April 2007

The world economic slowdown expected in 2007 should be of only moderate severity (3.8% after 4.1% in 2006). Steady growth in Japan and Europe along with the continued buoyancy of emerging economies will offset a loss of dynamism in the United States. The slowdown should moreover be modest and centred on particular economic sectors.
The recent tensions buffeting stock markets and the stagnation gripping the American property market have nonetheless served as reminders that various risks bear watching given their capacity to affect a relatively buoyant scenario for companies.
Overheating in several markets is, for example, attributable to abundant liquidity fuelled by massive reserves accumulated by China and oil-exporting countries and by surplus savings in Japan. Rapid credit expansion sometimes on terms that under-estimate risks presented by households, companies, or emerging countries has also been a major contributing factor.

- In recent years, property prices have thus registered particularly robust growth in several countries, industrialised like the United States, France, Spain, and Great Britain or emerging like Russia, Dubai or the Baltic states, spurred by large construction programmes. Household debt has increased sharply, however, and the spread between supply and solvent demand has grown wider. At this juncture the sales slowdown and price erosion in the United States augur a progressive adjustment with the difficulties concentrated on companies specialised in sub-prime loans and on the home construction and equipment industries. But payment failures could become more commonplace with mortgage foreclosures inflating the stock of available housing. In such case, an acceleration of the price decline and a contagion effect spreading to other countries would be real possibilities.

- Risks of a stock market crisis have also come back to centre stage with the wave of panic selling that erupted in March this year and the sharp decline of stock market indices in many emerging countries. The absorption capacity of those markets amid abundant liquidity sometimes amplified by foreign portfolio investment flows, notably to Asia, has been pregnant with risk. In some cases, corrections were indeed necessary after strong, bubble-like growth, especially in Shanghai, India, the Philippines, and Indonesia. The corrections have not yet run their course, however, and the slightest incident could again trigger volatile capital flight especially with those markets still suffering from their narrowness and in many cases from a lack of accounting rules or from governance shortcomings.
In industrialised countries, the disappointing figures announced for American growth compounded by the wariness directed at sub-prime mortgage loan operators have also affected the main stock markets. Corrections thus wiped out gains made from January 1 through end March on many of those markets with the Dow Jones, Nikkei, and Eurostox indices down 2.0%, 1.6%, and 2.4% respectively. Although that context, compounded by the prospect of slower corporate earnings growth in the United States, is less favourable than the conditions prevailing in 2006, stock markets in industrialised countries are nonetheless less risky than those in emerging countries.

- The financing of world economic imbalances has remained subject to many risks. While a scenario with the dollar crashing now seems less likely, that risk cannot be ignored. The slight easing of the American current account deficit expected this year should contribute to slowing the depreciation against the euro suffered by the dollar in 2006 and early 2007 (8% in 2006 and 3% since 10 January 2007). Two factors could, however, spur the dollar's depreciation: a narrowing of the interest rate spread between Europe and the United States and asset diversification by Asian and oil exporting countries. In that regard, the creation by China of an agency — funded with $200 billion — for investing the country's reserves and diversifying its holdings, will also be apt to destabilise expectations for the dollar even if China has no interest in seeing the dollar crash.

Those weaknesses constitute significant risks particularly for the operators deepest in debt and/or dependent on stock markets. Although a scenario of progressive adjustment is still the most likely in coming quarters, the risk of a more severe slowdown in the United States has been increasing. Companies would then have to contend with less dynamic sales coupled with an access to credit made more difficult by higher interest rates and the greater wariness of lenders in dealing with companies presenting a higher level of risk.

In that context, Coface negative watchlisted the United States A1 rating thereby causing increases of 10% in the world risk index and 20% in the industrialised country index due to the US economy's size.
The level of risk presented by companies in emerging countries, although remaining at higher levels compared to those in industrialised countries, has been increasing at a more moderate pace, up 1%,
In Central Europe, current account deficits and economic overheating prompted Coface to negative watchlist the ratings of Estonia (A2) and Latvia (A3). At a higher level of risk, meanwhile, Georgia's rating improved from D to C. In Asia, Thailand's rating deteriorated from a negative watchlisted A2 to A3 with political uncertainties affecting the business climate and economic conditions.
In the Near & Middle East, the increase in the average level of risk reflects the downgrading of Iran's rating from B to C amid deterioration of the country's economic situation and the growing financing difficulties experienced by companies in a context of lower oil prices and continued tensions over the nuclear issue.

