40_SC - Emerging Market Sovereign Research Series

SPECIAL COMMENT

SOVEREIGN & SUPRANATIONAL MARCH 25, 2014

This report is part of our ongoing coverage on China and Emerging Markets Prospects and Challenges. Access our archive of related research on this theme.

Analyst Contacts:

NEW YORK +1.212.553.1653

Bart Oosterveld +1.212.553.7914 Managing Director - Sovereign Risk [email protected]

Mauro Leos +1.212.553.1947 Vice President - Senior Credit Officer/Manager [email protected]

LONDON +44.20.7772.5454

Yves Lemay +44.20.7772.5512 Managing Director EMEA Sovereigns [email protected]

Sarah Carlson +44.20.7772.5348 Vice President - Senior Credit Officer/Manager [email protected]

Matt Robinson +44.20.7772.5635 Director of Sovereign Research [email protected]

SINGAPORE +65.6398.8308

Thomas J. Byrne +65.6398.8310 Senior Vice President/Manager [email protected]

FRANKFURT +49.69.70730.700

Dietmar Hornung +49.69.70730.790 Associate Managing Director [email protected]

Emerging Market Sovereign Research Series

External Vulnerabilities, Exposures, Mitigants and Credit Supports Creditworthiness of those with external imbalances, reliance on external funding and weak policy frameworks most vulnerable to financial market volatility

Recent financial market volatility and pressure on emerging market currencies has underscored the potential vulnerability emerging market sovereigns face during an extended period of uncertainty. Emerging market countries with external imbalances, reliance on external funding and weak policy frameworks will remain vulnerable to sentiment changes, capital flow adjustments or disorderly market reactions amid the monetary normalisation process in the US and ongoing concerns regarding emerging market growth prospects.

This compendium provides a point-in-time snap-shot of exposure to capital flow adjustments and disorderly market reactions for some of the largest emerging market sovereigns, along with mitigants that support creditworthiness and provide capacity to manage external financial and economic shocks. Our emerging market sovereign external vulnerability heat map summarizes our assessment of key external vulnerabilitiesone element of our assessment of sovereign creditworthiness.

Emerging Market Sovereign External Vulnerability Summary Heat Map Vulnerability indicators Policy space

Moodys Sovereign

Credit Rating

Current account balance,

% of GDP (2014F)

External Vulnerability

indicator* (2014F)

Gross borrowing requirement,

% of GDP (2014F)

Govt. FC Debt/ Total Govt. Debt,

% (2014F) CPI Inflation,

% (2014F) General govt. debt,

% of GDP (2014F)

Chile Aa3 stable -3.8% 126.9% 2.1% 17.4% 2.8% 11.9% China Aa3 stable +1.9% 16.5% 6.2% 1.2% 3.5% 34.2% Korea Aa3 stable +4.2% 46.8% 0.6% 1.6% 2.8% 36.5% Czech Republic A1 stable -1.5% 92.1% 10.2% 20.0% 1.3% 50.5% Poland A2 stable -1.5% 136.4% 8.3% 36.1% 1.4% 50.5% Malaysia A3 positive +4.3% 53.6% 10.3% 3.1% 2.8% 55.4% Mexico A3 stable +1.8% 60.0% 9.2% 18.5% 3.9% 31% Russia Baa1 stable +1.3% 22.6% 2.4% 20.7% 5.3% 14.6% Thailand Baa1 stable -0.6% 45.7% 8.2% 1.9% 2.9% 32.8% South Africa Baa1 negative -5.1% 84.1% 12.2% 7.9% 6.5% 45.9% Peru Baa2 positive -5.0% 20.7% 1.3% 49.1% 2.5% 17.1% Brazil Baa2 stable -3.0% 24.0% 12.5% 5.0% 5.7% 61.9% Colombia Baa3 positive -3.4% 60.0% 6.2% 25.2% 3.1% 32.4% Philippines Baa3 positive +2.5% 29.3% 7.9% 34.3% 3.5% 40.9% India Baa3 stable -2.9% 72.7% 12.0% 6.5% 9.0% 66.8% Indonesia Baa3 stable -3.1% 63.2% 3.7% 46.7% 5.8% 24.9% Turkey Baa3 stable -6.2% 171.3% 10.5% 30.0% 8.2% 35.2% Hungary Ba1 negative +1.5% 158.6% 23.1% 49.5% 2.4% 79.7% Argentina Caa1 stable -0.8% 101.1% 5.7% 62% 30.0% 48.5% Venezuela Caa1 negative +3.4% 610.5% 5.4% 51.1% 35.0% 34.1% Ukraine Caa2 negative -6.8% 300.4% 12.0% 51.1% 2.3% 47.6% * EVI = (Short-term External Debt + Currently Maturing Long-Term Debt + Nonresident Deposits Over One Year)/ Official Foreign Exchange Reserves

Central govt, debt only. Source: Moodys Investors Service

Minimal vulnerability, considerable flexibility Moderate vulnerability, moderate flexibility Elevated vulnerability, diminished flexibility

SOVEREIGN & SUPRANATIONAL

2 MARCH 25, 2014

SPECIAL COMMENT: EMERGING MARKET SOVEREIGN RESEARCH SERIES: EXTERNAL VULNERABILITIES, EXPOSURES, MITIGANTS AND CREDIT SUPPORTS

Table of Contents

KEY INDICATORS OF SOVEREIGN EXTERNAL VULNERABILITY AND CREDIT SUPPORT 3

INDIVIDUAL EMERGING MARKET SOVEREIGN EXPOSURES, VULNERABILITIES, MITIGANTS AND CREDIT SUPPORTS 7

ARGENTINA: Haphazard Policymaking and Unreliable Statistics Undermine Confidence in Capacity to Manage Adverse Shocks 8

BRAZIL: Strong Resilience to External Shocks, Despite Rising Debt Levels and Below-Trend Growth 10

CHILE: Very Low Vulnerability to External Shocks Due to Low Debt Levels, Fiscal Strength 12

CHINA: Capital Controls, Strong External Balance Sheet Insulate Sovereign and Economy from External Financial Shocks 14

COLOMBIA: Adequate Financial Buffers, Coherent Economic Policies Mitigate Negative Spillovers 16

CZECH REPUBLIC: Ample Liquidity, Floating Exchange Rate Keep External Vulnerabilities in Check 18

HUNGARY: Structure and Size of Debt, Large Financing Needs and Policy Unpredictability Present Risks 20

INDIA: Current Account Correction and Government Debt Profile Limit Sovereign Exposure, But Political and Growth Uncertainty Underpin Capital Account Volatility 22

INDONESIA: Reliance on Foreign Funding Poses Risks, But Sizable Buffers and Considerable Policy Space to Respond If Necessary 24

KOREA: Current Account Surplus and Strengthening Net International Investment Position Reduces External Vulnerability 26

MALAYSIA: Favourable Debt Structure, Minimal Currency Risk Mitigates High Public Indebtedness 28

MEXICO: Domestic Debt Orientation and Financial Buffers Limit External Vulnerabilities 30

PERU: Sizeable Foreign Exchange Reserves, Low Government Debt Burden Increase Shock-Absorption Capacity 32

PHILIPPINES: Continuing Improvement in Philippines Debt Profile Helps Funding Resilience 34

POLAND: EU Funding and IMF Credit Line Underpin Sustainable External Payments Position 36

RUSSIA: Low External Debt and Large Foreign Exchange Reserves Limit External Vulnerability 38

SOUTH AFRICA: Manageable Debt and Low FC Exposure Lessen Vulnerability to Rand Weakness 40

THAILAND: Political Crisis Eroding Thailands Traditional Buffers 42

TURKEY: Political Turbulence and Market Volatility Heightens Turkeys External Vulnerability 44

UKRAINE: Fragile External Liquidity Situation Due To Large Current Account Deficit, Unstable Access to Finance and Political Uncertainty 46

VENEZUELA: Precarious Foreign Exchange Reserve Levels, Dependence on Oil Exacerbate External Vulnerabilities 48


3 MARCH 25, 2014


Box 1: Key Indicators of Sovereign External Vulnerability and Credit Support While there are a vast number of different indicators of an individual sovereigns vulnerability to adverse external events that negatively affect creditworthiness, our heat map highlights what we consider to be some of the key indicators of vulnerability to external financial and economic shocks. Similarly, while there are various ways to assess a sovereigns so-called policy space to manage external shocks, our heat map concentrates on two key indicators of government and central bank policy capacity that provide an indication of a sovereigns capacity to mobilise fiscal or monetary policy to manage the negative effects of external economic or financial market influences.

