Country risk trends





Although remaining above the level reached in 2000, the world country-risk index* declined 15% in the 2003 second half. That trend augurs progressive improvement in the business environment and company payment behaviour in coming months. However, the index decline is essentially attributable to the ratings assigned to industrialised countries. Meanwhile, the level of risk on emerging countries has remained stable with the mean risk index for the Asian continent remaining far below that of Latin America, one of the highest.


Confirmation of economic dynamism in the United States and Asia marked the last quarter of 2003, contrasting with the sluggishness of the main euro zone economies. Those divergent macroeconomic trends have resulted in substantial improvement in company payment behaviour in the United States and only slight easing of payment default frequency in Europe.

On the financial and monetary level, steady market confidence has resulted in continuing low risk premiums on emerging countries. However, sharp dollar depreciation against the euro has paradoxically accompanied the American growth.

Meanwhile, oil prices have remained high in a still-tense geopolitical context with frequent attacks in Iraq impeding production start-up.

In 2004, growth should gain momentum and spread to most regions. West European and even Latin American countries should thus benefit in turn from economic recovery.
Some economic imbalances and geopolitical tensions will nonetheless continue to pose risks for the future.

- In the United States, the excessive fiscal and trade imbalances that have persisted for over three years could trigger brutal adjustments capable of stalling the economy. Higher interest rates resulting from the public sector's growing financing needs and a loss of foreign investor confidence could thus undermine spending dynamism and limit the financing capacity of companies.
- In Europe, the euro appreciation could cause a loss of competitiveness that would impede the expected export recovery and increase competition in the domestic market. Despite recent easing of rules on fiscal imbalances, it is unlikely that economic policies will be capable of massively stimulating activity.
- Affected by the unstable regional geopolitical environment, Near and Middle Eastern countries could again face an investment slump with oil revenues, after an exceptional year in 2003, likely to decline due to falling prices and especially to resumption of customary production levels. That situation would limit the stimulatory capacity of economic policies.
- In South America, unrelenting financial constraints necessitating economic austerity policies coupled with an insufficient economic recovery could spur discontent after the hopes inspired by election of representatives of the poorest population segments. That could affect financial market confidence.


MAIN FORECASTS

COFACE
2000
2001
2002
2003
2004
World production
4.1
1.3
2.1
2.7
3.6
Industrialised countries
3.6
0.9
1.6
2.0
3.1
United States
3.8
0.3
2.4
3.0
4.3
Japan
2.8
0.4
0.2
2.4
2.2
European Union
3.7
1.8
1.1
0.8
2.2
Germany
3.1
1
0.2
-0.1
1.8
United Kingdom
3.8
2.1
1.7
2
2.9
France
4.2
2.1
1.3
0.2
1.7
Italy
3.3
1.7
0.4
0.6
1.8
Emerging countries
5.8
2.8
3.7
4.5
4.9
Emerging Asia
7.2
4.3
5.8
6.0
6.4
Latin America
4.0
0.2
0.0
1.1
3.2
Central Europe and CIS
6.0
4.4
4.0
5.2
4.6
Middle East (+Turkey)
5.6
1.2
3.3
4.9
2.7
Sub-Saharan Africa
2.8
3.0
2.4
2.4
4.0



In the United States (rated A1), economic activity should gain additional momentum amid continued expansionary economic policy. Buoyed by the progressive easing of unemployment, household spending should remain robust, even if the very high levels of their car purchases and property investments will have little chance of persisting. In that context, the investment recovery should intensify.
In that more buoyant environment, the company situation should continue to improve. The Coface payment-default index, declining sharply since the 2002 second half, has been reflecting that trend. The situation has nonetheless remained difficult in sectors like civil aviation, electricity production and distribution, telecommunications, metals, or steel as well as the car industry and textiles where foreign competition has been squeezing profits in many cases.

