World risk: Operational financial risk ratings review

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FROM THE ECONOMIST INTELLIGENCE UNIT

RATINGS CHANGES

There were changes to risk scores in 26 countries during the latest monthly updating cycle of the Risk Briefing model. These led to upgrades of the overall score in only five cases, but there were nine downgrades. In the remaining 12 cases, offsetting adjustments in the underlying risk categories resulted in no net change to the overall score.

Risk Briefing rates operational risk in 180 markets on a scale of 0-100. The overall scores are an aggregate of underlying scores for ten categories of risk: Security; Political stability; Government effectiveness; Legal & Regulatory; Macroeconomic; Foreign Trade & Payments; Financial; Tax Policy; Labour Market; and Infrastructure. The model is run when events require it, and at least once a quarter for each country.

THIS MONTH’S WINNERS AND LOSERS

CURRENT PREVIOUS
RATINGS SCORES RATINGS SCORES
UPGRADES
Macedonia C 47 C 49
Sierra Leone C 57 C 58
Mali C 53 C 54
Egypt C 55 C 56
Croatia B 39 B 40
DOWNGRADES
Panama B 36 B 34
Yemen D 73 D 71
Czech Republic B 30 B 29
Estonia B 26 B 25
Ghana C 55 C 54
Italy B 37 B 36
Myanmar D 68 D 67
Singapore A 12 A 11
Sweden A 16 A 15
NO NET CHANGE
Brunei B 32 B 32
Cambodia C 59 C 59
Central African Republic D 72 D 72
Haiti C 60 C 60
Jordan C 43 C 43
Papua New Guinea C 53 C 53
Paraguay C 52 C 52
Saudi Arabia B 39 B 39
South Korea B 33 B 33
Syria E 87 E 87
Tajikistan D 71 D 71
The Gambia C 58 C 58

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UPGRADES

Macedonia

In the latest review of our operational risk model for Macedonia, one category has been upgraded while the score for another category has improved.

The score for macroeconomic risk has strengthened by five points, to 25. We are forecasting 3% growth in 2014, accelerating to 3.5% in 2015, on the back of strengthening private consumption, and government investment in infrastructure and reconstruction projects. Exports have also been playing a major role in driving growth, so there are some downside risks to our forecast, arising from the growth slowdown in the euro zone, especially Germany, Macedonia’s largest export market. We are forecasting very slight deflation for 2014, of 0.2%, after low food prices and a cut to regulated electricity prices pushed annual price growth into negative territory in the first half of the year. Base effects plus strengthening domestic demand should see annual inflation rise to above 2% a year in the coming years.

The score for financial risk has improved by 13 points, to 50. Macedonia is now operating a primary and secondary market in local-currency government securities, with maturities of up to ten years. It splits its longer-term securities between those with a foreign exchange clause, providing investors with protection in the event of a devaluation, and those without.

Consequently, Macedonia’s overall risk score has improved by two points, to 47.

Sierra Leone

In the latest review of our operational risk model for Sierra Leone, the score for one category has improved.

The score for macroeconomic risk has strengthened by five points, to 35. Monetary growth has outpaced expansion in domestic public debt in recent years as the government has sought to reduce reliance on expensive short-term Treasury bills, the main component of domestic debt. This is part of a wider drive to prevent crowding out of lending to the private sector.

Consequently, Sierra Leone’s overall risk score has improved by one point, to 57.

Mali

In the latest review of our operational risk model for Mali, one category has been upgraded.

The score for financial risk has improved by five points, to 58. According to World Bank figures from 2013, the ratio of domestic credit to the private sector to GDP was 22%. This is a marginal improvement from 20% in 2004, though the figure is still extremely low.

Therefore, the overall risk score has strengthened by a point, to 53.

Egypt

In the latest review of our operational risk model for Egypt, the scores for three categories have improved.

The score for security risk has strengthened by four points, to 64. Significant underlying tensions in Egypt remain, following the ouster of the Muslim Brotherhood’s Mohammed Morsi as president in July last year. However, the new president, Abdel Fattah el-Sisi, has managed to impose a measure of stability and predictability into the political process, and the Brotherhood is now severely weakened (reflecting both the authorities’ crackdown on the group, and a general loss of public support). As a result, the prospect of violent civil unrest has lessened, although any economic downturn could see people return to the streets once more.

