Short-term political risk: multiple downgrades as emerging markets see liquidity squeeze amid covid-19 crisis

The current economic crisis provoked by the covid-19 pandemic combined with the commodity price shock is having a pronounced impact on the short-term political risk classification of multiple countries as they see a squeeze in their liquidity position. Indeed, many countries have experienced a reduction in current account receipts (e.g. lower oil revenues, less tourism receipts), a reversal of capital flows and more difficult access to financial markets, for instance to roll over their short-term external debt or to raise new funds. Nevertheless, there are significant differences between countries. While advanced economies have ample room to support their economy through fiscal and monetary measures supported by their reserve currency status, this is often not the case for emerging markets and low-income countries. 

The reduction in current account receipts happens in various ways. Credendo has identified five main mechanisms. First of all, as the tourism sector comes to a halt due to the grounding of flights and the lockdown measures, a sharp drop in tourism receipts is expected. Worldwide, there are 75 countries for which tourism receipts represent more than 10% of their total receipts of the export of goods and services. For these countries, the impact is expected to be significant. The most pronounced effect is likely to be felt by smaller island economies, such as the Maldives and the Seychelles, which rely on tourism receipts for respectively 85% and 40% of their current account receipts. However, larger economies like Jordan, Tanzania and Thailand should also see their tourism receipts drop, which would also affect their liquidity, but to a lesser extent, as tourism represents a lower share of their current account receipts.

Secondly, the oil price shock is rippling through the economy of all oil exporters. Faced with both a demand and supply shock, the oil price has dropped by almost 50% since the beginning of the year. Thereby the oil price is expected to be significantly lower this year than was previously projected for 2020. While on the supply side the agreement within the OPEC+ group can potentially support prices, on the demand side the impact will remain significant, which is likely to result in prices still lower than in 2019 for the rest of the year. This has a huge impact on the current account receipts of countries such as Angola, Algeria, Iraq and Saudi Arabia, where the revenue from oil exports represents more than 70% of the total current account receipts. Nevertheless, the countries’ ability to weather this shock strongly depends on their external buffers and on their ability to borrow externally under adverse financial conditions. For example, richer Gulf countries such as Kuwait, the United Arab Emirates, Saudi Arabia and Qatar will be able to draw on their external buffers (foreign exchange reserves or sovereign wealth fund) and to borrow externally. However, for Algeria, the drop in oil price will lead to an even faster drop in the gross foreign exchange reserves and thereby potentially affect liquidity. This is also the case for Oman and Angola, which will face more difficulty in weathering the shock, given their small(er) external buffers and limited capacity to borrow externally.

Thirdly, other commodity exports are also under pressure. For instance, between the start of the year and the end of March, cotton prices dropped by 27%, zinc by 25%, copper by 20% and cacao by 8%. This is leading to a reduction in export receipts for countries that rely strongly on the export of the products that are affected by this price drop, such as Zambia (copper), Ivory Coast (cacao), the Democratic Republic of Congo (mainly cobalt), Benin (cotton) and Chile (copper). On top of the price drop, there is a risk that the volumes exported can also be reduced as factories remain closed and as the economic activity in the destination markets is slowing down. As with all the shocks, this impact could further worsen if the advanced economies enter a U- or L-shaped recession. The longer the duration of the covid-19 crisis and associated lockdown measures, the higher the probability that such scenario materialises, even if the authorities have already announced large support measures.

Besides the impact on commodity prices, the wider exports of goods and services are likely to suffer. It is evident that countries affected by the coronavirus and the confinement measures are reducing their non-essential imports. Countries exporting to these markets are therefore likely to see a reduction in their exports (beyond the impact on commodity exports). Besides intra-European exports, which are likely to be significantly impacted, we can expect the exports of other countries such as Cambodia, Tunisia, Argentina and Paraguay to be strongly impacted, as these states export a significant share of their production to countries hit by the coronavirus. As the number of covid-19 cases continues to rise and as more countries take confinement measures, it is expected that the exports of an increasingly large share of countries will be squeezed.

Lastly, remittances and labour income are not immune to the border closures and the sharp drop in the economic activity of the countries where migrants work. This risks having a pronounced impact on lower-income and middle-income countries for which this is a significant source of current account receipts. For example, Liberia, Haiti, Egypt, Honduras, Kyrgyzstan and Tajikistan rely on remittances and labour income from countries particularly hit by the coronavirus, which represent a significant share of their current account receipts.

However, all shocks have a two-sided effect on the balance of payments. While they lead to a reduction in export receipts for the countries that are exporting the goods or services, they also reduce the import needs of some countries. This effect is particularly pronounced for large importers of oil and gas, such as Pakistan, Ethiopia, Jordan, Tanzania and India, as prices dropped. They are expected to benefit from the lower energy prices to the extent that they did not lock in the previously higher prices through long-term import contracts. That being said, oil importers might also suffer from second-round effects of lower oil prices through lower remittance incomes, lower capital inflows (the so-called petrodollars) and less support from oil-exporting countries.

Besides the impact on current account balances, the reversal of capital flows away from emerging markets is expected to have a significant impact on the liquidity situation. Indeed, an unprecedented outflow of portfolio investments has been witnessed and a scaling back of foreign direct investments is likely. This directly influences liquidity, as it is more difficult to finance current account deficits. As a result, foreign exchange reserves and/or the exchange rate (depending on the exchange rate system) might be under pressure, leading to more difficulties in honouring external obligations such as imports and short-term external debts. As a result, more countries are likely to impose foreign exchange controls or call the IMF to the rescue. Already, an exceptionally large number of countries ¬– almost 95 – have simultaneously required the support of the IMF.

Aside from the direct effect of capital outflows, the adverse financial conditions also mean that the countries’ ability to roll over debt is more constrained. This adds to the difficulty of funding the current account deficits. Moreover, countries with significant debt service obligations are likely to be less able to roll over these loans. This is also evident when looking at the financial markets, where multiple bonds of emerging markets trade at a steep discount compared to their price at the end of 2019. This is most pronounced for countries such as Angola, Zambia and Ecuador but is also the case, to a lesser extent, for countries such as Kenya and Oman. Tajikistan, Kenya, Pakistan, Nigeria, Oman, Angola, Uganda, Ecuador and Colombia are countries that will face a rise in debt service in the coming two years while at the same time have relatively high MLT political risk classification – which represents the solvency of a country – and/or have relatively weak public finances, which somehow reduces their ability to borrow externally.

In light of these severe shocks, Credendo reviewed its short-term political risk classification for all countries, taking into account the direct impact of the shocks as explained above but also the existing external buffers. While for the majority of countries, the estimated impact does not lead to a downgrade of the short-term political risk, this is not the case for 34 countries. Out of these, seven (Belize, Ecuador, Grenada, Maldives, Oman, Saint Lucia and Senegal) were downgraded by two notches. An overview of all countries that were downgraded can be found in the table below.