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.) rose moderately due to the downgrade of Italy's rating to A3 for exporting businesses and Greece's companies negative watchlisting. The gap has thus widened between euro-zone companies, contending in some countries with economic stagnation if not recession, and North American companies whose environment has remained more buoyant. The emerging-country risk index has been stable after a long period of steady improvement. The exceptionally favourable conditions of recent months should peter out amid less-dynamic world demand and tighter American monetary policy. Significant new improvements will thus be unlikely in the near term. As such, only three countries have received rating upgrades, Uruguay and Gabon from C to B and Macedonia from D to C.

Materialisation of one of the main risks overhanging the moderate growth-slowdown scenario favoured thus far for 2005 marked the world situation in recent months.
Oil prices soared again exceeding $57 a barrel for North Sea Brent in late June while WTI exceeded the $60 threshold, a 40% increase since the year began. That new upsurge is doubtless attributable to seasonal factors like the start of summer in the United States or even non-recurring speculative operations. Structural supply and demand imbalances have nonetheless remained decisively important. With Chinese and Indian demand remaining robust, saturation of refinery capacity in the United States and limited available crude-production capacity have made the market very sensitive to disturbances capable of disrupting supply. For the first six months this year, the average Brent price was $49.40, substantially higher than the averages registered in previous years for the same period ($34.4 in 2004, $28.8 in 2003) and prices could remain high for the full year judging from their weak dissuasive effect on demand.
Such a situation would not be without consequences for growth. According to the IMF, a sustained $5 rise per barrel of oil in the past had a 0.3-point negative impact on world growth. An average price of $50, if not $55, would thus require significant downward revision of the latest world growth forecasts: 3% for 2005 based on a $46.50 barrel price for North Sea Brent. The most vulnerable importing countries would then include the United States and Asian or West European countries.

Microeconomically, the uncertain context notwithstanding, company solvency has generally remained good with payment behaviour tending to improve. Continued strong world demand, abundant liquidity in the markets, and good productivity levels have made it possible to offset higher production and transport costs resulting from the increasing cost of oil. Pressure on margins could nonetheless increase in big oil-user sectors like chemicals, transport, and steel. The pressure will be even greater on companies located in regions where final demand lacks dynamism. Meanwhile, the end of the multifibre arrangement along with increasing competition from Chinese products in many sectors could hurt companies unable to prepare for the changes.

Regionally, the main trends expected are as follows:

In the United States, despite a slowdown, growth should remain robust. However, the foreign trade imbalance has been growing. As such, continuation of the soft-landing scenario sought by authorities will depend on the Federal Reserve's capacity to moderate household debt and consumption.

In Europe, sluggish domestic demand has dampened economic activity in many countries. A loss of competitiveness and less dynamic world demand have been affecting exports. In that less-than-buoyant context, the institutional breakdown caused by the French and Dutch "no" to the Constitution and the disagreements over the EU budget have largely contributed to the euro exchange rate decline against the dollar. Should the low parity last it could spur an export rebound in coming months and ultimately prove to be the best news in the quarter.

Although Asia should continue to post enviable growth rates, a slowdown is nonetheless likely. That region should suffer from slower demand growth in industrialised countries. Moreover, continued high oil prices could also have a negative effect due to the region's great dependence on foreign energy sources. In China, although the expansion has continued, the pace may prove marginally slower than last year due to the corrective measures taken. In Japan, despite a robust start in the first quarter, the economy should suffer a marked slowdown amid weakening foreign demand.

Growth in Latin America, although sagging, has remained at historically satisfactory levels for the region. While the continent should still benefit from generally favourable conditions for the full year, foreign demand has been somewhat less buoyant. Moreover, implementation of tighter monetary policies due to renewed inflationary pressures has led to slower domestic-demand growth. Some countries have also remained vulnerable to possible tensions in financial markets.

In the Near and Middle East, oil market conditions have remained very favourable to exporting countries as evidenced by the latest upsurge of prices. The economies of other regional countries have been benefiting indirectly from the oil windfall and have generally continued to trend up thanks notably to buoyant exports and tourism. The region has nonetheless been subject to continued high geopolitical instability (Iraq, Iranian nuclear issue, Israel/Palestinian Territories, Lebanon/Syria). The election in Iran of an ultra-conservative president Mahmoud Ahmadinejad could affect relations with the international community, notably the United States and particularly on the nuclear issue. In Lebanon, after the Syrian withdrawal and legislative elections, how the political and economic situation will develop is still uncertain.

