April 2004 The world country-risk index* declined again in the first quarter this year. That moderate decline (4%) tends to confirm the outlook for progressive improvement in the business climate and company payment behaviour in coming months. The level of risks declined more sharply in industrialised countries (down 6%) with Japan's improved rating (A1) nonetheless contrasting with stable country ratings in the European Union. The decline of the emerging-country risk index was smaller (down 1%), resulting notably from rating upgrades for Hong Kong (A1) and Indonesia (B). In Latin America, despite rating upgrades for Chile (A2) and Uruguay (C) and positive watchlisting of Paraguay's 'D' rating, the regional risk index only declined slightly due to the relatively low weighting of those economies in regional GDP. * 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. Based on trends observed in the first-quarter this year, the economic growth registered in the United States and Asia has been spreading at highly differentiated rates. Japan has been a main beneficiary despite tensions surrounding the yen with dynamic regional demand, notably from China, continuing to buoy the Japanese economy. Similarly, raw material exporting countries have also been benefiting from that dynamism, which has put strong upward pressure on prices. In that context, the expected oil-price decline failed to materialise while prices remained all the higher (averaging $31 a barrel for North Sea Brent during the first quarter) with OPEC members limiting production quantities. Conversely, growth spread more progressively in Europe. Recovery has remained tentative in Germany, France, and Italy, countries representing over half European Union GDP. Moreover, the Madrid attacks late March renewed awareness of the permanence of world geopolitical tensions to which Europe can no longer consider itself a bystander. However, with those attacks occurring in a better economic context than that existing in September 2001, the economic consequences should thus prove less severe. The generally favourable growth outlook and improved payment and solvency indicators in many world regions should nonetheless not obscure the persistent weaknesses that could undermine economic activity in many of those regions. >> In Europe, the strong euro has been affecting the outlook for exports with domestic demand remaining sluggish in many sectors and, outside a possible easing of European monetary policy, the room for manoeuvre to stimulate economic activity seeming virtually inexistent. >> Growth in the United States, although strong, has not been creating many jobs while higher energy prices have had a negative impact on household purchasing power. >> The commitment of OPEC member countries to maintaining discipline on supporting prices and avoiding a replenishment of stocks has led them to organise a reduction of production quantities, which could affect their earnings despite high prices. >> In Latin America, growth has only been recovering slowly in many countries, which could increase social tensions in the region. That situation could undermine favourable financial market trends, notably with the question of Argentina's debt still unsettled. 20002001200220032004 World production4.11.32.12.73.7 Industrialised Countries3.60.91.62.03.1 United States 3.80.32.43.04.4 Japan2.80.40.22.72.6 European Union 3.71.81.10.92.0 Germany 3.11.00.2-0.11.6 United Kingdom3.82.11.72.23.0 France4.22.11.30.21.5 Italy3.31.70.40.41.5 Emerging Countries5.82.83.84.75.3 Emerging Asia 7.24.35.86.36.7 Latin America 4.00.20.21.33.5 Central Europe et CIS6.44.54.15.25.0 Middle East (+ Turkey)5.41.33.45.13.7 Sub-Saharan Africa 2.83.12.42.34.1 The industrialised-country risk index has declined over the past three months (down 6%) amid the upgrading of Japan's rating. Economic activity has been robust in North America. In the United States (rated A1), buoyed by still-very accommodating economic policy and despite the lack of a tangible employment recovery, growth has remained strong thanks to renewed company-investment dynamism and very firm household spending. The expected export recovery should further contribute to that robustness. In Canada (rated A1), the economy has been recovering after the sharp slowdown registered in 2003. With primary industries continuing to benefit from surging raw material prices, manufacturing industries have succeeded in adapting to the Canadian dollar's past appreciation to stem the decline of their exports within NAFTA and seem capable of increasing them. Domestically, the sharp decline of interest rates and prices of imported equipment has been spurring company investment. Household spending should also develop favourably in a context of job and income growth notwithstanding the persistent weakness of the automobile market and residential construction. That macroeconomic environment has been beneficial to companies whose profitability and, consequently, payment behaviour have continued to improve. In Japan (upgraded to A1), robust exports to Asia, notably China, have been mainly driving the recovery despite the yen's appreciation against the dollar of over 10% in a year. That robust external demand in conjunction with sharp improvement in company profitability has been