In the United States (A1 rating negative watchlisted), poor performance in both the car industry, with registrations expected to declined 1.2% in 2007, and residential construction, with new housing starts down 15% this year, has affected economic growth, which should only reach 2.4% in 2007. The difficulties experienced by the actors in those sectors, including credit institutions specialised in sub prime loans, give serious cause for concern. Households could moreover reduce their consumption due to both a high level of debt (with their financial obligations reaching nearly 20% of their disposable income) and the waning of the wealth effect linked to the valuation of their property holdings. The financial obligations of certain companies have increased, meanwhile, with the growing involvement of investment funds and numerous leveraged buyouts. That could lead to failures should credit terms tighten and the economic slowdown intensify. Those prospects have prompted Coface to negative watchlist the A1 rating.
At this juncture, however, positive factors still augur well for a soft landing. The employment picture has continued to improve, especially in services to companies. The continuing low unemployment rate has spurred wage increases and thereby household consumption. Exports have benefited from the weakness of the dollar and continued robust demand for capital goods from emerging countries, which has contributed to reducing a nonetheless still-large trade deficit: 5.9% in 2007.
Company payment behaviour has remained generally good. Profitability has remained satisfactory even if earnings growth has been slower with payroll costs now rising at a faster pace than productivity. The difficulties have remained concentrated on the car industry, residential construction, and home furnishings. Service companies closely tied to those sectors — dealers, credit institutions, promoters — have also been suffering. Should the slowdown intensify, however, Coface will revise upward its expectations of a 5% increase in payment incidents.

In Japan (rated A1) the growth recorded in 2006 will continue unchanged this year (up°2.1%). Exports, particularly by the car industry and electronics sector, will suffer from the American economic slowdown. They will, however, continue to benefit from dynamic regional demand and favourable exchange rates. Companies will continue to invest but at a slower rate. Household consumption will remain sluggish, up only 1% with wages only increasing moderately. Consumer prices will register only small increases, raising the spectre of deflationary risk. The public sector will continue to run large deficits with adoption of the measures needed to reduce them postponed in the run-up to the July senatorial elections. Companies will continue to enjoy satisfactory financial health even if major companies; which have consolidated their accounts, will see their profits sag. The sluggishness of household consumption will weaken the construction, property, wholesale trade, and hotel/catering sectors.







In Western Europe, economic activity has slowed very moderately with growth expected to reach 2.4% again this year against 2.8% a year earlier. Although exports have sagged somewhat due to the American economy and world trade downturns, domestic demand, especially household consumption has generally remained buoyant. Easing unemployment has been a contributing factor. Although the pace of wage increases has accelerated, productivity has been improving even faster. In that context, and barring a sudden property market downturn, companies should generally continue to enjoy satisfactory financial health. However, risks have remained concentrated on certain sectors like car-industry and aviation subcontracting or clothing.


In Germany (rated A1), after recording a historically excellent year in 2006 (up 2.7%), a very moderate economic slowdown (up 2.2%) is expected this year. Thanks to good geographic and sectoral specialisation, exports continue to be the main economic engine, the sagging American demand and world investment not withstanding. Companies have continued to invest at a robust rate amid a continuing lack of available industrial production capacity. The building sector's revival has remained on track.

Consumption still lacks dynamism but has held steady despite a three-point increase in the normal VAT rate counterbalanced by increased job creation and higher wages. Company payment behaviour has remained good underpinned by the comfortable margins generated by substantial productivity gains.

In Spain (rated A1), the strong economic growth has continued, up 3.5% for this year, despite a slight slowdown. Massive debt (125% of disposable income) and the increasing cost of servicing that debt attributable to interest rate increases have nonetheless tended to temper household consumption and property investment excesses. But easing inflation, tax reductions, and job growth have had a countervailing effect. However, the potential property price bubble burst could negatively affect consumption and economic growth. Therefore the evolution of the building sector has to be closely monitored. Exports, meanwhile, should also slow in phase with economic conditions in Europe. Conversely, investment by companies and public communauties has remained dynamic. Payment behaviour has remained satisfactory, despite occasional accidents, particularly in sectors exposed to Asian competition — textiles, small electric equipment, and computer assembly — and sectors confronted with delocalisations to Eastern Europe — the car industry, furniture, and printing. In general, the substantial and growing debt contracted by companies for investment or diversification purposes will bear watching.

