19th March 2012
The report from Fitch on the UK brought little new information, but reiterated the difficulties that face the UK economy:
"By historic standards, the scale of the fiscal challenge facing the UK is amongst the most demanding. The autumn statement in November 2011 extended real cuts in public spending to financial years 2015-16 and 2016-17, beyond the term of the current government. With a weak economic recovery that is vulnerable to adverse shocks such as higher oil prices and the Eurozone crisis, the risks to UK fiscal consolidation are material."
It added that for the UK to retain its AAA status debt needed to stabilise below 100% of GDP and ‘decline in the foreseeable future to below 90%'. The rating agency expects debt to peak at 93% of GDP in 2014/15.
The yield on the UK 10 year bond has moved up from 2.15% a week ago to 2.39%, but most other sovereign bond markets saw similar rises in yields, so the markets appear to be sanguine about Fitch's move. Certainly, the bond markets can be under no illusions about the problems facing the UK economy.
Fitch's Sovereign Review and Outlook, published a day later, showed the extent to which the rating agency is now adjusting to the new market environment. The UK is only one of a raft of downgrades and potential downgrades for developed markets, while emerging markets continue to be upgraded.
The report from Fitch, analysed all global sovereign ratings actions and concluded:
"Sovereign downgrades and upgrades fell largely along the developed and emerging market divide. Advanced economies accounted for 70% of downgrades and a single upgrade, or a 7-to-1 ratio of downgrades to upgrades in 2011, with euro zone members leading regional downgrades. In contrast, emerging economies represented just 30% of downgrades and 95% of upgrades in 2011 – a ratio of 0.2 to 1."
The rating agency makes the reason behind the shifting ratings clear: "The accumulation of international reserves, greater monetary and exchange rate flexibility, moderate fiscal deficits and debt, strong growth, and greater resilience to shocks underpinned a broadly positive credit and ratings outlook for emerging markets in 2011. With the exception of the Middle East and Africa, where the political and economic fallout from the Arab Spring took their toll on sovereign creditworthiness, emerging markets credit quality advanced strongly in 2011, with 19 sovereigns sharing in ratings upgrades, compared with 12 in 2010."
Latin America made the strongest headway, with eight upgrades and no downgrades. Emerging Asia also picked up momentum, closing the regional rating gap with Emerging Europe, which found itself more exposed to developments in the euro zone. One notable development in 2011 was the number of emerging markets that moved from speculative to the first rung of investment grade (‘BBB'), including Colombia, Indonesia, Latvia, and Romania.
In contrast Australia was the only developed market country to upgrade – moving from AA+ to AAA.
The UK's downgrade to ‘negative watch' is part of a wider trend of weakness in developed market sovereign credit. The rating agencies are catching up with the reality of the global economic picture, where emerging markets are in the ascendancy and developed markets may well be in terminal decline. In many cases, markets have already adjusted.
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