responsible for an industrial production recovery and an investment boom in export sectors. Household spending has finally begun to show signs of recovery and should strengthen amid favourable employment and wage trends and easing inflationary pressures. In that favourable context, the Coface payment-incident index has stabilised at a low level. Bankruptcies and the resulting amount of liability have continued to decline. Continued strong Asian demand should further contribute to improving the business climate for the rest of the year. West European countries, in general, have only registered a weak economic recovery, driven mainly by robust exports to the rest of world with the euro's past appreciation against the dollar ultimately producing only a moderate negative effect amid robust demand. Germany, France, and Italy, representing over 50% of European Union GDP should only manage a moderate recovery after the stagnation of last year. Household spending has continued to sag in those countries amid deterioration of the labour market and anxiety about the outlook for the social safety net in a context of shaky public sector finances. The sluggish expansion and low production capacity utilisation rates have also been deterring investment growth. Conversely, the United Kingdom, Ireland, Spain, Greece, and, to a lessor degree, Scandinavia have been posting better performance due notably to rapidly expanding domestic demand and/or the substantial contribution of information and communication technologies whose activity has been recovering. In that context, there has been generally little improvement in European-company payment behaviour, moreover highly differentiated by country. The risk index has remained stable in Central and Eastern Europe with the ratings of Russia and Poland, the region's main economies, remaining respectively in categories B and A4. Growth accelerated late 2003 and remained relatively strong in the first quarter this year in Central European countries, still fuelled by robust domestic demand and competitiveness gains on exports. Economic activity should strengthen this year (up 4.1% expected after gaining 3.6% in 2003) due notably to increasing demand from West Europe. On the foreign exchange market meanwhile, the zloty and forint have regained some strength after depreciating sharply until last February. In Poland (rated A4), the growth rate reached 4.7% year-on-year in the fourth quarter last year, bringing the full year result to 3.7%. Driven mainly by exports thus far, growth should reach about 4.3% this year, buoyed by a competitive zloty and strengthening foreign demand. Although the current account deficit should stay around 2% of GDP, financing needs will grow due to a sharp increase in amortisation of the debt. The main question marks concern investment, still constrained by uncertainties surrounding the European recovery and a lagging reform programme. The size of the public sector deficit (6.5% in 2003, 7.8% expected this year) has also remained a source of concern despite adoption by parliament of phase one of a fiscal reform programme. Finally, the announcement on 26 March of the Polish prime minister's resignation, which followed the split in his party (the Social Democratic Alliance, with a minority in the Diet), should put an end to dissension in its ranks. However, it does not eliminate the prospect of early elections before the September 2005 schedule date. In the Czech Republic (rated A2), the economy has been recovering at a moderate pace (up 2.9% in 2003), driven largely by private consumption, itself spurred by rising real wages. The strengthening of investment, already apparent late 2003, and foreign demand should contribute to bolstering growth this year (up 3.5% expected) despite initiation of an adjustment of public sector finances. Concurrently, an acceleration of exports will permit reducing the current account deficit slightly. Although that deficit will nonetheless remain high at 5.8% of GDP, increasing foreign direct investment inflows should facilitate covering external financing needs. Hungary (rated A2) is practically the only Central European country that suffered a growth slowdown in 2003 (up 2.9% after up 3.5% in 2002) attributable to a certain loss of export competitiveness and a reduction in public spending. However, that situation has caused no notable deterioration of company payment behaviour. The growth dynamic nonetheless improved during the year with investments and exports strengthening and GDP rising 3.5% in the last quarter. That augurs well for 2004 with growth expected to exceed 3%. Although declining markedly, the public sector deficit nonetheless reached 5.9% of GDP last year and external accounts deteriorated. That deterioration has generated increased external financing needs and covering them will depend mainly on increased debt due to the low level of foreign investment. Although capital volatility has spurred periodic tensions in the foreign exchange market, the forint has nonetheless strengthened lately due to improved economic fundamentals and economic policy management. Further east, in Russia (rated B), the legislative elections of December 2003 and especially the presidential election in March this year have strengthened the position