This list of indicators is not meant to be exhaustive; many factors ultimately determine a sovereigns vulnerability to external shocks and capacity to maintain debt servicing in the face of adverse external conditions. Nor is it meant to be a substitute for a holistic assessment of sovereign creditworthiness; many other factors affect a sovereigns credit quality and influence the rating we assign to its debt securities, as discussed in our Sovereign Bond Methodology.1

Key indicators of external vulnerability

Current account balance: The current account (when in deficit) gives an indication of how much foreign capital a country requires in order to close the gap between domestic savings and investment. Rapidly growing emerging market countries with high investment rates can sustain large current account deficits for many years against the background that a strengthening economic base improves a countrys ability to service growing external debt. Large and persistent current account deficits lead to a build-up of external debt if not financed by inflows of foreign direct investment (FDI).

Reliance on debt funding by non-residents to meet current account shortfalls exposes emerging markets to potential balance of payments crises if investor sentiment changescurrent account imbalances can lead non-resident (and also resident) investors to flee from domestic-currency assets, triggering massive exchange rate and/or asset price depreciation, the precursor to banking sector and wider economic crises.

Though each country is unique in its ability to finance a current account deficit, our view is that a current account deficit in excess of 5% of GDP represents elevated vulnerability to balance of payments risk (an element of the external vulnerability risk sub-factor within our assessment of sovereign susceptibility to event risk (Factor 4 in our Sovereign Bond Methodology)). This threshold roughly equates to one standard deviation from the mean current account balance of all sovereigns examined within this report.

Indicator of external vulnerability

Minimal vulnerability, considerable flexibility

Moderate vulnerability, moderate flexibility

Elevated vulnerability, diminished flexibility

Current account balance (2014F, % GDP)

CAD


4 MARCH 25, 2014


because, in a general run on the currency, non-resident depositors may attempt to withdraw longer-term deposits even if they have to pay a penalty to do so; deposits of less than one year are already included in short-term debt.) This ratio thus measures capacity to withstand a sudden loss of investor confidence resulting from heightened risk perception or a general emerging market liquidity squeeze.

An EVI greater than 100% can be a signal of vulnerability, resulting either from excessive short-term debt or a serious bunching of repayments on long-term debt, possibly exacerbated by insufficient reserves. This equates to the threshold between M- and L+ in the external vulnerability risk sub-factor within our assessment of sovereign susceptibility to event risk (Factor 4 in our Sovereign Bond Methodology). An EVI above 160% equates to high susceptibility to event risk in our methodology. (The detailed composition of short-term debt must also be considered, as some emerging markets that are major commodity exporters may have a high volume of trade-related short-term debt that is not vulnerable to withdrawal to the same degree as other sorts of external financing.)





External Vulnerability indicator* (2014F)

EVI


5 MARCH 25, 2014


General government foreign currency debt/general government debt is an adjustment factor within our assessment of fiscal strength (Factor 3 of our Sovereign Bond Methodology). For the purposes of this report, we highlight instances where foreign-currency denominated debt constitutes more than 40% as a proportion of total debt as a source of potential debt-servicing stress in the event of major exchange rate adjustment even when other measures of indebtedness may appear low. This threshold roughly equates to one standard deviation from the mean proportion of foreign currency debt of total debt for all sovereigns examined within this report.





General Govt. Foreign Currency Debt / Total Govt. Debt (%) (2014F)

FC


6 MARCH 25, 2014


ailing banking systems in response to tightened global liquidity conditions. In contrast, a legacy of heavy indebtedness can constrain a governments ability to respond to external shocks, forcing a government to tighten fiscal policy to avoid further debt accumulation. Considering the stock of general government debt also provides an indication of the degree to which past debt accumulation is susceptible to changes in the interest rate paid on maturing government debt to be rolled over, exposing the government to changes in investor sentiment and risk premia.

General government debt as a proportion of gross domestic product is a standard measure for scaling the size of general government debt (the debt of the central and subnational governments) to the size of the economy for cross-country comparative purposes. Although 40% equates to the mean debt-to-GDP level for all sovereigns examined in this report, market tolerance and investor willingness to rollover debt above this level is lower for emerging market sovereigns. We consider a debt level in excess of 60% of GDP (equating to roughly one standard deviation from the mean of sovereigns examined in this report) to represent significantly increased vulnerability for emerging market sovereigns, constraining their ability to use fiscal policy to manage adverse shocks. (This aligns to a M sub-factor score for debt burden in our assessment of Fiscal Strength, Factor 3 in our Sovereign Bond Methodology.)

Indicator of policy space Minimal vulnerability, considerable flexibility



General govt. debt/GDP (2014F)

Debt


7 MARCH 25, 2014


Individual Emerging Market Sovereign Exposures, Vulnerabilities, Mitigants and Credit Supports

Emerging markets have experienced considerable financial market volatility over the past nine months in anticipation of, and following the commencement of, the US Federal Reserves unwinding of extraordinary monetary stimulus (so-called tapering of its quantitative easing policy). The recent bout of financial market volatility earlier this year was exacerbated by emerging market growth concerns sparked by weakening Chinese manufacturing data.

The continuing global capital reallocation has driven considerable exchange rate depreciation in recent months (see Exhibit 2) and rises in market yields, particularly in those emerging markets that were the recipients of large amounts of foreign capital inflows during the quantitative easing period, such as Turkey and South Africa. Others such as Ukraine, Argentina and Venezuela have come under greater pressure, underscoring a diversity of vulnerabilities and exposures beyond just external factors and differentiation by the market regarding its assessment of individual sovereigns inherent mitigants to vulnerability and credit supports.

EXHIBIT 2

Emerging Market Currencies Under Pressure Exchange rate movements to the US dollar, year to date

Source: Haver Analytics

We expect emerging market countries with external imbalances, reliance on external funding and weak policy frameworks to be those most vulnerable to sentiment changes, capital flow adjustments or disorderly market reactions as the monetary normalisation process continues and growth expectations fluctuate with the latest data.

The following pages provide a snap-shot of external vulnerabilities for the largest emerging market sovereignsone element of our holistic assessment of sovereign creditworthiness. The individual sovereign-specific sections also highlight key credit mitigants that support credit quality and provide sovereigns with varying capacity to manage financial and economic shocks.

-24 -20 -16 -12 -8 -4 0 4 8 12

UkraineArgentina

RussiaHungary

TurkeySouth Africa

ColombiaChinaKorea

PhilippinesMexicoPoland

MalaysiaPeruChile

CzechVenezuela

ThailandIndiaBrazil

Indonesia


8 MARCH 25, 2014


Argentina: Haphazard Policymaking and Unreliable Statistics Undermine Confidence in Capacity to Manage Adverse Shocks

Vulnerability indicators Policy space

Current account balance

(2014F, % of GDP) External Vulnerability

indicator* (2014F)

Gross borrowing requirement

(2014F, % of GDP)

Govt. Foreign Currency Debt/ Total Govt.

