The Week Ahead - Special Edition: Assessing EM Sovereign Ratings with Fitch

Hello, everyone, and welcome to the special edition of the Mora Podcasts. I'm Yubin Parquelez, Chief Southeast Asia Economist at Nomura. I'm currently in Bangkok where we are holding our Nomura Research Forum at the sidelines of the ongoing IMF World Bank annual meetings. During discussions we're having so far, particularly with policymakers and top central bank officials. Today, we're very privileged to be joined by Thomas Rookmacher, Executive Director and Head of Asia Pacific Sovereign at Fitch, and Eric Arrispe, Senior Director and Head of Eastern European Sovereign also at Fitch. We will discuss and focus on EM Sovereign and how Fitch assesses credit worthiness in this environment where uncertainties high and countries are dealing with multiple shocks. We will also try to get into some country's specifics and Fitch's views on prospects of ratings changes, both downgrades and upgrades. Let's get stuck in. Hi Thomas and Eric, thank you again for joining our Nomura Research Forum here in Bangkok and participating in this panel discussion, which we just literally finished a few moments ago. Really interesting insight and fascinating. So thanks for that again. Well, thanks for having us, so you will. Great. So let me just start with this question on the frequency of some of these changes in the outlooks, which I noticed has increased. In my region, for example, we've got Thailand and Philippines having changes in outlooks. Is that a fair assessment that the frequency has increased and if so, what does that really reflect? Is it because of the more uncertain environment or is there some changes to your methodology as a result of this uncertainty? Yeah, I think it's a fair reflection. It's important to note that the ratings were very stable between in APAC, between the downgrades following the COVID shock and say one, two, two years ago. So we have seen a number of outlook changes, so some related to the several shocks that we've seen globally, but mostly for idiosyncratic reasons. So there are also developments which are just happening in countries which we think we need to respond to. And we've also, so you asked about methodology, so we've also changed our definition for outlooks, which is rather subtle. So previously we used to say something about the likelihood of a downgrades or an upgrade. And now we have slightly different words saying it may change, which is subtle, but in the context of rating decisions, it also has an impact. Okay. Eric, does it apply for you as well in your region in Eastern Europe? Thank you for having us. I think that first just to set the context, currently we have three negative outlooks and three positive outlooks in the Eastern Europe region for feature ratings, but it's important to take a look at the detail both in terms of geography but also in terms of category. So we have currently three sovereigns in CE on a negative outlook that's Poland, Hungary and Romania. Well, on the positive side we have Bulgaria, also part of the CE, but just responding probably to idiosyncratic factors such as the adoption of the Europe, putting our momentum. And the other two ratings on positive outlook are Serbia and Armenia both need to be category. So what we see is that the negative pressure are concentrated on the investment grade. And those are related to public finances, high deficits, rising debt as well as political challenges to take action. Well, on the sub-investment grade for Armenia, high growth, accumulation of reserves are the factors putting the positive outlook and Serbia is just below investment grade with a combination of good growth prospects, declining debt and improve external resilience. Okay, thanks. Yeah, we'll get to some country specifics later on, but in Asia, Thomas, is it still the case that external balances remain a rating strength? And how do you sort of see that relative to increased physical pressures and deterioration in that metrics? I think it's generally fair to say that Asian sovereigns have relatively strong external finances, particularly in North Asia and those sovereigns benefiting from the AI boom are clearly seeing further increase of the strength of their external finances. We've also seen a couple of frontier markets where the external finances have improved in the past couple of years, take Sri Lanka and Pakistan, which we both upgraded in the past year. Well, yeah, some other sovereigns see a weakening of their external finances. In terms of the physical finances, the public finances, I would say that we've generally seen deterioration since COVID shock, so the government debt to GDP ratio has risen for many sovereigns in the region, and it's something that we have to take into account as well. So a little bit more divergent picture on external balances, but physical balances have more across the board deteriorated, I guess the way to put it, okay, great. And for Eastern Europe, Eric, so I guess the question here is geopolitics and security risks may be more central as an issue from a ratings perspective, and at the same time we've got government facing higher defense spending plus all of their development and infrastructure needs. So have that likewise weakened sovereign metrics of the region? I would say there is a contributing factor, but not fully explains the deterioration that we've seen in public finances. So where does this pressure on defense spending come from first? Of course, as a result of the one Ukraine, there is the increased threat perception from Russia, so countries have decided to build up the military capabilities, especially those in the so-called Eastern flank. Also the fact that the U.S. has become less than committed, let's say, to NATO, also creates some uncertainty and pushes up the urgency of building these military capabilities. Now more recently, of course, what we have is this increased in reported hybrid activity, which is not only now present in the Eastern flank countries, such as Romania, Bulgaria and Poland, but also even impacting or importantly impacting some countries farther