2022 outlook stable as growth recovers and debt flattens : Moody
Dhaka November 15 2021 :
Moody’s Investors Service has published a report titled “Sovereigns – Asia Pacific 2022: outlook stable as growth recovers and debt flattens; rebuilding of buffers will determine pace of credit recovery”.
The outlook for sovereign creditworthiness in 2022 in Asia Pacific (APAC) is stable overall, reflecting our expectations for the fundamental conditions that will drive sovereign credit over the next 12-18 months, relative to 2021.
Economic growth rates in APAC are rebounding although the pace of recovery varies vastly. Debt burdens are stabilizing at higher levels than before the pandemic.
In 2022, shifting gears to a normalization phase will entail difficult policy choices for many governments, with attention turning back to medium-term social and environmental considerations, even with economic recovery just starting to take hold.
The ability of policymakers to balance competing economic and social policy goals, including the rebuilding of fiscal buffers, retraining attention on structural reforms, and anchoring the credibility of medium-term frameworks, will drive credit differentiation and determine where the pandemic has left significant burdens on credit profiles.
Ratings overview :
In 2021, six of our rating actions on APAC sovereigns were negative, while four were positive, leaving just three of our 25 rated economies with negative outlooks as of 10 November 2021 (see Exhibit 2). This contrasts with 2020, when 11 rating actions were negative and no positive actions were taken.
The number of APAC economies at each broad rating category has remained relatively
stable compared with 2020 and since the 2008-9 global financial crisis.
Liquidity, fiscal risks remain key negative credit drivers for low-rated economies Frontier markets continued to bear the brunt of the pandemic. For tourism-dependent economies – Maldives (Caa1 stable) and Fiji (B1 negative) – lingering travel restrictions and the hit to revenue from the collapse in growth hurt the public finances.
While Sri Lanka (Caa2 stable) is also exposed to tourism, the impact of travel restrictions was mainly felt on its external payments position. In October, we resolved a review for downgrade on Sri Lanka’s rating with a one-notch cut, on external liquidity risks.
A few other sovereigns have also faced increases in already elevated borrowing requirements, coupled with constrained access to financing, culminating in liquidity risks: in April, we revised the outlook on Papua New Guinea’s (PNG, B2 negative) rating to negative from stable.
This was followed by a one notch downgrade in Maldives’ rating. Laos (Caa2 negative) has carried a negative outlook since 2020, as liquidity risks prevail.
Positive rating actions driven by growth prospects, broadly easing fiscal and liquidity constraints A waning of previous pressures, stemming from moderating liquidity risks in Mongolia (B3 stable), and from improved monitoring around government guarantees in Vietnam (Ba3 positive), supported upward rating actions for these sovereigns.
For Vietnam and Taiwan, China (Aa3 positive) the change in outlooks to positive was also driven by strong prospects for growth, stemming from increasing competencies in higher-value-added electronic products. This should allow these economies to capitalize on supply chain reconfigurations that we expect to continue in a post-pandemic environment.
We also moved India’s (Baa3 stable) outlook to stable from negative in October 2021, given receding financial sector risks and scope for economic growth to gradually tighten the budget deficit.
Most APAC economies will rebound to pre-pandemic output levels by 2022 although pace of recovery will vary, with some seeing deeper scarring Most Asian economies will see growth rebound in 2022. However, differing degrees of exposure to vulnerable sectors and approaches
to reopening will result in a multispeed recovery, with several economies seeing deep economic scarring.
Varying recoveries will also shape the region’s sovereigns’ fiscal and debt dynamics.
» About half of APAC economies will see a growth rebound During 2022-25, more than half of APAC economies will return to or above pre-pandemic growth averages.
Some tourism-dependent economies – Macao SAR, China (Aa3 stable), Maldives, Fiji – will record growth considerably above recent rates as they recover from particularly weak output in 2020-21.
However, some economies will log growth below pre-pandemic levels: for Indonesia (Baa2 stable), the gap will be slim and we expect it to close as the recovery gathers pace.
By contrast, we expect China (A1 stable) will see a structural economic slowdown, reflecting policy efforts toward economic deleveraging and rebalancing, amplified by a deterioration in property market conditions and supply chain reconfiguration. And for some frontier markets, the pandemic has presented a permanent setback to growth.
Sovereigns with higher vaccination rates are positioned to recover faster Countries with lagging vaccination rates are primarily emerging markets – including Indonesia, Philippines (Baa2 stable) and Vietnam. Divergent approaches to reopening will result in varying paces of recovery, with some governments, such as Singapore (Aaa stable), seeking to treat the coronavirus as endemic, but others, including Hong Kong SAR, China (Aa3 stable) still taking a “zero-COVID” stance.
Diversified economies are at less risk from disruption For economies where the contribution from highly impacted sectors such as tourism is large, or those that rely on foreign labor, continued travel restrictions weigh on productivity and potential growth.