In France (rated A1), economic growth will remain moderate, up 2% expected this year like last year. Consumption is still the main growth engine buoyed by rising disposable income. Exports have been slowing, however, in phase with economic conditions in Europe. That has affected industrial production, particularly in intermediate products and the car industry. Company payment behaviour has stabilised at a level near the world average despite the continuing difficult situation in car-industry and aviation subcontracting, paper/cardboard processing, and textiles.

In Italy (rated A2), a slight slowdown is expected (1.5%) amid slower household consumption growth (up 1.7%) with tax increases, although moderate, only partially offset by favourable wage and employment trends. Although affected by sagging American and German demand, the export boom (up 4%) will continue to benefit from improvement in the products offered by Italian companies, which will continue to pursue restructuring and consolidation programmes to bolster their positioning on higher value added segments. In that context, some operators will have to shut down and payment incidents may occur, particularly in weak sectors like textiles, leather, consumer electronics, home appliances, and electric cable manufacturing.

In the United Kingdom (rated A1), economic growth will remain dynamic, up 2.6% expected this year like in 2006. While exports have suffered from the pound sterling's strength and from the American and European slowdowns, household consumption has benefited from good income growth and property market dynamism. Companies continue to enjoy satisfactory profitability even if industrial companies continue to underperform compared to services providers. Payment behaviour has remained satisfactory despite the difficulties experienced in car-industry subcontracting, paper processing, equipment distribution, and computer games and software.

The economic dynamism of CENTRAL EUROPEAN COUNTRIES should continue this year. Notwithstanding the slowdown expected in Hungary amid implementation of a fiscal austerity budget, the rest of the regional economy continues to benefit from robust domestic demand. Regional GDP including Turkey should thus grow at the same rate posted in 2006 (up 5.9%). Corporate solvency should remain satisfactory overall even if occasional payment failures will remain possible in the weak or very competitive sectors of Central European economies. In many regional countries, however, growing imbalances have accompanied the economic dynamism. A loss of appetite for reforms on a background of growing populism has delayed consolidation of public sector finances and adoption of the euro, a situation compounded in some cases by widening trade deficits that increase the region's vulnerability to currency crisis risk. Current account deficits have been running at high levels in Slovakia, Croatia, Turkey and Hungary while remaining limited in Poland and the Czech Republic. They have been peaking in countries where the expansion of credit has been excessive as in the Baltic States and to a lesser extent in Romania and Bulgaria where conditions conducive to emergence of speculative bubbles have moreover developed. Although foreign direct investment has covered a large proportion of the financing needs in the Czech Republic and Bulgaria, the coverage rate is moderate elsewhere, even very limited in most Baltic States and Hungary. Those imbalances have pushed exchange rate risk to high levels with the private sector in those countries having moreover taken on large foreign currency debt.


Economic growth was steady at about 6% in 2006 in the Czech Republic (rated A2) with companies generally growing stronger financially. Growth should slow slightly in 2007 amid sagging European demand. Domestic demand should, however, remain dynamic, underpinned by an improving job market, increased household disposable income, and expansionary fiscal policy. Investment should remain robust, particularly in electronics and the car industry. The current account deficit should remain at reasonable levels. With a public sector deficit rising to just over 4% this year, however, government officials have abandoned the objective of joining the euro zone in 2010.
In Poland (rated A3), increased investment, private consumption, and exports spurred an acceleration of economic growth late 2006, which thus reached 5.8% for the full year. Robust domestic demand should result in even stronger growth this year with inflation nonetheless remaining within reasonable limits. In that context, corporate solvency should remain satisfactory, especially in the more dynamic sectors like telecommunications, electrical engineering, and the car industry. Thanks to steady sales abroad, the current account deficit should remain at sustainable levels while robust public sector revenues should facilitate a slight reduction in a fiscal deficit representing a negative 3.4% of GDP. Intermittent exchange rate tensions will nonetheless remain possible due to a lack of reforms and the uncertain political environment.