to the west. So how do we look at that from the rating perspective? Based on feature assessment, we have identified the Baltics, I've been the most vulnerable to this geopolitical risk, because of its size, proximity and vulnerability to potential, you know, threat emanating from Russia. So from the moderate rate of rating, we have subtracted one notch qualitatively as explaining this risk. Now in terms of how do we view the current environment for Poland or Romania, for instance, I think that we don't think yet this increased hybrid activity presents a rating and downgrade pressure. However, of course, we look into what extent if sustained or intensified, this hybrid activity has a negative impact on investor perception, process of growth, investment in order to assess this. Final point, just to put in perspective, certainly the high-defense spending is, as I said, a contributing factor, but throughout the region, there are other explanatory variables for the fiscal deterioration and high debt, and just taking a context of Poland, right? From Poland, we had, in 2019, expenditure to GDP, 42% of GDP, now it's 51, as of 2025, 9% percentage point increased, while if you looked at the evolution of defense spending that has gone from 2% to close to 5. So there's other, about 6% percentage points increased that explains also by public heteroages, social transfer, high interest costs, which are also very important factors contributing to the fiscal deterioration and make it difficult for policymakers to address this. Interesting. Yeah, that's very clear. So now let's go to some country specifics, and Thomas, I'm really interested in this idea that even in this current environment, is there any prospects for some possible ratings upgrades? Let's say over a one-to-two-one, sort of one-to-two-year time frame in some countries in Asia. Maybe let's boliton to India and Malaysia for you. Yeah, sure. Well, we have stable outlooks on most of our sovereigns in Asia. We have one positive outlook on Uzbekistan in Central Asia, but no other positive outlooks. India and Malaysia, though, are positive stories over the longer term. India is growing at close to 7%, the investment Our private investments are starting to pick up, which is a good news as well. And yeah, the authorities have done quite a bit over the past couple of years to improve transparency, fiscal transparency. They're currently focused on deregulation. So those are positive developments. At the same time, yeah, as I mentioned, we have a positive outlook on India as the government debt to GDP ratio is still very high, and the fiscal consolidation is very gradual. And the interest payments to revenue ratio is also high. It's the highest among all the sovereigns in the investment-grade space. And in Malaysia? Yeah, Malaysia also a story of very gradual fiscal consolidation, and the economy is doing well in the context of strong FDI, the data centers. But yeah, at the same time, that is higher than what we see in peers, and that holds us back. Okay. And Eric, what about in your region, let's say, for countries like Hungary or Romania, prospects for any upgrades? So we currently have negative outlooks on both ratings. So negative outlook on Hungary's triple B rating since December last year, and that reflects the deterioration we saw ahead of the elections of this year, as well as weak economic growth. So we of course know that the regime changes we've seen both in terms of government, but also in terms of policy, with the objective of adopting the euro by the end of the decade, has created a positive sentiment in the market, reflected in lower financing cost, as well as a stronger foreign. However, for us, especially given the revision of the budget for this year, from about 3.7 to 7.5 percent of GDP, for us, it's important to know how the government is going to bring down the deficit to 3 percent by the end of the decade. And hence, we are very focused and looking at the fiscal strategy. We publish sooner rather than later to assess the measures, as well as the macro environment or assumptions in which the government expects to carry this very high fiscal adjustment. On Romania, we maintain a negative outlook on the triple B minus rating, and here are two stories. First, significant progress in reducing a 9.3 percent of GDP deficit back in 2024. And given revenue measures, as well as free some pensions and wages, the government is on track to reduce the deficit below 6 percent this year, based on our expectations. And that's under the environment, you know, on the external front that is not very benign, as well as very adverse local macro environment with negative growth this year. However, as you know, they have a prolonged political crisis with a caretaker government since May. So for us, it's important to understand, to what extent, the improvement that has been done now can be extrapolated to future years. And that's because of in spite of this deficit reduction that I highlighted, there's still some way in order to get to a level of deficit that is consistent with that stabilization, and that's our focus. Okay, got it. So still a few things to watch for these two countries to have a bit more of a stable outlook. Speaking of negative outlooks, Thomas, in Asia, you have Indonesia and the Philippines both having negative outlooks. So I guess the question to you is, the credit metrics has led to these negative outlooks. How have you observed them since you had the negative outlook? Have they been improving, or have they been deteriorating? Yeah, look, on the negative outlook on the Philippines, so that basically reflects deterioration in or growing concerns, I should say, on the medium-term growth potential. And yeah, what we've seen since the negative outlook is that growth has disappointed a bit in the sense that in the second quarter, it was 2.3% year-on-year, and that reflects a slowdown in public KPax. But private KPax has also been slow over the past couple of years. So yeah, we're wondering, to what extent growth, the 6% growth that we currently assume of the longer term will be possible. And that's