The world country-risk index( 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.) has improved (down 2.4%) reflecting the rating upgrades for countries in Europe, with the Netherlands and Bulgaria improving respectively to A1 and A4, and in Latin America, with Mexico upgraded to A3. Those positive trends offset the negative watchlisting of New Zealand's A1 rating and Thailand's A2 rating, as well as the removal of Kenya's C rating from positive watchlist status, which caused a very slight deterioration in the regional indices for Asia and Africa.

A moderate slowdown in the United States, recovery in Europe, and continued dynamic growth in Asia, including Japan, as well as in oil exporting countries should again mark the coming months. Even with oil prices still high, companies should benefit from a favourable economic environment. However, the record earnings posted by large groups, capable of taking advantage of delocalisations and world demand dynamism, have been in contrast with the difficulties met by companies specialised in low value-added niches and focused on mature and/or highly competitive markets. Costly inputs and stiff competition have been squeezing the margins of those companies and affecting their solvency, as evidenced by the chain reaction of bankruptcies of American car industry subcontractors and to a lesser extent by the squeezed margins of Chinese companies.
Moreover, geopolitical tensions and significant macroeconomic imbalances still imperil growth.

Concern over the Iran nuclear issue and Middle East tensions have been delaying a possible stabilisation of oil prices, with North Sea Brent barrel prices increasing a further 30% in the first quarter of this year. That situation has contributed to the widening trade deficits of many countries.
The size of the United States' current account deficit could cause a crisis of confidence in the dollar. The expected end of the cycle of rate hikes by the Federal Reserve would then give way to a sharp tightening of American monetary policy.
Such a scenario would jeopardise the abundance of liquidity in the markets and cause spreads to widen making it more difficult for the more-dependent emerging countries to meet their financing needs.
That context could increase the tensions affecting some currencies like the Turkish lira or the Hungarian forint.

COFACE	2001	2002	2003	2004	2005	2006
World production	1.6	2.0	2.8	4.1	3.5	3.8

Industrialised countries	1.1	1.3	1.9	3.1	2.5	2.7
United States	0.8	1.9	3	4.4	3.5	3.3
Japan	0.2	-0.3	1.4	2.6	2.7	2.9
European Union 15	1.8	1.1	0.9	2.1	1.5	2.1
Germany	1.1	0.1	-0.1	1	0.9	1.7
United Kingdom	2.3	1.8	2.2	3.1	1.8	2.2
France	2.1	1.1	0.5	2.2	1.4	1.9
Italy	1.7	0.4	0.4	1.1	0.2	1.2
Emerging countries	3.0	4.2	5.5	6.9	6.1	6.1
Emerging Asia	4.8	6.4	7.1	7.7	7.5	7.4
Latin America	0.2	0.2	1.7	5.7	4.0	4.2
Central Europe	2.9	2.9	3.9	5.4	4.2	4.4
CIS	6.1	5.2	7.7	7.8	6.6	6.4
Middle East (with Turkey)	0.7	3.3	5.9	6.9	5.8	5.8
Middle East (without Turkey)	2.2	2.5	6.2	5.3	5.7	5.5
Sub-Saharan Africa	3.4	3.4	4.2	5.1	5.1	5.6
World trade	0.1	3.4	5.4	10.3	7.0	7.4

The INDUSTRIALISED-COUNTRY risk index eased again slightly (down 1.4%) affected by the upgrade of the Netherlands' rating from A2 to A1. Although the expected level of risk on European Union companies thus moved closer to the industrialised-country average, it has nonetheless remained above the levels of both North America and Japan, due mainly to Italy's negative watchlisted A2 rating (A3 for export-oriented companies).

Companies in industrialised countries will benefit from generally robust demand in an environment marked by converging growth rates.

In the United States (A1), growth will only slow moderately. Increased public spending linked to the reconstruction efforts in Gulf of Mexico coastal states and the upcoming mid-term elections should largely offset the negative impact of rising interest rates. The still-buoyant environment and the very high degree of solvency enjoyed by American companies should enable them to cope with the continued high prices of energy and intermediate products. However, competitive pressures and the high cost of social services continue to represent major constraints affecting solvency in the more vulnerable and weaker economic sectors like the car industry or air transport. With the period of tightening monetary policy drawing to a close this year, the twin budget and trade deficit problem should regain the spotlight and contribute to spurring the dollar's decline. Although not considered a likely scenario by Coface, a severe dollar collapse nonetheless constitutes a risk that bears watching.