The industrialised country risk index rose sharply (up 2%) due to the downgrade of Italy's rating to A3. The average expected risk level on companies has remained higher in the European Union than in North America or Japan.

In the United States (rated A1), the economy has registered a moderate slowdown. Household consumption, representing 70% of GDP, seems to have lost some of its dynamism due notably to increases in energy prices and interest rates. Faced with weaker earnings growth, companies have been cutting back on investment. Despite the past dollar depreciation, the foreign trade imbalance has been growing. Continuation of the soft-landing scenario sought by authorities will depend on the Federal Reserve's capacity to moderate household debt and consumption.
In a still buoyant economic environment, company solvency has thus far remained good with the Coface payment incident index stabilising at its lowest level.

In Japan (rated A1), despite a robust start in the first quarter, the economy should suffer a marked slowdown amid weakening foreign demand. Less dynamic purchasing of capital goods and computer components by China and Asian countries in general has notably affected exports. The upsurge of household consumption registered early this year has given way to modest growth buoyed by a firmer labour market, slightly higher incomes, and easier access to bank credit. A slight economic upturn could develop next year spurred mainly by an export recovery.

In Western Europe, the economic slowdown has been coupled with persistently heterogeneous growth rates that vary by country, the Italian recession contrasting, for example, with the robust Spanish economy.

In Italy (negative watchlisted A2 rating downgraded to A3 for exporting businesses), the economic downturn registered end 2004 persisted in the 2005 first half, auguring stagnation at best for the full year. Despite reduced tax schedules, household consumption has remained sluggish due notably to persistent uncertainties about the outlook for the social safety net. Still facing competition from emerging countries in their traditional niches and less-than-dynamic growth in their main markets, exports have been stagnating with industrial production in decline. In that unfavourable context, productive investment could fall, the corrective action needed on equipment obsolescence notwithstanding. Moreover, the country's large fiscal deficit, representing 4% of GDP, will limit possibilities for authorities to revive the economy.
Company solvency deteriorated sharply in the past year and risk levels should remain high this year amid a generally gloomy economic outlook. A marked deterioration in exporting businesses' payments behaviour has motivated this downgrading. Elsewhere the average rating for companies trading in the domestic market remains A2 negative watchlisted.

In Germany (rated A2), after an unexpected first-quarter rebound largely attributable to a change in the working-day calculation method, growth prospects for the full year have remained moderate. Exports, although still the main growth driver, have been growing more slowly due to stabilisation of world demand and the negative impact of the past euro appreciation. Household consumption has been showing some signs of improvement. However, persistent unemployment, cutbacks on social security benefits, wage restraint agreements, and the unknown factor represented by the elections scheduled in autumn would nonetheless argue for caution. As such, the additional tax cuts have been increasing savings even more. However, investment has revived in response to gradual saturation of production capacity in export sectors.
The Coface payment incident index has been approaching the level existing prior to the dark 2001-2003 period, even if collection of delinquent debts is still difficult. Company bankruptcies have tended to stabilise. That mainly reflects the healthier financial situation of export-oriented companies whose margins have improved thanks to productivity gains resulting notably from delocalisation of the more labour-intensive activities and to wage restraint.

In the United Kingdom (rated A1), the economic slowdown that began last year has persisted. Despite the stabilisation expected in the next quarters, growth should register a marked downturn in 2005 attributable to past tight monetary policy and the ensuing stabilisation of property prices, which has limited household refinancing capacity. Overindebted, households have been reducing their spending in favour of savings even though interest rates have stopped rising and despite still-accommodating fiscal policy. Moreover, the economic slowdown affecting the continent has been hampering exports. Industrial production has been particularly suffering, which has notably resulted in a reduction in manufacturing jobs nonetheless offset by the many jobs created in the public sector.
The low level of payment incidents and decline of bankruptcies would tend to reflect an improving company financial situation. However, traditional sectors like textiles, food, metallurgy, mechanical engineering, and the car industry, more exposed to foreign competition or to high raw material prices, have remained weak.

