December 2004 COUNTRY RISK TRENDS __________________________________________________________ The stability of the world country-risk index(*) has been masking divergent trends in the company economic environment in industrialised and emerging countries. In industrialised countries, the gap has been growing between eurozone companies suffering from a strong euro and sluggish domestic demand and North American companies still benefiting from a buoyant economic environment. The risk level has been rising in West Europe (up 8%) reflecting the removal of the German company rating (A2) from positive watchlist status. Conversely, the situation has continued to improve for emerging-country companies (down 2.7%). In Central Europe, the index improvement (down 3%) reflects the upgrading of the three Baltic countries (Estonia to A2, Latvia and Lithuania to A3) and of Serbia/Montenegro (from D to C) as well as the positive watchlisting of Bulgaria's B rating. Meanwhile, the B ratings of Turkey and Algeria have acquired positive watchlist status. In Asia, the improvement (down 2.6%) is attributable to the upgrading of India to A3. In Latin America, the 3.4% index improvement reflects the positive watchlisting of Brazil's B rating and upgrading of Venezuela to C. Finally, the upgrading of South Africa from a positive-watchlisted A4 to A3 and of Madagascar to C explains the 3.4% drop in Africa's index despite the negative watchlisting of Cameroon's B rating. (*)The world country-risk index represents an average of Country @ratings weighted by each country's contribution to world production. The index is based on the world average risk level in 2000. The euro's sharp appreciation against the dollar and the volatility of oil prices marked the economic environment in the 2004 last quarter. Industrialised country growth gave signs of slowing after the exceptional dynamism registered in the first half. Conversely, many emerging countries continued to benefit from strong Chinese demand, high raw material prices, and low risk premiums in financial markets. Despite the macroeconomic uncertainties, company solvency generally remained good. Strong demand, weak inflationary pressures, and favourable financing terms partially offset the growing pressure on margins resulting from increased raw material costs. Credit risk nonetheless seems to have bottomed out. The decline of payment incidents seems to be levelling off, a trend consistent with the economic slowdown and less-bright growth prospects, notably for industrialised countries. The economic environment should nonetheless generally remain favourable supposing the absence of major shocks concerning the main risk factors: oil prices and the dollar. Oil prices should not fall far below the average level registered in 2004, or $38 per barrel of North Sea Brent. Higher stock levels and milder-than-expected early winter weather doubtless contributed to the sharp decline in barrel prices observed in December. Sources of upward price pressure have nonetheless not disappeared. With demand remaining strong (up 1.8% expected in 2005), shortage risks have remained substantial due notably to the limited production margins available and persistent tensions in the Near & Middle East. Moreover, OPEC has an understandable interest in avoiding a too-large decline in dollar-denominated prices. As a matter of fact, downward pressures on the dollar against the euro and yen are likely to persist. Prospects for reducing the twin American deficits still seem limited. It is possible, furthermore, that economic agents, notably Asian banks, may rely less on the dollar as a reserve currency, thus reinforcing the euro and yen appreciation trends. Regionally, the main trends expected are as follows: >> In the United States, the economic slowdown will be moderate. It will result from less-dynamic household demand after several years of euphoria. Nonetheless, the persistence of excessive twin deficits coupled with a too-sharp dollar decline could prompt tighter monetary policy that could further undermine economic activity.>> In Europe, a durable euro appreciation against the dollar and less dynamic world demand could negatively affect eurozone country growth with household consumption apparently unable to pick up the slack for exports threatened by major losses of competitiveness. A growth slowdown thus appears likely in West Europe although the economies of new country members should remain buoyant. >> In the Community of Independent States, the cancelled elections in Ukraine, which could lead to victory by the opposition, marked the political situation. The sharp cleavage in the country between its western and eastern parties will keep political risk at high levels whatever the new election's outcome. In Russia, although the economic situation is still good, the business climate has been deteriorating due to the shock waves generated by the Yukos affair and the possibility of moves against other oligarchies, like the group Alfa. >> Asia will remain a focal point of dynamic growth. However, the Chinese economy's soft-landing and the less buoyant demand in industrialised countries in conjunction with a slowdown in electronics will cause a moderate economic slowdown. In Japan, where exports had mainly been driving the recovery, the slowdown should be more pronounced amid slower growth of external demand coupled with a loss of competitiveness due to the yen appreciation against the dollar. >> In Latin America, steady raw material prices, a domestic demand recovery, a more stable political environment, and still-favourable financial market sentiment toward emerging countries will all be factors conducive to continued strong growth, even if it should slow somewhat overall from the exceptional level posted in 2004. >> Near & Middle Eastern countries will continue to contend with an unstable geopolitical environment. Oil exporting countries should nonetheless continue to improve their economic and financial situation benefiting from continued high barrel prices. In other regional countries, the upward trend of tourism, notably within the region, and exports should continue to buoy the economy. 200020012002200320042005 World production4,01,51,92,84,13,4 Industrialised Countries351,11,32,13,42,6 United States 3,60,81,93,04,43,3 Japan2,80,4-0,32,54,02,1 European Union 3,81,81,11,02,12,1 Germany 3,11,00,1-0,11,21,4 United Kingdom3,92,31,82,23,22,6 France4,22,11,10,52,12,0 Italy3,21,70,40,41,31,7 Emerging Countries5,82,83,95,06,25,4 Emerging Asia 7,14,45,96,57,16,3 Latin America 4,00,20,11,44,73,7 Central Europe et CIS6,34,44,05,66,45,6 Middle East (+ Turkey)5,70,93,35,55,64,7 Sub-Saharan Africa 3,13,22,73,94,54,7 World Trade12,50,23,35,18,87,2 DISCLAIMER : The present document reflects the opinion of COFACE Country Risk and Economic Studies Department, as of the date hereof and according to the information available at this date; it may be modified at any moment without notice. 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