Central & Eastern Europe: Improving Institutional Quality Crucial for Economic Outlook

Such progress in enhancing governance institutions is vital for CEE-11 given declining rates of growth potential and reliance on foreign capital for investment, including crucially on disbursement of EU funding, which is contingent on governments’ respect for the rule of law.

The region’s declining growth potential reflects now higher average income levels and declining contributions of labour to economic growth in view of demographic ageing. At the same time, earlier high FDI inflows to CEE-11 are presently in structural decline, suggesting maturing consumer markets, largely exhausted potential for privatisations and completion of large-scale physical infrastructure projects.

CEE governments’ governance and abilities to execute sound policies under scrutiny

CEE governments’ abilities to develop and execute sound policies leveraging their skills bases, improving productivity and strengthening the role of domestic capital markets for investment are under scrutiny.

Latest indications of institutional health in CEE-11 are mixed and reflect diverging institutional developments, judging by recently updated World Bank Worldwide Governance Indicators (WGI) – including as regards the rule of law and regulatory quality.

Rule of law has declined in Poland since 2014, and more recently in Hungary, but has improved in the Baltics. Poland and Hungary’s WGI scores are now around marks of countries such as Romania on subject of the application of the rule of law.

However, regulatory quality has remained sturdy in the region

Regulatory quality, defined as a government’s ability to formulate and implement sound policies in support of private-sector development – as the WGI category with the highest correlation with the level of investment of an economy – despite some decline, has, however, remained sturdy across the region.

Against this backdrop, the investment of Next Generation EU financing – and governments’ success in spending EU funds productively – will prove essential in determining economic outlooks in the CEE-11.

The European Commission has postponed approval of Hungary’s and Poland’s recovery programmes

The EU Commission has postponed approval of national recovery plans of Hungary and Poland, although we expect EU authorities to ultimately unlock EU recovery funding to Hungary and Poland after the countries have addressed rule-of-law concerns identified as part of EU-wide economic policy coordination.

Diverging trends in institutional quality may become increasingly relevant for the credit rating outlooks of countries such as Poland and Hungary as well as that of Romania should soundness of political institutions notably deviate from country fundamentals, materially affecting potential for economic growth and sound governance in the future.

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Levon Kameryan is Senior Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH. Jakob Suwalski, Director at Scope Ratings, contributed to writing this commentary.

The Prolonged Political Crisis in Romania Endangers Fiscal Consolidation and Reform Agenda

Tuesday, Romania’s Parliament voted in a no-confidence motion to bring down the minority government of Prime Minister Florin Cîțu of the National Liberal Party (PNL), after a period of tensions with Save Romania Union (USR), a centre-right party it established a coalition with late in 2020. This no-confidence motion of opposition Social Democrats and right-wing Alliance for the Union of Romanians (AUR) was supported by ex-coalition members of USR.

The collapse of the Romanian government increases political uncertainties, diminishing prospect for reform and fiscal consolidation.

An early election could be triggered if a new premier candidate is rejected

An early election could be triggered if Parliament rejects a new premier candidate twice consecutively. The largest group of the opposition, the Social Democrats, which promised to raise the minimum wage and increase pensions, has called for early elections in view of their recent gains in opinion polling. This, in turn, implies that rebuilding an earlier three-party coalition government, involving PNL, USR and Democratic Alliance of Hungarians in Romania (UDMR), may be the only feasible option for a majority government to avoid such snap elections.

Political stability vital to restoration of investor confidence

The reinstitution of political stability is vital for ensuring planned fiscal consolidation continues, important for restoring investor confidence as rising bond yields have taken their toll on primary market issuance. The lack of a governing majority could make it more difficult to pass important reforms, including those necessary for receiving critical EU funding.

Strong growth ought to provide an anchor for fiscal consolidation

Strong growth prospects of Romania ought to provide a relevant anchor for future fiscal consolidation. Scope expects growth of around 7% in 2021, revised up sharply from 4.8% under May 2021 forecasts, before 4.5-5% in 2022, buoyed by sizeable allocations of EU monies under the Recovery and Resilience Facility (of EUR 14.2bn in grants and EUR 14.9bn in loans, equivalent to 13.4% of 2020 GDP on aggregate).

The EU funding eases near-term liquidity bottlenecks as 13% of EU financing is expected to be immediately disbursed. However, in the absence of more profound fiscal reform, including significant enlargement of the tax base and higher tax compliance, the medium-run budgetary outlook remains unduly contingent upon sustained high rates of economic growth.

