First State bond manager questions Italy’s lowered credit rating

As Italy’s new prime minister started his first overseas trip to convince others of his country’s creditworthiness, a longstanding debt market fund manager questioned whether the land downgraded on multiple occasions since September even deserves its A rating.

Mario Monti today met European Commission president Jose Manuel Barroso and EU president Herman Van Rompuy, to promote his austerity plan to reduce Italy’s €1.9trn debt, ultimately aiming to stabilise the country’s credit worthiness.

But Helene Williamson, manager of First State Investments’ Emerging Markets Bond fund and its head of EMD, questioned if its current rating was justified.

“Given that, other than the ECB, there are not other buyers of Italy’s bonds, you question Italy being A rated. But in the developed world a lot of countries are not rated properly.”

By 2013 Italy faces annual gross financing needs equivalent to 22.6%, 23.5% and 18.9% of each respective year’s annual GDP. EMs face average gross financing needs of 9.3% and 7.7% of their 2011 and 2012 GDPs.

Since 2008 advanced world countries have suffered 68 downgrades. The last upgrade, of Japan in 2007, has since been reversed. One must look back to 2004 to find the last developed world upgrade that still stands.

Emerging economies, by contrast, have experienced more improvements than demotions, despite some downgrades during the Arabian world uprisings. Brazil and Kazakhstan have each won upgrades this month.

Williamson pointed to stronger economic growth prospects, lower debt levels, and fewer incidents of political meddling as some reasons EMs deserve to receive the upgrades they have since the crisis.

She added the average developed world fiscal deficit of 7.5% compares poorly with about 2% for EMs.

“It is not only that the credit quality is better today in EMs, but they will improve more than the developed world because most EMs have younger populations and little in terms of pension liabilities, which is clearly a big issue for a lot of the developed world.”

The average rating for EMs is BBB minus, and Williamson said the upgrade cycle would continue.

She said if the world fell into deep crisis again then few EMs – mentioning Hungary as one exception – would need to as the IMF for the kind of flexible credit it extended to EMs in the depths of 2008. “A lot of EMs are in an enviable position of facing this crisis,” she said

Apart from Northern Africa and Middle East, the risks are not, as many were in the past, from domestic politics – that is now Europe’s problem, Williamson said.

“The political risk in EMs is going down. In the past if anything EMs were held back because of politics and it was probably taken into account [by ratings agencies] and given a more negative weight. There are a number of countries where politics are much calmer than they used to be.”

Williamson said overall politics plays a much greater role in market movements now, evident by market reaction to “anything [German chancellor Angela] Merkel or Fed chairman Ben [Bernanke] say about how many bonds they’re buying, or QE3.

“That is moving the markets, because governments are much more activist than they used to be, and that will be one of the themes next year, too.”

Williamson added US politics was “incredibly polarised with a lot of brinkmanship, which you could see with the debt ceiling [impasse]”.

Markets are made even more sensitive by many leaders – from Greece to Germany – holding power only with slim majorities. “Merkel’s FDP coalition partner would not even get into parliament now, it is below the 5% threshold. It is difficult if you are in that kind of position to take unpopular measures, which is not helping things.”

She said ultimately Europe would need tighter integration, and a move from the central bank or IMF to halt its crisis.

She added, of eurozone requests to some EMs for aid: “I find it a little strange to ask a country with a GDP per capita of $5000 to raise money for rich Europeans, who have their GDP per capita going from $40,000 to $35,000.”

Williamson’s fund, trading primarily US dollar-denominated bonds, can range across debt, quasi sovereigns and corporates.

She said Hungarian, Lithuanian and Croatian paper recently underperformed, in part because European banks holding it had been selling. Additionally, Austria has restricted bank lending to central and Eastern Europe.

As EM corporates issue more paper – so far this year about $180bn, double the debt their sovereigns issued – Williamson will consider it, mindful not least of liquidity.

Where appropriate, she could also buy quasi sovereigns – State-backed but trading on spreads wider than debt – and names Russian Agricultural Bank, Brazil’s EMBS development bank, Mexico’s Petróleos Mexicanos as examples. Kazakhstan has only quasi-sovereign, not sovereign, paper.


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