In Japan (A1), companies have been benefiting from buoyant regional demand and competitiveness of their products. Sales abroad and profits derived from delocalised operations have bolstered the solvency of export and internationalised groups. The progressive consumption recovery and the banking sector's renewed solvency have both constituted factors conducive to more robust economic activity and improvement in the financial situation of all companies including those focusing on the domestic market. Some sectors like construction or mass distribution are nonetheless still shaky.

In Europe, the delayed effects of the euro's decline against the US dollar in conjunction with the German economic rebound (20% of regional GDP) should spur a moderate recovery. The upturn should be sharper in Germany (A1), the Netherlands with its rating upgraded from A2 to A1, Belgium (A1), Sweden (A1), and Finland (A1). However, the diversity of the various country situations will persist. Spain (A1) will thus continue to post the strongest growth rate in the region with domestic demand still buoyed by the low cost of credit and a property-based wealth effect. Export sectors have nonetheless been suffering from a loss of competitiveness linked to increased production costs compounded by competition from Central European and Asian countries.

In Italy (A2 negative watchlisted overall and A3 for export-oriented companies) and Portugal (A2 negative watchlisted), growth will remain weak despite the rebound expected this year.
Besides growth differentials, there are also disparities in company financial situations. Large international groups have thus been enjoying good competitiveness and exploiting buoyant world economic conditions effectively. Conversely, industrial companies lacking such international reach have found it difficult to cope with competition from low labour-cost countries and with rising input costs. The situation has been particularly shaky for companies located in countries with weak domestic demand and for those dealing in low-growth products.

The risk index for CENTRAL EUROPEAN COUNTRIES has eased slightly (down 1%) reflecting the upgrade of Bulgaria's rating amid its improved macroeconomic situation and prospective admission to the European Union. After that upgrade, the ratings of countries that recently joined the EU or that are poised to do so now range from A2 for Hungary (negative watchlisted) and the Czech Republic to A3 for Poland and Slovakia and A4 for Romania. Turkey, meanwhile, is still rated B and positive watchlisted.

Regional economic activity was dynamic in 2005 (up 4.2%) and should continue at a slightly higher rate this year (4.4%), driven by increased imports from the euro zone and robust domestic demand. The dynamic economic conditions have bolstered company solvency overall, which will nonetheless not exclude occasional isolated payment failures in weaker or highly competitive (retail) sectors in those economies.

Although economic conditions have remained good, imbalances have persisted. The public sector deficit has exceeded the Maastricht threshold at the regional level, reaching 6% of GDP in Hungary (A2 negative watchlisted). In that context, most large Central European countries should not be ready to join the euro zone before the end of the decade. The current account deficit has moreover remained sizeable (5% of GDP on average). Although external accounts have improved in the Czech Republic (A2) and Poland (A3), large imbalances have persisted in Romania (A4), Bulgaria (upgraded to A4), and Hungary. In Hungary's case, the persistence of severe "twin" deficits has generated a risk of strong pressure on the forint. Moreover, a sharp increase in the volatility of regional exchange rates has been apparent since early March, largely attributable to the monetary-tightening process engaged in industrialised countries. The slight increase in political risk attributable to the resurgence of populism in the region constitutes an additional element of weakness. The upcoming legislative elections in Hungary (April 2006) and the Czech Republic and Slovakia (June 2006) could bear out that trend.

As for Turkey (B positive watchlisted) meanwhile, growth has remained very robust, above the Central European country average. Company payment behaviour is still satisfactory with the number of payment incidents remaining stable and below the world average. Textiles have nonetheless been suffering from Chinese competition and the lira appreciation. Financially, Turkey differs from Central European countries by virtue of its limited public sector deficit (0.6% of GDP in 2005) . However, its current account deficit has been giving even greater cause for concern (6.3% of GDP in 2005) with the country's financing needs still mostly covered by volatile capital.

The average risk presented by countries in the COMMUNITY OF INDEPENDENT STATES has been stable, with Russia retaining its B rating. The other regional countries present higher levels of risk with ratings ranging from B for Kazakhstan and D for the other Central Asian countries. Ukraine, meanwhile, is still rated C. Growth slowed markedly there in 2005 due notably to investment sluggishness, itself linked to political uncertainties that the legislative election outcome this past 26 March did little to dispel with no formation alone claiming a majority. The political situation could remain unstable whatever coalition takes form.

