The world country risk* (The world country-risk index represents an average of Country @ratings weighted by each country's contribution to world gross production. The index is based on the world average risk level in 2000.) index has shown a slight improvement (-1.2%), thanks to a reduction in the risks in the European Union (-5.5%). Thanks to more sustained growth and better company solvency levels, the average rating for Italian companies (A2) is no longer placed on positive watchlist. In spite of this favourable trend, the level of risk associated with these companies is still one of the highest in Western Europe. As far as the new members of the EU are concerned, Slovenia's rating has been upgraded from A2 to A1 thanks to good management of the economy and the financial solidity of both the country and its companies. And as far as the emerging countries are concerned, the level of risk has stabilised following a slight deterioration over the last few months, resulting from a more uncertain international financial environment. The only change in fact concerns the A4 ratings for Morocco and Tunisia, which have been placed on positive watch-listed.

The first nine months of the year have once again been marked by strong pressure on company margins, notably as a result of high raw materials prices (in spite of the recent fall in oil prices), the rise in interest rates and the persistently fierce competition. There has nevertheless not been any significant deterioration in payments or in company solvency levels.
The reason for this is, on one hand, a favourable macro-economic environment due to world demand, which has remained sustained, and on the other, micro-economic adjustments made by companies over the last few years. The gains in productivity, sometimes resulting from major restructuring operations (such as in Japan or in Germany), have enabled high production costs to be offset.

The financial turbulence seen in the spring served as a reminder that imbalances in world growth persist and can provoke brutal adjustments likely to impact company payment behaviour. These adjustments could be all the more significant as the recent period has been marked by exuberance in the stock and property markets combined with a strong partiality for emerging country risks.

In addition to the risks linked to America's current account deficit, the property price trend is a major cause for concern. Significant falls in the United States, the United Kingdom or Spain would provoke a reduction in household consumption, which is the main growth engine in industrialised countries.

This sort of slowdown in demand would in turn provoke a significant fall in raw material prices, thereby impacting the solvency levels of the emerging countries dependent on these raw materials.

A loss of confidence in emerging country risks could provoke a rise in 'spreads' and have a significant negative impact on the currencies most exposed to the currency risk (i.e. the Hungarian forint, the Turkish lira and the South African rand etc). The uncertain political climates (protests in Hungary and a coup d'Etat in Thailand, etc….) serve as a reminder of how fragile these countries are.

Over-investment and an overheating of the economy in China could also generate a brutal slowdown, which would undoubtedly cause a chain of bankruptcies, as margins are very tight.

If these risks do not materialise, the most probable hypothesis would be a soft landing in the growth currently enjoyed by the industrialised countries, including the United States, where overall company profitability remains fairly high. Moreover, the emerging countries, whose financial situation has improved, today seem to be in a better position to resist the shocks caused by growth.

In the United States (rated A1), economic activity remains dynamic. After a slight slowdown occurring in the spring and summer, household consumption has momentum,underpinned by the fall in energy prices and an increase in salaries.
In 2007, however, growth is likely to see a downturn. Confidence will be affected by the turnaround in the property market, and this time the effect on household spending is likely to be more significant and more sustained. Conversely, company investments, public spending and exports should continue to show a good growth rate.

The Coface payment incident index reflects the excellent financial situation of companies in the US. Two sectors are nevertheless likely to encounter difficulties: the residential construction sector, in view of the decrease in the number of new housing projects, and the automotive sector, following whose production schedules for the 4th quarter of 2006 has been reduced. In 2007, company profits are likely to see much less rapid growth, on account of lower productivity gains and a significant rise in the cost of labour. The financial situation of companies as a whole should nevertheless stabilise at a good level.

In Japan (rated A1), growth is dynamic, still boosted by strong domestic demand. The new Prime Minister, Shinzo ABE, should continue to give it priority. Household consumption remains sustained owing to the rise in employment, salaries and summer bonuses. Furthermore, in global terms, companies now have more room to manoeuvre financially with regard to increasing the level of their investments. Exports, in spite of a slowdown, remain on an upward trend thanks to Asian and American demand.