The score for political stability risk has improved by five points, to 50. A more technocratic, economically liberal cabinet is now in place. Although parliamentary elections are expected soon, the next parliament is likely to be too divided and weakened (in large part a deliberate consequence of the elections law) to seriously undermine the direction of policymaking.

The score for legal and regulatory risk has strengthened by two points, to 43. The cabinet has announced plans to gradually phase out energy and electricity subsidies. As part of this process, the price of the most heavily used grade of petrol went up by 41% in July, with the price of diesel increased by 64%. Under the current schedule, energy subsidies will be entirely removed within five years.

Consequently, Egypt’s overall risk score has improved by one point, to 55.

Croatia

In the latest review of our operational risk model for Croatia, one category has been upgraded.

The score for macroeconomic risk has strengthened by five points, to 40. Our forecast for the public debt/M2 ratio in 2014 is 42.1%, falling to 38.7% in 2015, as the economy finally begins to grow again from 2015. However, given the weakness of the fiscal picture, we expect public debt/GDP to rise by 2016.

Consequently, Croatia’s overall risk score has improved by one point, to 39.

DOWNGRADES

Panama

In the latest review of our operational risk model for Panama, one category has been downgraded while the score for another category has deteriorated.

The score for macroeconomic risk has worsened by ten points, to 15. The change in score reflects an increase in the fiscal deficit in the first half of 2014 to US$1.5bn or 3.2% of full-year GDP. The deficit is now likely to widen to 3.7% of GDP for the year as a whole.

The score for foreign trade and payments risk has deteriorated by seven points, to 21. Trade spats have emerged in the past year with two of Panama’s largest export markets for free-trade zone (FTZ) goods—Colombia and Venezuela. Venezuela has restored ties with the new Panamanian administration, after severing relations with the previous government headed by Ricardo Martinelli earlier this year. Following Colombia’s mid-year presidential election, a reversal of protectionist measures, which have hurt Panama’s FTZ exports, is possible.

Consequently, Panama’s overall risk score has worsened by two points, to 36.

Yemen

In the latest review of our operational risk model for Yemen, one category has been downgraded and the score for another category has worsened.

The score for political stability risk has deteriorated by five points, to 80. There is a growing risk that the Houthi movement will forcefully overthrow the government. Its business policies are unclear, but could well be less favourable to businesses.

The score for macroeconomic risk has remained unchanged due to conflicting trends in its subcategories. The risk of a disorderly appreciation persists, given the country’s weak trade account, depressed oil output, and highly unstable security and political situation. However, the deposit of some US$400m at the Central Bank of Yemen by the Saudi government in July should support the authorities in their efforts to maintain the informal riyal peg to the US dollar. Confidence will be further buttressed by the US$553m Extended Credit Facility agreed with the IMF in September. On the other hand, although inflation has eased of late, the partial removal of fuel subsidies in late July (which may eventually be extended to a complete lifting of subsidies) is helping drive inflation back to double-digit levels. As a result, we anticipate that consumer price growth will average 11.1% in 2014-15.

The score for foreign trade and payments risk has worsened by seven points, to 43. According to World Bank assessments, the customs procedures are highly burdensome. The situation has been exacerbated of late by the worsening insecurity, in both the north and the south, which will set back the long-term goal of upgrading the Aden Container Port.

Consequently, Yemen’s overall risk score has deteriorated by two points, to 73.

Czech Republic

In the latest review of our operational risk model for the Czech Republic, the scores for two categories have improved while they have deteriorated for two others.

The score for security risk has strengthened by three points, to 11. Violent crime is not a significant problem for the government or businesses in the Czech Republic. According to the latest World Bank data, 0.4% of sales were lost due to theft, robbery, vandalism and arson, which is very low by international standards. The homicide rate is also very low, at 0.8 per 100,000.

The score for legal and regulatory risk has improved by two points, to 23. According to the Bank’s “Ease of doing business” index 2013, it requires 611 days to enforce a contract in the Czech Republic, which is relatively slow and inefficient. However, as per the same metric, only 27 procedures are required to enforce a contract, which is very low by international comparison.