In France (rated A1), growth has turned sharply down. Household consumption, although remaining the main economic driver, has registered a slight slowdown with the savings rate decline and wealth effect linked to high property prices not enough to offset the unfavourable employment trend and weak wage growth undermining purchasing power. Exports have lacked dynamism due to the European demand slowdown and a lack of competitiveness in some market segments. A moderate recovery could nonetheless develop by year-end. Exports should benefit from an improved foreign demand trend and the euro's decline. Although company investment should revive, consumption should continue to post moderate growth. Replenishment of company cash positions has nonetheless led to very gradual improvement in payment behaviour. However, that trend should weaken in a less buoyant environment this year.

In Spain (rated A1), economic activity has remained robust, still driven by domestic demand. However, foreign trade has continued to have a negative effect on growth. Slower import growth will not suffice to offset persistently poor export and tourism performance, affected by both the erosion of their competitiveness and unfavourable trends in their main markets. In 2006, domestic demand could sag slightly under the effect of heavy household debt, persistent inflationary pressures, and less dynamic growth in the construction sector.

The risk index for Central European countries has remained generally stable, declining only 0.2% due to the upgrade of Macedonia's rating from D to C. As expected, sagging foreign demand, the appreciation of foreign exchange rates last year, and weakening domestic demand led to an economic downturn. in the run-up to legislative elections in several regional countries, fiscal adjustment efforts will generally remain limited, which will hardly facilitate integration into the euro zone. Moreover, the rejection of the constitutional treaty by France and the Netherlands and the failure of budget negotiations at the last European summit have reopened the question of the prospects for enlargement and the financing that could be available to members. Uncertainties surrounding monetary policy in the United States have compounded those problems. All those factors could ultimately impede capital inflows and jeopardise exchange rate stability in the region.

In Poland (rated A3), after a particularly good year in 2004, growth has slowed due to a downturn of consumption and exports. However, a strengthening of investment should revive the economy from end 2005. Although sovereign default risk has remained limited, improvement of government finances still constitutes a major challenge in relation to the country's accession to the single currency. The level of the current account deficit, meanwhile, has remained under control. Debt amortisation has nonetheless been increasing thereby keeping external financing needs at appreciable levels. With foreign direct investment only covering a quarter of those needs, that situation has tended to keep the country dependent on financial markets. Finally, the political landscape, currently undergoing some reshuffling, has remained shaky. In a difficult social context, protest and anti-European movements have gained ground.

In the Czech Republic (rated A2), the economy should remain relatively dynamic this year and next buoyed by low interest rates, investment inflows, continued growth of capital spending, and a consumption recovery. Adjusting public sector finances has nonetheless remained a difficult task while current accounts have continued to run relatively high deficits attributable to invisibles trade imbalances. Financing those deficits has nonetheless not been a major source of concern with privatisations further increasing FDI inflows. Meanwhile, foreign debt has remained under control. Politically, the recent resolution of the governmental crisis notwithstanding, the centre-left coalition still has to contend with the ascendancy of anti-European parties.

In Hungary (A2 rating negative watchlisted), growth has been slowing due notably to sluggish economic conditions in the euro zone. Public spending will probably spur domestic demand in 2006, an electoral year. However, with its large budget deficit, relatively heavy public sector debt, and appreciable current account deficit, Hungary will nonetheless remain the regional country most vulnerable to a currency crisis. Although still one of the most advanced regional countries on reforms, Hungary's lack of meaningful fiscal consolidation policy has periodically caused uneasiness in the markets. Moreover, even if foreign direct investment has been recovering, it still only covers a very small fraction of external financing needs and foreign exchange reserves have not been at particularly comfortable levels.

