July 2004 After several months of improvement, the world country-risk index((*) The world country risk index represents an average of Country @ratings weighted according to their contribution to the region's production. The index is based on the world average risk level in 2000.*) underwent no major change during the second quarter this year (down 1%). That reflects a stabilisation of expectations concerning the business environment and company payment behaviour. Industrial country risk remained stable with the risk index still higher for West Europe than for North America or Japan. For emerging countries, a moderate improvement in the index (down 2%) essentially reflects improvement in the ratings for Thailand (A2) and positive watch listing of India's rating (A4), South Africa's (A3) and Poland's (A4). * The world country-risk index is an average of country @ratings weighted according to their contribution to world production. The index base is the world average risk level in 2000. Continued robust growth in the United States and Asia, including Japan, marked the second quarter, fostering dynamic world trade that also benefited European economies even if they have remained hampered by inadequate domestic demand. The dynamism of world demand, particularly in China, also spurred an upsurge of raw material prices, sometimes exacerbated by speculation. Regarding oil, moreover, geopolitical tensions in the Near East have driven prices to particularly high levels (nearly $40 per barrel of North Sea Brent). Furthermore, despite the generally bright macroeconomic context, stock markets have stabilised. After discounting improved company earnings, financial operators now seem wary of prospective American interest rate increases and increased production costs stemming from surging raw material prices. The expected American interest rate increase has also generated tensions now affecting emerging countries spreads. Overall, despite increased pressure on margins of companies operating in sectors affected by raw material price increases, the growth outlook and company payment indicators should continue to improve in coming months. >> Economic activity will remain buoyant in industrialised countries. Tightening policy should not jeopardise the American economy's dynamism. With domestic demand coming back to life, the Japanese economy should be less vulnerable to a possible slowdown in China. In the European Union, however, the admission of eight Central European countries should exacerbate the great disparity in economic activity by country. >> Emerging Asian countries should continue to enjoy robust growth, driven both by buoyant domestic demand and exports despite a possible Chinese growth slowdown. Meanwhile, many elections have taken place in the region without stirring unrest. >> In Latin America, steady raw material prices and world demand should continue to drive growth, buoyed moreover by improving domestic demand. Further increase in American interest rates could nonetheless undermine countries very dependent on financial market sentiment. >> Finally, high oil prices should continue to consolidate the financial position of exporting countries. Conversely, persistent geopolitical instability in the Near East has been affecting the economies most exposed to that risk 200020012002200320042005 World production4,11,42,12,83,93,5 Industrialised Countries3,60,91,62,13,42,9 United States 3,80,32,43,14,73,7 Japan2,80,40,22,73,62,4 European Union 3,71,81,11,02,12,2 Germany 3,11,00,2-0,11,61,7 United Kingdom3,82,11,72,23,12,7 France4,22,11,30,52,12,1 Italy3,31,70,40,41,01,6 Emerging Countries5,82,83,84,95,55,2 Emerging Asia 7,14,45,86,46,96,5 Latin America 4,00,20,11,33,83,4 Central Europe et CIS6,44,54,15,65,44,8 Middle East (+ Turkey)5,51,33,35,34,14,0 Sub-Saharan Africa 2,92,92,32,54,04,5 World trade12,50,13,14,56,86,6 After several months of improvement, the industrialised country risk index has stabilised. Only Switzerland's A1 rating, removed from the negative watchlist, progressed in the last quarter. In North America, growth has remained strong. In the United States (rated A1), economic activity has continued to strengthen. The improvement finally developing in the labour market has buoyed already dynamic spending by households even if the very high levels of their car purchases and property investments will have little chance of continuing with interest rate increases and discontinuation of tax breaks looming in the second half. Manufacturing companies, meanwhile, have been capitalising on the dollar's weakness and the world economic recovery to increase their exports. Investment and restocking have been gaining momentum. In that very buoyant environment, company profitability has continued to improve. Companies have been regaining control over their prices and should be able to withstand higher interest rates since they have largely given preference to long-term debt in recent years. In Canada (rated A1), the dynamism of the United States has been spurring exports and investment with steady household confidence — bolstered by reduced unemployment and the excellent public sector financial situation — buoying consumption. That macroeconomic environment has been beneficial to companies with their profitability and payment behaviour remaining at good levels. In Japan (rated A1), growth has accelerated, still buoyed by robust exports to regional countries and the United States as well as by increased spending spurred by the labour market recovery. Financial discipline is still