Debt (%) CPI Inflation

(2014F, % y.o) General govt. debt (2014F, % of GDP)

Argentina (Caa1 stable)

-0.8% 101.1% 5.7% 62.0% 30.0% 48.5%

* (Short-term External Debt + Currently Maturing Long-Term Debt + Nonresident Deposits Over One Year)/ Official Foreign Exchange Reserves

External vulnerabilities/exposures: Argentinas (Caa1 stable) currency declined more than 17% against the US dollar in the space of a week in January after the Argentine central bank limited its intervention in the market to preserve its international reserves.2 Official government reserves have plummeted to less than $30 billion from $52 billion in mid-2011, as a result of the countrys growing macroeconomic imbalances and which has pressured the sovereigns creditworthiness (see Exhibit 1). Argentina remains one of the few Latin American countries with a capital account deficit because of persistent outflows and a lack of access to international debt markets, a symptom of macroeconomic distortions, haphazard policymaking and past debt repayment transgressions. The trade surplus (goods and services), which for years helped prop dollar inflows, fell 50% in the first nine months of 2013 from 2012 levels (see Exhibit 2). Meanwhile, Argentina has one of the highest inflation rates among our rated sovereigns (well in excess of the official figure reported by the government), and continued currency depreciation will likely push inflation even higher to more than 30% this year.

EXHIBIT 1

Declining Foreign Exchange Reserves Pressures Creditworthiness International Reserves (US$ Billions)

Source: Central Bank of Argentina

EXHIBIT 2

Argentina's Declining Trade Surplus Trade Balance Seasonally Adjusted

Source: Haver Analytics; Instituto Nacional de Estadistica y Censos (INDEC)

Mitigants/credit supports: Argentina has relatively low dependence on external capital flows, having been essentially shut out of global capital markets for more than a decade. So it is less vulnerable to reversals in global investor sentiment. Argentina also has a relatively modest and improving debt burden: government debt as a proportion of GDP is just over 40% and the sovereigns debt to revenues ratio has been improving faster than its rating peers. Argentinas GDP per capita is also more than three times the median of B-rated sovereigns and its economy larger and more diversified than its peer group. However, the countrys haphazard economic policy decisions coupled with increasing

2 See Argentina Devaluation Is Credit Negative for Banks, Corporates, Insurers and Securitizations and No Sovereign Panacea, 27 January 2014

4

5

6

7

8

9$25

$30

$35

$40

$45

01.0

2.13

02.0

2.13

03.0

2.13

04.0

2.13

05.0

2.13

06.0

2.13

07.0

2.13

08.0

2.13

09.0

2.13

10.0

2.13

11.0

2.13

12.0

2.13

01.0

2.14

$ Bi

llion

s

International Reserves - left axis

ARS/USD - right axis

$0

$1

$2

$3

$4

$5

$6

$ Bi

llion

s


9 MARCH 25, 2014


questions about the reliability of official statistics make it extremely difficult to determine with certainty Argentinas real economic conditions. This diminishes confidence that regarding the countrys ability to manage adverse shocks such as the current pressure on emerging market currencies, as reflected in Argentinas Caa1 rating.

For further information: Credit Opinion: Argentina, Government of

Gabriel Torres Vice President - Senior Credit Officer +1.212.553.3769 [email protected]


10 MARCH 25, 2014


Brazil: Strong Resilience to External Shocks, Despite Rising Debt Levels and Below-Trend Growth




indicator* (2014F)


(2014F, % of GDP)

Govt. Foreign Currency Debt/

Total Govt. Debt (%) CPI Inflation


Brazil (Baa2 stable)

-3.0% 24.0% 12.5% 5.0% 5.7% 61.9%

* (Short-term External Debt + Currently Maturing Long-Term Debt + Non-resident Deposits Over One Year)/ Official Foreign Exchange Reserves

External vulnerabilities/exposures: Brazil (Baa2 stable) has a limited exposure to a reversal of portfolio inflows after attracting net flows equivalent to just 4.8% of GDP during 2010-2012. The countrys international reserve buffer is among the strongest of the five large Latin American economiesBrazil, Mexico, Chile, Peru and Colombiaproviding strong resilience to external shock despite relatively high public debt ratios and persistent inflation. The governments debt ratio is projected to rise to around 60% of GDP, significantly higher than the 45% median for Baa-rated peers (see Exhibit 1), and its annual gross borrowing requirement is higher than many other Baa credits. Meanwhile, the central bank raised the benchmark Selic rate for a sixth consecutive time to 10.5% to control inflationary pressures. All of this is occurring against the backdrop of an extended period of below-trend growth, with GDP expanding around 2% in 2011-14a marked slowdown from average annual growth of 4.8% between 2004 and 2008 (see Exhibit 2). The Brazilian real depreciated 13% against the dollar in 2013.

EXHIBIT 1

Brazils Rising Debt Level General government debt, % of GDP

Source: Moodys Investors Service

52

53

54

55

56

57

58

59

60

61

62

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E

%


11 MARCH 25, 2014


EXHIBIT 2

Brazils Growth Slows Real GDP growth, %

Source: Banco Central do Brasil; Moodys Investors Service

Mitigants/credit supports: Despite an anticipated increase in the current account deficit to around 3% of GDP in 2014, the external accounts do not pose significant credit risks. The bulk of the deficit continues to be financed by foreign direct investment. With international reserves equivalent to 16% of GDP, the government has more than sufficient resources to cover external financial obligations and to provide bridge liquidity to domestic borrowers, even if markets were to shut down. Short-term external debt is low at just 1.5% of GDP, foreign currency-denominated debt accounts for a mere 5% of total government debt, and non-residents hold only 16% of the governments domestic debt.

For further information: Credit Opinion: Brazil, Government of

Mauro Leos Vice President - Senior Credit Officer/Manager +1.212.553.1947 [email protected]

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014F

%

Real GDP growth Ave. 2004-2008 Ave. 2011-14 avg 2004-14

Avg 2004-14: 3.5%

Avg 2004-08: 4.8%

Avg 2011-14: 1.9%


12 MARCH 25, 2014


Chile: Very Low Vulnerability to External Shocks Due to Low Debt Levels, Fiscal Strength




indicator* (2014F)


(2014F, % of GDP)




Chile (Aa3 stable)

-3.8% 126.9% 2.1% 17.4% 2.8% 11.9%

* (Short-term External Debt + Currently Maturing Long-Term Debt + Nonresident Deposits Over One Year)/ Official Foreign Exchange Reserves)

External vulnerabilities/exposures: Chiles (Aa3 stable) external vulnerabilities stem from an elevated current account deficit and dependence on commodity exports, though neither represents a significant risk. The recent decline in global metal prices, investment income outflows and resilient domestic demand have led to a deterioration in the current account balance; the deficit is estimated at 3.8% of GDP this year from a surplus of 2% in 2009. However, foreign direct investment inflows are sufficient to finance most of the current account shortfalls, similar to other Latin American countries (see Exhibit). Official foreign exchange reserves are estimated at $43.9 billion in 2014, producing an external vulnerability indicator (EVI) in excess of 100% -- a figure associated with moderate external vulnerability.

While the free-floating Chilean peso can act as a natural hedge against external shocks, its high correlation with international copper prices can lead to moderate levels of volatility in the exchange rate. Commodities represent around 80% of Chiles exports, with the bulk being copper sales. Nevertheless, the Chilean peso has remained essentially unchanged against the US dollar in the past month, underscoring minimal external vulnerability.

EXHIBIT 1

Chiles Current Account Deficit Covered by Foreign Direct Investment Current account deficit, FDI, 2010-12 average


Mitigants/credit supports: Chiles low debt levels, low interest-rate burden and net creditor position provide it with a very high degree of insulation from external vulnerability. A debt-to-GDP ratio of 11.9% for 2014 is less than half of the Aa-rated peers median. Chiles debt structure is also highly favorable; the average maturity is over 10 years, rollover risk is low and foreign-currency denominated debt has declined to just 17% of total debt in 2013 from 90% of the total in 2003. Chiles EVI is expected to improve to 126.9% in 2014 from 147% in 2008, while potential multilateral lending

0.0

1.0

2.0

3.0

4.0

5.0

Mexico Chile Brazil Peru Colombia

% o

f GD

P

Current Account Deficit Foreign Direct Investment


13 MARCH 25, 2014


provides a cushion in addition to foreign exchange reserves in the event of a sudden stop of private capital inflows. Meanwhile, substantial fiscal savings and a budget deficit of a mere 0.5% of GDP provide the government sufficient financing options to manage internal and external shocks.