In Japan (rated A2 and positive-watchlisted), strong foreign demand coupled with sharp improvement in company profitability fostered by restructuring has spurred an industrial production upturn and an investment upsurge in export sectors like electronics, the car industry, or even steel. However, household spending has remained sluggish despite a strengthening labour market, a halt in the decline of wages, and a lower savings rate.
Despite the strength of exports, growth should remain moderate in coming months due to an investment downturn. Household spending will remain sluggish in an essentially restrictive fiscal context with income tax and VAT increases likely.
The decline of the Coface payment-default index and bankruptcies has been reflecting the improved economic conditions. That improvement needs to be tempered by prudence, however, with structural reforms and consolidation of financial system accounts remaining incomplete. Moreover, the current recovery has remained very dependent on exports, which could suffer from an excessive yen appreciation.


The European Union's country-risk index has been trending down (declining 12% in the 2003 second half) although remaining substantially (46%) above its level in December 2000.
Growth will recover progressively. Strong American and Asian demand should buoy an export recovery despite the euro appreciation, which has been undermining the competitiveness of European products. However, public sector deficits will still necessitate fiscal austerity policies and economic activity will vary by country with growth continuing to be much stronger in the United Kingdom and Spain than in France, Italy, or Germany.

In the United Kingdom (rated A1), growth has remained steady, fuelled by robust private and public spending. Conversely, despite stronger demand in the United States, exports have continued to decline, affecting industrial production and investment.
The economic activity should accelerate in coming months with industrial exports benefiting from the delayed effects of the pound sterling's decline against the euro. However, household spending and particularly residential investment will stabilise amid rising interest rates with households carrying heavy variable-rate debt.
Despite slight improvement in the Coface payment-incident index, the situation has remained generally difficult in industry, particularly in textiles, clothing, metals, furniture, printing, and mechanical engineering.

Spain's strong growth (country rated A1), which even accelerated sharply end-2003, has been in contrast with the sluggishness of neighbouring countries. The economy has been benefiting from infrastructure and housing investment and robust domestic consumption. Moreover, tourism has rebounded despite sluggish European economic conditions and the marked euro appreciation. In 2004, favourable trends for all demand components should contribute to spurring growth even more. Investment will continue to trend up thanks to expansion of infrastructure projects, which will offset the decline of construction after the excesses of recent years. Despite heavy household debt, spending should remain robust, buoyed by the decline of both unemployment and inflation. Moreover, improved European economic conditions will contribute to a new surge of exports.
The deterioration of company solvency resulting from the economic slowdown that began in 2002 reversed directions in the 2003 second half buoyed by the improving economic climate. That trend should continue in 2004 with the textile and clothing sector remaining nonetheless shaky.

In Germany (rated A2), the first-half recession gave way to a timid year-end recovery and improvement in confidence indicators. That recovery should intensify in 2004, buoyed by exports, which have been benefiting from improving world demand despite the strong euro. Increased industrial production will cause an investment upturn that rising stock market prices and increased backing by banks should help finance. However, the sizeable deficit will continue to constrain fiscal policy. Household spending will only recover progressively.
The sluggish economic conditions of 2003 have continued to affect company solvency as reflected by the Coface payment-incident index's continued high level, which remained 40% higher than the level reached in 1999-2000. The increase in bankruptcies nonetheless continued at a more moderate pace (up 6%). Although already perceptible in the payment-incident index's decline in the last months of 2003, the improvement expected in 2004 will nonetheless be very progressive.

In France (rated A2), after the economic stagnation of 2003, growth should progressively strengthen, fuelled by exports benefiting from the improved world economic environment. Despite income tax reductions, household spending will remain relatively sluggish amid continued high unemployment and company investment will only increase slightly with the production capacity utilisation rate still low and margins still tight. Despite adjustments to the Stability Pact, the government's room for manoeuvre on fiscal policy will remain limited and the strong euro could jeopardise an export upturn.
The deterioration of company payment behaviour noted by Coface has been consistent with the increase in bankruptcies. The improvement expected in 2004 will be very progressive. Some sectors like, textiles, smelting, or mechanical engineering have been particularly shaky.