necessary to consolidate the decline of non-performing loans and ongoing banking sector stabilisation process. The return of growth can only bolster the financial situation of companies with their payment behaviour already satisfactory. The bankruptcy trend has been reflecting that improvement. Besides the electronics industry, there has notably been substantial improvement in sectors like steel, the car industry, or chemicals with the market buoyed by Chinese demand. The strong region growth has continued to benefit Australia and New Zealand (rated A1) where the central banks have moreover been raising their base rates to stem the overheating of domestic demand, notably for property, which should thus slow somewhat. However, the export recovery should produce an offsetting effect and permit growth to remain robust. In Western Europe, the economic recovery that began in the second half last year has continued, spurred largely by renewed export dynamism. However, the overall growth rate has nonetheless remained very moderate and below the rates posted in the world's other industrialised regions. Furthermore, there have been large disparities between countries based on household spending levels. Finally, high unemployment and structural imbalances in public accounts have continued to hamper many countries. Germany, Italy, the Netherlands, and Portugal (all rated A2) are characterised by weak growth, depending mainly on the export recovery with household spending remaining sluggish amid high unemployment and public sector account imbalances. However, Germany has been enjoying more buoyant economic activity than the other three countries, benefiting particularly from improving sales to dynamic world regions like Asia, the United States, and Central & Eastern Europe as well as from its strong competitive position in capital goods. France, Belgium, Switzerland, and Austria (rated A1 except France rated A2) have been in an intermediate position with exports also strong. However, household spending, although remaining shaky, has been firmer in those countries. At the other extreme, in Spain, the United Kingdom, Ireland, Finland, Norway, Sweden, and Greece (rated A1 except Greece rated A2 due to the shakiness of its economic fabric apt to resurface after the Olympic Games) the dynamism of all demand components (notably consumption and exports) have permitted posting robust growth. Those diverse economic conditions, which sometimes combine with specific factors linked to a country's economic fabric, would explain why company payment behaviour has varied so widely across the region. However, the slow improvement noticeable in the second half last year has been firming up. The risk index has diminished in Central Europe (-5%) with Poland's rating put under positive watch list (A4) because of its dynamic growth and better payment behaviour of enterprises. The ratings of other new European members still range from A2 to A4 and are not subject to change. Growth has remained robust in Central Europe, driven by still-dynamic domestic demand and strengthening foreign demand. Politically, admission to the European Union of eight regional countries marked the second quarter. The euphoria that preceded that admission nonetheless petered out mid-June with the results of the European elections revealing record abstentions — higher in new member countries than in the "old" Europe of the Fifteen — and a punitive vote coupled with gains by populist movements. In Poland (positive watch listed A4 rating), uncertainties surrounding the political situation with the position of the new Prime Minister Marek Belka remaining shaky have contrasted with the robust economic recovery. After reaching 3.8% last year under the effect of a surge in exports spurred by the zloty depreciation, GDP growth could exceed 5% in 2004 amid strengthening domestic and foreign demand. A substantial imbalance in public sector finances has nonetheless continued to handicap the country. Although the current account deficit has remained relatively small, external financing needs have begun to grow again under the effect of increased debt amortisation. However, the country's moderate short-term debt and ample currency reserves will limit its vulnerability to a foreign exchange liquidity crisis. In the Czech Republic (rated A2), the economy should strengthen slightly this year (up 3.5%) with investment and foreign demand firming up. The country's dependence on capital markets increased due to its growing public sector and current account deficits. The country's vulnerability to a foreign exchange liquidity crisis has nonetheless remained moderate with its external financing needs still limited compared to export earnings, its currency reserves remaining ample, and foreign investment likely to recover after the decline registered in 2003. In Hungary (rated A2), after last year's slowdown (2.9% GDP growth) due to a loss of competitiveness and decline in public investment, economy growth has been accelerating, spurred by strengthening European demand and surging investment. The growth rate should be at least 3.5% this year. However, the persistence of large public sector and current account deficits has continued to hamper the economy. Nonetheless, improved economic policy management, the strengthening of exports — which should stem the deterioration of external accounts — and the expected foreign investment upturn should contribute to the bolstering of market confidence under way since February. Farther east, in Russia (rated B), growth