Credit quality struck an upbeat note in the emerging markets in the final quarter of 2003, with upgrades advancing over downgrades for the second consecutive quarter, a report released from Standard & Poor’s Ratings Services says.

Downgrades accounted for only 30% of all emerging market rating actions in the fourth quarter. Furthermore, for 2003 as a whole, 62 upgrades and 57 downgrades were recorded, resulting in a downgrade ratio of 48%, the lowest recorded since 1996.

The proportion of issuers listed with a negative bias has declined substantially relative to a year ago: as of January 20, 16% of rated issuers in the emerging markets were listed either with a negative outlook or a CreditWatch with negative implications compared with 24% at year-end 2002.

“Improved creditworthiness has been among the factors contributing to increased demand for emerging market securities in 2003,” Diane Vazza, head of Standard & Poor’s Global Fixed Income Research group, says. “Other helpful factors include a higher appetite for risk among investors in a record, low interest-rate environment in addition to country-specific domestic drivers.”

Looking ahead, the appetite for emerging market securities is expected to remain strong while the global economic recovery builds up momentum, and investor risk aversion declines. Nevertheless, there will remain significant credit quality variations by region, resulting in selective differentiation by investors.

Notwithstanding political developments in Russia that tarnished some of its lustre in the final quarter of 2003, issuers in Eastern Europe/Middle East/Africa (EEMEA) – notably Romania and Bulgaria – show the most promise in terms of potential upgrades, driven in part by the favourable economic and political trends in those countries.

In Asia and Latin America, issuers listed with a negative bias outnumber those listed with a positive bias, even though the negative bias has substantially declined since the end of 2002. The decline in negative bias was especially dramatic in the case of Latin America, where the proportion of issuers listed with a negative bias fell to 17% at year-end 2003 compared with 42% 12 months earlier.

Looked at by sector, telecoms appeared well poised to recoup some of its lost favour, even though downgrades still constituted half of all rating actions in this sector during 2003. Another sector that appeared well positioned to benefit from potential upgrades was banks. On the flip side, issuers in homebuilders/real estate, financial institutions and capital goods appeared among the most vulnerable to potential downgrades, with the proportion of rated issuers with a negative outlook in each sector listed at 50% or higher.

Rating activity in the emerging markets continued to maintain an upbeat tone in the fourth quarter of 2003. Both the number of upgrades and downgrades declined relative to the third quarter, but the downgrade ratio – ratio of downgrades to total rating actions – fell further to 30% from 36% in the third quarter. For 2003 as a whole, 62 upgrades and 57 downgrades were recorded, resulting in a downgrade ratio of 48%, the lowest recorded since 1996.

Much of the activity in the fourth quarter occurred in the sovereign domain, which recorded five downgrades and four upgrades. Downgrades affected Bolivia, the Dominican Republic (which was downgraded twice), Papua New Guinea (local-currency ratings only) and Poland (local-currency ratings only). The downgrade on Bolivia to ‘B-‘ from ‘B’ on October 20, 2003 reflected the intensifying policy challenges stemming from severe political and institutional deterioration, in the context of an extremely weak fiscal position. Ratings on the Dominican Republic were lowered to ‘B-‘ from ‘B+’ and again to ‘CCC’ from ‘B-‘ in light of the government’s failure to respond adequately to a deepening financial and economic crisis, and the risk of a delay in restarting a stand-by programme with the International Monetary Fund. Long-term local currency sovereign credit rating on Papua New Guinea was lowered to ‘B+’ from ‘BB-‘ on December 22, 2003, reflecting persistent weak public finances, lacklustre growth prospects, and difficult monetary conditions. Poland experienced a downgrade to ‘A-‘ from ‘A’ on November 5, 2003 in its long-term local currency sovereign credit and senior unsecured debt ratings as a result of widening fiscal deficit projections and the continued rapid increase in the government’s indebtedness.
On the flip side, three Southeast Asian nations – Indonesia, Malaysia, Thailand – and Turkey experienced upgrades in the fourth quarter. Ratings on the Southeast Asian nations were raised simultaneously on October 7, 2003 in recognition of their strong fiscal performance. Other factors that spurred the upgrades were stable exchange rates and increased inflow of foreign investment into Indonesia, a smooth leadership transition in Malaysia, and continued improvement in balance-of-payments flexibility in Thailand.

Meanwhile, the upgrade in Turkey’s long-term sovereign ratings to ‘B+’ from ‘B’ on October 16, 2003 reflected the significant progress made by the government towards meeting the year-end 2003 financial targets under its IMF-supported programme and its continued commitment to implement the programme in 2004.

All three regions saw an improvement in credit quality in 2003 compared with 2002. By region, EEMEA recorded the lowest downgrade ratio (15%) versus 33% in the Asia-Pacific region. Meanwhile, Latin America was the only region where downgrades still outpaced upgrades, but at 77%, the proportion of downgrades to total rating actions is much lower than the 87% and 92% recorded in 2002 and 2001 respectively. Downgrades in Latin America still reflected high refinancing risk and weak operating performance by lower rated issuers in the fourth quarter, although early signs from January indicate that a gradual recovery in demand and better operating performance has diminished refinancing risk.
Much of the improvement in the annual downgrade ratio resulted from the investment-grade segment (‘BBB-‘ and above). The downgrade ratio in the investment-grade segment declined to 38% in 2003 compared with 41% in 2002. Meanwhile, the downgrade ratio in the speculative-grade segment (‘BB+’ and below) also recorded a substantial improvement, dropping to 52% in 2003 versus 75% in 2002.