The country-risk index has declined relatively little in Central Europe (down 3% in the 2003 second half, down 11% since December 2000) despite the upgrading of many ratings. A continued A4 rating for Poland — the region's main economy — has been responsible for that relative stability, nonetheless reflecting the persistent weakness of many companies.

Economic activity has continued to trend up in Central European countries thanks to steady domestic demand or surging exports buoyed by competitiveness gains. Growth should accelerate slightly in 2004 benefiting from more buoyant economic conditions in West Europe. However, exchange rate tensions have re-emerged. In Hungary, 'twin' public sector and foreign deficits have undermined the forint, compelling the Central Bank to raise its interest rates sharply. In Poland, deterioration of public finances has also been responsible for a new weakening of the zloty. However, the currency's renewed competitiveness, which has spurred sales abroad, has bolstered growth and improved external accounts.

In Poland (rated A4), growth has resumed, buoyed by surging exports linked to the zloty depreciation and moderate improvement in domestic demand. As a result, inflation has remained low and the current account deficit has declined. However, uncertainties surrounding fiscal policy management have undermined market confidence. Parliamentary approval of the government's tax reform programme has remained uncertain, which could postpone the necessary consolidation of public finances. In 2004, an investment upturn should contribute to a slight acceleration of growth with exports remaining robust and thus permitting stabilisation of the current account deficit. External financing needs will remain moderate and the expected increase in foreign direct investment, after two slack years, should facilitate covering them.

In the Czech Republic (rated A2), growth has recovered at a moderate pace, driven mainly by private consumption. The slight exchange rate decline, low interest rates, and progressive upturn of foreign demand should buoy the economy in 2004. Meanwhile, foreign direct investment flows, which have been among the region's highest, will permit financing the still-sizeable current account deficit and limit reliance on foreign debt. Moreover, the government has obtained approval of tax reform, which augurs gradual improvement in public sector accounts, also substantially in deficit.

Meanwhile, Hungary (rated A2) had to contend with an economic downturn in 2003, attributable to a loss of competitiveness and weak foreign demand. An upturn should nonetheless develop in 2004, fuelled by exchange rate depreciation and more buoyant economic conditions in Europe. Although the public sector deficit has declined since the slippage registered in 2002, the objective of bringing it below 3% of GDP within two years will prove difficult to achieve. Moreover, external accounts have deteriorated markedly with surging imports compounding weak sales abroad. Meeting the resulting higher external financing needs will depend mainly on increased debt due to the low level of foreign direct investment. Although debt service has not been a source of concern, capital volatility, responsible for periodic tensions in the foreign exchange market, has been a definite weakness.

Slovakia (rated A3) has continued to perform well, posting growth rates among the region's highest. Driven mainly by exports, notably automobiles, the economy should strengthen slightly in 2004 thanks to continued expansion of sales abroad and a domestic demand upturn. A continued satisfactory growth rate and the planned social-spending cutbacks should permit the country to meet Maastricht fiscal criteria ahead of its neighbours. Meanwhile, export dynamism, unimpaired thus far by the exchange rate appreciation, has caused a sharp reduction of the current account deficit and improvement in foreign debt ratios.

Farther east, in Russia (rated B), the election calendar and Yukos affair consequences have marked the situation. The United Russia party's sweeping legislative election victory has ensured that the legislature will continue to scrupulously do the Kremlin's bidding. Although the Yukos Affair — doubtless part of Vladimir Putin's election strategy — has destabilised stock markets and should deter the expected return of foreign investments, its economic consequences have remained limited thus far.
The uncertainties currently surrounding the oil-sector's future should dissipate after the March 2004 presidential elections. Despite recurrent discord between clans, the economic and financial situation has continued to improve rapidly. A continued current account surplus for the fourth consecutive year and robust growth — underpinned by strong domestic demand — suggest that the improvement has affected various economic sectors. According to official statistics, company payment behaviour has improved markedly in domestic commerce. In percentage of GDP terms, the stock of defaults fell from 50% in 1998 to 14% in 2003. Growth has nonetheless remained shaky and notably very vulnerable to barrel price-fluctuations. Moreover, the business climate has remained uncertain with reform implementation continuing to pose problems. Companies have begun going deeply into debt again in international capital markets while the banking system has remained very shaky due to the increasingly lagging pace of reform.