has remained dynamic, buoyed by very high oil prices. The country's financial situation has continued to improve thanks to persistent current account and public sector surpluses and the decline of private capital outflows — which have caused currency reserves to increase. That positive dynamic is not attributable solely to oil prices with tax reform having been a success and fiscal policy being exercised in a disciplined and more transparent manner. Raw material sectors nonetheless continue to underpin growth whereas the manufacturing sector has remained hampered by a lack of competitiveness. To improve the business climate, painful reforms will be necessary: Extensive restructuring of the banking sector and natural monopolies is still pending and administrative and judicial reform seems essential to permit the many legislative changes adopted by Vladimir Putin's first legislature to take effect. The regional risk index for North Africa and the Near & Middle East has registered a 3% decline reflecting the upgrading of Iran to B; Geopolitical instability has persisted in the region and could affect tourism and investment. The sources of tension are numerous and interactive. With repeated attacks buffeting Iraq, the political transition should prove difficult and the risks of civil war are still high. Although resolution of the Israeli-Palestinian conflict could ease regional tensions, that outcome appears unlikely in the near term. Meanwhile, Al Queda's destabilising influence throughout the region and particularly in Saudi Arabia should not be underestimated. Since early this year, the region's oil-producing countries have been benefiting from high crude prices and strong external demand, which has permitted them to consolidate their economic and financial situations. In Saudi Arabia (rated A4), conditions in the oil market have been particularly beneficial to a country like this one with substantial excess production capacity. Exports have continued to drive the economy and strengthen the country's financial situation while permitting reduction of public sector debt. The political situation has nonetheless remained disquieting. Geopolitical instability and exacerbation of anti-American sentiment have spurred the activism of radical Islamist movements and increased their capacity to destabilise the incumbent regime. In that context, social tensions have been running high. That situation has been hampering the reform programme and investment. In Iran (upgraded from C to B), growth should continue. High oil prices have been affording government authorities the means to pursue expansionary fiscal policy, which has been benefiting the non-oil sector. With their victory in the legislative elections early this year, conservatives now control all organs of power with the continuing exception of the presidency. That effectively ends institutional power struggles and could enhance the clarity of economic policies. However, the country has been subject to regional tensions apt to deter investment. Algeria (rated B) has also been benefiting from the strong oil market. Politically, President Bouteflika's re-election has ensured continuity. In Egypt (B rating removed from negative watchlist), after a slowdown lasting several years, a moderate economic recovery has begun amid a still uncertain regional context. The economy has been benefiting from improved export competitiveness attributable to the pound's depreciation, which has also been buoying tourism. That more favourable environment should permit progressive improvement in company solvency. However, the country's limited access to foreign currency could still generate payment defaults. Finally, Turkey (rated B) has continued to post strong growth this year, fuelled by robust consumption and investment amid continuing disinflation. Since mid-2003, after the interest rate decline, refinancing public sector debt has been giving less cause for concern. Buoyed by the good economic conditions, company payment behaviour has remained satisfactory with the Coface company payment incident index remaining well below the world average. However, the prospect of higher interest rates in the United States, which has prompted a widening of spreads and weakening of the Turkish lira, has once again tested market confidence, with the country's financial situation overly vulnerable to swings in that intrinsically volatile confidence. Politically, the country has been enjoying unprecedented political stability as attested by the AK Party's victory in the April 2004 municipal elections. However, the Kurdish question has resurfaced with domestic and region turmoil remaining possible. An opportunity to start negotiations on EU admission — subject to the Commission's decision in December this year — will constitute a decisive factor in maintaining confidence. Latin America's risk index has been stable for three months, remaining above the emerging country average. Export dynamism, due mainly to high raw material prices, has been counterbalanced by spread increases prompted by the prospect of higher American interest rates, which has weakened a region very dependent on the markets. In Mexico (rated A4), economic growth has been accelerating since the fourth quarter last year, a trend borne out in the first half this year. Employment and industrial production have progressed thanks notably to increased demand from American industry benefiting subcontractors operating in Mexico. However, domestic demand has also been showing signs of recovery. GDP rose 