Fiscal consolidation and reform agendas remain key drivers of Romania’s credit ratings trajectory

We stress that the credibility of authorities’ fiscal consolidation and reform agendas is a key driver underpinning Romania’s credit ratings trajectory. Should Romania fail to form a stable coalition government near term that implements a credible fiscal and reform programme as envisioned under the recovery plan, this could undermine growth and public finance outlooks and result in a negative credit rating action from Scope Ratings. Our next review date of Romania’s ratings is scheduled for 22 October.

For a look at all of today’s economic events, check out our economic calendar.

Levon Kameryan is Senior Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Russia: Near-Term Economic Stabilisation Contrasts with Slow Reform Momentum, Climate Challenges

A recently proposed carbon levy by the EU, Russia’s largest trading partner, could potentially have a sizeable impact on the government’s budget that relies heavily upon oil and gas exports.

Strengthened public finances and accumulation of foreign-exchange reserves have enabled the Russian economy to withstand imposition of international sanctions and the Covid-19 crisis thus far comparatively well.

Russia’s output levels already recovered close to those pre pandemic. GDP ought to grow 4-4.5% for the calendar year 2021, revised up from 3% under our June 2021 forecasts, before 2.7% growth next year.

Greater economic stability has been met, however, with sidestepping of addressing structural weaknesses

Greater economic stability nearer term has, however, coincided unfortunately with an overlooking of the economy’s longer-run structural weaknesses.

Real disposable income of households declined by nearly 10% between 2013-2020. Russia’s growth prospects over this next decade are weak, of 1.5-2% annually, despite already comparatively low income per capita.

Structural reforms aimed at addressing underinvestment will prove crucial to increasing longer-run growth prospects, while global climate policies make the focusing upon of environmental issues a high priority.

Implementation of national investment projects has been sluggish

The government’s implementation of USD 360bn of national investment projects has thus far been sluggish. As of 1 August, only half of planned annual budgetary allocations have been executed. Delays of implementation weigh on the long-run health of the economy.

Fiscal vulnerability to Western environmental legislation

The economy’s carbon intensity and government reliance on energy exports for revenue make budgeting vulnerable to Western environmental legislation. Russia is the world’s fourth-largest carbon emitter, accounting for approximately 4.7% of world CO2 emissions.

Russia’s exports to the EU will be materially affected by the proposed carbon levy, designed to accelerate an EU switch to a lower-carbon energy mix and which could contribute to less demand for fossil fuel products.

The potential cost of an EU levy is still small compared to the overall size of the Russian economy, at around half a percent of Russian annual GDP, but this cost could, nevertheless, increase should EU expand the levy to include oil and gas.

Russia will gradually integrate climate-related issues into economic policymaking, as new regulations come into force in key export markets. In response to the EU, we see Russia potentially combining legal challenges to the planned carbon levy with offers of environmental-policy cooperation with Brussels in order to avoid the full impact of EU policies on its exports.

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Levon Kameryan is Senior Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Russia: US Sanctions On Sovereign Debt Signal Rising Risk Surrounding Geopolitical Tensions

Under a new Executive Order of 15 April, the US Treasury banned US financial institutions from purchasing newly-issued rouble and non-rouble denominated sovereign bonds on the primary market, in addition to other measures such as targeted sanctions of Russian companies in the technology sector.

These new sanctions in a context of increasing geopolitical tension in the Donbas region of neighbouring Ukraine suggest a more determined approach toward Russia under the Biden administration. As such, the risk of further sanctions remains high.

The US government seems to have pulled some of its punches

However, the decision not to immediately sanction secondary trading of Russian government bonds – matching the approach taken in 2019 regarding sanctions on Russian foreign-currency sovereign debt – limits the ultimate impact of the latest measures on Moscow’s room for financial manoeuvre. State-owned Russian banks should substitute for lost US and non-US foreign demand on the primary market and sell on to banks including US ones on the secondary market.

For now, the US seems to have pulled some of its punches: the sanctions are not as severe as they might have been and Washington has dropped plans to send warships to the Black Sea ahead of a possible summit between President Joe Biden and Russian President Vladimir Putin.

The significance of sanctions hinges on how Russia responds

The significance of sanctions for Russia’s BBB/Stable credit ratings from Scope hinges at this stage in part on how Russia responds, in terms of retaliatory measures as well as any escalation or de-escalation in tensions with Ukraine. Fresh US sanctions are still negative for foreign investment flows and the value of the rouble, and are likely to reduce foreign demand for rouble-denominated assets.