Economy-specific consumer sentiment and behavioral trends will also shape domestic demand. Trade-oriented economies should continue to benefit, although to a lesser extent as consumer demand for goods is moderating, particularly from the US (Aaa stable) and Europe, after a sharp rebound earlier in 2021. We expect the uplift from trade to be concentrated in specialized sectors, such as the electronics value chain (as in Taiwan, Korea [Aa2 stable] and Vietnam) and commodity producers.
A substantial number of sovereigns will suffer from economic scarring Despite the return to pre-pandemic growth rates, output in level terms will still fall short of our pre-pandemic forecasts by 2023.
We estimate that about one-third of APAC economies will experience limited economic scarring, while around 40% will see deeper scarring.2 On average, however, output losses will be less severe than in other regions. Some sovereigns facing permanent loss of output have concentrated economic structures or weaker institutional frameworks, such as Macao, Maldives and Papua New Guinea.
Supply chain reconfigurations may challenge some economic models, but present opportunity to boost productivity As the immediate effects of the pandemic start to ebb, companies are increasingly likely to reevaluate their production strategies and supply chains. For several large APAC economies that are manufacturing nodes in global supply chains, this could present some
challenges to their growth models in the short run, but drive greater productivity and innovation over time.
Supply chain reconfiguration is likely to accelerate Efforts to reconfigure supply chains have been in train for some time, precipitated by US-China trade tensions. The supply shock at the start of the pandemic, coupled with a sharp rebound from pentup demand for goods, and compounded by differing restrictions across economies has exposed fragilities in supply chains across
industries. This has raised demand for containerized exports from Asia, and pushed up freight rates.
Recent coal shortages and efforts to reduce energy intensity in China have further exacerbated supply chain disruptions. Companies may look to refine their supply chains by diversifying production networks and holding larger inventories.
This may result in productivity, innovation gains over longer term For many APAC economies that follow trade-oriented growth models, adjusting to new supply chains and trading relations will entail near-term costs as they seek to enhance competitiveness. Some key manufacturing hubs in the region, such as Korea and Taiwan, are ramping up production facilities in response to the ongoing global chip shortage, while others, such as Japan (A1 stable), are seeking to attract similar investments to secure domestic supplies.
A global trend toward nearshoring, amplified by environmental considerations, could move some production away from the region over time. Such reconfigurations may also have repercussions for China, which is an important node in global supply chains.
However, we do not expect supply chains to shift away entirely, given the established competitiveness of some of these exporters, as well as their proximity to China as a large consumer base. While disruptive in the near term, such shifts may encourage productivity and innovation among companies and governments alike.
Trade-open sovereigns that have well established capabilities in innovation (Singapore, Hong Kong, Malaysia [A3 stable], Taiwan) are likely to see more direct benefits to the real economy.
Debt burdens to peak in 2022 and stabilize, but at higher levels Median debt burdens will likely stabilize for most APAC economies in 2022, but bringing them down will be a challenge as the onus
remains on governments to support output.
Debt burdens are close to peaking for most economies in the region Following an increase of around two percentage points of GDP on average over 2020-21, about half of APAC governments will record a decline in their debt burdens in 2022 relative to 2021 estimates, as revenue starts to recover and some stimulus is gradually unwound. Although debt ratios will stay significantly
above pre-pandemic levels, median ratios remain lower in APAC than in other regions.
Many APAC emerging and frontier markets will continue to report a gradual upward drift in their debt burdens, but some advanced economies also feature (Australia [Aaa stable], Korea, New Zealand [Aaa stable]).
Scope for significant debt reduction will be limited Looking beyond 2022-23, deficits are unlikely to decline significantly further as spending pressures persist, leaving sovereigns weakly positioned to respond to future shocks.
The onus will fall on growth recoveries, including productivity increases, to drive further debt reduction. A few advanced economies (Japan, Korea, Australia) will face greater challenges given their weak potential growth or structural budget deficits and/or weak potential growth.
Among emerging markets, debt ratios have climbed substantially in tourism-dependent economies (Fiji, Maldives) and will take a longer time to stabilize; for most others (including Indonesia, Malaysia, India, Thailand [Baa1 stable]), debt burdens will flatten out at higher, varying levels.
Only a select few have experienced a compression in debt burdens, either on the back of strong growth (Vietnam, Taiwan) or from elevated pre-pandemic debt levels (in the case of Pakistan [B3 stable]).
Debt affordability is a risk for several emerging markets Accommodative monetary policy will continue to support debt dynamics in the near term, particularly for advanced economies. By contrast, for several emerging markets in the region, interest payments as a share of revenue materially increased over the past two years, and did not moderate in 2021, as revenue remained
While unconventional central bank support in some systems, such as in Indonesia and Philippines, alleviated interest costs, this did not offset deteriorating debt affordability. Particularly for those governments with weaker starting points – Sri Lanka, Maldives, Laos, Indonesia – limited debt affordability will leave less room for fiscal maneuver and continue to present government liquidity risks.