of Vladimir Putin, elected to a second four-year term with over 70% of the votes cast in the first round of voting. The country has continued to enjoy real political stability with its financial situation improving rapidly. Maintenance of current account surpluses for the fourth consecutive year and robust growth (7.3% in 2003) — underpinned by robust domestic demand — will constitute favourable elements in the macroeconomic framework. Official statistics reflect marked improvement in company payment behaviour in domestic trading. The stock of payment defaults in relation to GDP declined from 50% in 1998 to 14% in 2003. Economic growth has nonetheless remained shaky with the economy increasingly dependent on raw material sectors, which tends to make the growth rate highly vulnerable to barrel-price fluctuations. The economy has benefited from exogenous factors (high oil prices and the strong euro), which may not be durable. The business climate has remained uncertain. The legal action against the Yukos Company and its management could deter foreign investment projects (FDI inflows have remained very limited) and reflects the continuing discord between clans. Implementation of reforms has remained problematical. Companies have resumed taking on heavy debt in international capital markets. Moreover, the banking system has remained very shaky due to the increasingly slow pace of reforms. The Near and Middle East regional risk index eased 2% in the first quarter this year with negative watchlist status lifted for Israel, Tunisia, and Egypt. Conversely, Oman's rating was downgraded to A3. The index has nonetheless remained above its December-2000 level. The geopolitical instability that affects economic activity and the business climate explains the region's relatively high level of risk. Geopolitical instability has persisted in the region and could again deter tourism and investment. The sources of tension are numerous and interactive. Amid repeated attacks, the political transition in Iraq is proving difficult with risks of civil war remaining high. Although resolution of the Israeli-Palestinian conflict could ease regional tensions, that appears very unlikely in the near term. Meanwhile, al Qaida's destabilising influence throughout the region should not be underestimated. The region's oil-producing countries have continued to benefit from high crude prices since the year began. However, they may have to reduce production to support prices amid a seasonal decline of demand and increasing production by non-OPEC countries. The dollar's weakness against the euro is another factor that could encourage regional countries to comply with the cartel's quotas. A moderate economic slowdown and limited deterioration of external and fiscal balances could thus develop during the year. As expected in Iran (rated C), conservatives won a sweeping victory in the recent legislative elections. However, that change should have little perceptible impact on economic policy this year in the run-up to the presidential elections scheduled for 2005. Meanwhile, the nuclear issue has become a further source of tensions with the United States. In Egypt (rated B, negative watchlist status lifted), after a slowdown lasting several years, a moderate economic recovery has begun to develop in a still-uncertain regional context. Economic activity has benefited from improved export competitiveness attributable to the pound's depreciation, which has also been prompting a progressive return of tourism. That more favourable environment should foster progressive improvement in company solvency. However, the country's limited access to foreign exchange could still generate payment defaults. In Tunisia (rated A4, negative watchlist status lifted), the growth outlook for 2004 is bright. Tunisia continues to pursue prudent modernisation, diversification, and public sector deficit-reduction policy, facilitated by the country's political stability and the international community backing it enjoys. Investment flows have been increasing with debt ratios remaining reasonable and the country continuing to enjoy easy access to international capital markets. A balance-of-payments crisis is thus highly unlikely. That favourable context notwithstanding, company behaviour, notably in the textile sector, is still characterised by frequent payment incidents, which nonetheless often result in settlements. The high Coface index is more a reflection of late payments than actual instances of insolvency. Turkey (rated B) has been posting high growth buoyed by robust spending and investment amid continuing disinflation. Renewed backing by the IMF and American authorities has contributed to restoring a climate of confidence. Interest rates have declined in consequence, which tends to facilitate refinancing of public sector debt. The country should be able to cover its foreign-currency financing needs in the near term. In that favourable economic context, the Coface payment-incident index for companies has remained well below the world average, reflecting the good payment behaviour of Turkish companies. The wave of confidence observed has nonetheless remained shaky since it is still vulnerable to swings in market sentiment. Although that confidence will depend on relations with the