Research Report on the Transition Rate of Dagong Sovereign Credit Rating in 2016
Dagong Global Credit Rating Co., Ltd.
April 25, 2017
Since Dagong Global Credit Rating Co., LTD. (“Dagong”) officially began releasing credit rating reports on national sovereign states in 2010, its sovereignty rating has covered a hundred countries and regions across the five continents of Asia, Europe, Africa, America and Oceania. The total domestic GDP of rated countries now accounts for up to 97% of total global GDP.
In 2016, Dagong’s sovereign credit rating and rating transition presented the following features:
Firstly, the credit rating distribution still consisted of a more intermediate level with few high and low levels, and more investment grades than speculative grades; Secondly, the overall sovereignty credit rating remained highly stable. In 2016, sovereign credit ratings tended to be down-regulating but the down-regulation rate declined and the area involved shrank compared with that of 2015. Among these, the down-regulation trend of developed countries with high liability grew weaker. Rating down-regulation spread from developed countries to emerging economies; Thirdly, the sovereign debt default rate generally conformed to the principle that “the lower the credit rating is, the higher the default rate is”.
I. Distribution of sovereign credit rating
The distribution of sovereign credit ratings continues to maintain a normal distribution shape, and the investment grades concentrated in highly-developed areas such as North America, Europe, and Eastern Asia.
According to rating distribution, there was little change in the rating distribution of Dagong rated countries and regions in 2016 compared with 2015, with more features being presented at intermediate level and few at a high and low level. There were more investment grades than speculative grades. Specifically, up until December 31 2016, Dagong had rated (including solicited ratings and entrusted ratings) a hundred countries and regions with a rating distributing from AAA to C (a total of nine mother levels, nineteen sub levels, and no default level D). Countries and regions with domestic and foreign currency at BBB rating made up the largest proportion, at 23 each, an increase of two and one respectively compared with the previous year. The number decreased progressively in the order AA, A, BB, B, AAA, CCC, CC, C and D. Among these, the domestic and foreign currency ratings at AA, A and BB all decreased by one, the B level rating increased by one on a year-on-year basis, examples of CCC-C tended to be notably fewer compared with changes at other levels, and the number of foreign currency ratings at CCC increased by two. In 2016, the number of foreign currency ratings at D decreased by one. This followed the Argentine debt restructuring agreement and a recovery in the debt-paying ability for foreign currency. In June 2016, Dagong adjusted the foreign currency rating of Argentina from default level D to CCC.
From a geographical distribution perspective, the changes in Dagong sovereign credit ratings were also not obvious. The sovereign credit rating of countries and regions with a higher development level such as North America, Europe and Eastern Asia continued to maintain their investment grade. A hundred Dagong rated countries and regions were distributed over five continents (Asia, Europe, America, Africa and Oceania) and eleven regions (North Africa, Middle East, North America, Oceania, Northeast Asia, Southeast Asia, CIS, Latin America, Caribbean area, South Asia, Sub-Saharan Africa, Western Europe and Central and Eastern Europe). Up until December 31 2016, there had been 62 countries and regions with domestic currency ratings at investment grade and 38 at speculative grade (see Figure 2 for specific distribution), and both were the same as the previous year. Seen from the perspective of the proportion of regions’ investment grade, the CIS and North America were the highest, both at 100%. The second regions were Northeast Asia and Western Europe, with investment grades accounting for more than 80%. The lowest were South Asia and Sub-Saharan Africa, which stood below 30%. In 2016, the proportion of investment grade regions in North Africa and Middle East decreased by 7.7 percentage points to 61.5% on a year-on-year basis. This is mainly because Dagong adjusted the investment grade of Algeria from BBB- to the speculative grade of BB+ in 2016. The proportion of investment grades in Central and Eastern Europe increased by 6.3 percentage points to 56.3% on a year-on-year basis. This is mainly because Dagong adjusted the domestic currency rating of Romania from speculative grade BB+ to investment grade BBB- in 2016. The distribution of other regions saw no changes. The distribution of foreign currency ratings was generally the same as domestic currency ratings. The difference mainly embodied the investment grade of foreign currency in Central and Eastern Europe which was one less than that of domestic currency, and the speculative grade was one more than that of domestic currency. This was caused by the domestic currency rating of Romania being at investment grade BBB- while the foreign currency rating was at speculative grade BB+.
Ⅱ. Transition of Sovereign Credit Rating
(I) Downgrading was still the main tone of Dagong’s sovereign credit rating adjustment in 2016, but the downgrading rate declined, with the downgraded regional distribution narrowing.
In the tracking cycle of 2016 (from January 1 2016 to December 31 2016), Dagong conducted a total of 77 tracking ratings for 77 countries and regions.
