S&P Global Ratings looks at the sovereign ratings trends in 2024 with mixed feelings.   On one hand, a better-than-expected economic performance in 2023 supported a stabilization of sovereign ratings across the world (see table 1). An overall improving outlook balance signals that this trend could continue in 2024. On the other hand, fiscal consolidation that improved after the pandemic has stalled in 2022 and 2023. While still manageable, fiscal dynamics could come under pressure if funding costs stay high. The cushion for fiscal support for the economy is getting too thin to sustain current rating levels, should governments have to face yet another crisis.

Table 1

Fiscal consolidation is lagging across the world.   Only some sovereigns at the lower end of the ratings spectrum are showing signs of fiscal tightening--in most cases because they have no access to market financing or have recently defaulted, or both. As a result of a combination of post-pandemic fiscal support and higher cost of funding–stemming from central banks' substantive increases in monetary policy rates–both consolidation and deficit financing are proving more difficult to achieve.

This is more evident in developed and large emerging market (EM) sovereigns.   For example, we expect the Group of Seven nations to close 2023 with a weighted average fiscal deficit 33% higher than in 2019. We also expect the larger EM economies to close 2023 and 2024 with fiscal deficits that are 30% and 26% higher than 2019's results, respectively (see chart 1).

Chart 1

Overall stocks of debt, while down from the peaks of 2020, are still larger than before the pandemic (see chart 2), which could strain sovereigns with large fiscal deficits.   That is even after inflation has boosted nominal GDP and government revenues in a context where the cost of servicing this debt is exponentially higher.

Chart 2

Looking ahead into 2024, we still think that developed markets, as well as many investment-grade EMs, have a larger cushion until higher financing costs make their way through the sovereigns' debt profiles.   While this is a key factor behind most of our stable outlooks, the emerging risk is that should governments have to face another large crisis, ratings may face downward pressure.

Four sovereigns (Argentina, El Salvador, Mozambique, and Cameroon) defaulted in 2023 as of Dec. 1, and the risk of further defaults remains high.  In addition, five rated sovereign remain in default (Ghana, Lebanon, Sri Lanka, Suriname, and Zambia). We also currently have eight sovereigns in the 'CCC' category, highlighting the high risk of more defaults coming in 2024 (see table 2).

Table 2

Geopolitical risk is at its worst in decades and continues to pose destabilizing threats.  The Russia-Ukraine war continues in full force. The hopes of an improvement in the situation after the summer Ukrainian counteroffensive has passed, and the protracted conflict continues to present many uncertainties and risks on how events could turn out over the next few months.

In addition, the Oct. 7 attacks on Israel by Hamas ignited another source of geopolitical instability, this time in the Middle East.   Israel and Hamas are engaged in a full-on military conflict that could potentially drag in other nations like Iran and the U.S. with many negative consequences for the global economy. In Asia, the already-tense situation between China and Taiwan adds risks to a very fragile geopolitical environment. At any moment, if any of these conflicts and points of tension deteriorates further, we could quickly see pressure on food, energy, and other commodity prices complicating inflation-reduction, hurting economic growth, and putting negative pressures on sovereign ratings.

Finally, 2024 will be a big elections year globally.  More than 60 sovereigns, including the U.S., Mexico, South Africa, Ghana, Senegal, India, Indonesia, Pakistan, El Salvador, Panama, Uruguay, Dominican Republic, Taiwan, Finland, Iceland, Lithuania, Romania, Slovakia, and the European Union, will be going through general elections, which presents serious risks of policy swings and uncertainty.

Chart 3

Regional Outlooks

European developed markets

We rate 30 developed sovereigns in Europe, the highest concentration of wealthy states globally, including four members of the G-7. That said, while it will likely avoid recession in 2023 and 2024, we expect Europe's growth rate to be the lowest of all developed nations.

Our key concern is the fiscal trajectory. Specifically, in those larger European sovereigns, including Italy, Spain, and the U.K., where gross debt is close to or above 100% of GDP, we project government spending as of the end of 2023 to exceed pre-pandemic levels by 4 percentage points (ppts) of GDP.

These chronic fiscal imbalances are also a function of weak growth outcomes and constrained political appetite for frontloaded progrowth reform. We believe the cushion for fiscal support is too thin to sustain current ratings, should governments have to face yet another downturn. In this context, we have a negative outlook on France, where we see limited progress on lowering gross debt to GDP over the next three years, with underlying primary balances remaining in deficit into 2026 on the back of a spending level of 57% of GDP, which is 10 ppts above the G-7 average.

On the other hand, some smaller and faster growing economies, with larger services sectors (especially tourism) and a stricter line on energy subsidies, made greater inroads into putting debt to GDP on a steep downward path. For those reasons, during 2023, we upgraded three European sovereigns: Iceland, Ireland, and Greece, the last back to investment-grade for the first time since 2010. We also moved to positive the outlooks on the ratings of Cyprus, Portugal, and Andorra.

