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.*) country risk index has been stable at a generally low level. For industrialised countries, the gap has persisted between companies in the euro zone, still suffering from a strong euro and sluggish domestic demand, and those in North America where the economic environment has remained more buoyant. The emerging country risk index, meanwhile, has reached a historic low thanks to exceptional economic conditions in 2004 buoyed by soaring raw material prices, strong Chinese and American demand, and favourable trends in financial markets. With those exceptionally good conditions nonetheless expected to gradually wane, no new significant improvement will be likely this year. The tightening of American monetary policy could, notably, undermine the most debt-ridden economies. As such, the index has been stable after a long period of regular improvement. In Central Europe, it has been slightly deteriorating with the positive watchlisting of Romania's B rating being offset by the negative watchlisting of Hungary's A2 rating. The improved Latin American index is attributable to the rating upgrade of Argentina from D to C. Conversely, in Asia, the rating downgrade of the Philippines from A4 to B has caused a moderate deterioration of the regional index.

North American and Chinese demand remained dynamic during the first quarter this year. Most emerging countries thus continued to benefit from those buoyant markets and from moderate risk premiums. Conversely, in Western Europe, the sharp slowdown suffered by certain economies late last year has given way, to put it mildly, to modest performance in recent months.

Persistent pressures on oil prices and the dollar also marked the first quarter this year. After a lull late last year, oil prices have begun to rise again (gaining 37% between 1°January and 15 March) to reach an average of $47 a barrel since the beginning of the year. Prices drew support from increased demand attributable to a harsh winter season in the Northern Hemisphere and stronger-than-expected growth of demand from the United States and China. Meanwhile, the market has been concerned about disruptive factors that could affect supply (strikes in Nigeria, sabotage in Iraq, tensions between the United States and Venezuela, hurricanes, and so on) considering the limited reserve production capacity.

Similarly, the dollar's weakness against the euro in conjunction with the uptick of prices in the United States has prompted the Fed to continue the process of regular interest rate hikes. Although gradual and expected, those increases have nonetheless spurred tensions in emerging-country financial markets that have notably caused a moderate increase in spreads and a decline in stock prices.

Company solvency generally remained at good levels during the first quarter. Continued strong world demand made it possible to partially offset the pressure on profits resulting from higher production costs. That situation should persist for the rest of the year in a still benign economic environment, provided there are no major shocks on oil prices, the dollar exchange rate, or Chinese growth.

The main regional trends expected are as follows:

In the United States, growth should remain robust fuelled by the combined effects of still-dynamic household consumption and company investment. High energy prices and gradual tightening of monetary policy should not inordinately affect the economy.

In Europe, except for Spain, Scandinavia, Austria, and Ireland, economic activity has been growing more slowly since the 2004 last quarter. Stabilisation of European currencies at a high level against the dollar has been affecting exports while household consumption has been slowing in the United Kingdom and Switzerland. Prospects for an economic upturn in the second half have thus become more uncertain.

In Asia, the environment has remained generally buoyant. The Chinese economy has remained dynamic, while Japan, which verged on a recession end-2004, has resumed weak growth, which should benefit from a slight recovery of household consumption and investment. The entire region will nonetheless continue to be very dependent on the dynamism of Chinese demand.

In Latin America, growth should remain strong but not reach the pace registered last year. Although the continent will continue to benefit from generally favourable conditions, it will have to contend with less buoyant foreign demand. Meanwhile, resumption of inflationary pressures should prompt implementation of more restrictive monetary policy. Moreover, certain countries like Brazil have remained vulnerable to possible tensions in financial markets.

In the Near & Middle East, daily oil price increases have continued to buoy the economic and financial situation of oil exporting countries. In other regional countries, the upward tourism trend, particularly intra-region, and exports continue to underpin the recovery. However, since the assassination of former Lebanese prime minister Rafik Hariri in February this year, the political crisis gripping Lebanon and Syria has further unsettled an already unstable geopolitical environment (Iraq, Iran, and the Palestinian territories).