IMF, the fund's backing seems assured in the near term. However, the Kurdish question has re-emerged amid continuing possibilities for internal and regional unrest as well as for new terrorist attacks detrimental to tourism. The possibility of starting EU admission negotiations — with the country already enjoying candidate status – will constitute the crucial challenge this year. Although Latin America's risk index declined slightly in the past three months (down 1%) due to rating upgrades for Chile (A2) and Uruguay (C), it has remained above the emerging country average. The high level of risk in the region is attributable in general to the debt burden, dependence on capital markets, and limited fiscal room for manoeuvre to support economic activity. In Chile (rating upgraded to A2), growth has accelerated sharply with a 5% GDP expansion expected this year. The economic improvement in the United States, high growth in Asia, signature of free-trade agreements with its main trading partners, and a substantial increase in demand for copper have fuelled a marked economic recovery since the start of 2003. That dynamism has caused a sharp improvement in company solvency and payment behaviour. Moreover, the country continues to benefit from good fundamentals, mainly sound public finances and very moderate public sector debt. In Mexico (rated A4), although economic fundamentals have remained sound, growth has been very disappointing in the past three years (up 1.2% in 2003) with restoring competitiveness in relation to countries like China constituting Mexico's main challenge. An upturn has nonetheless been developing since the third quarter last year. Employment and industrial production gained in December 2003, thanks notably to increased demand from American carmakers benefiting subcontractors operating in Mexico. The main economic drivers in the 2003 last quarter notably included the services sector, thanks to telecommunications dynamism, financial activities, property, and agriculture. Full-year growth of 3.2% is thus expected for 2004. In Brazil (rated B), the political and financial environment has remained markedly better over the past year despite the first financial scandal involving the party in power. Moreover, although economic growth has remained too weak amid restrictive fiscal and monetary policies, a recovery nonetheless began to develop in the 2003 last quarter (up 1.5%). However, that somewhat disappointing recovery has not prompted economic institutions to adjust their growth forecasts of between 3% and 4% GDP expansion this year. Furthermore, unlike 2003 overall with spending and investment declining sharply and only foreign demand remaining robust, economic growth in the last quarter was much more balanced with consumption and especially investment beginning to recover. In Argentina (rated D, positive watchlisted), the economy has remained in a catch-up phase after the four crisis-years that gripped the country. Low capacity utilisation rates have permitted companies to take advantage of the peso's decline to retake the domestic market and, in some economic sectors — notably food, to develop exports. Although resumption of financial flows to industry will be essential in sustaining growth after the catch-up phase, that will depend on implementation of painful reforms. On 22 March, Argentina succeeded in obtaining adoption of the second revision of the IMF stand-by agreement, thus barely avoiding default on payments due to the fund. Venezuela (rated D) could again experience turmoil apt to undermine an economy still shaken by last year's strikes, which durably affected the oil sector. The revocatory-referendum question has continued to exacerbate tensions between supporters and opponents of President Chavez. In that context, the president has been maintaining his support among the poorest population segments via social policy based on instrumentalisation of PDVSA, the state oil company, probably to the detriment of productive investment in its sector. The bolivar's devaluation in February — intended to increase the value (in bolivars) of oil tax revenues (in dollars) — has penalised importing companies, already affected by exchange controls. It has also generated inflationary pressures that could impede the growth recovery. Finally, in the foreign policy arena, relations with the United States have worsened, causing an increase in oil prices. The average risk index for emerging Asian countries, already at a low level, declined 2% due to rating upgrades for Hong Kong (A1) and Indonesia (B). The robust growth, which should continue, has been bolstering company solvency in most regional countries. In East Asian emerging countries, economic activity has remained strong despite the avian flu crisis that affected to varying degrees some countries in the region during the first quarter. The consumption and investment upturn, notably in the more-developed Asian countries, has benefited the entire region. Moreover, North American economic dynamism and a favourable trend in the electronics sector have buoyed expansion of trade with industrialised countries, which continues to play an essential role for emerging Asian countries. The Chinese economy's increasing share in regional trade also continues to be a crucial