Hungary (rated A3) has remained economically weak and continues to face high currency crisis risk. Deteriorating public sector finances have remained the economy's Achilles heel. The austerity budget announced in June 2006 and the realistic draft budget established for 2007 augur well for a reduction of the fiscal deficit from 10% of GDP to just over 6%. Government debt representing 68% of GDP should nonetheless continue to grow. The slowdown linked to the tight fiscal measures already in effect late last year should persist this year with growth likely to fall to around 3%. Household consumption should sag slightly affected by the decline of disposable income and a high debt level, with half denominated in foreign currencies. The export sector should, however, perform better with the current account deficit likely to decline to under 5% of GDP in 2007 due to sagging demand for imported goods. Overall, weak consumption and higher taxes should result in lower corporate profit margins and investment rates. Corporate solvency has gradually deteriorated in the past few months and could suffer should the forint become very volatile.

Estonia and Latvia, respectively with negative watchlisted A2 and A3 ratings, are currently experiencing economic overheating associated with rapid credit expansion. Their growth rates reached record levels last year, up respectively 11% and 12%. Macroeconomic imbalances worsened, meanwhile, particularly in Latvia where the current account deficit rose to over 20% of GDP (13% in Estonia) while inflation increased to nearly 7% (4% in Estonia). The job market in those economies has moreover grown tighter, conditions conducive to emergence of property bubbles have developed, and growing foreign debt now exceeds 85% of GDP in Estonia and 100% in Latvia. Pursuit of tight fiscal policies has partially offset that deterioration and made it possible to keep public sector debt at low levels. Despite postponement of their entry into the zone euro, those countries have nonetheless remained committed to compliance with the Maastricht criteria. The major stakes that foreign banks hold in local banks have contributed to the apparent solidity of the Estonian and Latvian banking systems.


In Turkey (rated B), the lira collapse in spring 2006 and the interest rate increases decided by the Central Bank in response have had no significant economic impact. Foreign capital returned quickly and both the stock market and the lira recovered much of the lost ground. Economic growth was 5.6% en 2006 reflecting a moderate slowdown from the 7.4% rate posted in 2005. Barring a financial crisis, the economy should grow strongly again in 2007 with IFI projecting a robust 6.1% rate with the dynamism of the car industry, kitchen appliances and chemicals offsetting the weakness of textiles.
The Central Bank's interest rate increases have moreover averted an inflationary spike. Company payment behaviour has remained generally very satisfactory in that context and above the world average. In counterpoint to the economic steadiness, however, external imbalances have continued to deteriorate dangerously. With Turkey's financing needs the largest of all emerging countries, the stock of volatile capital has also been large. Although no crisis of confidence directed at Turkey seems to be developing at this juncture, a new currency crisis nonetheless continues to be the main risk especially in the current context of renewed instability in financial markets. Political tensions will moreover mark 2007 in connection with presidential and legislative elections, difficult negotiations with the European Union, and dissension over Iraqi Kurdistan. A currency collapse even more severe than in May 2006 will thus be possible in case of a political crisis or a crisis of confidence vis-à-vis emerging countries, but it will not be accompanied like in 1994 and 2001 by a crisis in the public and banking sectors, which have benefited from major consolidation efforts in recent years. Segments of the private sector, especially companies carrying foreign currency debt but with earnings denominated in local currency will, however, be more vulnerable.

In Russia (rated B), sagging oil prices will have little affect on continuing strong economic growth with GDP expected to gain 6.1% in 2007 after 6.7% in 2006. Household consumption will remain exceptionally dynamic. Besides a solid external financial situation, with Russia now boasting the world's third largest currency reserves, the country benefited from a sharp increase in foreign direct investment in 2006, despite the government's reluctance to open the energy sector to non-resident ownership. Economic conditions varied by sector, however, with some like the car industry or light industry suffering more from the real rouble appreciation, up 10% for the year. Machines tools performed well as did sectors like commerce and construction. Trends in the oil sector — whose expansion slowed markedly in 2006 due to a lack of investment — will particularly bear watching in 2007.