also important because the authorities have tendency to choose growth of our physical consolidation when they have to weigh physical support to the population and physical consolidation. So in that sense, to maintain a stable debt to GDP ratio, growth is particularly important for the Philippines. So in Indonesia, the negative outlook reflects policy, or questions about the consistency of policies, a very high growth target of 8% in policies which are difficult to see, to reach this high growth target. So there's uncertainty, uncertainty in terms of physical policy going forward. So since we placed the outlook on negative, the credit metrics haven't really changed. So most of these credit metrics look pretty similar. We have a physical deficit of still close to 3% budget ceiling. And growth is actually doing reasonably well. So Indonesia hasn't fallen off a cliff in that sense. So the uncertainties, the concerns, didn't really materialize. But the uncertainty is still there. So the underlying concerns haven't gone away. Yeah, got it. And then on Turkey, I guess the fund crisis has been happening recently. Is that having an impact on the way you think about the outlook or credit rating of Turkey? No, I think the policy response has managed to contain the damage or contagion to other parts of the financial sector. We've seen that the outflow of funds has not translated and increased effects demand that would lead to reversal in terms of digitalization that we've seen in recent years. And probably, you know, reserve offers that have been revealed since the start of the war in Iran have remained relatively resilient. Having said that, though, I think that the crisis highlights one of the challenges to Turkey's rate in going forward, which is the erosion of governance that we've seen since 2018 as a result of the centralization of power. So this fund crisis can reflect some of the institutional governance shortcomings that could wait on Turkey's rating trajectory going forward. Okay, got it. And what about inflation? I know they've done relatively well when it comes to the current account deficit and the fallout from the Middle East conflict and high energy prices. Is that still a big constraint? So we have Turkey's rating at double in minus with a stable outlook. And I would say that inflation, or to say very high inflation, represents the main policy challenge for Turkey. Because the result of high inflation, what you see is that real rates have to remain very high while also maintaining a very gradual pace of depreciation as the real appreciation of the leader is a key factor, where a key tool of the authorities to reduce inflation. That results in the phenomenon that we've seen already a couple of times in which shocks either domestic of externals, lead to outflows from the domestic capital markets, especially non-resistence concentrate on short-term investments. And that leads to international reserve volatility. As long as inflation remains high and this policy rebalance and fragile, it will be hard to see these volatile reserve levels translate in a sustainable improvement that would lead us to take a positive view on Turkey. I mean, we had a positive outlook at the beginning of the year as a result of this inflation gains, but also the higher reserve buffers. But as we saw as a result of the unwar, reserves came down for north of $50 billion in a very short period. So just highlighting the vulnerability but also the limited flexibility on the exchange rate side, which of course creates the challenge for the sustainability of international reserve accumulation. Okay. Yeah, makes sense. And finally, since we are in Thailand, Thomas LNVDU, so I guess Fitch just lifted the negative outlook recently to stable. So my question is, what gives you a question? the confidence that the fiscal trajectory is really improving despite the emergency borrowing decree, for example, which is very large and passed by Parliament. So the revision of the negative outlook to stable basically reflects that we've become more confident that Thailand's debt to GDP ratio will stabilize over the medium term. Not immediately next year, but we think that the debt to GDP ratio will stabilize under 63% of GDP. And so this is a result of, first of all, you know, the Thailand's economy proving more resilience than we had expected previously to the external shocks of the tariffs of the global energy crisis. And the outturns were also stronger than we expected in terms of the fiscal deficits for the general government on a GFS basis. And yeah, these deflationary pressures that were still likely to be persistent actually early in the year, February, we saw 0.9% deflation. So those deflationary pressures seem to be, yeah, gone for now, which also helps in terms of a debt dynamics context. And then there's the politics. So there were elections held in February. And the, yeah, initially, you know, when we placed the outlook to negative, there was a lot of uncertainty, would it lead to disruption, would it lead to, again, a coalition which would see, yeah, frequent leadership changes. And now we are more confident that there's a government in place which, yeah, should have the ability to pursue policies for the medium term, so including fiscal consolidation. So it makes a medium term fiscal framework also more credible in that sense. So it's not to say that there are no risks. This is still Thailand, Thai politics can be noisy, but yeah, we think that the risks are more balanced now and more, yeah, in line with what we are seeing in other countries in the region. Okay. Excellent. Thanks again to both of you for joining today. I really appreciate it. Thanks a lot, Cuban. Well, that's it for now in this special edition. Thank you again for listening to our podcasts edited and produced by John Dalton. Please like and subscribe to Nemora's podcast on Apple's Spotify and SoundCloud or your usual podcast provider. We'd love to hear your feedback, so please feel free to write a review and share this podcast to anyone you think might be interested. 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