growth factor. Meanwhile, although many elections will be held this year, they will nonetheless be unlikely to jeopardise continued robust economic growth in the region. After parliament forced centre-left President Roh — in office since February 2003 — to step down on 12°March 2004, a period of political uncertainty has been gripping South Korea (rated A2) pending a final ruling by the Constitutional Court (within six months) and the outcome of the April 2004 legislative elections (with the opposition conservative party no longer appearing likely to retain a majority). That interim period will be unlikely to facilitate continuation of the dialogue with a North Korea always ready to capitalise on an adversary's weaknesses. That situation will nonetheless be unlikely to jeopardise the country's continued economic development. South Korea has thus been currently benefiting from an economic upturn spurred by recovery of household spending and investment (notably by the public sector) and especially by robust exports, particularly to China and the United States. Growth forecasts for 2004 have thus been targeting about 6% (or double last year's rate). In China (rated A3), growth has remained high (slightly over 8% expected in 2004, after 9.1% in 2003) and could even raise fears of overheating in some sectors (property, the car industry, steel). Several factors continue to drive economic activity: high levels of household spending and investment as well as the expansion of foreign trade with China's progressive integration into the World Trade Organisation spurring the opening of its economy. Furthermore, the 'world's workshop' has continued to attract foreign investors, who are also anxious to establish a commercial beachhead in a market with such enormous potential. Meanwhile, with foreign currency reserves continuing to balloon, Chinese authorities have continued to face international pressure calling for revaluation of the yuan. Those authorities believe, however, that a moderate enlargement of the yuan's crawl band around the dollar could only take place once they consolidate the banking system, make progress on structural reforms, and fully integrate China into the world economy. Hong Kong (rating upgraded to A1), with its economy traditionally focused on exports to industrialised countries, has posted a marked growth upturn (with a gain of 5.5% expected in 2004), notably attributable to renewed demand for electronic equipment from the United States and to continued strong growth in China. Companies generally coped effectively with last year's economic slowdown as evidenced by the favourable Coface payment-default-index trend. However, some companies operating exclusively in the domestic market have continued to suffer from high production costs, attributable to high wages and property prices. The territory has also been striving to redefine it positioning and thereby derive greater benefit from the ascendancy of China with which a bilateral free-trade agreement — the Closer Economic Partnership Association — became effective early this year. In Malaysia (rated A2), after the smooth transition end October 2003 from Doctor Mahathir to the new Prime Minister, Abdullah Badawi, the governing coalition won a sweeping victory at the expense of Islamist fundamentalists in the early legislative elections held on 21 March 2004. The more robust economic activity is not only attributable to an export rebound — notably of electronic products (whose share has remained preponderant) — in a largely outward-looking economy but also to stimulation of domestic demand by expansionary fiscal policy. Thailand's economy (country rated A3, positive watchlisted) has been benefiting fully from the world economic upturn and notably from steady prices for its farm exports and stronger North American demand for its manufactured products. Domestic demand has nonetheless remained the main growth driver with both household spending and investment buoyed by accommodating fiscal and monetary policy. Despite the avian flu crisis in the first quarter this year, Thailand should thus boast one of the region's highest growth rates (about 7% expected for 2004). In the Philippines (rated A4), although the outcome of the May 2004 presidential election has remained uncertain, the incumbent President, Gloria Arroyo, still has the advantage. Moreover, the political situation has remained tense due notably to the activism of separatist Islamic movements. Continued strong household demand and expansion of exports by the electronics sector should nonetheless permit the country to sustain honourable growth rates with a gain of about 4.5% expected this year. Finally, in Indonesia (rating upgraded to B), steady farm prices and reduced inflation have been spurring household spending with investment notably buoyed by incentive policy in the oil and gas sectors. In conjunction with an upturn of exports to industrialised countries, those factors should permit Indonesia to achieve a growth rate of 4.5% to 5% in 2004. Politically, President Megawati has been maintaining the regime's stability and her re-election mid-2004 seems likely, lacking a credible alternative. 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. 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