For further information: Credit Opinion: Chile, Government of



14 MARCH 25, 2014


China: Capital Controls, Strong External Balance Sheet Insulate Sovereign and Economy from External Financial Shocks




indicator* (2014F)


(2014F, % of GDP)




China (Aa3 stable)

+1.9% 16.5% 6.2% 1.2% 3.5% 34.2%


External vulnerabilities/exposures: Chinas (Aa3 stable) external position is exceptionally strong: a robust current account surplus and strong capital controls insulate economy and reduce financial system vulnerability to global financial market disturbances. The current account has averaged a surplus of around 2% of GDP over the past four years (the sharp reduction from the 10.1% of GDP current account surplus in 2007 reflected rebalancing prompted by external demand changes and domestic policies), while Chinas positive net international investment position ensures an income inflow into the balance of payments that offset turbulence in trade performance or financial flows that transcend capital controls. While banking system credit growth has moderated from the surge in 2009, credit growth in the shadow banking system has boomed representing a potential domestic vulnerability. Nonetheless, we see that the banking system has substantial buffers to absorb possible credit costs, either indirectly or directly, from a deterioration in shadow banking system credit quality.

The central government runs a modest budget deficit; central plus local government gross financing requirements (budget deficit financing and debt repayment or rollover) have been edging up in recent years, but the total amount remains relatively modest (less than 8% of GDP). We expect the government to run modest deficits around 2% of GDP over the medium term.

EXHIBIT 1

Strong External Balance Sheet Provides Significant Buffer Net International Investment Position (2012)

Source: Moodys Investors Service, Haver

Mitigants/credit supports: Neither the government nor the banking sector relies on external funding. Chinas net international investment position was about 21% of GDP in 2012 (see exhibit), one of the strongest sovereign positions in our rated universe of large economies. Official foreign exchange reserves totalled $3.82 trillion at end-December 2013. The banking systems loan-to-deposit ratio is relatively low at around 70%. Net foreign assets increased in 2012 to $300 billion (3.7% of GDP)

-150 -100 -50 0 50 100

Portugal (Ba3)

Ireland (Baa3)

Greece (Caa3)

Spain (Baa2)

Italy (Baa2)

United States (Aaa)

France (Aa1)

Korea (Aa3)

China (Aa3)

Germany (Aaa)

Japan (Aa3)

% of GDP


15 MARCH 25, 2014


and the banks enjoy extraordinary back-up external liquidity from the countrys official foreign exchange reserves. Chinas gross domestic savings rate50.7% in 2012, the highest of any large economyis also a source of near-term credit strength, providing the government with a stable, low-cost domestic source of funding.

Furthermore, policy space is ample: inflation remains low affording considerable flexibility to the central bank and central government debt measures a relatively modest 34.2% of GDP providing headroom to manage economic or financial shocksalthough the central government may need to provide additional fiscal resources to local governments to bolster their finances and debt-repayment capacity after sizeable debt and contingent liability accumulation in the past few years,3 representing a sizeable contingent liability for the sovereign balance sheet that would increasing this key credit ratio if crystallised.

For further information: Credit Opinion: China, Government of

Tom Byrne Senior Vice President/Manager +65.6398.8310 [email protected]

David Erickson Associate Analyst +65.6398.8334 [email protected]

3 See New Report Shows Sizable Debt Accumulation by China's Local Governments, a Credit Negative, 3 January 2014


16 MARCH 25, 2014


Colombia: Adequate Financial Buffers, Coherent Economic Policies Mitigate Negative Spillovers




indicator* (2014F)


(2014F, % of GDP)




Colombia (Baa3 positive)

-3.4% 60.0% 6.2% 25.2% 3.1% 32.4%


External vulnerabilities/exposures: Colombias (Baa3 positive) currency has depreciated 1.4% against the US dollar since the start of the year, more than many other emerging market currencies, indicating potential balance-of-payments pressures and a reversal of portfolio inflows. External vulnerability stems partly from a current account deficit averaging around 3.1% of GDP for 2010-2012, implying a reliance on foreign financing to achieve balance of payments. Cumulative net portfolio flows into Colombia during 2010-12 totalled 3.7% of GDPless than some other Latin American economies but suggesting some exposure to a reversal in capital flows. The countrys dependence on oil exports as its main source of foreign revenue also renders it susceptible to shocks in oil prices in the event of a global economic slowdown.

EXHIBIT 1

Rising Reserves Reduce External Vulnerability Official Foreign Exchange Reserves (US$ Bil.)

Source: Haver Analytics Central Bank of Colombia

Mitigants/credit supports: Diminishing Colombias external vulnerability are its foreign-exchange reserves, which more than doubled to $35 billion (9.4% of GDP) between 2005 and 2012, sufficient to cover short-term external debt and maturing long-term principal payments and produce an EVI well below 100% (see Exhibit 1). Debt-to-GDP has improved faster than similarly rated countries: central government debt is forecast to fall to 32.4% of GDP this year from 43% in 2003 and debt-to-revenues ratio will drop to 197.5% from 324% in the same period, implying considerable policy space.

0.05.0

10.015.020.025.030.035.040.045.0


17 MARCH 25, 2014


The central bank also has the capacity to stimulate the economy through interest rates given a moderate inflation rate should external financing suddenly dry up. The key interest rate has been maintained at 3.25% for 10 straight months. More generally, coherent and predictable macroeconomic policies, an impeccable debt-servicing track record and ample access to financing in domestic markets provide credit support. We expect growth will accelerate to 4.5% this year from 4% in 2013.

For further information: Credit Opinion: Colombia, Government of



18 MARCH 25, 2014


Czech Republic: Ample Liquidity, Floating Exchange Rate Keep External Vulnerabilities in Check




indicator* (2014F)


(2014F, % of GDP)




Czech Republic (A1 stable)

-1.5% 92.1% 10.2% 20.0% 1.3% 50.5%


External vulnerabilities/exposures: The Czech Republics (A1 stable) current account deficit is driven by a negative income balance that reflects the repatriation and reinvestment of accrued profits on the existing stock of inward direct investment, a common theme for countries that attract large amounts of foreign direct investment (FDI). Non-resident holdings of government debt are relatively low, and external debt issuance plays a purely complementary role in the sovereigns funding strategy given that the bulk of financing comes from domestic debt issues. Although yields on domestic and external issuance have increased marginally in recent weeks, the overall cost of funding remains low, reinforcing the perception of the Czech sovereign as a regional safe haven in Central and Eastern Europe. Nevertheless, the economy remains fairly undiversified and its high degree of openness leaves it exposed to fluctuations in external demand.

Mitigants/credit supports: Liquidity and external debt-servicing vulnerabilities remain low. The External Vulnerability Indicator (EVI) remains below 100%, reflecting an adequate reserve cushion that mitigates foreign-exchange risks and a favourable external debt structure for all sectors of the economy. Short-term external debt represents approximately one-quarter of total external debt, while public sector external indebtedness accounts for less than 40% of the total, limiting the sovereigns exposure to volatility in non-resident funding. A deep, albeit underdeveloped, domestic capital market provides ample funding and insulates the sovereign from external financial market volatility. Moreover, fiscal policy credibility remains a key credit strength, reflecting the sovereigns progress toward narrowing the fiscal imbalance despite a very challenging economic and political environment.

EXHIBIT 1

Stable Yields Post-tapering Reflect Regional Safe Haven Status Czech Republic sovereign yield curve, %

Source: Bloomberg

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

3mo 6mo 9m 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y 15Y 25Y 50Y

%

2/19/2014 2/19/2013


19 MARCH 25, 2014


Loan growth relies on deposit-funded domestic credit rather than bank lending financed through external indebtedness. The countrys financial sector remains healthy with very low risk of shocks that could adversely affect the sovereigns balance sheet. Meanwhile, the flexible exchange-rate regime serves as an important shock-absorption mechanism. These characteristics limit the sovereigns exposure to potential damage stemming from a sudden stop, while well-anchored inflation expectations, an affordable debt burden and moderate debt ratios provide policy space to manage economic and financial shocks.