 The country-risk index for the Near and Middle East has remained very stable, down 2% during the 2003 second half, and 13% above its December 2000 level. The region's relatively high risk-level is attributable to its geopolitical instability, which has been impeding economic activity and undermining the business environment.

In the Middle East, geopolitical instability could continue to affect most countries in the region and has remained the main risk factor, likely to hamper economic activity, tourism, and investment and moreover delay structural reform programmes. In the still-possible worst-case scenario, the Iraq situation could degenerate into civil war opening the door to demands for independence along ethnic and confessional lines, which would in turn entail risks of regional conflict. Moreover, al-Qa'ida's destabilising influence should not be underestimated. Although resolution of the Israeli-Palestinian conflict could contribute to easing regional tensions, there has been little room for optimism on that score with the roadmap proving difficult to follow and support for the Geneva iniative remaining limited.
Economically, the main exporting countries, all OPEC members, will probably decide to reduce their production to support prices with countries outside the cartel increasing production and the dollar depreciating against the euro. They should consequently experience an economic slowdown and relative deterioration of their external and fiscal balances after having benefited from an exceptional year in 2003.

After the overthrow of Saddam Hussein's regime and lifting of United Nations sanctions, Iraq (rated D) has remained a poor country to be rebuilt politically and economically, its enormous natural resources notwithstanding. Sabotage and terrorism have been increasing reconstruction costs and delaying the process of restarting government administration and the economy.
In coming years, oil revenues will be insufficient to cover the operating expenses of the administrative apparatus, service the debt, and finance reconstruction costs. Although restructuring of foreign debt and mobilisation of international aid will be necessary, they will remain subordinate to normalisation of the country's political and legal situation, which will precisely constitute the main element of uncertainty. Insecurity has been heightening tensions within the population with political, ethnic, and religious cleavages intensifying. Until the political situation is normalised, risks of civil war will remain substantial.

In Iran (rated C), the opacity of company financial information has continued to make risk taking a very haphazard enterprise. The non-oil sector has been benefiting from a policy of support through public spending and from reforms being implemented progressively. The country's financial situation has improved thanks to high oil prices since 2000 while foreign debt has remained relatively low. In the near term, however, the economy should grow at a more moderate rate amid the expected reduction of oil revenues and external accounts could fall into deficit again, which should nonetheless not pose any problems considering the comfortable level of foreign currency reserves. The economy has remained very dependent on the oil sector with the public sector remaining predominant. Despite its importance, the structural reform programme has only been progressing slowly in a difficult political context. In that regard, the outcome of the February 2004 legislative elections will be a watershed.

Oil market trends in 2003 also benefited Saudi Arabia (rated A4), permitting the country to significantly increase its production with barrel prices remaining high. Those exceptional conditions thus spurred the economy, permitted reducing public sector debt, and bolstered the country's financial situation. The kingdom's commitment to supporting crude prices should prompt it to reduce its production in 2004, which could result in an economic downturn, resumption of fiscal deficits, and deterioration of external accounts. The external financial situation has nonetheless been giving little cause for concern with the debt burden limited in relation to foreign currency earnings. The country has remained vulnerable to an oil-market downturn and its price-support policy could cause it to lose market share. Reforms will be necessary to attract the foreign investment needed to diversify the economy, establish sustainable growth, and balance public accounts. The process has nonetheless been lagging amid resistance from conservative quarters and the unstable social climate, exacerbated by geopolitical uncertainties.

In Turkey (rated B), the wave of terrorist attacks in Istanbul in November 2003 has apparently not undermined the climate of confidence re-established thanks to renewed backing by the IMF and American authorities. Although very sensitive to political risk, financial indicators have continued to trend up with the lira remaining stable and spreads tending to decline. Interest rates have fallen sharply, which has facilitated the financing of public sector-debt. The country appears to have covered its short-term foreign exchange financing needs. Moreover, growth has been high, buoyed by robust consumer spending and investment amid continuing disinflation. In those favourable economic conditions, the Coface company-payment-incident index has remained well below the world average, reflecting the good payment behaviour of Turkish companies.