2%, the largest quarterly gain since 2000. In Brazil (rated B), the long awaited resumption of growth in the first quarter this year (2.7%) is still mainly attributable to robust exports, notably agricultural. Nonetheless, domestic demand has also been improving although still not exhibiting much dynamism. Growth forecasts by economic institutes envision GDP growth between 3% and 4% this year and next. However, that will depend on the capacity of monetary authorities to continuing reducing domestic interest rates. Inflationary pressures linked to increased oil prices coupled with the prospective tightening of American monetary policy, could inhibit the easing of monetary policy that will nonetheless be necessary to sustain economic growth. Moreover, the political climate could become less consensual in the run-up to the local elections scheduled next October. In Argentina (rated D, positive watchlisted), the economy has remained in a catch-up phase after the four crisis years suffered by the country. After GDP growth exceeding 10% in the first quarter, industrial production and construction nonetheless sagged in April. That decline is attributable to the energy shortages' initial effects. Although forecasting institutions have maintained their forecasts of growth exceeding 5% this year due to the first quarter performance, they have underscored the uncertainties linked to the difficult-to-foresee impact on growth of the energy shortages. Forecasts for 2005 have been much more prudent (under 3%) with bottlenecks and especially the lack of credit likely to severely impede growth. The already-low average risk index for Emerging Asian countries shed 3% mainly due to the upgrading of Thailand to A2, Pakistan to C and India's positive watch listed A4 rating, and in spite of Philippines' negative watch listed A4 rating. The robust growth, which should continue, has been bolstering company solvency in most regional countries. In emerging Asian countries, growth has remained high buoyed by both robust domestic demand and dynamic foreign trade not only with industrialised countries but also with China. Fears of a possible economic slowdown in China attest to its growing role in regional trade. Most regional countries, furthermore, enjoy sound financial situations despite lagging in structural reform implementation. Meanwhile, numerous recent and upcoming elections reflect the strengthening of democratic processes and, in most cases, a commitment to continuing economic opening up programmes under way. In South Korea (rated A2), after his party's victory in the April 2004 legislative elections, centre-left President Roh, whom the outgoing Assembly removed from office in March 2004, was reinstated in May 2004 by the Constitutional Court. Those developments have permitted restoring political stability and could facilitate renewing the dialogue with North Korea. The executive branch now possesses the means to push ahead on reforms and foster the country's continued economic development. Although the domestic demand recovery has firmed up thanks notably to accommodating fiscal policy, exports are still the main economic driver due to the continued expansion of sales to China (now Korea's first trading partner) and strengthening demand from the United States. In China (rated A3), growth has remained robust (over 8% expected in 2004), prompting fears however of overheating in some sectors (property, car industry, steel) and a more or less sharp slowdown. High levels of private consumption and investment as well as expanding foreign trade have been fuelling economic activity. Furthermore, China's greater integration into the WTO has contributed to the continued opening of its economy with foreign investors remaining attracted to this growth dynamo. Meanwhile, although currency reserves have become increasingly bloated, international pressure calling for the yuan's revaluation has been easing. In any case, government authorities have insisted that a moderate enlargement of the yuan's crawl band around the dollar could only take place once they consolidate the banking system and make progress on structural reforms. In Indonesia (rated B), steady farm prices and easing inflation have been buoying household spending with the decline of interest rates bolstering domestic investment. Those factors, in conjunction with a modest recovery of exports to industrialised countries and China, should permit a slight increase in growth this year. However, that expansion will be more moderate than in other Asian countries due to the extent of structural impediments with Indonesia needing to increase its efforts on economic reforms and foster a significant return of foreign investors. Politically, after the inroads made by opposition parties in the April 2004 elections, the outcome of the presidential election in July/September this year is now uncertain. However, no significant changes in economic policy appear likely. In Thailand (rating upgraded to A2), domestic demand has remained the main growth driver with accommodating fiscal and monetary policies buoying both private consumption and investment. The economy has also been benefiting from steady farm export prices and improvement in North American demand for its manufactured products. A somewhat contrived fiscal situation notwithstanding, the country has kept its external accounts in surplus and continued to reduce foreign debt with the reduction of short-term debt allied with ample currency reserves. Although Thaksin Shiwanatra's government has been slow