A moderate downturn is probable in 2007 and exports are likely to see the knock-on effect of a less dynamic American economic environment. Company investment levels are also likely to mark time, under the effect of the slowdown in the international economic environment. Household consumption will remain healthy.

The financial situation of companies as a whole is satisfactory: reduced over-capacity and debt have restored profitability levels, and profits are still on an upward trend. The Coface payment incident index remains significantly lower than the world average, with the number of bankruptcies on the decrease for the 5th consecutive year. The situation is tough but is nevertheless improving in the construction, retail and hotel/catering sectors. Company solvency levels should remain, on the whole, good over the next few months.

In general terms, WESTERN EUROPE has seen a significant recovery this year. Exports have benefited from the strong world economy, and notably from vigorous capital expenditure. Household consumption has been boosted by a substantial fall in unemployment, accommodating economic policies and the persistent dynamism of the residential property market. This return to stronger growth can notably be observed in Germany, France, Italy, and the Benelux and Alpine countries. Activity in Portugal, however, remains sluggish.

Spain, Ireland and Scandinavia continue to report higher growth levels than the European average, thanks to persistently dynamic domestic demand. Finally, the United Kingdom has returned to satisfactory growth levels after a brief pause.

A global downturn is expected in 2007. Exports will suffer from the American economy's slowdown and the appreciation of European currencies. Domestic demand is also likely to be hit by the tighter economic policy (both in monetary and budgetary terms). Providing the property market does not show an abrupt, profound turnaround, however, and there is no further slide in energy prices, this slowdown should be moderate.

In Germany (rated A1), exports are still showing growth, which is encouraging companies to increase expenditure on equipment and facilities. The slide seen in construction investments seems to have come to a halt. Consumption is showing signs of a recovery and the expectation of certain purchases linked to the rise in VAT on January 1, 2007, should also have a favourable impact at the end of the year.

Whilst several economic policy measures, applicable in 2007 (including the 3 point rise in the VAT rate), will help reduce the budgetary deficit, they will nevertheless exert pressure on household spending. Furthermore, exports are likely to decelerate, in connection with the world investment slowdown and the delayed impact of the expected rise in the euro.

In spite of moderate economic growth, company solvency levels are satisfactory. This is clearly reflected in the fact that the Coface payment incidents index is at a good level and that the number of bankruptcies continues to fall. Margins have recovered thanks to numerous relocations, a salary moderation policy and the streamlining of production systems.

In France (rated A1), growth has seen a significant recovery, underpinned by a rise in household consumption and exports. In spite of a slight increase in revenues and higher accommodation and energy costs, household consumption is still buoyant thanks to readily-available and cheap credit, and better employment opportunities (government-assisted jobs notably). Furthermore, exports are enjoying more dynamic European demand, largely thanks to the recoveries seen in Italy and Germany.

This growth, however, is likely to lose momentum in 2007. Exports will suffer as a result of the European slowdown, and the different national economic players will remain on the cautious side in view of the forthcoming elections.

Whilst company solvency levels are benefiting from this recovery, certain sectors still remain fragile. The transformation of plastic, ironwork, casting and coach-work sectors are suffering as a result of the automotive sector's slowdown and the rise in the cost of raw materials. Road transport has been hit by the soaring rise in fuel prices, textiles by Asian competition and IT equipment distribution by the fast rate of obsolescence and the downward price trend.

In Italy (rating A2, removed from negative watchlist) the second half of 2006 should confirm the moderate recovery seen in the first half, in view of the good economic environment, an increasing diversification of the economy and a satisfactory business climate. Exports in particular are being boosted by the more buoyant European economy, despite the fact that they are still hampered by the competition offered by emerging countries and their lack of price competitiveness. Household consumption has shown timid growth, but the expected return of confidence linked to the more open political horizon, together with the generous salary agreements now in place, should speed things up more.