Emerging EMEA

Some stability has returned to rating trends for the 55 EM sovereigns in EMEA we rate, and we think this could continue into 2024. We upgraded six sovereigns (including Cameroon to 'CCC+' in the aftermath of a technical default) and downgraded five. Upgrades were skewed toward large hydrocarbon/commodity exporters, including Congo-Brazzaville, Oman, and Saudi Arabia.

On a positive note, some of the more acute macroeconomic side effects of the Russia-Ukraine war have started to fade, in line with stabilizing energy prices. Median inflation across all 55 emerging EMEA sovereigns receded to 7.0% this year versus nearly 10% in 2022, albeit still over twice the 2019 average.

Looking into 2024, emerging EMEA sovereigns have limited remaining fiscal space. The government interventions to protect households from the pandemic and higher food and energy prices have together added an average of 13.5 ppts to gross sovereign debt for this cohort since 2019 (excluding oil exporters), bringing the overall median to about 60% of GDP.

While we have an improving economic forecast for several sovereigns in eastern Europe--like Poland, Romania and Hungary--uncertainties around the Russia-Ukraine war and the political appetite for fiscal consolidation remains.

Most frontier markets sovereigns remain with limited access to external financing, or are excluded altogether, and rely on more costly and shorter-term local financing.

Lastly, ratings dynamics in the sovereigns in the Gulf Cooperation Council (GCC) remain positive on the back of high oil prices, though the Israel-Hamas war present risks and uncertainty to the 2024 outlook.

Table 3

Americas

The average sovereign rating in the Americas has returned to close to pre-pandemic levels. In 2023, economic growth was better than expected. While inflation and financing cost remain elevated, the region saw an improvement on its overall credit quality. That said, we expect weak external demand in advanced countries, along with the lingering effects of higher interest rates, to limit growth in 2024.

U.S. and Canada.   A sharply divided U.S. government, with each party narrowly controlling one house of Congress, sets the stage for political developments until national elections in November 2024. In early June, President Joe Biden signed legislation to suspend until January 2025 the U.S. government's statutory debt ceiling, which had become binding in January 2023. The law was approved after protracted negotiations between the president and then Republican House Speaker on fiscal and other policies. Subsequently, the House Speaker lost his position due to opposition inside the divided Republican party. Persistent political polarization reduces prospects for substantial fiscal legislation to pass in 2024.

Economic growth in Canada is likely to dip to 0.7% in 2024 from 1.1% this year due in large part to weak consumption and domestic demand. Unemployment is set to rise above 6% next year. Such concerns and the government's low popularity raises the likelihood that the next federal election will be held before its latest due date of October 2025. However, in contrast with the U.S., in Canada the lack of a majority government has not led to material policy or legislative impasses.

Latin America and the Caribbean.   Economic growth is likely to decline toward 1.2% in 2024 on average in Latin America from 1.7% in 2023, reflecting in large part deceleration in both Brazil and Mexico, the two biggest economies in the region. Weak external demand in advanced countries, along with the lingering effects of higher interest rates, will limit growth in 2024. Inflation is likely to decline throughout Latin America, giving scope for moderate cuts in the central bank policy interest rate.

The Latin American region is the world's largest net exporter of food, positioning it to benefit from the growing demand for products--including soybeans, meat, and corn--coming from the expanding middle class in Asia. The rearrangement of global supply chains, leading to "near shoring," offers opportunities to many regional countries to insert themselves in new production networks. Foreign direct investment (FDI) has been rising around 40% in Mexico in 2023, much of it due to near shoring.

Table 4

Asia-Pacific

The stable outlooks on practically all long-term foreign-currency sovereign ratings in the region suggest that there will be few, if any, rating changes in the next year or so. We expect economic and financial conditions to allow most sovereigns in Asia-Pacific to maintain their current creditworthiness in the next one to two years.

Economic growth in 2024 is unlikely to be as strong as 2023 but will remain resilient in most cases. Domestic demand in major economies will likely expand at slower rates in 2024. The relative strength of consumer demand in many parts of the region this year owed much to rebounding spending as the pandemic-related restrictions were removed. This momentum has slowed, and spending growth will likely moderate toward more normal rates of growth in the year ahead.

Like in the rest of the world, high inflation has forced some governments to spend on measures to cushion the impact of higher prices on their population. Interest payments in local currency terms also rose for governments with significant foreign currency debts when their exchange rates weakened. Otherwise, budgetary shortfalls would have been smaller.

Prospects of better future fiscal performance are particularly important for China. The pandemic and the troubles in its real estate sector have materially weakened public finances over the past two to three years. The Chinese economy has struggled to find its footing as real estate sector activities remain weak and external pressures constrain both exports and investment. The fiscal repair that we expect will keep China's credit metrics at its current 'A+' rating level may not come in the next couple of years if sluggish economic momentum continues to prevent the government from meaningfully improving its fiscal performance.

Table 5