Moody's: 2016 global sovereign credit quality stable despite downside risks

While sovereign ratings around the world will likely remain broadly stable, risks to global growth and capital flows could negatively influence credit quality in 2016, says Moody's Investors Service in its annual Global Sovereign Outlook, published today.

"Going into 2016, our credit outlook for global sovereigns is stable overall, but there is more scope for negative surprises than for positive ones," says Alastair Wilson, Managing Director of Global Sovereign Risk at Moody's.

The proportion of Moody's-rated sovereigns with a stable outlook (75%) has slightly reduced compared with a year ago (almost 80%), and the share of negative outlooks has risen (to 17% from 13%).

"We expect that the two engines of global growth -- the US and China -- will continue to perform reasonably well. However, we could see a negative effect on sovereigns around the world if the global economic slowdown is sharper than expected," says Mr. Wilson.

One trigger for such a sharper slowdown would be lower than expected growth in China. China's slowdown also contributed to the fall in commodities prices, which has undermined growth in various regions, leaving sovereigns in those regions more exposed to further economic or financial shocks.

Exposure to slower growth in China including through trade links and reliance on commodities exports is greatest in Latin America and Asia Pacific, though sovereigns in these regions are generally well-insulated from shocks. Sub-Saharan African commodity exporters are also heavily exposed, and with smaller buffers.

The wider European region and North America have limited exposure as China does not represent the main export market for these countries, though they have some indirect exposure through trade links with regions that have been affected.

Another important risk is the potential for event-driven shocks to capital flows.

"Events such as the eventual tightening of US monetary policy may lead to potential shocks that would reverberate globally, should they affect capital flows and investor sentiment." said Wilson.

However, a broad-based emerging markets crisis is unlikely, according to Moody's. If such a shock were to occur, it would primarily affect countries which have large external debt positions, large current account deficits and low FDI coverage.

More generally, the impact of broader shocks on individual sovereigns will reflect country-specific factors, says Moody's. It notes that underperformance on government reform targets can render sovereigns more vulnerable to economic and fiscal shocks as well as diminish investor confidence.

While some governments are making progress, others have been relatively slow to develop economic and fiscal reform, or measures have not been as successful as targeted. In some countries, governments have been unwilling or unable to implement reforms.

Finally, domestic and geopolitical risks, primarily related to the Middle East, East Asia, and Greece, also remain an underlying threat in particular regions, especially the Middle East, East Asia, and Greece.