Growth could see a slight fall-off in 2007. Despite a drop in unemployment, household spending will slow a little, in view of the budget squeeze required to offset the major deterioration in the public accounts. Exports should yet see moderate growth, thanks to enhanced competitiveness.
Reinforced by this slightly brighter economic situation, the Coface payment incident index has returned to the levels seen before the steep decline of 2004. The frequency of payment incidents, however, is still well above the world average. The weakest sectors are leather, textiles, electronics (manufacturing, assembly and distribution), household electrical appliances, and the manufacture of metal parts and tubes.

In Spain (rated A1), growth remains vigorous, despite being unbalanced. Indeed, it is essentially underpinned by property investment and household consumption, whereas the contribution made by foreign trade is very negative.

In 2007, this growth should see a slight deceleration and start to become more balanced. In spite of a continued fall in unemployment and an increasingly expansionist budgetary trend, the progressive rise in interest rates, coupled with the high level of household debt, is likely to culminate in a negative impact on private consumption and investment in residential property. Exports should benefit from slight productivity gains and the rise in imports should slow down, in line with domestic demand.

In spite of a deterioration over the first few months of 2006, the Coface payment incidents index remains in line with the world average. Sectors such as textiles, leather, household electric appliances, small electrical equipment and computer assembly, however, are particularly exposed to Asian competition. Moreover, the possibility of an abrupt turnaround in the property market cannot be excluded. The impact of this on the economy as a whole would be extremely negative.

In the United Kingdom (rated A1), the economy has returned to a dynamic level, with a significant recovery in exports and consumption (the latter being boosted by a revival in the property market). This positive climate is encouraging companies to increase their investments.

Growth should stabilise at a level close to its potential (2.5%) from the end of the year and maintain the rate in 2007. The rise in the pound and a weaker American and European demand is likely to impact exports, however, and the recent rise in interest rates is likely to slow household demand through a deceleration in credit and property prices.

The level of the Coface payment incident index remains below that of the world average. Nevertheless, industrial companies, (notably those linked to the automotive industry), and the telecoms/IT equipment distribution sector, remain more vulnerable than most.

CENTRAL EUROPEAN COUNTRIES are continuing to show sustained growth, thanks to lively domestic demand and strong foreign trading performances. The acceleration reported in the first half would suggest an average growth rate of around 5.5% in 2006, prior to a slight slowdown in 2007, provoked by: a fall in western European demand, a rise in domestic interest rates and the adoption of a tight budgetary policy (as is the case in Hungary). The equity and foreign exchange markets have partly recovered, following the turbulence seen in May/June of this year, but the situation remains fragile, especially in Hungary where "twin" deficits persist. From a global perspective, the appetite for reform is much less voracious in this region, and several of the new EU member countries have been forced to delay adoption of the single currency.

In Poland (rated A3), the economic climate remained favourable in the second quarter (+5.5% after +5.2% in the first). Dynamic investment levels, private consumption and foreign sales should consequently boost growth up to 5.5% this year, although this trend should lose momentum in 2007, notably impacted by the slowdown in foreign demand. The current deficit remains limited in view of the GDP, and strong export performances are improving foreign indebtedness ratios. Nevertheless, the current public deficit (and the struggle to contain social spending), would suggest a delayed entry into the euro zone (no target has been fixed as yet). Furthermore, there are still uncertainties as to the government's privatisation policy and its attitude towards the central bank's independence, whilst, at the same time, the political situation is deteriorating, with the collapse of the governing coalition on September 21.

In Hungary (rated A3), the GDP saw a more moderate increase in the second quarter of 2006 (+3.8%) than in the first (+4.6%), and the full-year growth forecast is nearly 4%. In 2007, however, a significant slowdown is probable, and growth is likely to come down to around 2.5% as a result of the introduction of a strict budgetary plan. Inflation should also see a significant increase, with a rise in taxation and administered prices, whilst the central Bank continues with its tight monetary policy. The forint, having descended to its lowest level against the euro at the end of June 2006, has shown a slight recovery. It is nevertheless likely to remain volatile, as the budgetary and current deficits are still high (both around 7% of GDP in 2007) and reforms are lacking. What is certain is that the violent social unrest seen over the last few days is making the government's task extremely difficult.