Similarly, in Russia, although a favourable economic situation has persisted, buoyed by the exceptional level of oil prices, the business climate has remained affected by the many contradictory signs coming from the Kremlin concerning the energy sector's future.

(*)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.

The risk index for industrialised countries has remained stable with the expected average risk level higher for companies in the European Union than for their North American or Japanese counterparts.

In the United States (rated A1), economic activity is still robust even if household consumption, which represents 70% of GDP, and spending on housing should lose some dynamism amid rising prices, notably for energy, higher interest rates, and disappearance of the effects of tax breaks. Conversely, exports will benefit from the dollar's weakness. That situation will sustain company investment dynamism. In that favourable economic environment, companies will continue to post good profitability. They have recovered some control over their prices, a welcome development in a context of increasing costs. Having reduced their debt moreover, they should be able to withstand the higher interest rates.

In Japan (rated A1), the flat period late 2004 has given way to moderate growth since the start of the year. Exports and industrial investment have resumed growing at comfortable rates. The end of the wage decline in services and small and medium enterprises coupled with the resumption of hiring should spur household spending. Restructuring programmes and exports have allowed many companies to post higher earnings. Industries that export intermediate products, high technology, and capital goods, along with their subcontractors have particularly benefited from that favourable context. Conversely, construction, retail, and small and medium enterprises in general have continued to experience difficulties.

In Western Europe, economic growth has been slowing since the fourth quarter last year. Stabilisation of European currencies at a high level amid soaring raw material prices has affected the region's exports. Meanwhile, unemployment, fears about the outlook for the social safety net, and oil price swings have been undermining consumer and investor confidence. Large fiscal imbalances have been limiting the expansionary policy options available to governments despite the recent easing of Maastricht rules. That context will limit the prospects for a scenario of recovery starting in the second half.

Italy, Portugal (negative watchlisted A2 rating), Germany (rated A2), and the Netherlands (rated A2) are thus characterised by weak growth and an appreciable level of payment-default risk. The first two countries have been registering weak export performance that domestic demand, albeit more buoyant, has been unable to offset. Although benefiting from good sales abroad, Germany and the Netherlands have been suffering from sluggish household demand.

In Italy, growth is still weak. Amid competition from emerging countries in its traditional niches and a lack of dynamism in its primary markets, its export performance has remained poor. Despite introduction of lower tax schedules, household consumption has remained sluggish, due notably to persistent uncertainty about the outlook for the social safety net. In that less-than-buoyant context, the pace of productive investment growth has been insufficient to cope with facilities obsolescence. Non-payment risk has remained at high levels.

In Germany, the weak growth these past months could give way to a second half recovery in phase with household consumption, which has already been giving some signs of improvement due to the backlog of postponed durable goods purchases. Prudence will nonetheless still be in order amid continued high unemployment, uncertainty about the outlook for the social safety net, and increasing numbers of wage-restraint agreements between unions and employers. While remaining the principal economic driver, exports should grow at a slower pace due to the stabilisation of world demand and negative impact of the euro appreciation. Conversely, investment by companies should finally begin to recover buoyed by progressive saturation of production capacity in export sectors. Although company payment incidents and bankruptcies have been levelling off, the improvement has mainly concerned companies focusing on exports or possessing production facilities abroad.

Spain, the United Kingdom and, to a lesser extent, France (all rated A1), whose growth has essentially depended on robust domestic demand, have been less exposed to credit risk. Benefiting from cash positions bolstered by sharp turnover growth in 2003 and 2004, companies in those countries should be able to cope with a moderate slowdown.

In the United Kingdom, growth has lost some of its dynamism. Although interest rates have stopped rising and fiscal policy has remained accommodating with elections nearing, the slowdown begun last year has persisted. It is attributable to the effects of past tightening of monetary policy and stabilisation of property prices, which have limited the refinancing capacity of households. Already debt-ridden, they should substantially reduce their spending in favour of savings. Though the decline of company bankruptcies would suggest that the difficulties endured by British industry have been waning, it is necessary to distinguish between high technology sectors that have been posting excellent performance, including on exports, and traditional sectors faced with stiff competition and likely to suffer even more from the household spending slowdown.

