In May 2016, ACFS hosted a Boardroom Briefing event with three presenters from Fitch Ratings: Eileen Fahey, Chief Credit Officer; David Wong, Regional Credit Officer for the Asia-Pacific; and Mervyn Tang, Director for Asia-Pacific Sovereigns. They presented on the topic of Fitch’s ‘Risk Radar’, which identifies hypothetical geo-economic scenarios that are not included in Fitch’s credit ratings and ranks these scenarios in terms of favourability/unfavourability, urgency, and impact.
Eileen noted that ratings have historically been created through a ‘bottom-up’ approach, but that after the global financial crisis Fitch decided that it needed a more macro perspective. The Risk Radar analyses a number of hypothetical scenarios, including: ‘Brexit’ (Britain’s potential exit from the European Union); a ‘hard landing’ in China; deflation in the Eurozone; a mild US recession; persistently low oil prices; rising US interest rates; and US medium-term fiscal challenges. At present, every scenario is a downside risk.
On Brexit, Fitch’s base case is that the United Kingdom (UK) will vote to stay in the European Union at its referendum on 23 June 2016. If Brexit does eventuate, Fitch is concerned that foreign banks based in London will move to continental Europe, and that protracted trade negotiations post-referendum will weigh heavily on the UK economy. This will have negative ramifications for employment, property prices, and immigration, and will lead to a sharp depreciation of the pound sterling.
On the Eurozone economy, Fitch is concerned about the banking system and the failure of banks to clean up problem assets. If deflation were to emerge, it would exacerbate pressure on public finances and negatively impact on consumers. Fitch’s base case is that quantitative easing will continue to keep the Eurozone out of deflationary territory.
It was previously the case that persistently low oil prices had a positive impact on ratings. However, this scenario has recently moved into the negative zone of Fitch’s Risk Radar. Low oil prices have not been as beneficial to US and European consumers as expected. At the same time, low oil prices affect a number of oil-exporting sovereigns and energy companies.
Fitch’s base case for the Chinese economy is GDP growth of 6.5 – 6.8 per cent. The ‘hard landing’ scenario imagines a massive slowdown, to 2 per cent, by 2017. A hard landing would have severe repercussions for Latin American nations that export to China, such as Brazil, Chile, Bolivia, and Peru. Fitch has already downgraded Brazilian corporates, and other corporates in the region are also at risk if the ‘ceiling’ sovereign rating in their countries is lowered.
David presented a second Risk Radar that was specific to the Asia-Pacific region, with a closer examination of China. Fitch’s analysis indicates that China’s policymakers still have plenty of tools to maintain economic growth. However, the ‘rebalancing’ process is at a very early stage, and without sustainable rebalancing the threat of a hard landing will not disappear. A hard landing would have severe impacts on Asia-Pacific countries that trade with China, with the commodity, heavy industrial, automotive, chemical, and banking sectors being among the most affected. A hard landing could also see a more volatile yuan and trigger a large devaluation.
In the Asia-Pacific region, countries like Korea and Thailand have benefitted from low oil prices. Some sovereigns have been able to cut fuel subsidies that have long been a fiscal drag. Commodity exporters like Malaysia and Mongolia have been negatively affected.
Mervyn presented Fitch’s analysis of the Australian economy. The base case is that iron ore prices continue to remain depressed, around $45 per tonne in 2016-17, and that nominal GDP will grow at around 4 per cent. Growth has remained robust because many iron ore miners have a breakeven price of around $35 per tonne, so they have been able to continue production (albeit with cost cutting). There is a similar dynamic in the LNG industry, which features low marginal costs. However, weaker corporate activity is resulting in lower corporate tax receipts. Household leverage is high and rising, but total non-financial sector leverage is similar to that of other AAA-rated economies.
At a global level, Australia is one of only a handful of countries to have maintained its AAA rating. AAA-rated countries typically have high incomes, strong governance, effective institutions, and credible policymaking. Apart from these factors, the AAA category is very diverse. Australia has low GDP volatility but one of the highest deficits of any AAA-rated economy. Wealthy city states like Singapore and Luxembourg have very strong external and public balance sheets, and high but volatile growth. Switzerland and Norway have similar levels of gross government debt to Australia, but run budget surpluses. Germany and the Netherlands have high levels of public debt and weaker growth, but run current account surpluses and are net creditors.
Fitch expects Australia to stay stable at AAA. One of the main threats to this rating is the risk of a sustained structural (rather than cyclical) widening of the deficit, with no concomitant response from the government. Fitch noted that it has recently downgraded Finland on account of diminished demand for its major exports, including paper and Nokia products.
An audience member asked about borrowing to finance public infrastructure. Mervyn responded that this would have an impact on Australia’s debt and deficit but also growth potential. Fitch’s assessment would depend on whether the investment is in efficient infrastructure or ‘bridges to nowhere’.