In the Czech Republic (rated A2), activity remains buoyant, in spite of a moderate slowdown in the second quarter (+6.2%, representing a slowdown on a full-year basis, following +7.1% in the first quarter). Investments, boosted by public spending on equipment and amenities as well as foreign direct investment, coupled with consumption, boosted by the rise in household spending power, should remain the principal sources of growth this year and in 2007. Exports should continue to benefit from the rise in car production and productivity gains, but the current deficit is once again expanding as a result of domestic demand. The public deficit is also showing an increase, as a result of the reduction in taxes and the rise in social spending; and the government's lack of executive power (with no majority in Parliament), does not augur well for a budgetary adjustment in the short term. Given this environment, the authorities have abandoned all hope of joining the euro zone by 2010.

In Russia (rated B) growth remains strong, despite the fact that one can observe a slight slowdown. High raw material prices have led to a rise in the population's actual revenues, and this mechanism will continue to underpin activity. In the big towns, the expanding middle class is enjoying a rise in salaries and is consequently increasing its consumption. Net exports are also on the up, principally thanks to the oil price effect.

Industrial production has seen a slowdown. The mining sector stagnated in 2005. In the manufacturing sector, activities exposed to international competition have suffered from the rise in the actual exchange rate. Machine tools and electronic products have been hit particularly hard by the competition offered by imported goods. The food-processing sector has nevertheless shown strong resistance and the sectors less exposed to foreign competition, such as construction and retail, have shown sustained growth. Furthermore, the State has reinforced its presence in both the energy sector (either directly or through public companies - becoming the leading oil producer in the country with its control of Rossneft and Sibneft) and the manufacturing sector (cars, machine tools and diamonds). This "State capitalism", however, could well turn out to be somewhat inefficient.

The country's financial situation is continuing to improve: High budgetary surpluses and a significant reduction of the public debt are continuing to lower the sovereign risk, and currency reserves are continuing to increase. Coface's observation of Russian company payments is good and company solvency levels have improved since 1998. Furthermore, domestic company payment defaults now represent less than 10% of the GDP (as against 50% in 1998) according to official statistics. Nevertheless, corporate governance remains a problem. Financial and shareholding transparency is distinctly lacking. Creditor's rights do not work in practice, as the legal system is still awaiting a widespread reform.

Growth in ASIA is still extremely dynamic. It is benefiting from both an acceleration in Chinese demand and buoyant regional investment and consumption. Except in the case of Hong Kong, which has seen a slowdown following an exceptional year in 2005, growth is either stable or in the process of accelerating in all areas. Nevertheless, several factors are continuing to hamper company earnings. The high cost of raw materials and the pressure on prices (exacerbated by competition from China) are impacting margins. In addition to these two factors, one must also take into account a recovery in the upward trend observed in the main currencies (the impact of the default episode in June 2006 was dispelled within a few months), coupled with the more restrictive monetary policies implemented in view of the inflation risks. Given this environment, the electronics sector, in particular, is seeing its margins shrink.

In Thailand (A2, placed on negative watch), the political situation is continuing to deteriorate, with the announcement of a military coup d'Etat on September 19, 2006. The Prime Minister (T. Shinawatra) was in New York at the time for the UN's Annual General Meeting. This coup d'Etat came as a surprise, as it is the first one in 15 years (the country had 17 between 1932 and 1991). General Boonyarataglin, the Commander in Chief who headed this coup, announced the suspension of the constitution and all institutions, emphasising his loyalty to the King (a very respected figure) and promising a speedy return to normality. The political calendar, however, has once again become uncertain. New legislative elections were scheduled for mid-October 2006, following the cancellation of the April elections, when Thaksin Shinawatra's party came out on top (but the level of participation was low). It is also possible that this confusing situation is here to stay, as Thaksin Shinawatra, despite being in a weaker position and out of favour with the urban population, remains popular in rural areas. His policy to support small farmers has been well received in the countryside. His party was furthermore favourite to win (although with a small majority) the ballot scheduled for October. He is therefore unlikely to relinquish power easily.

