The legacy of this Covid-19 crisis includes much higher government debt and structurally wider budget deficits, reflecting the shift in fiscal orthodoxy as governments have turned their backs on austerity, which was the default policy paradigm to differing degrees after the Global Financial Crisis.
Structurally weakened government balance sheets are credit negative, but still highly accommodative monetary policy – particularly from the Federal Reserve, ECB, Bank of England and Bank of Japan – has been compensating by ensuring continued low rates. The G4 central banks have enhanced roles as lenders of last resort.
In Europe, important institutional reforms with the agreement on the EU Recovery Fund and joint EU debt issuance is another credit positive development brought about in response to the pandemic.
More sovereign issuers on Negative Outlook than Positive; greater crisis effect on emerging countries
Since the Covid-19 crisis started, Scope has downgraded two sovereign issuers of the 36 credits it evaluates (Turkey, Belgium), while upgrading two (Lithuania, Ireland). Eight countries globally are presently evaluated by our agency on Negative credit Outlook (three EU member states, five non-EU) with one on Positive Outlook (Greece).
In emerging economies, the crisis has held greater net negative consequences for sovereign credit risk as governments’ balance sheets have weakened without domestic central banks being able to provide commensurate monetary support.
The global economy has fresh momentum, but recovery is likely to stay uneven and subject to setbacks
The good news is that the global economy has renewed momentum, supported by vaccination programmes, which have accelerated across many countries. However, vaccines are not equally available everywhere, so the economic recovery does not look as sustainable in emerging economies as it may in advanced ones.
However, full economic normalization remains vulnerable even in advanced economies to setbacks as segments of populations are yet to be vaccinated, virus variants present latent health-care risks and the withdrawal of extraordinary economic stimulus potentially lays bare higher unemployment and corporate insolvencies.
Governments may have to re-introduce some restrictions to deal with possible future increases in coronavirus cases, though we do not expect a repeat of the economic disruption of 2020 as vaccinations continue and countries adapt to new ways of doing business.
Upside revision of 2021 global growth driven by stronger US growth; monetary policy to remain accommodative over immediate future
The slight upward revision to our 2021 global GDP forecast stems mostly from a revised outlook for the US (+2.2pps to 6.2%) compared with six months ago. In contrast, we have revised down our forecast for euro area growth by 0.9pps to 4.7% and revised down China’s by 0.6pps to 9.3%, with forecasts for the UK and Japan unchanged from December projections at 6.6% and 3.0%. The impact of the pandemic on labour markets remains comparatively benign due to government interventions, with unemployment rates averaging 8.3% in the euro area this year, 5.7% in the US and 4.6% in the UK.
Monetary policy will remain accommodative over the immediate future, even as scale-back of net asset purchases is contemplated. We expect policy rates in the US, euro area and Japan to remain on hold at least through 2022. The UK will likely increase its base rate to 0.25% by end-2022, with the People’s Bank of China raising its loan prime rate 10bps in 2021 and in 2022.
Further tightening of global financial conditions represents a central risk to the economic baseline
A central risk to the Agency’s economic baseline is a further tightening of global financial conditions, in the form of higher long-term treasury yields, a significant correction in bubbly global equity markets and/or depreciation of exchange rates. This could be a result of a more significant “taper tantrum” in which inflation returns more dramatically or for longer than currently foreseen by global central banks, forcing behind-the-curve adjustments of policy setting and signalling. This risk is evidenced as central banks start advancing projections for interest rate increases.
Such an adverse scenario could test economies, particularly in emerging markets, which have accrued debt and are grappling with fragile recoveries.
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Giacomo Barisone is Managing Director of Sovereign and Public Sector ratings at Scope Ratings GmbH.