The coming elections have been dominating the political situation. Unable to run again in March 2008, Vladimir Putin has put forward two potential heirs, both first deputy prime ministers: Dmitri Medvedev, liberal, President of Gazprom, notably responsible as minister for the social sphere, and Sergueï Ivanov, former defence minister close to the FSB (ex-KGB), whose recent functions included responsibility for the industrial-military complex. The prospective succession will, in any case, proceed under tight Kremlin control. With governance still the country's main weakness, neither the growing presence of the state and state-run companies as shareholders in many sectors nor the recent tensions involving foreign oil operators has contributed much to improving the business climate.

Strong growth should continue in Emerging Asia. A moderate slowdown will develop in 2007, up 7.5% after 8.1% in 2006, with the impact of an American slowdown (limited in our scenario) palpable in the region's small open economies, notably Singapore and Hong Kong. Thailand will also suffer an economic slowdown with domestic demand less dynamic in a more uncertain political context. Weaker growth is also likely in South Korea under the combined effect of wage sluggishness and the won appreciation. The other Asian economies will continue to enjoy strong growth buoyed by diversification of foreign trade and very steady domestic demand.
After reaching record highs in 2006 and early this year, linked to the influx of volatile capital, Asian stock markets suffered from a wave panic selling by market operators that resulted in sharp declines in stock market indices. The wave began on the Shanghai exchange (down 8.84% on 27/02/07) triggered by rumours of a capital gains tax in China in conjunction with the less bright outlook for the American economy. Steep index declines also buffeted the other Asian stock markets with Malaysia down 13% and India and Hong Kong down°9%.
The Philippines, Pakistan, India, and Thailand have clearly been the focus of excessive portfolio investment. That means that those stock markets will be particularly vulnerable to a crisis of confidence. Massive capital flight and the resulting sharp index declines should, however, have a limited impact on economic growth with market capitalisation limited in relation to GDP except in the Philippines (114%) and India (84%). The impact could nonetheless have a destabilising effect on the exchange rates of countries with balance of payments weaknesses (Indonesia, Pakistan, the Philippines and to a lesser extent India).

Growth forecasts for China (rated A3) have been revised up to 10% for 2007, down slightly from 10.7% in 2006 with the current account surplus reaching new highs and investment growth (up 16% in 2006, up 15% expected in 2007) only slowing marginally. In that context, overcapacity in sectors like the car industry, steel, or property could increase and the margins of companies in those sectors could shrink further, which has sustained continued high credit risk in the private sector. Government officials have reaffirmed their concern over the social costs — increasing inequality and protest — of uncontrolled growth.

To regulate growth, officials raised interest rates by 0.27 points, the fourth such rate hike since 2004, on 20 March 2007. But other administrative measures intended to cool the economy will be likely later this year with the yuan probably appreciating faster than the current 3% yearly rate against the dollar. The government will extend major financial support to rural populations especially by extending social coverage that currently benefits only 50% of country dwellers. Those measures seem nonetheless unlikely to significantly slow economic growth or put an end to land requisitions.

In India (rated A3), GDP growth for the financial year ending 31°March°2007 was revised up to 9.2% despite the farm sector's poor performance with the economy underpinned by the dynamism of both services (up 11%) and industry (up 10.1%). Very rapid development of goods and services exports has allowed India to cope with its soaring oil bill. The current account deficit, although growing, has remained manageable at 1.4% of GDP. A marked influx of foreign direct investment, increasing to $9°billion in 2006/07 from under $5 billion in past financial years, has offset the boom in Indian corporate investment abroad. The tightening of monetary policy necessitated by the upsurge of inflation should, however, cause a mild economic slowdown with growth easing to 8.5% in 2007/08. Despite evidence of overheating, India should nonetheless remain in a phase of strong growth in coming years, driven by high savings and investment rates, the presence of competitive groups, and development of a middle class fuelling consumption in a favourable demographic context.