This political crisis also comes at a time when the economic environment is less buoyant. Its impact on the baht (which was already suffering in June 2006, but which increased between June and September), the stock-market and direct investments could be significant. Activity is still strong but it started to slow in the second quarter. Investment and consumption were hit particularly hard.

Exports, however, have been relatively dynamic, which has meant that trading volumes have remained high. Prior to the coup d'Etat, the level of growth forecast for 2006 was favourable (despite being one of the lowest on the Asian continent) at 4.3 %. The coup d'Etat, however, could affect the confidence of the economic players and could impact on domestic demand.

Thai industry is facing fierce competition from China in the electronics and textile sectors. Company balance sheets are generally showing smaller margins and a high level of debt. One can consequently observe that competitiveness is being eroded, which could eventually have a negative impact on company solvency levels. Nevertheless, for the time being, the Coface payment incident index is not showing any significant deterioration.

In China (rated A3), growth is now out of control, with an 11.3 % increase in the GDP during the first half of 2006. Investments and credit have risen well beyond the government's objectives. This situation primarily shows that the "standard" economic policy instruments are having little success in slowing activity. Administrative measures and perhaps an acceleration in the rise of the yuan must be implemented between now and the end of the year. Furthermore, this situation is doing nothing to help the over-capacity problem, which already exists in the automotive, property, and iron and steel sectors. On a full-year basis, growth will exceed 10% in 2006. A slowdown seems inevitable. This will undoubtedly be controlled, but it will occur in an over-investment environment, which will have a knock-on effect on company payment behaviour.

We can already observe an increase in payment delays in the private sector and a stabilisation of profits. Faced with the fierce competition created by a saturated domestic market, companies are unable to pass on the different cost increases and rises (raw materials, interest rates and soon exchange rates) in their final prices. We should add that the existence of informal credit (evaluated at 30% of the total banking credit liabilities) could lead to further insolvency problems.

In India (rated A3), industrial production showed its strongest growth for 10 years in July (+12.4%). Manufacturing output has increased by 13.3% over a period of one year. Activity is still underpinned by vigorous domestic demand. The serious stock market correction that occurred last spring had no impact on the economic climate. Nevertheless, this dynamic environment is overshadowed by a situation of ever-increasing imbalance. In spite of a major rise in exports, strong domestic demand and high oil prices have caused deterioration in the trade balance. Moreover, the significant increase in budgetary revenues, resulting from strong growth, has not prevented a further deterioration in the budgetary deficit, as a result of a major slide in spending. This growth rate (between 8% and 9%) is therefore unsustainable. Nevertheless, it should remain at a good level until the end of 2006 and throughout 2007 (growth of around 7.5%). This growth is in fact underpinned by stable foundations, which include a high level of competitiveness in the services sector and in industry, well-contained foreign indebtedness ratios and comfortable currency reserves.

The Latin America risk index remains stable. In 2006, regional growth should be satisfactory (4.5%), as the zone remains one of the principal beneficiaries of the strong Asian and American demand for raw materials and agricultural products. 2007 should see a slight deceleration (with estimated growth of 3.7%), as a result of the slowdown forecast in the United States and probable drop in the cost of raw materials. Domestic demand should nevertheless continue to replace, to a certain extent, the activity generated by foreign trade. Furthermore, the budgetary and monetary policies are now globally more stringent, enabling public finances to be streamlined and inflation to be reduced. Moreover, the fact that world demand remains sustained means that the foreign accounts will continue to improve. This environment should help reduce the level of foreign debt, and Latin America has rapidly eliminated the impact of the financial upsets, which affected all the emerging countries in May/June 2006. Major points of weakness still exist, however, and the region's ratios remain less favourable than those of most of the other emerging zones, with the exception of sub-Saharan Africa. Furthermore, the question of control over natural resources and the division of wealth may be at the heart of the increasing tension, which is having a negative impact on investment.