For further information: Credit Opinion: Czech Republic, Government of

Jaime Reusche Vice President - Senior Analyst +1.212.553.0358 [email protected]


20 MARCH 25, 2014


Hungary: Structure and Size of Debt, Large Financing Needs and Policy Unpredictability Present Risks




indicator* (2014F)


(2014F, % of GDP)




Hungary (Ba1 negative)

+1.5% 158.6% 23.1% 49.5% 2.4% 79.7%


External vulnerabilities/exposures: Hungarys (Ba1 negative) high government debt, estimated at 80% of GDP for 2013, as well as the structure of the debt expose the sovereign to shifts in investor sentiment. Although general government debt has stabilised, its trajectory remains uncertain as the economy is only slowly emerging from an extended period of low growth and remains quite susceptible to currency weakness. Exacerbating external vulnerabilities is the governments large refinancing needs, which reflect the relatively shorter duration of borrowing that it has access to. In 2013, its gross borrowing requirement of 20 billion was equivalent to 21% of GDP, significantly higher than its regional peers in Central and Eastern Europe. Foreign-currency refinancing risks are also reflected in a moderately high external vulnerability indicator (EVI), which at nearly 160% of foreign exchange reserves in 2013 compares less favourably than the Ba peer average.

EXHIBIT 1

Hungary has the Largest Gross Borrowing Requirement Among Regional Peers % of GDP, 2013

Source: Official National Sources, Moodys

EXHIBIT 2

Almost Half of Outstanding Forint Debt is Owned by Foreign Investors [1] % of GDP

[1] excludes T-bills Source: AKK, Moodys

The share of domestic debt held by foreigners increased to 45.3% of total domestic debt by end-August 2013, from an already-high 35% pre-2008 average. While this in part reflects the increase in global liquidity and availability of capital for emerging markets, these investors tend to be less sticky than domestic long-term investors, and as a result are much more susceptible to capital flight during external shocks. Meanwhile, 40.9% of outstanding debt was denominated in foreign currency as of 2012 (compared to the Ba1 median of 33.9%), rendering Hungary vulnerable to exchange-rate movements.

02468

101214161820

Latv

ia (B

aa2)

Bulg

aria

(Baa

2)

Lith

uani

a (B

aa1)

Slov

enia

(Ba1

)

Pola

nd (A

2)

Turk

ey (B

aa3)

Czec

h R.

(A1)

Slov

akia

(A2

)

Rom

ania

(Baa

3)

Hun

gary

(Ba1

)

0% 20% 40% 60% 80% 100%

National Bank of Hungary BanksRetail Insurance & pension fundsInvestment funds Public sectorOthers Foreign investors


21 MARCH 25, 2014


Mitigants/credit supports: Partly mitigating these external vulnerabilities, Hungarys current account has been in surplus for four consecutive years, averaging +0.9% of GDP between 2010 and 2013 (reflecting trade surpluses resulting from the contraction in domestic demand and its consequent compression on imports), reducing reliance on external funding to meet a savings-investment gap. We expect this trend to continue, with the current account likely to reach a surplus of 1.5% of GDP in 2014. While foreign-currency liquidity metrics are currently favourable given current account surpluses and high reserve levels, the large external debt stock and unpredictable policy environment continue to expose the economy to shocks emanating from investor sentiment changes.

EXHIBIT 3

Current Account Surplus and Foreign Exchange Reserves Only Partly Mitigate External Vulnerabilities % of GDP

Source: National Bank of Hungary, Moodys

For further information: Credit Opinion: Hungary, Government of

Alpona Banerji Vice President - Senior Analyst +44.20.7772.1063 [email protected]

0

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35

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-10

-8

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-4

-2

0

2

4

6

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013F 2014F

Current Account Balance [LHS] Net FDI [LHS] Foreign Currency Reserves [RHS]


22 MARCH 25, 2014


India: Current Account Correction and Government Debt Profile Limit Sovereign Exposure, But Political and Growth Uncertainty Underpin Capital Account Volatility




indicator* (2014F)


(2014F, % of GDP)




India (Baa3 stable)

-2.9%% 72.7% 12.0% 6.5% 9.0% 66.8%


External vulnerabilities/exposures: Indias (Baa3 stable) current account deficit, which widened to 4.7% of GDP in FY 2012/13, represents a vulnerability to global financial volatility. The deficit declined to an estimated 0.9% of GDP in the latter months of 2013, as a combination of currency depreciation and a global growth recovery spurred exports while controls on gold imports lowered the import bill. But continued high inflation poses risks, as it lowers international competitiveness and keeps demand for gold high such that any easing of controls will result in a widening of the current account deficit again. Moreover, if the outcome of the national election in April/May 2014 heightens policy uncertainty and erodes investor confidence, it could lead to capital outflows and renewed pressure on the currency.

High inflation and already wide fiscal deficits limit the monetary or fiscal stimulus that can be applied to revive GDP growth, which has decelerated significantly since 2011. Lower growth has reduced domestic banks asset quality and profitability. Banking sector stress could exacerbate and prolong the slowdown, which would then risk significant international capital outflows as well.

EXHIBIT 1

Low FC Exposure Insulates Government From Exchange Rate Volatility Govt. debt denominated in foreign currency, % (2012)

Source: Moodys

EXHIBIT 2

Long Tenors and Fixed Rates Insulates Governments Effective Interest Costs Average government debt maturity, years (2013)

Source: IMF, Moodys

Mitigants/credit supports: As was evident in 2013, Indian authorities are able to enlist a variety of policy tools, including increased controls in some areas and liberalisation of controls in others, to stem the adverse impact of international market volatility. Official foreign exchange reserves, equivalent to around 17% of GDP, remain adequate to cover current account and external debt repayment needs.

0102030405060708090

100

Latv

ia (B

aa2)

Bulg

aria

(Baa

2)Ro

man

ia (B

aa3)

Azer

baija

n (B

aa3)

Gua

tem

ala

(Ba1

)Pe

ru (B

aa2)

Hun

gary

(Ba1

)U

rugu

ay (B

aa3)

Indo

nesia

(Baa

3)Ph

ilipp

ines

(Baa

3)Ic

elan

d (B

aa3)

Nam

ibia

(Ba

a3)

Colo

mbi

a (B

aa3)

Turk

ey (B

aa3)

Kaza

khst

an (

Baa2

)M

oroc

co (B

a1)

Barb

ados

(Ba1

)Co

sta

Rica

(Baa

3)Ba

hrai

n (B

aa2)

Indi

a (B

aa3)

Braz

il (B

aa2)

0

2

4

6

8

10

12

14

16

Jord

an (B

a3)

Egyp

t (Ca

a1)

Paki

stan

(Caa

1)Bu

lgar

ia (B

aa2)

Ukr

aine

(Caa

2)La

tvia

(Baa

2)Ro

man

ia (B

aa3)

Hun

gary

(Ba1

)Tu

rkey

(Baa

3)M

oroc

co (B

a1)

Braz

il (B

aa2)

Spai

n (B

aa2)

Colo

mbi

a (B

aa3)

Icel

and

(Baa

3)In

dia

(Baa

3)So

uth

Afric

a (B

aa1)

Phili

ppin

es (B

aa3)

Indo

nesia

(Baa

3)Ire

land

(Baa

3)Pe

ru (B

aa2)


23 MARCH 25, 2014


Monetary policy has been assertive in addressing inflation, and if effective, it will keep a key source of medium term growth and balance of payments risk in check.