In France, the slower growth is attributable to a slight drop in household consumption, which is nonetheless still the main economic driver and has continued to grow at a good pace buoyed by very accommodating monetary and fiscal policy. Conversely, export growth has been hampered not only by the euro's past appreciation against the dollar but also by unfavourable geographic and sectoral specialisation and erosion of competitiveness. Company investment has also lacked dynamism. Low financing costs have contributed to increasing company profits though that has mainly benefited the largest companies and those present in export markets.

In Spain, growth has remained very dynamic, still buoyed by infrastructure spending and household consumption and spending on housing. Increased welfare spending, the persistence of negative real interest rates, and a wealth effect linked to the appreciation of property values have continued to have a favourable impact. Conversely, exports and tourism have continued to suffer from erosion of their price competitiveness and unfavourable trends in their main markets. The benign economic climate has generally benefited company solvency.

The risk index for Central European countries has been slightly increasing after a long period of improvement. The positive watchlisting of Romania's B rating has been effectively offset by the negative watchlisting of Hungary's A2 rating. After reaching record levels in 2004 (up 5.2%), regional growth, although still dynamic, should sag slightly this year (up 4.5%). The region's main weakness will remain its public sector and current account imbalances. Because of fiscal adjustments they will have to make, certain countries have already seen their admission to the euro zone postponed. Meanwhile, with the increase in the yields of American securities, regional exchange rates have been subject to new tensions these past weeks.

In Poland (rated A3), growth accelerated in 2004, driven by domestic demand and exports. The company financial situation improved sharply. A slowdown nonetheless developed in the second half and that trend should persist in 2005. Improving the government's financial situation and stemming the growth of public sector debt have remained a major challenge linked to the country's admission to the euro zone. However, steady performance in foreign trade has allowed Poland to keep the current account deficit under control. Amortisation of the debt has nonetheless been inflating external financing needs and with foreign direct investment covering at most one-third of those needs, the country will tend to remain dependent on financial markets.

In the Czech Republic (rated A2), economic growth should improve slightly this year due to more dynamic consumption (credit expansion, reduced unemployment) and the firmness of investment and exports (strong foreign presence in manufacturing, productivity gains). Nonetheless, the public and external account deficits will remain relatively large. Covering the current account deficit has not, however, been a major source of concern with privatisations expected to increase foreign direct investment inflows.

In Hungary (A2 rating negative watchlisted), after an upturn in 2004, growth should stabilise in 2005 provided the investment slowdown registered late last year proves to be temporary and economic conditions in Germany do not deteriorate excessively. Public spending should stimulate domestic demand. However, although the economic context is still favourable, Hungary has remained the Central European country most vulnerable to a foreign exchange crisis due to its large fiscal deficit, relatively heavy public sector debt, and substantial current account deficit. Moreover, foreign direct investment, although currently improving, has only been enough to cover a quarter of external financing needs and foreign exchange reserves have remained relatively limited. In that context, the risk of speculative attacks on the forint is not negligible. A significant depreciation of the currency would have a negative impact on economic activity and particularly on the financial situation of companies carrying heavy foreign currency debt.

In Romania (B rating positive watchlisted), growth registered a sharp rebound in 2004, buoyed by domestic demand and exports. While remaining dynamic, consumption and sales abroad should slow somewhat this year. Although a widening current account deficit has been a subsidiary effect of that dynamism, foreign direct investment, which has been increasing, and borrowing abroad, whose cost has dropped considerably, have permitted the country to finance that deficit with no major difficulty as evidenced by the comfortable level of foreign exchange reserves. Government authorities will nonetheless have to continue their efforts to reduce public sector deficits and thereby keep external imbalances under control.

In Bulgaria (B rating positive watchlisted), the growth dynamism, continued fiscal discipline, and active management of public external debt have been responsible for a sharp improvement in government solvency. The growth rate should drop slightly in 2005 due to a slowdown of domestic demand and exports. Although the current account deficit has remained substantial, foreign direct investment has been increasing significantly.