Growth has continued to trend up in Russia. The high raw material prices have caused an increase in real personal income and that mechanism will continue to buoy economic activity. Moreover, Coface has recorded good payment experience on Russian companies, which have been able to restore their solvency since 1998. Domestic company payment failures are now below 10% of GDP (against 50% in 1998) according to official statistics. However, corporate governance is still a problem. Financial and ownership transparency standards have been comparatively low compared to other large emerging countries.

The average risk index for countries in Emerging Asia has remained at the lowest level of all emerging countries despite very slight deterioration (up 0.7%) after the negative watchlisting of Thailand's A2 rating. The political crisis linked to opposition to the Thai Prime Minister has developed in an already deteriorated context for companies with their margins shrinking sharply amid fierce competition from China. They could suffer further from the baht's increased volatility spurred by the political tensions.

As a whole, Asia is still characterised by robust growth underpinned by buoyant domestic demand and good export performance. The region posted 7.5% growth in 2005 and should achieve a similar result in 2006. China (A3) has shown no sign of faltering with domestic and foreign demand still posting steady growth.

However, the need — reasserted by authorities during the annual People's Assembly in March 2006 — to establish more balanced growth with relatively less investment and more consumption has tended to increase pressure on company margins and sustain an appreciable level of credit risk. In India (A3), strong domestic demand is still driving growth. On the supply side, comparative advantages have been buoying growth in sectors like computers, outsourcing, steel, pharmaceuticals, and textiles.

The rest of Asia, meanwhile, has successfully withstood the twofold shock of rising raw material prices and Chinese competition with companies absorbing the higher production costs by squeezing their margins. That has notably been true in the electronics sector, particularly exposed to competition from China. Based on Coface's experience, payment behaviour has nonetheless been good. Facing China, companies have either strengthened their positions in high value added products [Hong Kong (A1), Taiwan (A1), Malaysia (A2)] or conversely have taken positions in products further down market [Vietnam (B), Indonesia (B)]. In that regard, Asian textiles (Pakistan (C) in particular) have ultimately fared very well since the elimination of quotas in 2005. Trends in politically weaker countries have been favourable with Indonesia (B) notably remaining on track for strong growth and its financial situation continuing to improve. In the Philippines (B positive watchlisted), the state of emergency declared in February 2006 — and quickly lifted — hardly affected market operator confidence with sovereign risk continuing to improve. In Thailand (A2 negative watchlisted), the increasing opposition to Prime Minister Thaksin Shinawatra and the holding of early elections have developed in a context of baht weakness and industrial sector's loss of competitiveness, in a country with a specialisation very close to China's.

The risk index for Latin America eased markedly (down 8.4%) with Mexico's rating improving from A4 to A3. Across the region, companies have been benefiting from both strong export markets and an improved household demand trend. The general risk level in the region has nonetheless remained above the emerging-country average.

In 2006, growth should continue in Latin America at a satisfactory rate (slightly more than 4%) despite a slightly less buoyant international environment, with domestic demand expected to pick up some of the slack for foreign trade. Although the international expansion has been conducive to continued improvement in external accounts, the region has remained vulnerable to fluctuations in world raw material prices. Meanwhile, Latin America has continued to benefit from the effects of generally stricter monetary and fiscal policies, which have paved the way for an easing of inflation and consolidation of public sector finances. In conjunction with abundant international liquidity, that overall trend has resulted in a decline of spreads on sovereign bonds of most regional countries to historically low levels.

Even if that context has been conducive to continuation of the external debt reduction process, debt ratios, although improved, are still higher than in other emerging regions, particularly in relation to exports. The same holds true for public sector debt ratios, especially in Argentina (C) and Brazil (B positive watchlisted). The relative inadequacy of the investment rate (slightly under 20% of GDP in 2005) still limits the region's growth potential.

In Mexico, the decline of average risk on companies (rating upgraded to A3) reflects an improvement in their payment behaviour that the brighter growth outlook should reinforce. With the country's sound economic and financial fundamentals moreover, the uncertainties linked to the upcoming July presidential and legislative elections should only have a limited impact. However, Mexico is still dependent on economic conditions across its northern border with some companies continuing to face competitiveness problems.