In Chile (rated A2), growth is likely to be less vigorous this year (although it will remain sustained at around 5.5%), as the strike in August at the biggest mine in the world had a negative impact on copper production. The main reason for this slowdown, however, is the more restrictive monetary policy and the contra-cyclic budgetary policy, which are affecting domestic demand (particularly investment). This demand will nevertheless remain the principal driving force for activity in 2007 (with growth estimated at 5%), amidst a slightly less favourable international environment. The country is also benefiting from a very low level of public debt, a slight surplus in the foreign accounts, moderate foreign debt (essentially private), a solid currency and a very robust financial system. Given this environment, payment behaviour is very satisfactory and company solvency levels remain good.

In Mexico (rated A3), at the beginning of September, the electoral Tribunal ratified the result of the presidential election, held on July 2, 2006, which was narrowly won by Felipe Calderon. His party, the PAN (conservative) does not, however, have a parliamentary majority. Amidst this tense political climate, marked by the ongoing dispute initiated by his principal rival, A.M.L. Obrador, of the PRD (centre left), the new President will have to work with the opposition parties (notably the PRI, the former dominant party), to pass the necessary structural reforms. The macro-economic stability policy should nevertheless remain in place, as it is supported by a fairly broad consensus. In spite of the political climate, growth should see a revival this year (over 4%); domestic demand is and must remain the principal source of growth, with investment being the most dynamic component.

Activity is likely to be more moderate in 2007 (3.5%), notably as a result of a probable slowdown in the North American economy, on which Mexico remains extremely dependent. The country nevertheless retains solid economic and financial fundamentals. Given this environment, the payment incident index has improved. However, in the textile sector, and for certain maquiladoras (sub-contracting export companies), payments are suffering from lengthening delays.

In Brazil (rated B, placed on positive watchlist), President Lula is likely to win the October elections and the country's cautious economic policy should consequently remain in place. 2006 should see a modest recovery, with growth of 3.3%; this trend should subsequently continue in 2007, with an estimated growth rate of 3.6%. Domestic demand will once again be the principal driving force, notably due to the continuation of the relaxed monetary policy. Furthermore, dynamic export performances, in spite of the high real, will continue to generate current surpluses and will significantly reduce foreign financing requirements. The country's foreign vulnerability is on the decrease, as a result of a considerable reduction in the foreign indebtedness ratios. The public debt is still high and too exposed to a shift in interest rates. From a micro-economic perspective, companies are benefiting from stronger cash-flow positions, but certain sectors are facing fierce competition, notably as a result of the price of the real. Moreover, credit, which is still costly, could be at the origin of the lengthening of payment delays vis-�-vis suppliers.

In Colombia (rated B), growth, following a deceleration forecast in 2006 (with a growth rate of 4.5%), should again see a slight fall-off in 2007 (with an estimated rate of 4%). Activity is and will remain principally underpinned by consumption and investment. Given this environment, payment behaviour should remain satisfactory, with companies fulfilling their obligations on time. The foreign accounts will see a slight deterioration, notably whilst awaiting a free-trade agreement with the United States at the beginning of 2007, but exports are diversifying and the fall in oil production should be partially offset by the increase in coal production. The foreign indebtedness ratios are improving, but significant fiscal reforms are still necessary if the public finances are to be made healthier and the high level of public debt reduced. The re-election of President Alvaro Uribe, at the end of May 2006, would suggest a continuation of the orthodox economic policy, but the institutional weaknesses persist, along with the security problems.

In Peru (rated B), President Alan Garcia (centre left), in office since the end of July 2006, should continue to adopt a fairly cautious economic policy, whilst at the same time trying to reduce the pronounced inequalities. Growth should remain strong in 2006 and 2007, boosted by sustained domestic demand and increased exports of natural gas, ore, and agricultural and textile products, given that a free-trade agreement with the United States will come into force in 2007.

The foreign accounts should consequently retain a slight surplus, and the foreign indebtedness ratios are improving, following early repayment to the Paris Club creditors in 2005. The country, however, remains exposed to a turnaround in financial market confidence and world raw material prices, and the banking system remains weakened by significant dollarization.