The Russian economy’s resilience against external shocks has been strengthened

However, Russia’s economic reorientation over past years partly in response to earlier sanctions has strengthened the economy’s resilience against external shocks.

This enhanced resilience of Russia’s economy includes foreign investors’ diminished share of rouble-denominated treasury bonds – down at around 20% currently, from 35% in March 2020 – as financing needs are met increasingly via domestic sourcing.

The domestic banking system is well capitalised. Public debt is low, at less than 20% of GDP and mostly denominated in rouble. The government’s Eurobond issuance activity has, in addition, increasingly been reoriented to euros rather than dollars. Official reserves are high, standing at USD 580.5bn at the start of April, equivalent to nearly five times maturing external debt within one year. Finally, a more self-sufficient Russian economy contracted by only 3% last year, comparatively mild relative to the recessions of many economies in the rest of Europe. We expect growth of 3-3.5% in 2021.

However, Russia’s economic outlook still remains subdued without substantive structural reforms, while the full impact of sanctions will emerge only over time, as US and European sanctions have driven a deterioration in an already weak business and investment climate by discouraging investment, of domestic and foreign origin alike.

For a look at all of today’s economic events, check out our economic calendar.

Levon Kameryan is Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH. Jakob Suwalski, Director at Scope Ratings, contributed to writing this commentary.

For a look at all of today’s economic events, check out our economic calendar.

CEE 2021 Economic Outlook: Region Set for Uneven 2021 Rebound amid Higher Debt, External Risks

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We forecast real GDP in the EU’s 11 member states in central and eastern Europe (CEE-11) to grow next year by 4.1% after a contraction of 5.3% in 2020. Meanwhile, Russia’s economic recovery in 2021 is set to be sluggish (2.5%), following a softer contraction in 2020 (-4.5%) compared with that of many other major economies around the world. In Turkey (growth forecast of 0.7% in 2020 before 6.2% in 2021), the risk to the economy’s external-sector stability remains real.

The Covid-19 crisis has proven exceptionally difficult for the CEE region on several fronts, from unprecedented supply and demand shocks to regional services sectors to disruptions to global supply chains in which several countries are heavily exposed – such as those with large automotive sectors. However, enhanced economic resilience of recent years has allowed EU CEE economies to be better positioned to cope with the crisis of 2020 than over 2008-09 with the global financial crisis.

The second set of lockdowns are likely to have halted or reversed many recoveries over the winter period, following the rebound in economic activity mid-year. However, Scope expects a renewed, uneven recovery to be underway by the spring of 2021 even though it will not be until after 2021 that output returns to pre-crisis levels in most economies of the region.

EU agreement on recovery fund provides an economic tailwind

Uncertainty will remain elevated for some period to come, with much hinging on progress in distributing coronavirus vaccine, though we see some encouraging economic tailwinds, notably an agreement around EU funds after Poland and Hungary’s earlier veto threat was pulled.

Regional central banks are unlikely to tighten monetary policy any time soon as they seek to sustain the recovery amid generally benign inflationary conditions. Here, Turkey is an exception – needing to maintain a tight rates policy to regain market confidence. We generally expect less volatility in regional currencies next year compared with 2020 as economic growth recovers.

Fiscal risks, Turkey’s monetary policy among top themes to watch

We identify several other important themes for 2021:

  • Russia’s macroeconomic reforms have led to a higher degree of economic self-sufficiency, mitigating the negative impact of this year’s crisis on the economy. However, the uncertain outlook for the oil sector, even after the OPEC+ agreed on a hike in petroleum supplies from January on, geopolitical risks and the absence of more profound structural reforms to raise potential growth are set to weigh on recovery.
  • Despite a near-term market-friendly shift in policy frameworks as represented in the Turkish central bank’s November 2020 rate hike, a market-friendly reorientation of Turkey’s economic policies will need to not only be maintained but strengthened. 2021 is expected to be a bellwether year for the country’s ratings trajectory.
  • For Georgia, a ratings concentration in 2021 will be on external-sector and fiscal risks, as well as on structural reform progress. We expect 4.5% growth in Georgia next year, after a 5% contraction in 2020.
  • Fiscal risks have increased, especially for non-euro-area CEE governments. Romania’s and Turkey’s public debt ratios are expected to continue increasing from about 35% in 2019 to above 60% by 2024. For most other CEE countries rated by Scope, however, we see stabilisation and/or eventual gradual declines in debt ratios. CEE countries need to advance domestic capital markets to ensure the stable rollover of higher post-crisis public-debt stocks.
  • The new long-term EU budget for 2021-27 presents a major opportunity for CEE-11 to boost investment, including in spending to address environmental risks related to climate change. CEE governments need, moreover, to raise labour-force participation rates after the crisis and address shortages of skilled labour.

