While the initial impact of the U.S. rating downgrade will grip CEEMEA markets in an indiscriminate fashion, some degree of differentiation will begin to develop, particularly between the strong and weak credits of the region, Portfolio.hu reports quoting BNP Paribas' research note. Hungary is one of the weakest links in the region.
Risks to Hungary
Ratings agency Standard & Poor’s announced on Friday night that it had downgraded the U.S. credit rating from AAA, which it enjoyed since 1917, to AA+ because "political brinkmanship" had made the government’s ability to manage its finances "less stable, less effective and less predictable." Moody’s and Fitch have not yet followed, although the former warned of such a possibility.
"While the initial impact of the US rating downgrade will grip CEEMEA markets in an indiscriminate fashion, we think that some degree of differentiation will begin to develop, particularly between the strong and weak credits of the region," Portfolio.hu reports quoting CEEMEA strategists' at BNP Paribas research note.
The note says that there is a 'strong credits’ group, which includes South Africa, Israel, and the Czech Republic, and a 'weaker credits’ group, which includes Hungary as well as Poland, and Turkey.
"In this group of countries, central banks generally do not have the luxury to cut interest rates in order to boost domestic demand as it might lead to sizeable currency losses. This is particularly the case in Hungary and Poland, assuming the CHF enjoys more safety bid."
The analysts said Hungary is "at a very high risk," adding that last week's news that local governments would seek to "reprofile" their CHF obligations was badly received by markets.
"The latest release confirms our view that notwithstanding the returning pension assets and the crisis taxes revenues due at the end of the year, the government is at risk of undershooting the 2% of GDP budget surplus goal (2.9% of GDP deficit plus the returning pension assets)," Portfolio.hu quotes Raffaella Tenconi's, analyst at Bank of America Merrill Lynch, comment.
"Rising risk aversion and concerns about the budget outlook in coming years will continue to weigh on Hungarian assets in coming weeks," she added.
Although emerging markets fundamentals are generally better, "no EM is immune from the deepening problems in the US and Europe," commented Capital Economics in a note to clients today.
Neil Shearing, Senior Emerging Markets Economist at Capital Economics in London, believes growth everywhere is likely to slow over the next year. "It would be complacent to downplay the risks to EM growth posed by economic shocks in the West," he added.
While Shearing believes that the initial impact of the S&P downgrade on US markets should be short-lived, he warns that growth in the world’s largest economy "is likely to remain sluggish at best for some time." "Meanwhile, the problems in the euro-zone pose an even greater threat to global stability."
Impact of eurozone crisis on EM
In Shearing’s view the impact of such scenario on EMs will come via two main channels: weaker demand for exports and a disruption to global capital flows.
According to him, there are four main reasons why economies of Emerging Europe look most vulnerable. (1) They rely more heavily on exports to the troubled euro-zone. (2) They are more dependent on foreign capital to finance spending and roll over external debt. (3) High budget deficits (if not debt) mean that there is limited scope for policy stimulus, if needed. (4) The region’s largest economy, Russia, will be hit hard if oil prices fall back, as he expects.
Elisabeth Andrew, analyst at Nordea Bank, shares Shearing’s view. "Up until the end of last week, Emerging Markets currencies were relatively stable, cushioned by generally better fundamentals, but the US downgrade that prompted the G7 and central banks to act with the ECB purchasing Italian and Spanish government bonds, has pushed volatility markedly higher also in Emerging Markets currencies generally today," Andrew said in a research note.