In Thailand (downgraded from a negative watchlisted A2 rating to A3), the political situation has deteriorated with inconsistent decisionmaking by the new government in power since the September 2006 coup contributing to a worsening business climate. Introduction of measures to control volatile capital late last year (that led to a sharp 20% decline in the stock market index end December 2006), revision of shareholder rules for joint ventures, and promotion of a self-sufficiency concept have severely eroded the image of a country traditionally hospitable to foreign investors. The resignations of respected government officials have moreover undermined the credibility of the team that took power after the September coup. The elections scheduled for October this year and the revision of the constitution appear susceptible of postponement. The political calendar has become more confused and not very predictable. The possible disbanding of ex-Prime Minister Thai Rak's party could feed the already-perceptible mood of discontent and disappointment. Renewed violence in the country's southern region and the unexplained attacks perpetrated on New Year's day in Bangkok have stoked the current tensions.
There have been some palpable economic consequences. Domestic demand slowed markedly late last year with the growth expected this year revised down to 4% from 5% in 2006. That new deterioration has developed in a context of Thai exports losing their competitive edge due to the strong baht and Chinese competition. Electronics exports in particular could suffer from an American demand slowdown. Although companies could weaken in the current context, the Coface payment experience has given no evidence of deterioration thus far.

In Latin America, regional growth (4.3%) should sag slightly in 2007 in a somewhat less buoyant international environment and with domestic demand continuing to make a crucial contribution. Still-strong world demand should, however, allow efforts to consolidate external accounts to continue. The foreign debt reduction process appears on track moreover while adoption of more suitable monetary and fiscal policies has facilitated ongoing efforts to reduce inflation and consolidate public sector finances. The limited regional repercussions of the turbulence that recently buffeted international stock exchanges reflects the enhanced capacity of Latin American countries to withstand bouts of instability in financial markets. Persistent structural weaknesses will, however, limit the region's growth potential. The political situation is marked by an upsurge of demands on the sharing of wealth coupled in some cases with radical governmental policy options that affect the institutional and business environment. In that context, although corporate solvency has continued to improve, buoyed by favourable economic conditions, risks linked to an uncertain business environment have persisted in some countries. Some sectors can moreover be faced with particular difficulties like the Asian competition undercutting textiles or the vulnerability of agriculture to weather conditions.

In Brazil (rated A4), the PAC plan for spurring economic growth, adopted in January this year, entails a $235 billion programme for public and private infrastructure investment intended to foster 5% growth during President Lula's four-year term in office.

Although not reaching the PAC target, the economic recovery should continue in 2007 with private consumption the main growth engine and easing inflation making it possible to continue to relax monetary policy. The high real exchange rate notwithstanding, the dynamism of some export sectors will suffice to generate a current account surplus that will allow Brazil to sharply reduce its external financing needs, largely covered moreover by foreign direct investment, and consequently to mitigate its external vulnerability. Despite better management, however, public sector debt is still too large with failure to deal with the reforms needed to develop more sustained growth constituting the PAC's main weakness. In that context, corporate solvency has improved overall and especially in growth sectors like the sugar industry, construction, steel, aviation, and, to a lesser extent, the car industry. Some sectors, however, like pharmaceutical distribution and consumer electronics, may, have to contend with particular difficulties or even with foreign competition strengthened by the high real exchange rate.

In Mexico (rated A3), growth should be more moderate in 2007 due to the slowdown of the United States' economy on which the country remains heavily dependent, notably as an outlet for over 85% of its exports. The recent upsurge of inflation, attributable mainly to an increase in food prices, particularly for tortillas, should prompt a tightening of monetary policy. The new conservative president Felipe Calderon, who took office in December 2006, plans to pursue a policy of macroeconomic stability. The external deficit should remain limited due notably to oil exports and emigrant worker transfers with foreign direct investment expected to cover Mexico's financing needs. The already moderate debt ratios should decline further and the new fiscal responsibility law should spur improvement in the public financial situation. Although reforms will remain essential notably to improve the efficiency of state-owned companies in the energy sector, they will come up against stiff resistance with the new president's party lacking a parliamentary majority. In a context slightly less favourable than in 2006, corporate payment behaviour should only deteriorate very moderately. Traditional sectors like textiles or the dairy industry, however, continue to face competitiveness problems.