In Turkey (B rating positive watchlisted), after strong growth in 2004 (up 9%), capital goods imports registered an early-year slowdown linked to a relative downturn of domestic demand. The expected scenario thus entails a controlled correction of the overheating registered last year. Notwithstanding a large external imbalance, the Turkish lira has remained overvalued. The lira gained 5% since the year began. That situation has kept foreign exchange risk at high levels, especially with the shortage of available domestic credit compelling companies to assume massive foreign currency debt to finance their investments. The payment behaviour of Turkish buyers is nonetheless still very good and the country's overall financial situation has continued to benefit from the confidence of market operators.

Further east, in Russia (rated B), the full-year growth rate was very high in 2004 (7.1%) despite a notable year-end slowdown. Economic conditions and the country's overall financial situation have been currently benefiting from the exceptional oil-price levels. The situation has nonetheless remained dependent on exogenous factors. Economic activity has suffered from a deterioration of the business climate that has caused an investment slowdown in the oil sector and could affect extraction in 2005. Uncertainties about the Rosneft merger with Gazprom and contradictory announcements concerning foreign investment have exacerbated the climate of instability surrounding property rights and spurred capital outflows. Although the pace of structural reform has slowed markedly — with the reform of natural monopolies making virtually no progress — implementation of a bank deposit insurance system has nonetheless constituted a step forward for a still-weak banking system.

The regional risk index for North Africa and the Near & Middle East has remained stable, near the emerging country average. The continued upward trend of oil prices can only bolster the economic and financial situation of the region's oil exporting countries: the United Arab Emirates, Qatar, and Kuwait rated A2, Saudi Arabia rated A4, Algeria rated B and positive watchlisted, Iran rated B, and Libya C. Oil prices have been breaking new records so far this year and the average price for 2005 could surpass the $38 a barrel average for North Sea Brent registered in 2004. Similarly, the trend toward gradual improvement has remained on track in the region's non-oil countries. However, the region's geopolitical instability has remained the primary risk factor and continued to cloud the outlook.

In Lebanon (rated C), radicalisation of the political turmoil could thus exacerbate an already precarious economic situation. The steadiness of tourism, construction sector dynamism, capital inflows, and decline of interest rates in 2004 doubtless contributed to improving the economic situation and reducing external and fiscal imbalances. Furthermore, the international aid mobilised end 2002 gave Lebanon some breathing space, allowing it to reschedule loans at low interest rates, meet payment obligations, and replenish foreign currency reserves. Sovereign risk has nonetheless remained very high with Lebanese banks — well capitalised, liquid, and profitable at this juncture — remaining exposed to that risk and to a crisis of confidence among depositors. Finally, the external account situation has remained shaky due to its great dependence on foreign capital. Radicalisation of the political crisis gripping the country since the assassination of former prime minister Rafik Hariri could thus spark a crisis of confidence affecting foreign capital inflows and trigger an economic collapse. So far, there have been no massive capital outflows and Bank of Lebanon has been able to support the currency, which is pegged to the dollar ($1= LBP 1513).

Latin America's risk index improved again, shedding 0.7%, with the rating upgrade of Argentina from D to C and the positive watchlisting of Uruguay's C rating. The region's good performance is attributable to export dynamism and abundant liquidity in financial markets, which has contributed to keeping risk premiums at very low levels. The index has nonetheless remained above the emerging-country average. Some countries are still vulnerable to a sudden increase in American interest rates or to the vagaries of domestic politics. Moreover, the tightening of monetary policy necessitated by the upsurge of inflation should affect growth in 2005.

That will notably be the case for Brazil (rated B). Its positive watchlist status has been maintained, however, despite the economic slowdown registered in the fourth quarter last year, attributable notably to the high level of interest rates. Inflationary pressures made it necessary to raise the SELIC rate to 19.25% last 16 March. The GDP growth rate nonetheless remained robust in 2004, reaching 5.2% for the full year, the highest growth rate in eight years. Strong export growth as well as domestic demand have been buoying economic expansion. Rising domestic interest rates and a slightly less favourable international environment should affect economic activity in 2005 with GDP growth dropping to 3.5%. It will nonetheless be healthy growth with no accompanying deterioration of public finances or generation of current account deficits. Due to its heavy debt, however, the country has remained dependent on financial market sentiment. Moreover, bottlenecks (insufficient lending to companies, deficient infrastructure) continue to hamper growth and could trigger a new round of structural inflation.