Although the governments debt and annual financing needs are high, its debt structure benefits from a robust domestic private savings rate and the statutory liquidity requirement for banks, which mandates banks hold a certain level of government securities. As a result, government debt is owed largely domestically, in rupees, at low real interest rates and relatively long tenors: Low foreign currency exposure insulates the Indian government from exchange rate volatility associated with changes in global liquidity and capital flows (see Exhibit 1); the governments debt contracted mostly in long tenors and fixed rates insulates the governments effective interest costs from interest rate spikes (see Exhibit 2).

For further information: Credit Opinion: India, Government of

Atsi Sheth Vice President - Senior Credit Officer +1.212.553.4873 [email protected]


24 MARCH 25, 2014


Indonesia: Reliance on Foreign Funding Poses Risks, But Sizable Buffers and Considerable Policy Space to Respond If Necessary




indicator* (2014F)


(2014F, % of GDP)




Indonesia (Baa3 stable)

-3.1% 63.2% 3.7% 46.7% 5.8% 24.9%


External vulnerabilities/exposures: Despite a moderate debt burden and low financing requirements, shallow local capital markets expose Indonesia (Baa3 stable) to foreign financing risk and the vagaries of volatile financial markets. The governments reliance on external sources of funding has led to a large proportion of its debt stock denominated in foreign currency; exchange rate volatility impairs fiscal strength. The current account has shifted into structural deficitaveraging around 3% of GDP for 2012-14from a surplus as recently as 2011. Meanwhile, the countrys moderately large negative net international investment position reflects the economys overall reliance on external financing. Nevertheless, the Indonesian government has continued to demonstrate access to international capital markets even during periods of heightened risk aversion, underscoring its investment grade status. The Indonesian rupiah has appreciated almost 7% against the US dollar since the start of the year.

EXHIBIT 1

Reliance on Foreign Funding Poses Risks for Indonesia 2012 General Government External Debt

Source: National sources, IMF-World Bank-BIS Quarterly External Debt Statistics, and Moodys Investors Service.

Mitigants/credit supports: Notwithstanding Indonesias reliance on external financing, Indonesias debt profile continues to improve, mitigating currency and refinancing risks and supporting creditworthiness. Since 2008, the share of foreign currency-denominated debt has fallen from over 52% to about 45%; the proportion of variable-rate debt has decreased from 22.9% to less than 18%; while the government has increasingly shifted away from concessional sources of financing, from 43.2% to around 30% now.

0

10

20

30

40

50

60

70

80

% o

f Gen

Gov

t D

ebt


25 MARCH 25, 2014


The combination of narrow fiscal deficits with a favourable maturity profile has also led to relatively small gross financing requirements for the government: according to the IMF gross borrowing requirements are extremely low at 4.0% of GDP for 2014 (compared with Brazil: 19.1%; South Africa: 12.2%; Turkey: 11.0%; India: 12.2%). Meanwhile, policymakers emphasized stabilization with a particular emphasis on containing the current account deficit following the first wave of volatility to affect emerging markets in May of last year. This has resulted in relatively benign outcomes for growth, the external payments position, and inflation in recent months.

The central banks foreign exchange reserves increased to $102.7 billion in February 2014, up from the trough of around $93 billion reached in July 2013 and providing a sizable buffer against further cross-border liquidity stress. In addition, Indonesias bond stabilization framework could help to mitigate destabilizing capital outflows. These buffers provide a degree of resilience to funding shocks, while Indonesias favourable fiscal and debt ratios provide considerable headroom to respond to economic shocks: general government debt is low at less than 25% of GDP.

For further information: Credit Opinion: Indonesia, Government of

Christian de Guzman Vice President - Senior Analyst +65.6398.8327 [email protected]


26 MARCH 25, 2014


Korea: Current Account Surplus and Strengthening Net International Investment Position Reduces External Vulnerability




indicator* (2014F)


(2014F, % of GDP)




Korea (Aa3 stable)

+4.2% 46.8% 0.6% 1.6% 2.8% 36.5%


External vulnerabilities/exposures: Koreas strong external position, relatively low level of government foreign-currency denominated debt, and low domestic-currency external debt reduce vulnerability of the governments balance sheet to global financial market turmoil and exchange rate volatility. Less than 2% of total government debt is denominated in foreign currency. Meanwhile, supported by competitive export industries, the current account has been in surplus every year following the 1997 Asian financial crisis (reaching a record high in 2013), and the International Investment Position (IIP) continues to strengthen (Koreas net liability IIP shrank to 3% of GDP in December 2013, down from 17.5% of GDP in December 2007).

EXHIBIT 1

External Vulnerability on a Declining Trend


EXHIBIT 2

Supported by Current Account Surpluses


However, Koreas key exposure to global financial market turbulence remains the banking systems relatively high dependence on wholesale funding in foreign currencies. Although commercial banks reliance on short-term off-shore funding has declined appreciably in the past five years, the overall loan-to-deposit ratio remains above 100%, representing a sovereign credit exposure (105% in June 2013, down from a peak of 141% in December 2007).

Mitigants/credit supports: General government budget surpluses (including net receipts of social security funds) have contributed to a very low gross financing need of only 0.7% of GDP in 2013, one of the lowest of all advanced economies. Coupled with low government debt levels and well-anchored inflation expectations, policymakers have considerable headroom to respond to economic shocks. Meanwhile, Koreas large holdings of official foreign exchange reserves provide substantial resilience to funding shocks: official international reserves reached $335.6 billion in December 2013 (equivalent to 28% of GDP), up substantially from the $200 billion level at the end of 2008. Korea has multilateral and bilateral currency-swap arrangements in place to supplement its own foreign exchange liquidity

0

10

20

30

40

50

60

70

80

90

100

0

10

20

30

40

50

60

70

80

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

F

2014

F

External Debt/CA Receipts (%) (LHS)

External Vulnerability Indicator (%) (RHS)

0

1

1

2

2

3

3

4

4

5

5

-20

-18

-16

-14

-12

-10

-8

-6

-4

-2

020

01

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Net International Investment Position/GDP (%) (LHS)

Current Account Balance/GDP (%) (RHS)


27 MARCH 25, 2014


position: $38.4 billion of the regional Chiang Mai Initiative Multilateralizations (CMIM) $240 billion international reserve pool back-up would be available to Korea; the Bank of Korea also has a $56 billion equivalent swap agreement with Chinas PBOC.

For further information: Credit Opinion: Korea, Government of

Tom Byrne Senior Vice President/Manager +65.6398.8310 [email protected]

David Erickson Associate Analyst +65.6398.8334 [email protected]


28 MARCH 25, 2014


Malaysia: Favourable Debt Structure, Minimal Currency Risk Mitigates High Public Indebtedness




indicator* (2014F)


(2014F, % of GDP)




Malaysia (A3 positive)

+4.3% 53.6% 10.3% 3.1% 2.8% 55.4%


External vulnerabilities/exposures: Malaysias (A3 positive) strong external position and large pool of domestic savings limit vulnerability to external financial shocks. Nevertheless, net portfolio inflows into Malaysia during 2010-2012 surpassed the accumulated total of the previous decade, representing vulnerability to a sudden stop or reversal of these flows. The risk of consequent domestic interest rate volatility in the event of a shock, however, is mitigated by ample onshore liquidity conditions that, in turn, reflect a large pool of domestic savings equivalent to around 34% of GDP. Indeed, Malaysia experienced a net outflow of portfolio investments in 2013 with only a limited impact on domestic funding conditions.

Meanwhile, Malaysias fiscal deficits continue to be wider than A-rated peers, while the debt burden at 54.8% of GDP as of 2013 somewhat constrains policy space. The reliance of government revenue on oil and gas receipts renders Malaysia vulnerable to adverse changes in emerging market energy demand and commodity prices. Direct petroleum-related receipts equate to nearly one-third of total federal government revenue.

Mitigants/credit supports: Capital market depth, the large buffer of foreign exchange reserves, and favourable debt structure guard against a disruptive reversal of the non-resident accumulation of Malaysian government debt. Malaysia has amassed a substantial foreign exchange reserve buffer over the past decade totalling US$130.6 billion in February 2014, which has seen the External Vulnerability Indicator (EVI) decline to around 50%, far lower than nearly 100% at end-1998. The governments debt stock features a relatively long average term to maturity and is consequently less susceptible to refinancing risks. Nearly two-thirds of the debt stock has residual maturities of three years or more.