In Argentina (rated C), the expansion trend is continuing this year (with growth forecast at 8%), notably as a result of the support policy adopted by the authorities, but this growth should see a deceleration in 2007 (at 6%), whilst inflationist tensions remain strong, in spite of the controlled prices. The dynamic foreign trade situation, resulting from strong world demand for primary or transformed products and an under-evaluation of the exchange rate, favours a continuation of the current surplus. Furthermore, the cancellation in June 2005 of part of the bond debt in default made it possible to rebuild the currency reserves and totally reimburse the IMF at the beginning of 2006 (i.e. prior to the due date). Nevertheless, the public finances situation is still precarious and foreign indebtedness ratios are still high. Furthermore, the approaching presidential election (October 2007) is hampering the progress of both the scheduled reforms and the increase in the public service prices, which in turn is discouraging investment, notably in the energy sector. Given this environment, the financial situation of companies that focus on export is healthier than that of companies purely operating in the domestic market. Furthermore, uncertainties with regard to the legal framework still exist.

The regional risk index for North Africa and the Near and Middle East has fallen (-0.7%) as a result of the placing on watchlist of Morocco and Tunisia (A4), in view of a good economic environment, an increasing diversification of their economies, and a satisfactory business environment.

With regard to the Near East: following a significant rise in the price of a barrel of oil, which reached its highest point of $78 at the beginning of August (a consequence of the war in Lebanon and closure of the Prudhoe Bay oil-field in Alaska), the downturn observed since is nevertheless unlikely to hamper the strong prospects enjoyed by the region's oil-exporting countries. Most of the economies in the region are underpinned by the oil boom, which provides the financing for numerous investments on an unprecedented scale in infrastructures and the non-oil or oil supply and services sectors. This is notably the case with the Gulf monarchies, led by Saudi Arabia and the United Arab Emirates (rated A2). The deflation of the financial bubble in the spring of last year purged the markets and should have no marked consequences on activity, amidst an environment that remains buoyant. Nevertheless, the property sector needs monitoring. This oil asset has also provided a means of shedding national debt; this is notably the case with Algeria (rated A4), almost all of whose re-structured debt was reimbursed early, and Saudi Arabia, which had accumulated a significant domestic public debt.

The other countries within the region (which either do not export oil or only on a small scale) are in general benefiting from a strong foreign direct investment trend and, for some, oil dollars from the Gulf. The geo-political tension, however, is still impacting the level of risk. This is the essential cause of uncertainty, and the "July war" in Lebanon, in addition to its catastrophic consequences on the country itself, has modified the situation for the entire region, which could ultimately favour the negotiation option.

In Morocco (Rating A4, on positive watchlist), growth should reach 7.3% in 2006, mainly due to agriculture, services and building and public works. The textile sector is recovering and the tourist industry is performing well. The regular production of non-agricultural GDP highlights the increasing independence of the GDP in relation to rainfall levels. This economic environment is reflected in the Coface payment incident index, which, having shown a decline, has stabilised at a level close to the world average. The vigorous growth in public and private investments, aimed at diversifying the economic fabric and attracting activities with strong added value, should bolster trading volumes in 2007 and beyond. This favourable economic climate should facilitate a recovery in the public finances.
In spite of the shocks suffered in 2005 to the trade balance, the country's current account showed a surplus of 1.9% of the GDP, reflecting the positive balance generated by expatriate remittances and the tourist industry. This surplus should be maintained in 2006 and 2007, and will help moderate foreign financing requirements and therefore further reduce the weight of the foreign debt (the servicing of which will absorb less than 10% of currency revenues in 2006).

In Tunisia (rated A4, watch-listed with positive implications), underpinned by the services and agricultural sectors, growth should be over 5% in 2006. It could be maintained at this level in 2007, thanks to domestic demand, which will remain dynamic. Private consumption and investment are in fact being boosted by the efforts made in the public sector to develop infrastructures, together with those made by companies to modernise their production plant. Moreover, the slowdown in 2005 has not affected company solvency levels, and the Coface payment incident index has progressively moved closer to the world average, illustrating an improvement in company financial situations, in spite of the heavy competition faced by the textile sector.
he buoyant economic environment is facilitating management of the public finances, whose deficit should remain below 3% of the GDP, thereby reducing the weight of the public debt. Moreover, in 2005, the reduction of the trade deficit, brought about by the increase in exports and the healthy invisibles balance, brought the current account deficit down to 0.6% of the GDP. Maintaining the deficit at this level in 2006 and 2007 should help reduce foreign financing requirements, and bring the servicing of the debt down to 9% of exports.