In Mexico (rated A4) surging inflation has also necessitated a tightening of monetary policy. Although economic activity is still dynamic, some sectors continue to suffer from competitiveness problems opposite China. Textiles in particular should suffer greatly from the lifting of quotas. Those factors underlie company payment behaviour still marked by frequent payment incidents.

In Argentina (D rating upgraded to C), after a brief slowdown late in the first half last year, an upturn developed in the second half with growth reaching 9% for the full year. After four crisis years, the economic catch-up process has continued, buoyed by a very favourable external environment. Forecasts for 2005 have been more prudent. Although bottlenecks in both infrastructure and industry should slow the economy, GDP growth should still exceed 5%. The successful restructuring of Argentina's private debt with a 76% compliance rate has removed an element of uncertainty thereby allowing resumption of negotiations with the IMF. Sustaining the growth will nonetheless depend on reforms particularly of the financial system to foster resumption of substantial lending and thus productive investment. Finally, resolution of the energy-price and public service-tariff question will be essential to allow infrastructure investment to resume.

Uruguay (C rating positive watchlisted) has benefited from the improvement in Argentina's situation, registering a robust recovery, up 12% in 2004, after four recession years. Exports have been growing strongly thanks to increased prices and world demand for food products. In 2005, growth should remain dynamic, reaching about 5% of GDP. The new president, Tabare Vazquez, should follow pragmatic policies like those adopted by President Lula in Brazil. Although the country has remained financially weak since the 2002 crisis, IMF backing and the successful restructuring of bond debt in agreement with creditors, unlike Argentina, have permitted capital to begin flowing back into the country.

In Venezuela (rated C), the economic and political situation has undeniably improved after two recession years with 17.4% growth in 2004. Besides a catch-up effect, that dynamism is attributable to increased oil prices and resumption of production. Moreover, the exchange controls instituted in February 2003, although hurting some private companies, have allowed the country to stem capital outflows and replenish foreign currency reserves. Some weaknesses have nonetheless persisted. Burdensome regulations and the exchange controls have affected the business environment. That situation has hardly been favourable to the private sector and tended to cause late payments. Furthermore, although President Chavez victory in the referendum last 15°August shored up his legitimacy, the political situation has remained shaky.

The average risk index for emerging Asian countries has remained at the lowest level of all emerging countries. Furthermore, the persistence of relatively strong growth should bolster company solvency in most regional countries. In 2005, Asia should continue to outperform other emerging regions in growth terms. A slowdown will nonetheless be probable with that region strongly dependent on foreign trade and thus likely to suffer from the effects of more moderate demand growth in industrialised countries and the electronics sector and of the soft landing of China's economy.

In China (rated A3), the soft landing seems to be taking shape due notably to the more moderate pace of investment growth resulting from correctives measures aimed at overheated sectors. However, the support afforded to loss-making state companies along with some haphazard investments have contributed to sustaining high levels of non-performing loans in public banks. Meanwhile, a continued foreign trade surplus and ongoing foreign direct investment inflows have spurred steady growth of foreign exchange reserves. In that context, government authorities now accept the idea of moving toward a more flexible exchange rate system, and they could undertake a modest enlargement of the yuan's fluctuation band this year.

India (rated A3) has continued to post high growth (6%), despite a slowdown linked to farm sector underperformance. However, the steadiness of services and industry has allowed the economy to hold up well with a marked improvement in payment behaviour.

In South Korea (rated A2), exports, although growing more slowly, are still the main economic driver due to the firmness of sales in China. Private consumption has nonetheless been giving signs of a slight recovery after remaining at low levels for two years amid heavy household debt. The country has also benefited from sound economic fundamentals while the government has adopted a more pragmatic approach on economic matters with its room for manoeuvre limited by a very narrow parliamentary majority.