The score for political stability risk has worsened by five points, to 30. The conflict in Ukraine has led to a sharp decline in relations between the EU and Russia. The EU has imposed sectoral sanctions on Russia which will impair its growth prospects, and also bars exports of certain equipment and dual-use technology for the oil and military sectors. A fall in exports to Russia will have an appreciable impact on growth in EU countries. We have already downgraded our forecast for German growth in response. Russia makes up only around 3.2% of the Czech Republic’s direct exports. However, Russia also stands at the end of important supply chains which include Czech industrial producers. The score for foreign trade and payments risk has deteriorated by eight points, to 29. Russia, which is formally a member of the G-8 (although the other members of the club have threatened to exclude it), has imposed a ban on food imports from the EU in response to EU sanctions against its banking and oil sector. Anti-Western sentiment is strong in Russia, and there is a risk that further measures could be adopted by Russia to limit EU imports.

Consequently, the overall risk score for the Czech Republic has worsened by a point, to 30.

Estonia

In the latest review of our operational risk model for Estonia, the scores for two categories have deteriorated.

The score for political stability risk has worsened by five points, to 35. The continuing escalation in EU tensions with Russia over its military involvement in Ukraine, including an exchange of economic sanctions at the end of July, has dampened the economic outlook of the euro zone economies as a whole, including that of Estonia.

The score for foreign trade and payments risk has deteriorated by 11 points, 36. Estonia is one of the countries that will be affected by Russia’s ban, from August 1st 2014, on food imports from the EU, in retaliation for the extension of “phase three” sanctions by the EU on Russia, after its failure to pull back support for separatists fighting Ukrainian government forces in the wake of the shooting down of a passenger plane in mid-July.

Consequently, Estonia’s overall risk score has worsened by one point, to 26.

Ghana

In the latest review of our operational risk model for Ghana, the score for one category has improved and one category has been downgraded while the score for another category has deteriorated.

The score for foreign trade and payments risk has worsened by four points, to 54. Public debt is increasing rapidly as Ghana grapples with large fiscal and current-account deficits. Exacerbating the situation, the plunge of the cedi currency over the last year is increasing the burden of foreign-currency denominated borrowing.

The score for financial risk has deteriorated by five points, to 63. The wider economic difficulties being experienced by Ghana are placing a strain on the local stockmarket. Although the market is posting growth, liquidity remains relatively low and the market remains much less developed than in other countries in the region, especially Nigeria and South Africa.

The score for labour market risk has improved by three points, to 68. While far from perfect, education standards in Ghana compare favourably to many countries in the region. Finding skilled labour is difficult, especially in the relatively new oil and gas sector, but technical colleges and other schemes are being established.

Consequently, Ghana’s overall risk score has worsened by one point, to 55.

Italy

In the latest review of our operational risk model for Italy, one category has been downgraded.

The score for macroeconomic risk has deteriorated by ten points, to 70. The Italian economy fell back into recession in the first half of 2014. A range of indicators suggest that a further contraction is possible in the third quarter. The Economist Intelligence Unit is now forecasting that real GDP will contract by 0.3% in 2014, having fallen by 2.4% in 2012 and by 1.9% in 2013. With weak aggregate demand holding down prices, consumer price inflation has been on a downward path since the fourth quarter of 2012. In August 2014 consumer prices declined by 0.2% year on year. Barring a major external shock, we continue to expect that Italy, and the euro area as a whole, will avoid a deep deflationary downward spiral, but the risks have increased for Italy in recent months.

Consequently, Italy’s overall risk score has worsened by one point, to 37.

Myanmar

In the latest review of our operational risk model for Myanmar, one category has been downgraded.

The score for security risk has worsened by four points, to 61. The recent violence in Mandalay and the kidnappings in the Chinese copper mines suggest that business owners or workers may be targeted for attacks.

Consequently, Myanmar’s overall risk score has worsened by one point, to 68.

Singapore

In the latest review of our operational risk model for Singapore, the scores for two categories have worsened.

The score for security risk has deteriorated by three points, to 7. Public anger over rapid immigration has increased, and the government is struggling to contain rising anti-immigrant sentiment. For example, the accidental death of an immigrant labourer triggered riots in December 2013, representing one of the city state’s worst incidents of civil unrest in years.

The score for macroeconomic risk has worsened by five points, to 35. In the second quarter of 2014 real GDP growth slowed to 2.4% year on year, from 4.8% in the first quarter. As a result of the weak second-quarter outturn, we have revised down our forecast for real GDP growth in 2014 as a whole to 3.5%, from 4.1% previously.

Consequently, Singapore’s overall risk score has worsened by one point, to 12.

Sweden

In the latest review of our operational risk model for Sweden, the scores for two categories have deteriorated.