The country-risk index for Latin America has remained stable (down 0.6% in the 2003 second half) and 9% above its December 2000 level. The lack of a growth upturn has been offsetting definite improvement in the financial situation. The generally high level of risk in the region is attributable to very high debt levels, dependence on the markets, and limited room for manoeuvre to bolster economic activity.

In Latin America, improved financial parameters and renewed lender confidence have been in contrast with economic conditions that have remained very depressed virtually throughout the subcontinent. External account deficits have been shrinking under the combined effect of export growth and reduced purchases abroad resulting from the decline of local currencies in 2002. Although public finances have also been improving as a result of the disciplined policies adopted, those polices have been hampering economic activity.

In Brazil (rated C and positive watchlisted), the political and financial environment has undeniably improved thanks to the new government team's pragmatism.
Economic growth has nonetheless remained sluggish amid restrictive fiscal and monetary policies. Weak demand has been handicapping companies, particularly in sectors focusing on the domestic market like the car industry and retail. The country technically slipped into recession during the 2003 first half. The growth rate in the second half, although positive, remained very disappointing. That stability has nonetheless been masking industrial sector expansion offset by the unexpected decline in the farm sector and stability in services. Investment has been rising as has been consumer spending, albeit very timidly. The progressive decline of interest rates and strengthening of the local currency, which has been easing financial constraints, has caused slight improvement in company payment behaviour and a reduction of bankruptcies. A virtuous circle of growth could thus develop. Continued easing of monetary policy should permit more balanced and progressively more robust growth in 2004.

In Argentina (rated D and positive watchlisted), the economy seems to have taken off and recovered a degree of normalcy since collapsing in the 2002 first half. The low production capacity utilisation rate has permitted companies to capitalise on the peso's decline to reconquer the domestic market and, in some sectors, notably food, to develop exports. After the four crisis years endured by the country, growth has thus been robust thanks to a catch-up effect and should continue to be strong in 2004 with the 1998 production peak not yet reached. However, resumption of financial flows to industries will be essential to permit growth to continue beyond an initial catch-up phase. However, that will depend on implementation of painful reforms.

In Chile (rated A3 and positive watchlisted), improved economic conditions in the United States, strong growth in Asia, improved copper prices, and an interest rate decline have permitted a significant economic recovery since early 2003, causing a sharp improvement in company solvency and payment behaviour. However, part of the industrial sector has been suffering from the renewed competitiveness of neighbouring countries. Thanks to conclusion of free trade agreements with its main trading partners and to good fundamentals, essentially sound public finances and very moderate public sector debt, Chile should nonetheless fully benefit from the world growth recovery in 2004.

In Venezuela (rated D), political uncertainties still constitute the main risk factor with tensions between President Chavez' supporters and opponents remaining very high. Stabilisation of the political climate will nonetheless be essential since the crisis has caused a deep recession. Capital flight has necessitated strict exchange controls that have been severely handicapping companies as evidenced by the Coface payment-incident index's deterioration. Progressive recovery of oil production will thus not be very likely to permit a true economic upturn. Moreover, an oil price decline in 2004 could further undermine the country. In such conditions and lacking clarification of the political context, the company situation should remain very shaky.

In the Dominican Republic (rated C), the bankruptcy of the country's third bank, Baninter, in May 2003 had a negative impact that was as much political and social as it was economic and financial. The country suffered its first recession in thirteen years. Although the Baninter rescue's cost to the government will only be sustainable if the country rapidly implements the IMF reform programme, a segment of the population has been violently opposing that programme, which has been temporarily suspended due to the non-budgeted cost of nationalising two electricity distributors. In that context and considering its limited foreign currency reserves and extensive dollarisation, the country has remained vulnerable to sudden capital flight. The decline of the peso's exchange rate has been particularly undermining companies carrying dollar debt and cashing revenues denominated in the local currency. The outlook for 2004 has remained very uncertain.