In Saudi Arabia (rated A4), the GDP has almost doubled since 2002. The oil boom has led to soaring performances in the non-oil sector and the development of large-scale projects. This favourable economic environment (which should last) is stimulating investor and consumer confidence, which, moreover, remains relatively insensitive to the region's geo-political uncertainties. Given this environment, the impact of the equity market correction, which occurred in the spring of 2006, should be limited. In spite of slight price tension, inflation remains under control. The country's financial situation is excellent, and the accumulation of significant foreign and budgetary surpluses since 2003 has considerably reduced the public debt and led to the creating of healthy currency reserves.

In Israel (rated A4), the economic consequences of the Israel/Lebanon conflict should remain limited. The measures implemented to streamline the budget, coupled with the re-start of privatisations, have boosted consumer and investor confidence. The growth of this economy (which is open, diverse and has strong potential) is nevertheless dependent on the international economic environment. The failure of the Lebanon conflict has weakened the coalition formed following the elections held in March 2006, and has destroyed all the objectives for a withdrawal from the West Bank. The forming of a national union government in the Palestinian Territories, however, could form a basis for re-initiating the peace process. The Iranian nuclear issue is still perceived as a direct threat.

In Lebanon (rated C), the "July War" will have a serious impact on the economy in 2006, which was starting to pick up again after the upsets of 2005, following the assassination of the ex-Prime Minister Rafik Hariri. The destruction of numerous infrastructures and the blockade imposed by Israel over the last two months are hampering activity (tourism, industry, construction, retail etc) and will result in a recession and a deterioration of both the budgetary deficit and the current deficit. This situation is creating problems for companies and their payment behaviour may feel the impact. The mobilisation of international aid should, however, enable the country to sustain its currency and prevent it from defaulting.

The influx of capital and the reconstruction dynamics should facilitate the recovery of the country's economy in 2007, and shift the macro-economic balance. The security situation, however, which is still precarious, continues to discourage both investors and tourists, as the hypothesis of renewed hostilities between the Hezbollah and Israel cannot be ruled out.

The conflict has modified the domestic political landscape and the different components of the Lebanese mosaic must find a new balance if a civil war is to be avoided. These economic and political weaknesses are somewhat unfavourable to structural reforms and the economy is likely to remain dependent on international aid on a sustainable basis.

In Turkey (rated B), the fall in the lira last spring and the rise in interest rates implemented by the Central Bank to offset this, have not as yet had any significant economic impact. The growth rate is high at 8.5% for the 2nd quarter and industrial production increased by a further 9.5% in July (over a period of one year). The partial recovery of the lira in June, and then subsequently over the summer (the depreciation is now only approximately 10% since the beginning of the year) and the rapid return of flows to the emerging countries explains, to a large extent, a significantly more moderate impact than expected. A modest slowdown is nevertheless still expected for the second half, as a result of the high interest rates, which add to the cost of consumption and investment loans.

The negative side to this much more resistant activity than expected is the foreign imbalance, which is not diminishing and is a cause for concern for the markets. Imports continue to show lively growth and a record current deficit, equivalent to 7.4% of the GDP, is now forecast for 2006. Although the financing requirements are partly covered by foreign investments, they are also covered by volatile capital, which could still be diverted from the country (as was the case in May). The increased political tension, with the approach of the 2007 elections, the rise in terrorist attacks, the tension with Iraqi Kurdistan and the problems linked to membership of the EU may be a cause for concern for the markets, especially in the event of a possible new risk aversion phase. The lack of reduction in the foreign imbalances means that Turkey remains the most vulnerable country to a turnaround in foreign investor confidence.

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