In Chile (rated A2), an economic rebound driven mainly by domestic demand should mark the current year. Coppers sales, meanwhile, continue to dominate foreign trade with the many free trade agreements facilitating geographic diversification of exports. The current account should thus be near equilibrium despite increased imports and profit repatriation by foreign companies with the country's financing needs — covered by foreign investment — remaining at reasonable levels. Application of a strict rule on fiscal surpluses has moreover facilitated reducing public sector debt to only about 5% of GDP.


In that context, company payment behaviour has been very satisfactory except for weaknesses in a few sectors: the dairy, leather/shoe, and wood/furniture industries.

In Colombia (rated A4), strong growth should continue, underpinned mainly by domestic demand with tightening fiscal policy helping to contain inflationary pressures. Amid improved economic and financial conditions, the IMF agreement that expired end 2006 was not renewed. With the Andean Trade Preference and Drugs Eradication Act expiring mid-2007, a free trade agreement with the United States should pick up the slack in 2008 subject, however, to US Congress approval. Corporate solvency should thus remain satisfactory with companies meeting their payment obligations on time. The political situation is, however, still Colombia's main weakness amid not only a persistent climate of great insecurity despite the weakening of the FARC rebel forces but also the recent revelations of ties between paramilitary groups and some members of the parliamentary majority backing the conservative president Alvaro Uribe.

In Argentina (rated C), growth should remain robust in 2007 due particularly to the accommodating policies pursued by government in the run-up to the presidential election in October this year. Foreign trade dynamism, buoyed by strong world demand for commodities and a policy of exchange rate undervaluation, should help maintain a substantial current account surplus. In that context, corporate financial health has improved. The economy has, however, been in an overheating phase amid limited reserve production capacity, stimulatory fiscal policy, and, price controls notwithstanding, severe inflationary pressures. The unrestructured-debt problem has moreover been blocking Argentina's access to international financial markets with its foreign debt ratios remaining high. However, neither the interventionist economic policy currently pursued nor the upcoming presidential election will be conducive to implementing reforms, which has been deterring investment particularly in the energy sector. Uncertainties surrounding the legal and judicial framework moreover continue to affect the business.

In Ecuador (rated C), a political crisis erupted early March with the new, leftwing populist President Rafael Correa, who began a four-year term in January this year, seeking to set up a constituent assembly against the will of the majority opposition in the unicameral congress. The resulting political tensions could affect household and corporate confidence and the new government's economic policy options have moreover been a source of concern for investors with officials raising the spectre of not honouring all foreign debt obligations to free up resources for social spending. Although timely payment of $135 million in international bond debt on 15 February temporarily soothed financial markets, it failed to completely eliminate the skittishness with the government sending mixed signals that undermine its credibility.

The new president has moreover expressed the wish to revise the formula for sharing oil resources with international companies and to have his country join OPEC. Meanwhile, the complete suspension of talks on a free trade agreement with the United States, Ecuador's first trading partner, will affect foreign trade performance. In that context, the improvement in public sector finances, external accounts, and foreign debt ratios achieved in recent years could be in jeopardy.

The regional risk index for North Africa and the Near & Middle East has worsened due to the downgrading of Iran's rating from B to C.
The world demand slowdown for oil and particularly demand from the United States late 2006 has reversed the trend on barrel prices, which had peaked at over $78 in August during the war in Lebanon. For oil exporting countries, the oil market downturn has resulted in slower GDP growth and reduction of external and fiscal surpluses, which had reached record levels in 2006. The downturn not withstanding, oil prices have nonetheless remained high, around $60 currently, underpinned by production adjustments, particularly in Saudi Arabia, faithful to its "swing producer" role. In recent years, those countries have moreover been able to reduce their debt loads (particularly Algeria and Saudi Arabia) and accumulate solid financial holdings. In such conditions the investment dynamic should remain on track in most cases. The property sector, which has been an important growth engine in the United Arab Emirates, especially in Dubai, will continue to bear watching with supply apt to exceed demand in 2007 and to contribute to the price decline. A scenario of a sudden market collapse has not appeared likely with the market controlled by a limited number of financially solid groups capable of adjusting supply and with demand moreover expected to remain robust.
The financial market correction underway since February 2006 has been particularly severe in Dubai and Saudi Arabia with the economic repercussions nonetheless remaining limited. The losses suffered by small investors should result in a consumption slowdown, offset however by steady public and private investment. The banking sector seems relatively unscathed with banks moreover reporting excellent results for 2006. The trend on non-performing debt could, however, affect their earnings performance in 2007. In that still generally positive context, Iran has relegated itself to the sidelines. The Iranian government has weakened the economy via profligate spending of oil revenues while the business climate has suffered from the country's growing economic and political isolation.
Other regional countries, exporting little or no oil, have generally benefited from increasing FDI (foreign direct investment) and in some cases from the petrodollars of Gulf monarchies. In Lebanon, however, political tensions continue to cloud the outlook with geopolitical uncertainties remaining in varying degrees a risk factor that has kept FDI below its potential.