 The mean country-risk index for Emerging Asia has remained stable at a low level. Robust growth has been bolstering company solvency in most regional countries. That situation should persist in coming months.

In emerging East Asian countries, economic activity recovered more strongly than expected in the 2003 second half after suffering to varying degrees from the SARS crisis in the first half. The domestic demand upturn, notably in the more developed countries, has been benefiting the entire region. The Chinese economy's increasing impact on regional trade has also become a crucial growth factor. Moreover, the North American economic recovery and a strengthening electronics sector have been buoying expansion of trade with industrialised countries, which have continued to play an essential role for East Asian emerging countries.

In China (rated A3), growth has remained high (slightly over 8% expected in 2004) and could even raise fears of overheating in some sectors. The economy has continued to benefit not only from high levels of household spending and investment but also from expansion of exports after the country's accession to the World Trade Organisation. WTO membership has been contributing to opening the economy and prompting investors to transform China into the world's workshop while striving, moreover, to establish a commercial foothold in a market with enormous potential.
Meanwhile, due to the continued ballooning of foreign currency reserves, public authorities have been facing growing international pressure calling for re-evaluation of the yuan. Although resisting those pressures thus far, the authorities have nonetheless admitted that a shift toward a flexible exchange rate would be desirable. They believe, however, that a moderate enlargement of the yuan's crawl band around the USD could only take place after the country consolidates the banking system, makes progress on structural reforms, and becomes fully integrated into the world economy.

The economies of Hong Kong (rated A2 and positive watch-listed), Singapore (rated A1), and Taiwan (rated A1), traditionally focused on exports to industrialised countries, have registered an upturn fuelled notably by the recovery of demand for electronic equipment in the United States. However, due to poor performance in the 2003 first half attributable to the negative impact of the SARS crisis, full-year growth will remain moderate for those countries (up 0.8% for Singapore, 1.9% for Hong Kong, and 3% for Taiwan) before rebounding more sharply in 2004.

After suffering its first recession in five years in the 2003 first half, South Korea (rated A2) has been enjoying a slight economic recovery since the second half fuelled by a modest upturn of household spending and investment (notably by the public sector) and especially by strong exports, particularly to China and the United States. The growth rate forecast for 2004 is 5%.

Domestic demand, buoyed by household spending, permitted Indonesia (rated°C) to sustain growth slightly under 4% in 2003 and notably offset sagging tourism revenues since the attacks in Bali (October 2002) and Djakarta (August 2003). Politically, President Megawati's room for manoeuvre has remained limited in the face of the Army and Islamic parties. Her re-election in 2004 has nonetheless appeared certain lacking a credible alternative while an investment and export upturn should contribute to 4% growth in 2004.

Farther south, in India (rated A4), progressive improvement of relations with Pakistan has marked the political situation with a ceasefire along the border announced end-November 2003. The countries have resumed diplomatic relations and reopened transportation links. Basically, however, the core disagreement over Kashmir has remained deadlocked. Domestically, the BJP and Congress party have been preparing for the legislative elections. According to initial results of the various regional elections held late 2003, the BJP has registered gains, apparently capitalising on the country's good economic performance.
Indian growth should continue to trend up thanks to an expected investment upturn and steady household spending. It has remained shaky, however, due to consumption's substantial dependence on the farm sector, which employs 65% of the labour force and is itself dependent on weather conditions. The high level of the Coface payment-incident index reflects the frequency of late payments by companies, generally linked to management deficiencies rather than instances of insolvency. The index has been essentially trending down due to the current strong growth.
The public sector deficit has remained high and the current electoral period, with regional elections throughout the year and legislative elections in autumn 2004, will not be conducive to fiscal adjustments. Public sector domestic debt has thus continued to increase at a disquieting rate. Foreign-currency financing needs have nonetheless been declining thanks to steady IT-services exports and the continued high volume of private remittances. The good economic conditions will also permit stabilising external debt ratios.

* The world country-risk index represents the average of Country @ratings weighted by each country's contribution to world production. The base index value is the average level of world country risks in 2000.



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