A Tale of Divergence

At this time last year, the global economy was growing at a decent pace, interest rates were rising, and the U.S. dollar was strengthening. But, over the past twelve months, policy uncertainty has risen, momentum has slowed, and at least 33 central banks—covering most of the global economy—have cut rates. While many emerging markets benefitted in the post-financial crisis environment, investors and debt holders are increasingly cautious, leading to another bout of capital leaving riskier markets. What does this mean for EDC’s country risk rating outlook?

Well, it depends. Emerging markets are often lumped into a single category, based on the false assumption that global risks affect most markets similarly. In an environment of heightened uncertainty, risk rating trends reveal a stark divergence between resilient and vulnerable markets. Over the last year, our data show that not all risks impact emerging markets equally. In a highly globalized environment, the nuances of a particular country can make or break it.

Here are a few examples from EDC’s latest Country Risk Quarterly. 

Vietnam and Thailand are on the upswing. Despite global trade tensions, these booming Asian markets are reaping benefits. Vietnam presents an abundance of opportunities, ranging from agriculture to energy renewal infrastructure. Thailand has also been a key destination for Canadian agriculture and advanced technology products. Both markets are distinguishing themselves as an alternative path to entering Asia, given the U.S.-China trade dispute. And it’s working. Great opportunities, but what about the risks? Due to their position as production alternatives, their respective governments have been increasingly attracting foreign investors by implementing pro-business policy reforms focused on competitiveness. In turn, risk is declining, and this trend is unlikely to be reversed. One risk to keep in mind, however, is that lower cost production centres tend to be more vulnerable to technological evolution and competition. And there is still some way to go to strengthen the institutional and regulatory environment. It will therefore be prudent to evolve with the tide. 

On to the bad news. Two themes have taken a turn with varying degrees of intensity. First, access to financing is tightening for markets that quickly accumulated debt during the boom, like Argentina. Starting in 2015, Argentina was a darling in South America. The country put out a 100-year bond that was oversubscribed. While there was reason for optimism in Argentina, it was disproportionate to underlying risks. On the tail of slipping global optimism and an already challenging 2018, this year has been no better. Upcoming elections are expected to result in a change in government, and the worry is that the next administration will reverse the trend of pro-business reforms and bring instability. This policy uncertainty, coupled with large currency swings, has spooked investors, and there’s an emerging consensus that Argentina is headed for a large debt restructuring. This will hurt domestic activity, particularly as the government implements policies to reduce large outflows of foreign exchange.

The second issue is the political fragility plaguing some previously bright spots. Nigeria is now being hit by both rising violence and escalating debt. While it benefitted from high oil prices in the recent past, Nigeria no longer has the safety of large commodity-related inflows to keep voters happy. As oil prices have fallen, the government’s ability to manage its finances has faltered. Nigeria’s inability to prudently manage windfalls and prepare for the hard times has in part led to the government renegotiating oil contracts. Not only are investors worried, it’s also constraining current activity. Adding to the financial troubles are rising security concerns. Nigeria holds significant oil reserves, but mismanagement has exacerbated the inability to address the rising violence.

Over the last twelve-to-eighteen months, global trade tensions have led to winners and losers. Shifting investor appetite did the same. While certain markets have been able to withstand the oscillation, others have been hard hit. From our assessments, for every EDC country risk rating upgrade, there has been two downgrades, most changes occurring in emerging markets. This signals that over the next twelve months, global trade uncertainty, slowing growth and timid foreign investing will continue to peel away the layers of excess added during the recovery from the Great Recession and expose the structural strengths and weaknesses of markets. But it’s not all doom and gloom because there are growing divergences amongst the emerging cohort.

The bottom line?

In this environment, proceed with caution and awareness. There are risks, some more challenging to overcome than others. Rising uncertainty also allows for the brave and informed to find opportunities. How we perceive country risks can shift on a dime; leveraging resources like EDC’s Country Risk Quarterly to stay up to date with the latest developments can help you jump into new markets with eyes wide open.

This was written by Andrea Gardella, Senior Economist at Export Development Canada.