Moreover, the low proportion of government foreign-currency debt relative to the total debt stockjust 3.1% at end-2013 (see Exhibit 1)implies a very low exposure to exchange-rate risk, and the fixed-rate and long-tenor of the debt ensure stability against fluctuations in government bond yields.


29 MARCH 25, 2014


EXHIBIT 1

Minimal Foreign-Currency Exposure Mitigates High Public Indebtedness 2013E Govt FC Debt/Total Govt Debt

Excludes euro area countries Source: National sources and Moodys Investors Service

Malaysian Government Securities (MGS) held by foreigners rose to 42.8% at end-September 2013, from 13.5% at end-2008. However, over this time, the government has shifted its financing mix towards more shariah-compliant instruments called Government Investment Issues (GII); non-residents hold only 1.6% of GII, and only 25.5% of the total local currency-denominated debt stock. In addition, the enduring current account surplusalthough narrower than historical trendsand large domestic institutional investor base suggests that the increased absorption of Malaysian government securities (MGS) by foreign investors does not necessarily represent a heavy reliance on external funding.

For further information: Credit Opinion: Malaysia, Government of


0

5

10

15

20

25

30

35

Malaysia (A3) Slovakia (A2) Israel (A1) Czech Republic (A1)

A Median Mexico (A3) Baa1 Median Poland (A2)

% o

f Gen

Gov

t D

ebt


30 MARCH 25, 2014


Mexico: Domestic Debt Orientation and Financial Buffers Limit External Vulnerabilities




indicator* (2014F)


(2014F, % of GDP)




Mexico (A3 stable)

+1.8% 60.0% 9.2% 18.5% 3.9% 31.0%


External vulnerabilities/exposures: Because Mexico (A3 stable) attracted substantial capital inflows during the quantitative easing period, it is potentially exposed to a reduction or reversal of capital flows. Cumulative net portfolio flows totaled 15.2% of GDP during 2010-2013 (compared with 5.8% for Peru, 4.8% for Brazil, 3.7% for Colombia and 0.4% for Chile), going mainly into fixed-income instruments, i.e., government bonds. Mexico also has comparatively high short-term external debt payments, double that of Brazil, representing about 20% of total external debt. About 40% of the governments debt is external driven by increased non-residents debt holdings.

EXHIBIT 1

Mexico Received the Most Portfolio Inflows Amongst Latin Americas Largest Economies During the QE Period Cumulative net portfolio flows, 2010-12

Source: National central banks, IMF

Mitigants/credit supports: The country relies only partially on foreign portfolio inflows to finance a moderate current account deficit which has averaged only 1% of GDP over the past five years. Official foreign-exchange reserves are more than sufficient to cover maturing long-term plus short-term external debt . At an estimated $180 billion as of mid-February (equivalent to 14% of GDP), the level of reserves translates into an EVI of less than 60%. Further, close to 90% of domestic debt is long-term, while 70% of funding for external debt came from the capital markets and 20% from multilateral banks.

Additionally, sound macroeconomic policies also help to reduce the economys vulnerability to shocks. A relatively moderate budget deficit implies the government has fiscal headroom to respond to economic shocks. The recently approved Oil Fund will create additional fiscal buffers. Our expectation

13.3

5.84.8

3.7

0.4

Mexico Peru Brazil Colombia Chile

% o

f GD

P


31 MARCH 25, 2014


of a gradual shift in GDP growth to the 3% to 4% range from 2% to 3% prior to recent reforms was a key driver of our recent decision to upgrade Mexicos rating to A3 from Baa1.4

For further information: Credit Opinion: Mexico, Government of

Mauro Leos Vice President - Senior Credit Officer/Manager +1.212.553.1947 [email protected]

4 See Key Drivers for Moodys Decision to Upgrade Mexicos Sovereign Rating to A3 from Baa1, 10 February 2014


32 MARCH 25, 2014


Peru: Sizeable Foreign Exchange Reserves, Low Government Debt Burden Increase Shock-Absorption Capacity




indicator* (2014F)


(2014F, % of GDP)




Peru (Baa2 positive)

-5.0% 20.7% 1.3% 49.1% 2.5% 17.1%


External vulnerabilities/exposures: Although Peru (Baa2 positive) has a relatively low level of total public debt, just under half of it is denominated in foreign currency. In addition, more than half of the governments domestic currency debt is held by non-residents. The countrys current account has deteriorated substantially in recent yearsPeru posted its first trade deficit in more than a decade in 2012. Meanwhile the highly dollarized economy and banking sector are vulnerable to exchange rate-related risks. The central bank has intervened by selling foreign exchange reserves to limit downward pressure on the Nuevo Sol, which depreciated 9% last year against the US dollar. Portfolio flows (totaling net 5.8% of GDP during 2010-2012; see Exhibit) present a vulnerability to volatile investor sentiment. Finally, due to a high share of the countrys exports is commodities, mainly copper and gold, it is exposed to volatility in prices and waning global demand.

EXHIBIT 1

Peru Received Substantial Portfolio Inflows During the QE Period Cumulative net portfolio flows, 2010-12

Source: National central banks, IMF

Mitigants/credit supports: Limited reliance on external bank lending and portfolio capital flows, along with foreign exchange reserves of nearly $67 billion (equivalent to 30% of GDP) through the end of August 2013, leave Peru well positioned to weather more challenging external financial conditions. Peru received a net 16.1% of GDP in foreign direct investment (FDI) between 2010-2012, the highest level among the five large Latin American economies. Despite a sizeable current account deficitforecast to widen to nearly 5% of GDP this year from 3.6% in 2012FDI remains sufficient to finance the current account gap. FX reserves cover almost 500% of its short-term external debt and long-term debt maturities, generating one of the lowest EVI scores in the emerging market cohort and indicating considerable financial shock absorption capacity.

13.3

5.84.8

3.7

0.4

Mexico Peru Brazil Colombia Chile

% o

f GD

P


33 MARCH 25, 2014


In addition, the country has a very low government debt burdenless than 20% of GDP, down from 47% in 2003while fiscal surpluses in five of the past seven years suggest considerable policy space to manage economic shocks. Propelled by strong private sector investment, the Peruvian economy has displayed remarkable and enduring dynamism over the past decade with average annual growth of nearly 6.5%. The economy is well positioned to continue growing at 5% to 6% annually if current investment and mining prospects materialize.

For further information: Credit Opinion: Peru, Government of

Aaron Freedman Vice President - Senior Credit Officer +1.212.553.4426 [email protected]



34 MARCH 25, 2014


Philippines: Continuing Improvement in Philippines Debt Profile Helps Funding Resilience




indicator* (2014F)


(2014F, % of GDP)




Philippines (Baa3 positive)

+2.5% 29.3% 7.9% 34.3% 3.5% 40.9%


External vulnerabilities/exposures: The Philippines (Baa3 positive) financial account has registered strong inflows since 2010 prompted by extraordinary monetary easing in advanced countries, especially for portfolio investments. However, while subject to potential deceleration or reversal, these capital flows do not pose as large a vulnerability as in other emerging markets. The persistence of the current account surplus since 2003 provides a degree of resilience against external financial shocks, supported by continued growth in overseas Filipino remittances and increasing receipts for services exports. The banking system is also virtually immune to contagion from external shocks. It is largely deposit-funded, aided in part by the steady flow of remittances, and exhibits a lack of dependence on external funding and low exposure to the export sectorrepresenting a stable source of financing for government debt and minimal contingent risks to the governments balance sheet. Underscoring the Philippines limited vulnerability, the peso and Philippine government bond yields have remained relatively stable through recent global market volatility.