The score for political stability risk has worsened by five points, to 15. Geo-political tensions between the EU and the US have escalated over Russia’s intervention in Ukraine, prompting Sweden’s government to focus on bolstering its military capabilities. Trade sanctions are likely to have only a limited direct effect on Swedish businesses, but increased uncertainty related to the conflict in Ukraine (and also the Middle East) has increased volatility on the financial markets.

The score for foreign trade and payments risk has deteriorated by seven points, to 14. The EU’s imposition of harsher “phase three” economic sanctions on Russia was followed by retaliatory trade restrictions on selected EU imports. Sweden’s direct exposure to these sanctions is limited, but an indirect impact may stem from weaker demand in Germany – a key trading partner. There is also a risk of harsher sanctions being imposed. Export-oriented businesses should expect weaker demand from the euro area and some potential knock-on effects for domestic confidence and financial-market volatility owing to uncertainty over the outlook.

Consequently, Sweden’s overall risk score has worsened by one point, to 16.

NO NET CHANGE

Brunei

In the latest review of our operational risk model for Brunei, the score for one category has deteriorated.

The score for macroeconomic risk has worsened by five points, to 30. The 3.3% year-on-year contraction in GDP recorded in the first quarter of 2014 is likely to be followed by a gradual recovery as oil and gas output rebounds after maintenance work, but we expect the full-year outturn to be slightly negative in 2014, before Brunei returns to positive growth in 2015.

Overall, however, Brunei’s risk score has remained unchanged, at 32.

Cambodia

In the latest review of our operational risk model for Cambodia, the score for one category has strengthened.

The score for security risk has improved by three points, to 61. The agreement between the ruling party and the main opposition party, and the latter’s decision to end its boycott of parliament makes the possibility of political protests slightly less likely. However, economic hardship and industrial unrest could still lead to violent demonstrations.

However, the overall risk score stands unchanged, at 59.

Central African Republic

In the latest review of our operational risk model for the Central African Republic (CAR), the score for one category has improved.

The score for foreign trade and payments risk has strengthened by four points, to 50. With the renewal of IMF support (through a Rapid Credit Facility approved in May) and the gradual resumption of aid inflows, the government will be under less financial stress. The government in August also returned to the local bond market, with a small six-month Treasury bill issue. Hence, despite ongoing economic troubles, the risk of a financial crisis has fallen.

Overall, however, the CAR’s risk score has remained unchanged, at 72.

Haiti

In the latest review of our operational risk model for Haiti, the score for one category has strengthened.

The score for legal and regulatory risk has improved by two points, to 63. The current Haitian government has taken major strides to try to attract new foreign direct investment to the impoverished country, and this makes it highly unlikely that it would threaten to expropriate foreign assets because this would add a further disincentive to investors in an already difficult business climate.

Overall, however, Haiti’s risk score has remained unchanged, at 60.

Jordan

In the latest review of our operational risk model for Jordan, the score for one category has deteriorated.

The score for macroeconomic risk has worsened by five points, to 20. Although our current forecast assumes real GDP growth in excess of 3% in 2014-15, there is a significant risk that the pace of expansion could be lower on the back of continuing regional instability. In particular, the security chaos in Iraq, in the wake of the territorial gains made by Islamic State, is resulting in severe disruption to exports to Iraq (Jordan’s largest market in 2013). Jordan’s free zones have been especially hard hit; these zones had benefited from a wave of new investment in recent years, as Jordanian and Arab investors both took advantage of generous tax concessions to start manufacturing and re-export businesses targeting Iraq as a key market.

Overall, however, Jordan’s risk score has remained unchanged, at 43.

Papua New Guinea

In the latest review of our operational risk model for Papua New Guinea, the score for one category has worsened.

The score for political stability risk has deteriorated by five points, to 55. In addition to introducing several anti-democratic policies over the past year that have tightened his grip on power, the prime minister, Peter O’Neill, has recently tried to stop a corruption investigation against him, dismissing the police commissioner and deputy commissioner, as well as purging a number of parliamentary opponents. He is defying an arrest warrant against him issued in June 2014 by the anti-corruption body, Task Force Sweep, and has appointed a new acting police commissioner.

Overall, however, Papua New Guinea’s risk score has remained unchanged, at 53.

Paraguay

In the latest review of our operational risk model for Paraguay, the score for one category has strengthened.

