Emerging Market Sovereign Pressures to Persist in 2019

The key sources of the pressure on emerging markets (EMs) over the summer remain in place, Fitch Ratings says in a new report. The impact of tighter US monetary policy, a strengthening dollar, and risks to global trade and growth will continue to be felt in 2019.

EM vulnerabilities are reflected in Fitch's sovereign rating Outlooks and recent rating actions. Of the 15 sovereign ratings on Negative Outlook, only three are in developed markets. Notable negative EM sovereign rating actions in 2018 included two Outlook revisions for Argentina (B/Negative) and a downgrade of Turkey (BB/Negative).

Global economic growth remains supportive of sovereign credit quality generally, and the sustained recovery in hard commodity prices since 2016 has given a boost to EM exporters. However, a combination of country-specific events and risks, and wider developments - including US rate rises, tighter financial conditions and trade protectionism - have resulted in Fitch reducing its growth forecasts for several EMs during 2018.

Further dollar appreciation and tighter global financial conditions are likely to discourage capital flows to EMs. The rise in foreign-currency EM debt in recent years exacerbates the impact of a rising dollar on the availability and cost of financing for EMs. The direction of the dollar is critical for EMs and is inversely correlated with EM sovereign ratings.

Some external adjustments are under way and policy responses are being mounted, but these are not costless. For example, interest rate rises may help contain pressure on EM currencies, but monetary tightening from a relatively loose starting point is another barrier to growth.

And while many EM central banks typically say that they only intervene in currency markets to smooth volatility, data suggests that they may spend reserves to prevent even greater depreciation, depleting external buffers.

External and fiscal balance sheet pressures are most evident in Latin America and the Middle East and Africa (MEA). Fitch's EM sovereign ratings reflect not only a sovereign's degree of vulnerability to tighter global financing conditions and shifting capital flows, but also its ability to navigate resulting economic and balance sheet pressures, which vary considerably from sovereign to sovereign.