In Turkey (B rating positive watchlisted), the economy has been in a moderate slowdown phase, welcome after it nearly overheated last year. Consumption and investment have remained dynamic. Company payment behaviour is still satisfactory. Financially, public and foreign debt ratios have been declining with that performance underpinned by tight fiscal policy and appreciable progress on reforms. Turkey's financial vulnerability has nonetheless remained substantial. The extent of its foreign currency financing needs, amid a growing current account deficit, has forced the country to assume massive debt. With the financial situation still vulnerable to a greater-than-expected increase in American interest rates, currency risk has been high. Moreover, due to their increased debt, companies will be vulnerable to a lira collapse. Politically, the decision to begin European Union accession negotiations in October 2005 is conducive to maintaining confidence. However, the European institutional breakdown, compounded by an upsurge of nationalism in reaction to European foot-dragging, could slow the process of convergence with the EU.

Further east, in Russia (rated B), the country's financial situation has remained very satisfactory even if growth has been slowing just when oil prices are peaking. Deterioration of the business climate has been affecting investment, needed as much in the energy sector to sustain export growth as it is in a manufacturing sector suffering from a lack of competitiveness. The wave of tax investigations following the Yukos affair as well as reluctance to welcome foreign investment have been bad for the economy and spurred renewed capital flight. Moreover, risk has remained high in a banking sector vulnerable to an economic downturn. Insufficient company transparency and ineffective creditor and shareholder protection still affect the economy. Politically, difficulties in managing reform of welfare benefits, which has sparked protest, and a gradual loss of influence in the Community of Independent States would suggest that the government's strategy is becoming less effective.

The regional risk index for North Africa and the Near & Middle East has been stable, near the emerging country average. Oil-based economies have been riding the oil windfall (UAE, Qatar, and Kuwait rated A2, Saudi Arabia rated A4, Algeria rated B and positive watchlisted, Iran rated B, and Libya C). After increasing 33% on average to $38.40 a barrel in 2004, oil prices could set a new record this year and reach $50 to $55 a barrel. Concurrently, the trend toward gradual improvement in other regional countries has remained on track. However, geopolitical instability has remained the main risk factor and continues to cloud the outlook.

In Iran (rated B), good oil market conditions since 2000 have given the country the means to pursue expansionary monetary policy. That policy has spurred the growth rate with the non-oil sector expanding strongly. The financial situation has improved with foreign debt remaining moderate. However, high inflation has accompanied that favourable trend and the growth rate has been insufficient to generate substantial standard of living improvements and create enough jobs to reduce the unemployment rate. Reforms will be necessary to consolidate the conditions for growth and create jobs. Since the election of ultra conservative Mahmoud Ahmadinejad as president on 24 June, conservatives now control all the Islamic Republic's institutions. That situation could compromise pursuit of the economic reforms President Khatami has been trumpeting. In the foreign policy arena, moreover, relations with the international community could become more strained, particularly on the nuclear dossier.

In Lebanon (rated C), Rafik Hariri's assassination on 14 February 2005 triggered a political upheaval that resulted in withdrawal of the Syrian occupation under pressure from the public and the international community. Since then, legislative elections took place peacefully in May/June and gave a parliamentary majority to Saad Hariri's Movement for the Future and its anti-Syrian allies, with Fouad Siniora, a close ally of Rafik Hariri and former minister of finance, named prime minister. The political environment has nonetheless been anchored in continuity since two pro-Syrians have remained in office, President Lahoud (Christian) and Nabbih Berri (Shiite head of Amal) leading Parliament.
The February turmoil resulted in a loss of confidence in the currency that forced the central bank to draw on its currency reserves to maintain parity with the dollar (USD 1 = LBP 1,513). After declining 19% between 14 February and 15 April, the Bank of Lebanon's reserves regained 7% of the initial amount by mid-June.
With the political uncertainties since February notably affecting tourism and investment and capable of causing a growth slowdown this year, reviving the economy and replenishing currency reserves will depend on the country's capacity to overcome religious cleavages, restore confidence, and mobilise international community aid.
Due to the excessive level of public sector debt (180% of GDP), sovereign risk will remain very high. Debt service will continue to weigh on government finances (with interest on the debt representing 57% of fiscal revenues) and generate additional debt. That risk would become unsustainable in case of devaluation of the pound (half the public debt is denominated in foreign currency) with spillover effects on a banking system very vulnerable to sovereign risk (about half of assets in 2003).