For a look at all of today’s economic events, check out our economic calendar.

Levon Kameryan is Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Central and Eastern Europe Faces Challenge of Safeguarding Economic Resilience after the Pandemic

Annual real GDP in the eleven CEE countries will contract by around 5.3% in 2020, compared with 8.9% in the euro area.

We believe that this crisis is different for Central and Eastern Europe. CEE countries are better positioned to cope with the economic fall-out of this year’s crisis compared with the significant ramifications during the global financial crisis of 2008-09.

More balanced growth and improved financial stability enhance economic resilience

Three key factors have increased economies’ resilience and supported credit ratings in the region since the global financial crisis. First, the countries have developed more diversified engines of growth with consumption and investment becoming important growth drivers alongside net exports. Rising employment and wages have helped ensure incomes are gradually catching up with those of more mature western European economies.

Secondly, better debt management strategies have led to longer government debt maturities and a higher proportion of local currency issuance – enhancing the resilience of public finances. Thirdly, financial stability has improved including via declines in net external financial liabilities.

Anchoring higher growth in the CEE region has been investment, running at a yearly average of nearly 23% of GDP over the past decade compared with less than 21% of GDP in the euro area. However, to maximise the economic impact of such investment, governments need to spend more on training workers and focus on long-term growth-enhancing investment.

More investment in labour markets, productivity, ESG needed to ensure sustained convergence

The region’s governments need to address three main issues to ensure living standards continue convergence with western Europe’s: improving labour supply and productivity, deepening domestic capital markets, and addressing environmental, social and governance (ESG) issues, making use of EU financing.

The EU’s Resilience and Recovery Plan could emerge as a major supporting factor for such endeavours if governments are prepared to use proceeds productively and comply with ESG-related guidelines, such as investment in renewables and setting appropriate social and governance standards.

We have seen that historical absorption rates of EU budget funding vary substantially across the CEE region. While the absorption rate of European Structural and Investment Funds during the 2014-20 period is currently 55% in the Baltic states, the rate has stagnated at levels around or even below 40% in Romania, Croatia and Slovakia.

Ageing populations require a larger and better-qualified workforce to preserve economic competitiveness over the medium term, and the CEE region is no exception. Subdued productivity growth in many CEE countries has reflected limited spending on research and development, the latter running below a euro area average of 2.2% of GDP yearly and converging only slowly despite inflows of foreign direct investment.

Higher investment in education and research, coupled with institutional reforms to strengthen governance, is key for future sustainable growth in the region.

CEE countries could also accelerate growth by using economies’ potential to accelerate green transitions at a lower cost, given greater scope than western European peers in improving energy efficiency in production and consumption. Long-running disagreements with the EU over the ‘Rule of Law’, even after expected compromise around the EU’s 2021-27 budget, could turn into a more important risk were such disagreements to result in lowered investment from abroad to economies such as Poland and Hungary.

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For a look at all of today’s economic events, check out our economic calendar.

Levon Kameryan is Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Central & Eastern Europe Sovereign Update: Full Economic Recovery to be Gradual and Uneven

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Lingering uncertainties over the duration of the Covid-19 pandemic are the main downside risks to the CEE region’s growth prospects in Q4 2020 and 2021 which are also tied to the uneven and slowing economic rebound in western Europe – assuming that governments impose restrictions to contain the renewed wave of Covid-19 infections that are less economically damaging than they were in March and April.

We acknowledge that daily coronavirus cases and fatalities have reached record levels in many countries of the region, which will inevitably have an adverse impact on economic recovery.

That said, this year’s slump in GDP in Central and Easter Europe may not be as bad as it looked several months ago due to less severe declines in Q2 output and a stronger Q3 rebound that we expected at the time of our previous forecasts in July.

Decisive monetary-policy action by the region’s central banks and fiscal stimulus from governments have spared the region from a possibly markedly larger economic contraction this year.

Keep expectations in check of a rapid and uniform economic recovery in Q4 2020, 2021

However, we would caution against expectations of a rapid and uniform economic comeback in 2020. The regional recovery, after significant interruptions, will remain vulnerable to setbacks in 2021 even if we expect gradual economic normalisation to resume by early next year.

Scope has marginally improved its 2020 forecast for Poland (A+/Stable) to a 3.9% decline in output from 4.2% forecast three months ago, reflecting the economy’s relatively modest exposure to international tourism and global supply chains, both badly disrupted by the pandemic.

