measures are in place, and protective equipment is more available. In addition, the availability of vaccines has allowed for inoculation to start, albeit at a slow pace. We currently expect most of the rebound will be delayed to the second and third quarters of 2021, when conditions should start to normalize. This means the eurozone is likely to expand by about 4.8% in 2021, following the estimated contraction of 7.2% in 2020.

Governments' ability to gradually repair their balance sheets in tandem with the policy decisions of monetary authorities will be key.

If, as we expect, governments can channel their resources such that economic activity picks up and recovers the ground it lost, we should see many of our ratings remain at the current levels in 2021-2022. Conversely, if the pandemic persists, demanding additional stimulus amid lower-for-longer economic growth, that could weigh on sovereign creditworthiness and lead us to take more negative rating and outlook actions.

Emerging EMEA.  2020 was a tough year for the 53 sovereigns that we rate in Eastern Europe, the Commonwealth of Independent States (CIS), sub-Saharan Africa, and the Mideast.

Most of these, like other emerging market economies, have been severely hit by the pandemic. And unlike developed markets, their capacity to use countercyclical policies to effectively support their economies is more limited. Fiscal deficits widened considerably, to 7.3% of GDP last year from an estimated 1.7% of GDP average in 2019.

Within this context, we downgraded 13 EMEA emerging market sovereigns in 2020 (excluding moves to 'SD'), eight of them sub-Saharan governments, which suffered from a combination of volatile commodity prices, flagging internal demand, and increasing health expenditure.

For 2021, we are projecting that EMEA emerging market economies will grow 3.8%, on average, as positive carryover effects from 2020 and a gradual improvement of the epidemiological situation benefit external demand. China's recovery is projected to remain strong, boosting export prospects for African and Mideastern economies in particular. Currently, 50% of our negative outlooks globally are in EMEA emerging market sovereigns, most prominently in sub-Saharan Africa and, to a lesser extent, in Central and Eastern Europe and CIS.

Asia-Pacific

APAC enters 2021 with a relatively more constructive outlook for its sovereign ratings. The balance remains stable with a negative bias on the back of the economic shock the pandemic has generated. As of Dec. 30, 2020, four governments have negative outlooks (Australia, Fiji, Indonesia, and Malaysia), 16 have stable outlooks, and one has a positive outlook (New Zealand).

Like in the rest of the world, COVID-19 will be the key risk for APAC sovereign ratings over the next six to nine months. After large increases in 2020, we expect general government deficits across APAC sovereigns to start coming down in 2021. However, if coronavirus infection rates are not contained and more lockdowns are needed, these improvements may be significantly less than we expect, which could drive negative rating actions.

China.  China's economic recovery is holding up--we expect GDP to expand 7% in 2021--which is a relief for regional economies exporting to China. Still, key to a sustainable recovery, in our view, will be a pickup in consumer demand, since exports and public investment that led the recovery in 2020 are unlikely to operate at the same pace in 2021.

That said, we expect the geopolitical environment to remain complicated. Even though a new administration has come to Washington, the expectation is that the U.S.-China relations will remain tense in the foreseeable future. Still, we do not expect new U.S. measures to seriously affect the Chinese economy. The risk, however, is that the Chinese government may react in a forceful manner that could derail investor confidence and hurt its growth prospects.

Americas

U.S. and Canada.  The wealth and economic flexibility of Canada and the U.S. give them more scope than the rest of the Americas in managing similar economic challenges. We expect a gradual withdrawal of fiscal stimulus in both countries as the pandemic recedes this year, helping to stabilize their general government debt burdens in the coming years. Amid much political controversy during an election year, the U.S. government undertook similar countercyclical economic policy as other advanced countries. Although political polarization is likely to remain high this year, we expect broad continuity in macroeconomic policies, reflecting the institutional strength and checks and balances of its political system.

In Canada, political consensus on key economic and other policies to combat the pandemic facilitated the minority federal government in undertaking massive fiscal stimulus. Canada's relatively low general government debt burden prior to the pandemic allowed it to spend generously during the pandemic without weakening its financial profile and sovereign rating. However, we expect Canadian fiscal policy to be less expansive this year.

Latin America and the Caribbean.  The pandemic has hit the region hard, and it has deepened the credit quality deterioration that has occurred in Latin America and the Caribbean since the peak of the bonanza years in 2014.

Following the downgrades of 11 sovereigns and the defaults of four in 2020, the region enters 2021 with nine sovereign ratings with negative outlooks.

The challenge of recovering from the pandemic and sustaining economic growth will be more difficult in Latin America and the Caribbean than in much of the world (including Canada and the U.S.), partly because of long-standing political and institutional weaknesses and growing risk of social and political tensions.

The numerous downgrades last year and the nine negative outlooks in the region today reflect the rising net general government debt, weaker external positions (due largely to growing external debt), poor GDP growth prospects after the pandemic recedes, and potential worsening of our institutional assessments.