Latin America's risk index has been stable (down 0.1%) despite the upgrade of Uruguay's rating to B. Economic conditions are still generally satisfactory buoyed by export dynamism, firm domestic demand, and an abundance of liquidity in financial markets conducive to keeping risk premiums very low. A slowdown has nonetheless developed amid the tightening monetary policy necessitated by an upsurge of inflation and a somewhat less buoyant international environment. The index is still above the emerging country average with some countries remaining vulnerable to a sharp increase in American interest rates or domestic political volatility.

Brazil's B rating has remained on the positive watchlist despite the economic slowdown registered since end 2004 and which intensified in the first quarter this year with 2.9% GDP growth. Those less favourable economic conditions are partly attributable to SELIC rate increases to 19.75% necessitated by inflationary pressures. Export dynamism along with domestic demand have nonetheless continued to underpin the economy. The food industry has been particularly benefiting from strong world demand. Company payment behaviour has remained satisfactory. Brazil's growth has been "healthy", achieved without undermining public sector accounts or worsening the current account deficit. The country is nonetheless still dependent on financial market sentiment due to the size of its debt while economic growth has been hampered by bottlenecks (limited credit for companies, infrastructure deficiencies) that could revive structural inflation.

In Mexico (rated A4), economic activity has remained generally dynamic. Some sectors, however, are having difficulty coping with competition from China. The peso appreciation against the dollar in recent months, and thus also against the yuan, could weaken some companies. Textiles have notably suffered from cancellation of quotas. Those factors explain why company behaviour is still subject to frequent payment incidents.

In Argentina (rated C), growth is still robust, buoyed by both a domestic demand recovery and the strong world demand for raw materials, notably soybeans. The strength of the upturn is largely attributable to a catch-up phenomenon after four recession years that left substantial unused production capacity. In peso terms, GDP has just returned to its 1998-first quarter level. First quarter results this year nonetheless reflect a sharp slowdown with only 0.5% quarter-on-quarter growth against 2.2% rate on average for the four previous quarters. Slower investment growth and limited production capacity should hamper economic activity.

Uruguay (upgraded to B) has been experiencing a robust recovery after four recession years with the growth rate reaching 12% in 2004. Exports have been growing strongly spurred by increased raw material prices notably for farm products. Domestic demand has also been recovering, buoyed by both consumption and investment. In 2005, growth should remain dynamic and possibly reach 6.5% of GDP. The new leftwing president, Tabare Vazquez, officially leading the country since 1 March, has been pursuing a pragmatic policy of cooperation with multilateral financial institutions much like President Lula of Brazil. On 8 June, Uruguay moreover obtained a standby loan from the IMF. The country has nonetheless remained financially shaky with debt ratios since the 2002 crisis among the highest for emerging countries.

In Venezuela (rated C), growth has also been very robust after two years of severe recession. Although driven mainly by revenues generated by high oil prices and an easing of exchange controls, the exceptional growth is essentially attributable to an underlying catch-up phenomenon. The economic growth should continue to grow this year and next, buoyed by a still very favourable environment for hydrocarbon exporting countries. Besides oil prices, however, the main uncertainty concerns PDVSA's capacity to maintain adequate levels of production. Red tape and exchange controls have also affected the business environment, a factor hardly beneficial to the private non-oil sector and apt to cause late payments.

The average risk index for emerging Asian countrieshas remained at the lowest level for all emerging countries. In 2005, Asia should again enjoy a growth rate higher than other emerging regions. A slowdown is nonetheless probable since that region, with its great dependence on foreign trade, will likely suffer from the less buoyant demand in industrialised countries and the electronics sector. Continued high oil prices may have a similar negative effect due to Asia's great dependence on foreign energy sources. Moreover, a very slight slowdown may develop in China, which now constitutes a major trading partner for other Asian countries due to its greater integration in regional and world trade. Regional demand will thus have to play a decisive economic role, which would allow it, if necessary, to cushion the impact of less dynamic foreign trade.

In China (rated A3), the expansion has continued at a pace faster than the government's objective with the economy only likely to slow moderately as a result of corrective measures intended to temper investment growth in overheated sectors. With large external account surpluses, the country has continued to build up impressive currency reserves. In that context, although the yuan's US dollar-peg regime will have to evolve with moderate enlargement of its fluctuation band possible by end 2005, authorities do not envision implementation of a more flexible system before consolidating the financial system. Meanwhile, non-performing loans resulting mainly from the backing of unprofitable state-owned companies continue to strain the banking system. Public sector finances have moreover remained weakened by the cost of industrial and bank restructuring.