In Saudi Arabia (rated A4), although the external demand slowdown, significant since the 2006 second half, continues to affect oil sector production, continued high hydrocarbon prices have sustained a climate conducive to investment (infrastructure, industry, property). The non-oil sector has remained the primary growth driver, underpinned by public spending and abundant market liquidity. In such conditions, a decline in household consumption resulting from the misfortunes of small investors hurt by the stock market corrections should have limited impact on GDP growth. Overall, the growth rate should remain stable around 4%. The country should continue to run comfortable external and fiscal surpluses albeit in decline from their record levels of past years. In that context, corporate earnings have been good and the Coface payment incident index has remained below the world average.

In Algeria (rated A4), the high hydrocarbon prices have resulted in solid external and fiscal surpluses. The oil windfall has allowed the country to accelerate foreign debt repayment and build up foreign currency reserves. The economy underperformed in 2006 due to a hydrocarbon production slowdown and delays in implementing the growth stimulation programme through public spending. In 2007, growth should benefit from increased gas production, acceleration of public investments, and firm household consumption spurred by civil service wages increases. Security situation has however to be watched. Companies should benefit from a context remaining buoyant overall and their payment behaviour will be unlikely to deteriorate.

In Israel (rated A4), the economy rose 4.8% in 2006 with repercussions of the conflict in Lebanon limited to a loss of under a point of growth for the full year. In 2007, the economy should grow at a 4.5% rate, buoyed by public spending on defence and reconstruction and by investment. Despite the increased fiscal spending, the government should hold the public sector deficit to 4% of GDP. External accounts continue to improve thanks to the dynamism of services. European and Asian demand should offset a possible slowdown of American demand. Financing needs will remain limited and largely covered by the inflow of capital and foreign direct investment. The Coface payment incident index for Israeli companies has remained below the world average.

In Egypt (rated B), the outlook for 2007 is still bright. The ongoing reform programme should continue to foster a propitious business climate. Further increases in gas production capacity have benefited the oil and manufacturing sectors. The external financial situation has been improving amid favourable trends for the traditional sources of currency earnings and increases in foreign direct investment spurred by privatisations. In that context, the business environment has improved and the Coface payment incident index has been below the world average. The fiscal and public sector deficits, however, still give cause for concern. Consolidating public finances will be a crucial objective.

In Iran (B rating downgraded to C), radically expansionary fiscal policy, intensified by President Mahmoud Ahmadinejad since his election in 2005, has reduced public sector financial surpluses despite the high oil prices in recent years and limited the build-up of reserves in the Oil Stabilisation Fund. Amid moderating oil prices in 2007, the likely new public spending excesses should result in an estimated 2.8% fiscal deficit. External accounts, meanwhile, will only show a slight surplus. Public spending underpinning household consumption has been driving growth coupled, however, with high 17% inflation. Tensions with the international community over the nuclear issue and the restrictions imposed by the United Nations in December 2006 have undermined the business climate and deterred investment. The increasing wariness of foreign banks and the lack of domestic financing could affect corporate payments.

In Lebanon (C rating negative watchlisted), after the economic recession triggered in 2006 by the July/August conflict with Israel, political instability has affected the strength of the recovery. Lebanon — saddled with record public sector debt representing 180% of GDP — was successful in obtaining pledges of massive international aid at the conference of donor countries held in Paris in January. But that aid will remain largely conditioned on implementation of structural reforms, difficult to achieve considering the political tensions.

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