The score for macroeconomic risk has improved by five points, to 25. Political risk has subsided with last year’s election of Horacio Cartes and with Paraguay’s formal re-entry to Mercosur in early 2014. Paraguay’s generally good prospects for GDP growth and export volume growth into the medium term will be supportive of the currency. In addition, after initial market nervousness in mid-2013 and again in early 2014, the transition away from extraordinarily loose monetary policy in the US has gone fairly smoothly and should not present major risks of capital outflows from Paraguay (which at any rate receives very few inflows of portfolio capital). Finally, although foreign direct investment (FDI) has been slow to pick up as dramatically as the government hoped with the passage of public private partnership framework legislation last year, the prospects for moderate inflows of FDI do appear good.

Overall, however, Paraguay’s risk score has remained unchanged, at 52.

Saudi Arabia

In the latest review of our operational risk model for Saudi Arabia, the scores for two categories have improved.

The score for legal and regulatory risk has strengthened by three points, to 50. After years of delay, it appears that long-mooted judicial reforms are finally making progress. In particular, the government has begun the process of setting up so-called “specialised courts”, demonstrated by the opening of the first court focused solely on family matters in August. More pertinently for business, commercial courts are now planned to begin operating in early 2015, which will be staffed by a swath of newly trained judges.

The score for financial risk has improved by four points, to 25. Domestic credit growth has picked up of late, in the wake of a concerted drive by the commercial banks to strengthen their balance sheets and increase their loan-loss provisions. Non-government credit growth has outstripped deposit growth over the past two years, and consumer lending growth hit all-time highs in 2013 (albeit this has raised concerns about future non-performing loans). Equally, lending by the five state credit institutions has also increased, after their capital was boosted in 2011. Finally, the opening of the stockmarket to direct share-buying by foreigners from early 2015 will potentially make it a more fruitful place for companies looking to raise funding via an initial public offering.

Overall, however, Saudi Arabia’s risk score has remained unchanged, at 39.

South Korea

In the latest review of our operational risk model for South Korea, the score for one category has improved.

The score for government effectiveness risk has strengthened by four points, to 50. The World Bank ranks South Korea 7th out of 189 countries globally for the ease of doing business. The country occupies a position in the top quarter in the world in nearly every category except for “registering property” and “protecting investors”—those are areas where the country still ranks in the top half of surveyed nations.

Overall, however, South Korea’s risk score has remained unchanged, at 33.

Syria

In the latest review of our operational risk model for Syria, the score for one category has deteriorated.

The score for labour market risk has worsened by four points, to 79. Generally labour laws in Syria are extremely restrictive, with cumbersome rules for firms regarding hiring and firing. With the civil war still raging, the regime is highly unlikely to tackle the country’s onerous labour regulations, despite pre-war commitments to liberalise the business environment.

Overall, however, Syria’s risk score has remained unchanged, at 87.

Tajikistan

In the latest review of our operational risk model for Tajikistan, one category has been downgraded while the score for another category has improved.

The score for security risk has strengthened by four points, to 50. Violent crime will only pose a moderate problem to businesses/government over the forecast period. Although the homicide rate is low, domestic instability—particularly tensions between the centre and the regional authorities—remains a problem. For example, in May 2014 violent unrest occurred in the eastern region of Gorno-Badakhshan after discontent against the authorities came to a head. Poverty and high levels of corruption will mean that tensions between the centre and the regional authorities could flare up again over the forecast period.

The score for financial risk has worsened by four points, to 83. The authorities have drawn down heavily on foreign-exchange reserves since the start of 2014: reserves fell to US$300m at end-June (from US$460m at end-2013). It appears that these have been used to support the somoni, which has only depreciated moderately so far this year, despite a sharp fall in the Russian rouble. The Economist Intelligence Unit believes that the authorities will be unable to prevent a sharper depreciation of the currency in the coming months due to their limited reserves. Such depreciation has already occurred in the neighbouring Kyrgyz Republic which is also closely linked to developments in Russia.

Overall, however, Tajikistan’s risk score has remained unchanged, at 71.

The Gambia

In the latest review of our operational risk model for The Gambia, the score for one category has worsened.

The score for legal and regulatory risk has deteriorated by two points, to 65. In May The Gambia’s national bank expropriated two local units of Nigerian banks, after they fell below the minimum capitalisation threshold. The central bank has subsequently returned control of one of the institutions, but not the other. However, this is indicative more of potential weaknesses in the banking sector than a substantial change in the authorities’ attitude towards expropriation of foreign assets.

Overall, however, The Gambia’s risk score has remained unchanged, at 58.