Economic prospects in Turkey (B+/Stable) remain finely balanced, given the tense geopolitical situation in the eastern Mediterranean and the Caucasus and ebbing foreign investor confidence in Ankara’s domestic economic policy, reflected in declining foreign-exchange reserves and a weakening currency. Scope forecasts Turkey’s output to fall 1.4% this year, revised from -4.2% in July forecasts.

We have also moderated our forecast for the scale of the 2020 recession in Russia (BBB/Stable) as well to -5.5% from a previous expectation of -6.8%. Russia’s sizeable fiscal and FX reserves enable an extensive policy response in support of its economy, but uncertainty over oil prices, upcoming fiscal consolidation and sluggish private-sector demand may impede recovery.

Recessions this year could also be milder than previously expected in the Czech Republic (AA/Stable) at -7% compared with -7.5% in July, Romania (BBB-/Negative) -5.5% vs -6.3%, Slovenia (A/Stable) -7% vs -7.6% and Bulgaria (BBB+/Stable) -5% vs -7%. Scope’s forecasts for a deep contraction in GDP are unchanged in Hungary (BBB+/Stable) at -6%, Slovakia (A+/Negative) at -8.1%, and Croatia (BBB-/Stable) at -8.9%.

The economic outlook is less gloomy in the Baltics this year. We forecast a fall in GDP in Lithuania (A-/Positive) of -1.5%, revised from a previous forecast of -7.6%, after surprisingly resilient economic activity in the second quarter; Estonia (AA-/Stable) revised to -5.5% from -7.7%; Latvia (A-/Stable) to -5.5% from -8%/. Georgia (BB/Negative) faces a steep recession this year equivalent to a 5% drop in GDP.

Monetary policy to remain unchanged, supporting the economy through this crisis

For CEE euro area member states, the ECB’s asset purchase programmes underpin low borrowing rates, bolstered by the euro’s reserve-currency status. We don’t expect monetary tightening by most non-euro-area CEE central banks near term, as they remain focused on providing accommodative financial conditions in support of weakened economies. The Turkish central bank is one exception, with pressures for tighter monetary policy stemming from rising inflationary pressure linked to the Turkish lira’s loss in value this year.

The strength of recovery across CEE depends in part on labour markets. Governments’ short-time work schemes have forestalled sharp rises in unemployment. The possible extension of support programmes assisted by the EU’s SURE loans will prove crucial in containing future rises in jobless rates.

Much is also riding on the efficient deployment of the recently agreed EU budget, including the EUR 750bn recovery fund, which should support recovery in EU member states of the region and facilitate needed medium-term investment.

Scope expects a rebound in growth for most economies in the region next year, ranging from 3.5% in Russia to 7.2% growth in Turkey under its baseline scenario which assumes that pre-crisis output levels are reached in most country cases by early 2022.

For a look at all of today’s economic events, check out our economic calendar.

Levon Kameryan is a Sovereign and Public Sector analyst at Scope Ratings GmbH.

Central & Eastern Europe Economic Update: Rebound has Begun, but Full Recovery only after 2021

Click here to download Scope Ratings’ Q3 2020 Central and Eastern Europe Sovereign Update.

A full recovery in most central and eastern Europe (CEE) countries to 2019 pre-crisis output levels is unlikely until after 2021. Under Scope’s baseline scenario, the expected significant GDP contractions in Q2 2020 in all CEE economies will be followed by recovery from Q3 2020. “We expect average capacity utilisation in CEE to return to around 90% of pre-crisis levels from Q3 under the assumption of a continued global recovery,” said Levon Kameryan, analyst in sovereign ratings at Scope.

“The speed and resilience of the regional recovery, however, will depend on several factors, including the impact of Covid-19 on regional economies in the second half, underlying structures of economies, the size and effectiveness of domestic as well as EU stimulus programmes – the latter representing a major opportunity for the EU CEE member states, the recovery in neighbouring Western Europe, and developments in global energy markets and investor sentiment, especially key for Russia and Turkey, but also for other CEE countries,” said Kameryan.

Accommodative monetary policies expected to be maintained, but also hold risks

Scope expects highly accommodative monetary policies to be maintained throughout the region over 2020, with only a few central banks likely to deliver more cuts, however, as inflation falls to or below targeted levels due to the pandemic’s severe adverse impact on domestic demand. As uncertainties regarding the duration of the Covid-19 crisis and associated risks to growth linger, we expect regional currencies to remain volatile, although they may strengthen further on the back of improving global sentiment.