In Thailand (rated A2), incumbent prime minister Thaksin Shiwanatra won a sweeping victory in the February 2005 legislative elections. The growth outlook has been somewhat less bright even though investment and exports are still trending up. In any case, the Thai economy's size and diversification along with reconstruction efforts should suffice to offset the negative effects of the tragic tsunami that devastated the Phuket tourist region late December 2004.

In the Philippines (downgraded from a negative watchlisted A4 rating to B), the financial situation has not been improving. Although expatriate remittances have been buoying household consumption, slower growth of foreign demand, high oil prices, and progressive increases of interest rates could affect economic expansion.
Moreover, with an accumulation of large fiscal deficits, public sector debt has reached excessive proportions and, lacking sufficient domestic savings and foreign direct investment, the country has thus been dependent on financial markets. As such, increased world interest rates would complicate repayment of foreign debt that has been high in relation to GDP. The country's limited proportion of short-term financing will nonetheless mitigate liquidity-crisis risk in the near term.

In Indonesia (rated B), the late December 2004 tsunami's economic impact should be relatively limited despite its human cost thanks to the economy's size and diversification and to international financial aid. Moreover, the new president Susilo Yudhoyono has appeared more actively committed to implementing structural reforms and thereby improving the business environment. As such, domestic and foreign investment has been a government priority, particularly as regards infrastructure, and it should pick up the slack for private consumption as the economic growth driver in 2005. Meanwhile, its weaknesses notwithstanding, the country's macroeconomic stability has continued to improve.

The regional risk index for sub-Saharian Africa has been generally stable with the rating upgrade of Mozambique only improving the index by 0.2%. The average risk level has remained high for the rest of the region.

In South Africa (rated A3), all economic sectors posted positive growth in 2004, including manufacturing despite the handicap for exports caused by the rand's strength. The outlook has remained favourable for 2005 (4.5%). Exports and robust domestic demand will drive the economy. Interest rate levels have been conducive to private investment while pursuit of strict fiscal policy has provided the government with ample leeway to undertake public investment programmes. In that context, company payment behaviour has remained excellent. Meanwhile, despite a widening current account deficit, the country's external financing needs have remained moderate and its foreign debt limited (21% of GDP) while its currency reserves have registered a twofold increase. That trend has contributed to reducing traditional sources of weakness: a persistently high level of short-term debt (including, inter-company debt) and insufficient foreign direct investment inflows.

Since 2000, Mozambique (C rating upgraded to B) has been enjoying a period of strong growth that should continue this year (up 7.3%). Private investment (particularly foreign direct investment in large projects), good harvests, and increasing aluminium production have been the main growth drivers. The service start-up of the large FDI projects should spur significant development of manufacturing, transport, and telecommunications industries. Furthermore, the outcome of the December 2004 elections has borne out the country's political stability. Mozambique has nonetheless continued to suffer from major imbalances. Public sector finances have been in poor shape and external accounts have been running deficits, which the substantial growth of gas and aluminium exports has helped to reduce. Finally, implementation of structural reforms at a satisfactory pace has allowed the country to reach the completion point in HIPC programme for highly indebted poor countries in 2002, resulting in reduction of its public foreign debt.

In Cameroon (B rating negative watchlisted), the public sector financial situation deteriorated last year, a trend reflected by the country's payment behaviour, prompting the IMF to suspend its programme. Implementation of the 2005 budget, under the new minister of finance's supervision, has thus far appeared to offer promise of avoiding the slippage registered in the past. The negotiations under way with the IMF have nonetheless still not come to conclusion. However, economic activity should remain at satisfactory levels despite the impact of fiscal austerity measures.

Kenya (C rating positive watchlisted) has remained in an uncertain situation. Tensions within the government coalition have impeded implementation of structural reforms (financial sector, public sector, privatisations) and the anti-corruption campaign seems to have stalled, prompting criticism by donor countries. Economic growth has nonetheless accelerated since last year (up 2.2% in 2004 against up 3.5% in 2005 according to forecasts), buoyed by the tourism recovery and steadiness of the transport and telecommunications sectors.