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Standard & Poor’s Ratings Services has issued its first report assessing the impact that a war in

  • Iraq could have on sovereign creditworthiness. The report states that governments that rely heavily upon commercial cross-border financing may be more at risk than rated sovereigns in the Middle East. 

    The article, entitled “The Consequences of a War in Iraq on Sovereign Credit Ratings”, states that Standard & Poor’s current 93 sovereign ratings include as a premise that a war with Iraq would be short and decisive. A longer war, however, would tilt the risk to the downside in key areas. These include:

    • Political risk. Standard & Poor’s believes that the current leadership of rated sovereigns in the Middle East can withstand economic and political shocks without losing the broad support of their populations for market-oriented programmes, and that public protests, if they occur, would not seriously threaten the existing institutional frameworks. The most serious risk could stem from policy mistakes made under the stress of regional conflict and of policy paralysis in the face of civil dissent, which, in turn, could result in lower ratings.

    • Growth prospects. A prolonged war would keep oil prices high, which, in turn, could lead to a global economic contraction. The fiscal accounts of many sovereigns would worsen, and trade and capital flows would fall. In such an environment, structural flaws in an economy may become more pronounced. Sovereign ratings that have a negative outlook (such as Brazil, Guatemala, Jamaica, Morocco, and the Philippines) would be particularly at risk.

    • Fiscal flexibility. Several sovereigns (notably Brazil, Israel, Lebanon, the Philippines, and Turkey) enter this period of uncertainty with the declared aim of tightening their fiscal stance. However, the ability of governments to raise revenue and cut spending will diminish if a war is prolonged, and ratings could suffer where reductions in budget deficits do not occur.

    • External finances. Heightened uncertainty during a war would likely lead to increased risk aversion on the part of international banks and cross-border investors. Countries with large commercial external financing requirements (be they from the public or private sectors) would be at greater risk than those that do not rely upon confidence-sensitive capital flows. Sovereign ratings at risk during a prolonged conflict would include those of Brazil, Jamaica, and Turkey. To a lesser extent, the ratings of Belize, the Dominican Republic, Mexico, and the Philippines could also come under pressure.

    The study concludes by noting that a war of limited duration would have little negative impact on current sovereign ratings. However, according to sovereign analyst John Chambers, a more difficult war would be a greater challenge, one that will not necessarily lessen as the distance from Baghdad increases. “Sovereigns that rely upon commercial cross-border debt to finance external borrowing requirements or that enter this period with an inappropriately loose fiscal stance may be far from the conflict but could have their creditworthiness hurt more than those nations closer to the fray,” he concludes.