“The quantitative easing kickstarted by several central banks in the region to back large fiscal stimulus packages and stabilise domestic capital markets is likely to play a bigger role in regional monetary policy toolkits going forward,” said Kameryan. “But we caution that such tools should continue to be used prudently to avoid capital outflow and elevated currency pressures, especially in emerging countries with higher reliance on external financing and weaker public finances.”

The CEE central banks, alongside the forceful actions of the G4 central banks, in most cases have helped contain debt-financing costs in the region. This has resulted in improved investor assessment of sovereign risk, as reflected in a decline in regional one-year euro and dollar sovereign CDS spreads after the sharp increases in March and April, although the magnitude of recent declines has varied by country and spreads remain elevated in the case of Turkey.

Major 2020 output declines across the region

Among EU CEE economies, the most moderate output drop is projected in Poland (4.2%) in 2020, thanks to the economy’s high diversification, and resulting lower exposure to international value chains and tourism. Hungary (2020 growth forecast: -6%), Czech Republic (-7.5%) and Slovakia (-8.1%) are the most exposed to global value chains in CEE, reflecting higher dependencies on respective automotive industries, which had to temporarily halt production. The ability of economies to adapt to structural changes in the automotive sector will be important for maintaining comparative advantages in the post-Covid-19 period, given as well the EU’s increasing budgetary focus on the low-carbon society.

Scope is now projecting a 2020 output drop in Romania of 6.3%, with less room for fiscal stimulus given already elevated budget deficits entering 2020. The Croatian economy is seen contracting around 9% this year, Slovenia’s by 7.6% and Bulgaria’s by 7%. On 10 July, Bulgaria and Croatia’s admissions to the Exchange Rate Mechanism II and Banking Union were announced formally by the European Commission. Lastly, the small, open Baltic economies are foreseen contracting by 7.5-8% in 2020.

Russia’s recovery will be challenged by OPEC+ arranged cuts in oil production, lower-for-longer oil prices, and weak household consumption due to the crisis. The rating agency has revised its 2020 growth forecast for Russia down to -6.8%, from -4.9%. Scope expects continuity with regards to prudent fiscal and monetary policies following the constitutional changes in Russia, though more profound structural reforms on the domestic side to raise the economy’s weak growth potential are unlikely any time soon.

Turkey’s economy is forecasted to contract by 4.2% in 2020. In addition to the severe adverse economic impact of the public health crisis, Turkey’s macroeconomic stability remains exposed to increasing external sector risks, including declines in reserve adequacy and significant exposure to lira depreciation and periods of capital outflow. On 10 July, Scope revised the long-term ratings of Turkey to B+, from BB-.

Finally, Scope forecasts Georgia’s real GDP to contract 5% in 2020, due to the economy’s dependence on tourism and travel services, which account for around 30% of Georgia’s GDP, including indirect impacts.

For a look at all of today’s economic events, check out our economic calendar.

Levon Kameryan is Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

US Dollar’s Global Dominance Remains Intact; EUR and RMB Still Far Behind but for How Long?

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EU and Chinese governments will have to do more to promote international use of their respective currencies. If and when they do, a shift from the dollar to the euro or renminbi might take place more precipitously than currently thought possible, says Levon Kameryan, analyst at Scope.

“Greater use of the euro and renminbi would grant EU and Chinese governments more monetary, financial and political autonomy while fostering a more stable international financial system by providing credible alternatives to the dollar,” says Kameryan.

The use of an international currency extends well beyond its role as a foreign exchange reserve for central banks. It fulfils the three traditional functions of money for both private and public actors: a medium of exchange, a unit of account, and a store of value.

“The dollar has dominated these areas for several decades, conferring considerable advantages for the US (rated by Scope an under consensus AA) in terms of public debt sustainability as well as economic and political leverage, and leading to inertia against the possible adoption of alternative currencies,” says Kameryan.

Rivals to the dollar in the future?

The euro is perhaps the most plausible rival for the dollar given the weight of euro area countries in world GDP (15%) and trade (25%), as well as member states’ growing prominence in global capital markets.

Several developments already point to a greater reliance on the euro, such as: the upgrade of the ECB’s payment systems infrastructure; Rosneft’s and Novatek’s (the biggest Russian oil and liquid gas producers) decision to switch to the euro from the dollar for all exports; and the European Commission’s work towards strengthening the international role of the euro, which includes active consultations with private and public market participants.