EXHIBIT 1

Declining Foreign Currency Debt Reduces Exposure Foreign currency-denominated debt

EXHIBIT 2

Anchored Inflation Expectations, Lower Interest Rates Have Enhanced Debt Affordability

Source: Bureau of the Treasury

Mitigants/credit supports: The Philippines external strengths are reflected in the falling external debt-to-GDP ratio and the ample stock of gross international reserves, which now exceeds the countrys total external debt. Although the Philippine government is among the largest sovereign issuer of US dollar-denominated securities in the Asia-Pacific region, it met nearly all of its gross funding needs through domestic sources in 2013, thereby reducing its foreign currency-denominated debt exposure (see Exhibit 1). This reflects the countrys healthy external payments position and the ample liquidity in its banking system. Credit support also come from a track record of narrow fiscal deficits, well-

30

35

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45

2008 2009 2010 2011 2012 2013

% o

f Nat

iona

l Gov

t D

ebt

4.5

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6.5

7.5

10

15

20

25

2009 2010 2011 2012 2013

%

% o

f Nat

iona

l Gov

t Re

venu

e

Int Payments (LHS) Avg Int Rates

Avg Foreign Rates Avg Domestic Rates


35 MARCH 25, 2014


anchored inflation expectations and a declining debt burden that implies considerable policy space to manage the impact of unfavourable external financial or economic shocks.

Meanwhile, the structure of government debt continues to improve: the proportion of government debt denominated in foreign currency continues to fall; well-managed inflation and favourable liquidity conditions have contributed to lower interest rates that have enhanced debt affordability (see Exhibit 2); the government is less indebted to non-residents (irrespective of currency denomination) compared to its rating peers (see Exhibit 3), and is thus less susceptible to sudden stops or reversals of capital flows; and the government also continues to proactively address refinancing risks by lengthening the average maturity of its debt to around 10 years, from about seven years as of end-2009.

EXHIBIT 3

Lower Foreign Funding Requirement Reduces Risks Relative to Peers 2012 General Government External Debt

Source: National sources, IMF-World Bank-BIS Quarterly External Debt Statistics, and Moodys Investors Service.

For further information: Credit Opinion: Philippines, Government of


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f Gen

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t D

ebt


36 MARCH 25, 2014


Poland: EU Funding and IMF Credit Line Underpin Sustainable External Payments Position




indicator* (2014F)


(2014F, % of GDP)




Poland (A2 stable)

-1.9% 136.4% 8.3% 36.1% 1.4% 50.5%


External vulnerabilities/exposures: Polands (A2 stable) external finances have been historically weaker than those of A-rated peers given a recurring current account deficitthat averaged 4.9% of GDP in 2008-2012reflecting the persistent gap between domestic savings and investment, and the economys domestic demand-dependant growth model. Dynamic growth has helped underpin government finances despite fiscal deficits that averaged 5.6% of GDP in 2008-2012. Non-resident holdings of domestic debt have increased substantially since the global financial crisis, reflecting Polands regional safe haven status in Central and Eastern Europe, but exposing the sovereign to shifts in investor sentiment or financial market volatility.

Mitigants/credit supports: Polands liquidity and external debt-servicing vulnerabilities are moderate. Despite the reliance on external funding, current account deficits have narrowed substantially since 2012 (particularly in 2013 where we expect the current account deficit to have decreased to 1.6% of GDP) and been mostly covered by broadly-sourced foreign direct investment averaging 2.5% of GDP in 2003-2012 and large amounts of EU fund inflows. Although yields on domestic government debt have risen marginally in recent weeks, an abrupt shift in non-resident sentiment is unlikely.

EXHIBIT 1

Substantial Current Account Adjustment in 2013 Cumulative current account deficit, billion

Source: National Bank of Poland and Moodys

-20.0

-16.0

-12.0

-8.0

-4.0

0.0

2013 2012 2011


37 MARCH 25, 2014


Stronger external finances following the notable narrowing of the current account deficit and continued inflows of EU funds underpin Polands sustainable external payments position. In addition, the risk of a sudden stop in external financing is mitigated by Polands fully floating exchange-rate regime and the Flexible Credit Line (FCL) granted by the International Monetary Fund (IMF), both of which support the sovereign credit profile. Despite Polands comparably low levels of foreign-exchange reserves, the FCL serves as an anchor for market confidence and offers an efficient and cost-effective allocation of resources, acting as an insurance policy that provides adequate financial coverage even under extreme conditions or financial market volatility.

For further information: Credit Opinion: Poland, Government of



38 MARCH 25, 2014


Russia: Low External Debt and Large Foreign Exchange Reserves Limit External Vulnerability




indicator* (2014F)


(2014F, % of GDP)




Russia (Baa1 stable)

+1.3% 22.6% 2.4% 20.7% 5.3% 14.6%


External vulnerabilities/exposures: Russias (Baa1 stable) total external debt to GDP ratio of around 35% in 2013 remains moderate in international comparison.5 Banks have reduced their external vulnerability since 2008 by building-up foreign assets to a larger extent than foreign debt which resulted in a slight net external creditor position as of Q3 2013. While the corporate sector has continued to accumulate external debt (also to a larger extent than external assets) in nominal terms, its net external debt to GDP ratio declined to 9.5% as of Q3 2013 from 13% in 2007. While the overall level of corporate external debt is still rather moderate at around 20% of GDP, this represents a potential exposure for the sovereign. Furthermore, persistently large capital outflows from Russia have led to an overall decline in FX reserves despite the current account surpluses last year.

Meanwhile, a sharp and prolonged drop in oil prices represents the key external vulnerability risk, given the countrys high macroeconomic correlation (and government revenue correlation) to oil price cycles. A low probability but potentially high impact event risk for Russias external liquidity situation would be the imposition of severe economic sanctions against Russia in the context of the ongoing stand-off with Ukraine, in particular if rolling over external debt were to be affected for a prolonged period

Mitigants/credit supports: Russias external vulnerability is mitigated by its positive current account balance, a very low external vulnerability indicator and Russias international creditor position implied by a positive net international investment position. While Russias current account surpluses have declined from 6% in 2008 to around 1.6% in 2013 and will, according to IMF projections, decline further to 1.4% of GDP by 2015, this is not yet a cause of concern from a susceptibility to event risk perspective.

5 The median debt level of Moodys rated countries in 2013 was 36% of GDP and the mean 49% of GDP.


39 MARCH 25, 2014


EXHIBIT 1

Russia benefits from significantly larger hard-currency reserves than EM peer group Foreign Reserve incl. gold (as % of GDP)

Source: Bloomberg, Haver

EXHIBIT 2

Russia boasts a strong current account balance % GDP

Source: Bloomberg, Haver

Furthermore, Russias benefits from a cushion due to large foreign exchange reserves of around US$456 billion at end 2013. While the foreign exchange reserves, which form the denominator of the EVI index, are below pre-crisis levels implying a lower shock absorption capacity, the more flexible exchange rate will reduce the potential drawdown on reserves in comparison to the pre-crisis period in case of another sharp drop in oil prices.

For further information: Credit Opinion: Russia, Government of

Thorsten Nestmann Vice President - Senior Analyst +49.69.70730.943 [email protected]

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40 MARCH 25, 2014


South Africa: Manageable Debt and Low FC Exposure Lessen Vulnerability to Rand Weakness




indicator* (2014F)


(2014F, % of GDP)




South Africa (Baa1 negative)

-5.1% 84.1% 12.2% 7.9% 6.5% 45.9%


External vulnerabilities/exposures: South Africa (Baa1 negative) runs sizable twin deficits: the current account deficit widened to 5.8% of GDP in 2013 and fiscal deficits have averaged in excess of 4% of GDP since 2009. The export basket is heavily concentrated in commodities, which exposes the economy to variations in global prices. Moreover, output and infrastructure constraints in particular extremely tight energy supplies have limited the ability of export volumes to respond to upturns in demand for almost a decade. The current account deficit is financed mainly with equity and portfolio inflows, which slowed in t

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40_SC - Emerging Market Sovereign Research Series