In India (rated A3), growth only slowed moderately in 2004-05 despite insufficient monsoon rains. The economy has thus become less dependent on the farm sector with its dynamism buoyed by emergence of high technologies, pharmaceuticals, and the car industry. Thanks to that buoyant context, company payment behaviour has improved as evidenced by the decline in payment incidents. Companies have nonetheless remained marked by insufficient transparency and the still limited possibilities for recourse in case of non-payment. Exports have continued to expand and private transfers have remained high with currency reserves increasing in consequence. However, public sector debt has remained excessive. Politically, the government coalition — its heterogeneous composition notwithstanding — should stay in power through comprises that could result in relative gridlock. Although relations with Pakistan have eased, the current talks are likely to produce few meaningful results on questions like Kashmir.

In South Korea (rated A2), the economy should suffer a slowdown. Export growth has been less dynamic due to a sales downturn in the country's main markets, China, the United States, and Japan. Foreign demand has nonetheless continued to drive growth with private consumption struggling to improve after performing weakly during the past two years amid heavy household debt. In that context, the situation has been difficult for smaller companies due to their financing problems and high raw material costs. Although the country still boasts solid economic fundamentals, the government's room for manoeuvre has been very limited, lacking a parliamentary majority since the legislative by-election end April 2005.

The regional risk index for sub-Saharian Africa has been generally stable, with the upgrade of Gabon's rating only reducing the index by 0.3%. The rest of the region continues to represent high risk on average.

In South Africa (rated A3), the outlook for 2005 is still favourable (4.1% growth). Exports and dynamic domestic demand will drive the economy. The interest rate level has been conducive to private investment and the tight fiscal policy pursued by authorities has given them ample leeway to undertake public investment programs. In that context, company payment behaviour has remained excellent. Moreover, despite a widening current account deficit, the country's external financing needs have remained moderate and its debt limited (21% of GDP) with the level of its currency reserves registering a twofold increase. That trend has contributed to reducing the country's traditional factors of weakness including the still high level of short-term debt (wherein intercompany debt) and insufficient foreign direct investment.

Gabon (rating upgraded from C to B) has been benefiting from the financial ease generated by higher oil revenues and from tight fiscal management pursued in the framework of the IMF programme signed in 2004. The country has posted fiscal and external surpluses allowing it to improve its payment behaviour, reduce its arrears, and sustain growth, which has been nonetheless insufficient despite the non-oil sector's dynamism. Moreover, despite improvement in external accounts and the new Paris Club rescheduling agreement since June 2004, the external debt burden is still heavy. Meanwhile, diversification of the economy has continued with substantial foreign direct investment in the mineral and wood sectors and in infrastructure that will ultimately facility managing the post-oil era. Preparations for presidential elections in December 2005 and legislative elections in 2006, which the incumbent president and his party should win lacking credible opposition, should not jeopardise current policy with a heightening of social tensions constituting the only significant risk factor.

In Cameroon (positive watchlisted B rating), the public sector financial situation deteriorated in 2004 and affected the country's payment behaviour, which led the IMF to suspend its aid programme thereby causing postponement until 2006 at the earliest of the debt cancellation expected under the HIPC programme for highly indebted poor countries. With the 2005 budget implemented under the new minister of finance's supervision thus far appearing to offer promise of avoiding the fiscal slippage of the past, a one-year staff-monitored programme was signed with the IMF in April. Meanwhile, economic activity should remain satisfactory despite the impact of fiscal austerity measures (4.5% growth in 2005, 5% in 2006).

Kenya (rated C positive watchlisted) has remained in an uncertain situation due to tensions within the government coalition that have impeded implementation of structural reforms and anti-corruption measures, a situation that has drawn criticism from donor countries. At this stage, however, those political tensions have had no effect on the economic situation. The dynamism of the farm, tourism, and telecommunications sectors has contributed to a sharp growth upturn, which could reach 3.3% in 2005 and 4% in 2006.