Tighter EU and euro area financial-sector integration, through completing the Capital Markets and Banking unions, would increase the attractiveness of euro-denominated assets. The availability of safe assets, which would greatly benefit from the creation of a euro area common debt instrument – such as a “eurobond” or sovereign backed bond securities – is also key in achieving more widespread adoption of the euro.

Negotiations around a Next Generation EU recovery fund for 2021-24 go in this direction.

For Chinese authorities, the further opening of capital accounts to foreign investors, progress in enhancing the supervision and reduction of financial vulnerabilities, strengthening of the rule of law and improved sovereign creditworthiness will be key to raising the renminbi’s international appeal.

So far, only gradual signs of dollar’s decline

So far, there have been gradual signs only of the dollar’s diminished dominance.

  • Foreign exchange reserves: dollar-denominated assets currently represent about 61% of global allocated reserves, though this share has fallen from above 71% in 1999. The euro’s share is much smaller at only 20.5% of holdings, after peaking in 2009 at 28%. The use of the renminbi, though marginal today, has almost doubled over the past three years to 2%.
  • Currency choice for central banks: The share of IMF member countries that adopt the dollar as an exchange-rate anchor has declined to 19.8% in 2018 from 26.5% in 2010.
  • Energy-market transactions: the dollar is the dominant currency in the energy sector but trading volumes in Shanghai crude oil future contracts denominated in renminbi, launched in 2018, have at times been not too far off from those of the Brent or West Texas Intermediate.

Current US policies could reduce dollar reliance

US foreign and trade policies may also incentivise governments to reduce their reliance on the dollar while the country’s persistent fiscal and current account deficits in a highly politically polarised environment may gradually weaken investor confidence in the currency.

Investors and policymakers alike should assess the risks and prepare for the possibility of a reduced role for the dollar in coming years or decades.

“It makes sense to take action today to protect against the possibility, even if it looks remote for now, of a sudden loss in confidence in the dollar, which could lead to a global liquidity crisis with severe economic consequences without an alternative global currency in place,” says Kameryan.

For a look at all of today’s economic events, check out our economic calendar.

Levon Kameryan is Analyst in Public Finance at Scope Ratings GmbH.

Central and Eastern Europe: Monetary Policy is easing Covid-19 Capital Market Disruption

“The capacity to implement bond-buying programmes and interest-rate cuts by central banks has varied considerably across the Central and Eastern Europe (CEE) region, while government borrowing rates have risen in some countries with elevated external-sector and public-finance risks alongside observation of sizeable portfolio outflows,” says Levon Kameryan, an analyst at Scope and author of a new report on CEE capital markets developments.

Overall, in the case of euro area CEE countries, low borrowing rates and investors’ relatively sanguine sovereign risk assessments reflect actions undertaken by the ECB – notably the large-scale asset-purchase programmes – in addition to the euro’s reserve-currency status. 10-year yields for euro area CEE governments increased only modestly so far in 2020 at currently around 0.6% for Slovakia and Slovenia, and below 0.3% in the case of the three Baltic states.

Monetary easing in non-euro EU CEE has abetted fiscal stimulus programmes

Among non-euro area EU CEE, large-scale fiscal stimulus packages in Poland, the Czech Republic and Hungary are backed by central bank policy responses that mitigate the tightening in financial conditions. Quantitative easing by the countries’ central banks might amount to as much as 10% of GDP in the case of Poland and 3% of GDP for Hungary.

The National Bank of Poland also reduced its reference rate by 50bps twice this year to 0.5% effective from April. The Czech central bank, on the other hand, has not announced quantitative easing so far, but has reduced its benchmark two-week repo rate three times to 0.25% by early May, from 2.25% in February. Hungary’s local-currency 10-year yield has reverted to January levels at 1.9% at time of the writing, after picking up to 3.3% mid-March. On the other hand, Czech and Polish yields of 0.8% and 1.3% respectively are currently somewhat lower than they were in January pre-crisis.

In the region, Romania, however, has less room for a bolder policy response due to elevated exchange-rate risk given a high proportion of foreign-currency public- and private-sector borrowing, as captured in Scope’s BBB-/Negative ratings for Romania.

The Romanian central bank cut its policy rate by 50bps to 2% in March and started its first-ever QE programme in April, although the size is modest. The central bank is unlikely to make further aggressive interest rate cuts that would risk weakening the value of the leu. Romania’s local currency 10-year government bond yield had increased to 4.4% at the time of the writing, from 4.1% as of January lows despite the policy rate cut, reflecting the country’s weak public finances, exacerbated by higher spending triggered by the 2020 crisis.