In the political arena, after the election of the Indian leader of the Movement toward Socialism Evo Morales as president of Bolivia (D) end December 2005, and the election of the Social Democrat Michelle Bachelet in Chile (A2) in January 2006, elections will further mark the political calendar this year in several important countries, with a number of them, notably Ecuador (C), subject to continuing social or political tensions. The victories of pragmatists or populists in elections held in April/May in Peru (B), in May in Colombia (B), July in Mexico, October in Brazil, and December in Venezuela (C) will be of no mean consequence for Latin America's future. Fiscal or monetary slippage will remain possible and the uncertain political climate could cause turbulence in financial and foreign exchange markets. Currently engaged, however, in a virtuous circle of sound macroeconomic management, Latin America does not appear likely to fall victim to past bad habits.

The regional risk index for North Africa and the Near & Middle East has been stable. The oil sector that has dominated the regional economy continues to be growth oriented even if the International Energy Agency has just revised demand-growth forecasts downward. Geopolitical risks are still high, however, and they continue to cloud the outlook.

Regional geopolitical tensions heightened in the first quarter. The Hamas victory in the Palestinian Territories has roiled the region's political landscape. That could lead to reconfiguration of the international aid on which the Palestinian Territories are so dependent and provide Iran (B) with an opening to increase its influence. Moreover, resumption of the peace process now seems unlikely in the foreseeable future. Iran, meanwhile, has resumed its uranium enrichment program and the International Atomic Energy Agency has submitted the case to the UN Security Council. Considering the economic stakes, the adoption of tough sanctions seems unlikely with a policy of small steps and hedging apparently the most probable scenario. With the degree of uncertainty nonetheless remaining high, however, companies and banks should exercise caution.

Economically, the continued upward trend of oil prices has nonetheless been more moderate than a year earlier. Although the $61.50 average price per barrel of North Sea Brent for the first eleven weeks this year was 30% above the prior year average of $47, the increase for the same period in 2005 was 48%.

After three euphoric years of vertiginous index growth spurred by the oil windfall and good earnings performance by companies, a crisis of confidence seems to have gripped Middle Eastern stock markets since end February. With the markets overvalued, however, corrections were inevitable. The price/earnings ratio had reached unrealistic levels (45 to 1) notably in Saudi Arabia, or three times that of the MSCI (Morgan Stanley Capital International Inc) index for emerging countries. Despite the essentially salutary effects of those corrections, they can nonetheless have a negative impact on small investors forced to sell at a loss and on banks that granted loans for stock purchase and whose assets may deteriorate in quality due to the consequent increase in non-performing loans.

The regional risk index for sub-Saharan Africa — the region that continues to register the highest level of risk — rose very slightly reflecting the removal of Kenya's C rating from positive watchlist status.

Overall, economic activity should still benefit from the good market conditions for raw materials with the price of oil and gas as well as minerals like precious metals, iron, copper, zinc, and aluminium continuing to trend up. Besides the oil-producing countries, that situation has also benefited countries like Zambia (C), Ghana (C), and Tanzania (B). In that context, South Africa (A3) has strengthened its position as the continent's economic engine. With robust domestic demand (consumption and investment) and good export performance spurring a faster growth rate, the favourable economic conditions have bolstered company solvency.

However, although continued efforts on structural reform implementation and economic diversification have brightened the growth outlook, the rate of expansion will nonetheless remain highly dependent in many countries on the vagaries of weather and politics.

In Kenya (C), the robust economic activity registered in the past two years could thus suffer from the effects of the drought with a decline in both farm and hydroelectric production having already depressed growth forecasts from 5.5% to 4.5%. Moreover, heightened political tensions since the failure of the November 2005 constitutional referendum and the persistence of problems with corruption affecting the current government could slow the pace of reforms and the flow of funds from money lenders. Those developments prompted the lifting of the country's positive watchlist status.

For sub-Saharan African countries, however, the improved economic conditions have generally not produced a corresponding improvement in their accounts. Although most oil-producing countries will continue to post large surpluses in their public sector accounts, the other countries will continue to struggle to adjust still insufficient revenues, particularly limited by a narrow tax base, to their continuing large needs (infrastructure, poverty reduction, public health and notably the impact of AIDS, education). Those problems affect growth and the attractiveness of regional markets to companies.

The external account situation in non-oil exporting countries will moreover remain difficult despite the increase in their raw material exports and the debt reduction facilities granted to them. The increased spending on oil and especially on imports of capital equipment and food products by countries particularly affected by the drought (East Africa) will weigh on their trade balances. In any case, both internal and external financing needs in those countries, whose solvency will remain shaky, will be essentially covered by international aid and, for some countries, by foreign direct investment inflows.