Normalization will entail difficult policy choices for many governments The ability of policymakers to rebuild fiscal buffers, retrain attention on structural reforms, and anchor the credibility of medium-term frameworks will drive credit differentiation and determine where the pandemic has left significant burdens on credit profiles.
Monetary policy challenges center around preserving debt affordability, macro-financial stability Demand-supply mismatches as growth rebounds, particularly on the back of subdued prices in 2020-21, raise the risk of rising inflation.
This could spur some central banks to start moving to a tighter policy stance once a reliable economic recovery is in sight, adding to interest costs. For lower-rated economies that rely on foreign currency borrowing (Sri Lanka, Laos, Mongolia), progressive policy normalization in advanced economies will add to pressures on the interest burden, potentially raising liquidity or external vulnerability risks further. In Sri Lanka, foreign currency funding costs are already prohibitive, and while local currency borrowing costs are relatively anchored, any policy tightening would weaken debt affordability further, given the government has increased its exposure to short-term debt.
The withdrawal of forbearance or unconventional support will present financial stability challenges for some economies. In China, policy has resulted in a significant tightening in financing conditions for highly leveraged property developers such as China Evergrande Group (Ca negative). In Indonesia, how the central bank manages an unwinding of its purchases of government bonds under the burden-sharing agreement can have implications for financial market stability and policy
Fiscal policy will involve balancing pandemic support with longer-term commitments Many governments continue to grapple with the health-related costs of the pandemic, even as long-standing challenges pose spending pressures.
These include achieving more inclusive growth and addressing income inequality, reckoning with the social costs of aging populations, and meeting climate goals. Many governments will meet the cost via greater flexibility in reinstating previous fiscal rules, including debt and deficit ceilings.
Malaysia has raised its debt ceiling, while Indonesia’s goal to reinstate its 3.0% deficit ceiling by 2023 will be a challenge.
In some cases, deep domestic capital markets mitigate high or rising debt burdens (Malaysia, India). Where there is a credible plan to shortly stabilize or reduce debt burdens, or revenue-raising steps are in place, credit implications will be contained.
External vulnerabilities are contained for most sovereigns While funding3 has tightened for emerging markets in recent months, conditions remain looser overall than pre-pandemic (see Exhibit 10). Most emerging markets have well-established access to external funding, which has allowed them to continue to issue debt at a reasonable cost throughout the past year.
This contrasts with sharply rising external vulnerabilities in many frontier markets, especially in economies running large structural current account deficits, with elevated refinancing needs and high reliance on financial inflows.
Laos, Maldives and Sri Lanka all faced material difficulties in 2021 in accessing the international dollar bond markets, as reflected by rising risk premiums for their issuance.
Governments’ focus on inclusive growth, sustainability will dominate policies as social and political
pressures mount post-pandemic Leaderships face backlashes over pandemic management in several economies in the region. Effects on income inequality and structural unemployment in a post-pandemic world may spur further political challenges. Environmental risks and geopolitical tensions are also likely to remain prevalent.
Preexisting social and political risks have intensified following the pandemic Dissatisfaction with country-specific management of the control of infections, vaccine rollouts (inequitable distribution, supply and vaccine hesitancy) and the provision of economic support has resulted in popular backlash against administrations in several economies.
Unemployment rates have increased in most economies across the region. Where elections are scheduled in 2022 (the Philippines, some states in India and Korea) these considerations will be at the forefront of electorate decisions, while in other economies, they may prompt off-calendar
In a prelude of this, Japanese Prime Minister Fumio Kishida’s October 2021 election victory rested on a campaign that centered around addressing income inequality and accelerating responses to climate change. More broadly, debate around income inequality, racial divisiveness and structural unemployment may create political noise, increasing challenges to policy effectiveness, although we expect the direction of reforms and policies to remain broadly unchanged.
Renewed policy focus on inclusive, green growth Social pressures will likely drive a greater emphasis by governments on inclusive growth, as well as on measures to address social equity. Meanwhile, climate change and energy transition, which were key priorities before the pandemic, have returned to the fore, with several governments outlining their plans to achieve net-zero carbon
emissions, with implications for hydrocarbon exporters and consumers.
Geopolitical relations will likely continue to dominate the political landscape Potential flashpoints around the region include the intensification of strains in Taiwan-China relations, and tense Australia-China relations, with the Australia-UK-US trilateral agreement for Australia’s acquisition of nuclear submarines marking a reassertion of US-China tensions.
Meanwhile, tensions with North Korea, in parts of South and Southeast Asia over the South China Sea, and the Himalayan border dispute between India and China also continue to simmer