Severe external risk in Turkey

External risks in Turkey are further exacerbated by economic mismanagement, with real interest rates in negative territory after incremental rate cuts, which have amplified weakness in the exchange rate. The Turkish lira is currently trading around 10% lower against the dollar and 7% weaker against euro compared with end-February. Turkey’s 10-year lira government borrowing rates have increased sharply in 2020, to 13.3% at time of writing, from January lows of under 10%, despite cuts of 250bps in central bank policy rates over the same time period.

Additional fiscal measures and rate cuts forthcoming in Russia

In contrast, Russia’s fiscal stimulus has so far been modest, with additional fiscal measures and interest rate cuts likely to be forthcoming given its substantial liquid reserves (National Wealth Fund assets of 11.3% of GDP) and policy space. Direct purchase of government bonds on the secondary market is not expected to be on the central bank’s agenda, but longer-term repo funding of banks to support such purchases is possible.

Russia’s 10-year yield fell to 5.4%, supported by monetary easing, after picking up to over 8% mid-March, when Brent crude oil prices fell below USD 30 a barrel.

Russia’s reserves cover almost five times outstanding short-term external debt and support the external resilience of the Russian economy. On the other hand, Turkey’s official reserves cover only about 70% of short-term external debt, which poses a significant risk of a deeper balance-of-payment crisis if lira depreciation gets worse.

Read more in the rating agency’s report on CEE markets

Levon Kameryan is an Analyst in Public Finance at Scope Ratings GmbH.

Sovereign External Risk Ranking 2020: Covid-19 Lays Bare Country Risks to External Shocks

In the 2020 update of its external vulnerability and resilience rankings, Scope says volatile market conditions, vastly exacerbated by the coronavirus outbreak, and falling oil prices in 2020 have exposed the vulnerabilities of many countries’ balance of payments.

Lebanon defaulted on a USD 1.2bn Eurobond, Argentina and Ecuador’s debts re-entered selective default, and Zambia is on the brink. There are concerns about a wider emerging market debt crisis.

Meanwhile, with Brent prices at below USD 30 a barrel at the time of this writing (and US WTI trading around zero), crude is significantly below levels all oil exporters require for balanced budgets.

Assessments of external vulnerabilities are vital in evaluating debt repayment capacity

“Assessments of external vulnerabilities are vital in monitoring and assessing countries’ capacities to repay debt with economies under such severe stress,” says Levon Kameryan, analyst at Scope and co-author of the new report.

Scope has updated its external vulnerability and resilience two-axis grid, a framework it first introduced in 2018, which assesses countries on a) vulnerabilities to a balance-of-payments crisis and b) degrees of resilience in the advent of such a crisis.

Georgia (rated BB/Negative by Scope), Turkey (BB-/Negative) and Argentina (unrated) are 2020’s risky-3 as three economies that not only have vulnerability to the onset of balance of payment problems, but also show significant weakness in their respective abilities to cope in crisis.

“Argentina enters this year’s risky-3, edging out Ukraine, which was in the original 2018 risky-3 roster, while Ukraine, Colombia, Pakistan and Serbia (all unrated) remain highly at-risk economies just outside the top three most at risk,” says Kameryan.

At the other end of the spectrum, Taiwan (unrated), China (A+/Negative), and Switzerland (AAA/Stable) are home to economies that are the most robust to external shocks. Taiwan replaces Japan (A+/Stable) in this year’s sturdy-3.

Scores for major Western economies vary

Scores for major Western economies vary. The United States (AA/Stable) receives strong marks on external resilience, supported by dollar primacy (as the fourth most resilient economy in the 63-country sample), although the US displays significant external vulnerabilities. Italy (BBB+/Stable) and Germany (AAA/Stable) continue to display external sector strengths – supported by current account surpluses.

Italy’s external resilience is helped also by nearly 70% of Italian debt held by the resident sector. France (AA/Stable) has average scores, but Spain (A-/Stable) continues to score weakly on both axes of the framework. The UK (AA/Negative) displays deficits especially on external vulnerabilities.

Inside the EU, Scope finds that Cyprus (BBB-/Stable), Croatia (BBB-/Stable) and Romania (BBB-/Negative) are the three EU member states facing the greatest external sector risk.

On the flip side, Malta (A+/Stable), Luxembourg (AAA/Stable) and Denmark (AAA/Stable) are the EU’s sturdy-3, says Kameryan.

Read more in the 2020 external vulnerabilities and resilience report and rankings.

Levon Kameryan is Analyst in Public Finance at Scope Ratings GmbH.