to implement some reforms and restructuring programmes and been having some problems with the Muslim minority, it still enjoys relatively strong popular support and seems likely to win the legislative elections in January 2005. In the Philippines (negative watch listed A4 rating), although private demand and electronics sector exports have continued to drive growth, deterioration of public sector finances and the excessive level of public debt have represented the main source of concern. Moreover, unlike other Asian countries, inadequate domestic savings and foreign direct investment, deterred by a difficult business environment, have made the country partly dependent on foreign capital to cover its financing needs. Although obtaining the necessary financing has not posed major problems thus far, the resulting foreign debt has remained at high levels in relation to GDP. Risks of a market crisis have nonetheless remained limited in the near term due to the relatively small proportion of short-term financing. Politically, despite President Arroyo's re-election in May this year, the situation has remained difficult due to the authorities' inability to reduce the degree of inequality, poverty and corruption or contain the Islamist rebellion in the south of the archipelago. In India (positive watch listed A4 rating), although the Congress Party's unexpected success in the May 2004 legislative elections rattled financial markets, that should nonetheless have little impact on the country's very strong growth. Robust domestic demand from an emerging middle class, essentially urban and employed in the rapidly expanding services sector, has been buoying economic activity, which is of course also still dependent on a farm sector that supports 65% of India's population and thus on weather conditions. However, that vulnerability seems to be growing progressively smaller due to the boom in services. The country has been able to post a remarkable increase in currency reserves and substantial improvement in external debt ratios. The government's financial situation has nonetheless remained in poor shape with the lack of fiscal adjustments causing an accumulation of a heavy public sector debt. Politically, relations with Pakistan have been progressively improving. The Coface payment incident index for Indian companies — long above the world average due to the frequency of late payments by companies — has fallen sharply in the past year. A persistent lack of financial transparency nonetheless still characterises Indian companies. In Pakistan (rating upgraded to C), the economic and financial situation has continued to improve as evidenced by economic conditions buoyed by dynamic domestic demand and the good performance of external accounts. A structural reform programme initiated under IMF auspices has been bolstering that improvement. Overindebtedness has been decreasing thanks to a substantial increase in private remittances, a high level of currency reserves, and notable reduction of public sector debt ratios underpinned by disciplined fiscal policy. However, the structural problems hampering the country's economy have persisted. Its specialisation has remained focused on low value-added goods with the weight of the farm sector exposing economic performance to the vagaries of weather. Political risk has remained high. Although Pervez Musharraf's position has been shaky, the army is still very powerful, so much so that a scenario of a break-off with current pro-Western strategy seems unlikely. Moreover, relations with India have been improving with bilateral talks making notable progress, particularly on the thorny Kashmir question. Sub-Saharan Africa's regional risk index registered a 4% decline reflecting South Africa's positive watch listed A4 rating. Elsewhere in the region, the level of risk has remained high. In South Africa (positive watch listed A4 rating), after a gloomy year in 2003 (1.9% GDP growth according to estimates that could be revised upward), growth prospects have improved for 2004 (3%) with inflation under control. All economic sectors posted positive growth in the first five months this year, including manufacturing, due to domestic demand, and raw materials, due to world recovery. Meanwhile, the disciplined fiscal policy pursued by government authorities, re-elected in April, has given them ample room for manoeuvre to boost the economy. External accounts have remained in balance. With moderate external financing needs, the country has little foreign debt. Conversely, foreign direct investment inflows have been insufficient and short-term debt has been a significant, although decreasing, burden in relation to the country's currency reserves. Company payment behaviour, unaffected by the 2003 slowdown, has been excellent. 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. Information, analysis, and opinions contained herein have been elaborated from numerous sources believed to be reliable and serious; however, COFACE does not guarantee in any manner whatsoever that the data contained herein are true, accurate and complete. Information, analysis, and opinions are provided for information purpose only and as a complement to material or information which shall be collected otherwise by the user. COFACE does not have any procurement obligation but only obligation of means and shall incur no liability whatsoever for losses arising from the use of or reliance on the information, analysis and opinion herein provided. 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