Fed exit adds to challenges for emerging markets

This is despite expectation that global growth would gradually pick up pace in the second half as the US gathers steam and the eurozone approaches a cyclical turning point. Its latest forecasts for world GDP growth are 2.4 per cent in 2013, 3.1 per cent in 2014 per cent and 3.2 per cent in 2015. 

Global sovereign ratings remain under downward pressure, it noted. 

The US Federal Reserve's forward guidance on monetary policy, slower growth rates, and lower commodity prices add up to a less favourable economic and credit environment for emerging markets, the rating agency said in its latest bi-annual global sovereign review and outlook.

The Fed tightening will increase risks facing weaker emerging markets including those with large external financing requirements (current account deficits and maturing external debts) and low foreign reserves, high levels of leverage, vulnerable debt structures (foreign currency, short maturity and non-resident creditors), those that have seen strong inflows of hot money and bank credit growth, or have weak policy macroeconomic frameworks or credit fundamentals.

The US Federal Reserve's forward guidance on monetary policy, slower growth rates, and lower commodity prices add up to a less favourable economic and credit environment for emerging markets, Fitch Ratings said in its latest bi-annual global sovereign review and outlook.

The Fed's comments on the timing of 'tapering' quantitative easing and eventually raising of interest rates precipitated a broad market sell-off and increased volatility since the middle of May, even though the comments should not have been a great surprise and reflect more upbeat US growth prospects. Fitch does not expect the first rate hike until mid-2015, and only then if the US economic recovery is secure. Nonetheless, the uncertain process of the Fed's exit from unprecedentedly loose policy settings is likely to generate periodic bouts of market volatility.

Emerging market bonds, currencies and equities were hit disproportionately hard by the market reappraisal of US monetary policy, despite prior concerns that capital inflows and exchange rates were excessively strong. Fitch does not anticipate widespread EM credit distress owing to a secular improvement in EM credit fundamentals, which reduces risks from tighter global liquidity, higher interest rates and FX risk. However, the Fed move adds to concerns over slowing growth, China's financial stability, softer commodity prices and a series of political shocks in some emerging markets. 

The Fed tightening will increase risks facing weaker emerging markets including those with large external financing requirements (current account deficits and maturing external debts) and low foreign reserves, high levels of leverage, vulnerable debt structures (foreign currency, short maturity and non-resident creditors), those that have seen strong inflows of hot money and bank credit growth, or have weak policy macroeconomic frameworks or credit fundamentals.

In Europe, the intensity of the eurozone crisis continued to ease in H113, despite recession, record unemployment, uncertainty following the Italian elections and the bail out in Cyprus which led to bank failure, capital controls and a domestic debt default . 

“Nevertheless, we do not view the crisis as over. Our long-standing view is that a resolution of the crisis will require on-going country-level fiscal and structural adjustment, greater progress towards a banking union and a broad-based economic recovery across the currency union.”

In the first half of this year, Fitch announced 13 notches of downgrades of foreign currency ratings, compared with 10 notches of upgrades; as well as two sovereign defaults: Cyprus (local currency IDR) and Jamaica.

The upward trend for EM ratings appears to have stalled. There were six upgrades for emerging markets in the first half - Lithuania, Mexico, Thailand, the Philippines and Uruguay - the latter two to investment grade - and Jamaica from default. 

There were downgrades for Egypt, Jamaica (by four notches) and South Africa, as well as China (local currency rating).