In terms of the direction of rating adjustment, downgrading was the main theme in 2016, with the adjustment of local and foreign currency ratings moving in the same direction with narrowed regional distribution compared with 2015. In 2016, 11 countries and regions were downgraded, namely Algeria, Angola, Bahrain, Belarus, Brazil, Garner, Morocco, Oman, Saudi Arabia, South Africa, and Venezuela, with a downgrading rate of 14.3%. This was 2.1 percentage points less than in 2015. Downgraded areas were mainly located in North Africa and the Middle East, Latin America and the Caribbean region, sub Saharan Africa and Eastern Europe. Among the countries and regions of North Africa and the Middle East, the rating of the sub Saharan region increased significantly. The credit ratings of some countries were continuously downgraded in successive tracking periods, such as Brazil and Venezuela. The main reasons for the downgrading were as follows: The decline in international oil prices impacted the wealth creation capability of the Middle East as well as that of North Africa and the nations to the south of the Sahara. This led to a sharp deterioration in the fiscal and external situation, the dramatic shrinkage of foreign exchange reserve assets, and a rising debt burden. These factors eventually worsened the government solvency of countries such as Algeria, Bahrain, Oman, Saudi Arabia, and Angola; Low international commodity prices highlighted some countries’ economic vulnerability, along with political instability, power and infrastructure bottlenecks exacerbating the downward pressure on the economy, fiscal deterioration and rising external risks. These factors increased sovereign credit risk significantly, notably in the case of South Africa, Ghana and Morocco; the sovereign credit vulnerability of Brazil and Venezuela in Latin America was most significant and characterized by a deep recession, political turmoil, limited space for monetary and fiscal policy adjustment, as well as outstanding fiscal and external imbalances. These factors have caused these country’s sovereign credit ratings in recent years to be repeatedly downgraded; due to the crisis in Russia and the domestic reform lag, Belarus’ economic imbalances are still prominent, and there are serious shortages in international reserves, as well as greater pressure on currency stability which keeps the pressure on government solvency. In 2016, three countries’ sovereign credit ratings were upgraded, namely, Argentina, Ireland and Romania. The rate of upgrading was 3.9%, representing an increase of 0.3 percentage points compared to 2015. Among these, Argentina managed to rid itself of its foreign currency debt default through debt restructuring negotiations in 2016 and solvency was restored; Rapid economic recovery and better external conditions continued to improve Romania’s solvency; the momentum of the economic recovery and continuous improvements in fiscal conditions steadily reduced the Irish debt burden, which improved solvency.
In terms of the scale of adjustment, for local currency ratings, there were 11 countries (or regions) which experienced 1-level adjustment and three countries (or regions) with 2-level adjustment. The 2-level adjustment countries were mainly the countries and regions with the most obvious deterioration in sovereign credit risks, such as Brazil, Venezuela and Bahrain. The level of foreign currency adjustment was slightly different. The number of 1-level adjustment countries for foreign currency rating was one less than that for local currency, and there was one more country for 3-level adjustment countries for foreign currency. This was caused by the 1-level upgrade for Argentina’s local currency (from CCC up to B-), and 3-level upgrade for its foreign currency. The main reason for the upgrades was that the New York court lifted the restrictions and the defaulted debt was properly resolved. This helped Argentina’s foreign currency solvency to recover. The country’s new government promoted a range of economic and financial reforms designed to help solve Argentina’s long-term economic imbalances and improve government debt sources.
(II) Dagong’s adjustments to the sovereign credit rating outlook were also dominated by downgrading, and the trend of downgrading became more obvious.
In 2016, Dagong’s adjustments to the sovereign credit rating outlook were also dominated by downgrading. The upgrading odds of local currency outlooks declined, while the odds for downgrading increased. The change to foreign currency outlooks was relatively smaller. In 2016 the numbers of countries and regions seeing their credit rating outlooks changed were 17 and 15 respectively, which accounted for 22.1% and 19.7% of the total number tracked. These figures were down by 1.6 and 0.3 percentage points respectively compared to 2015. The odds for the upgrading and downgrading of local currency outlooks were 6.5% and 15.6% respectively, declining by 6.2 and increasing by 4.7 percentage points respectively compared to 2015; and the odds for the upgrading and downgrading of foreign currency outlooks were 5.3% and 14.5% respectively, a narrower margin than in 2015.
In 2016, five countries had their local currency outlook upgraded, among which four were adjusted to stable from negative. These were Argentina, India, Malta and Morocco, and another, Pakistan, was adjusted to positive from stable. In Argentina the risk of an economic imbalance was slowly released, fiscal consolidation was implemented, and the debt became stable, although at a high level. All these factors were helpful in stabilizing its debt repayment capability. In India, general government debt was heavy, but rapid economic growth driven by domestic demand helped to alleviate the fiscal deficit, leading the mid-term general government ratio onto a downward path. In Malta, the economy grew rapidly. Both the fiscal deficit and debt burden began to fall and the government’s debt repayment capability showed improvement. Stable governance keep Malta’s political stability and consistency at a relatively high level, and with fiscal consolidation continuing, the fiscal deficit narrowed. This contributed to the stabilization of government debt at a high level. In the mid-term, the general government debt of Pakistan fell from a high level slowly, thanks to an improvement in economic growth potential and the narrowing of the fiscal deficit. The debt structure continuously improved and debt repayment improved too.
Twelve countries had their local currency outlook downgraded, all of which were downgraded from stable to negative. They were Algeria, Angola, Australia, Bahrain, Democratic Republic of the Congo, Ecuador, Ethiopia, Kazakhstan, Oman, South Sudan, Turkmenistan and Uruguay. Most of the countries whose outlooks were downgraded were resource-abundant ones. As the international prices of commodities, such as crude oil, copper, agricultural products fell down, the wealth creation capabilities of these countries were seriously damaged, with both the fiscal deficit and current account deficit deteriorating. At the same time, external risks rose, all of which threatened the government’s debt repayment capability.
Dagong sovereign credit ratings maintained relatively high stability as a whole; the regions having their ratings downgraded changed moved from high-debt advanced countries to emerging market economies. These showed a similar trend as the development of global sovereign credit risks.
According to the one-year transition rate matrix, Dagong sovereign credit rating maintained a relatively high level of stability by achieving a maintenance rate above 90%. As for the direction of the transition, the ratings were mainly downgraded except for several upgrades in the BB, CCC, CC and C group. As for the scale of the transition, countries whose local and foreign currency ratings were A-, BBB+ and B all had one case downgraded by 2 sub-ratings, while cases whose foreign currency ratings were D had one upgraded by 3 sub-ratings, which shows that the transition scale enlarged compared to 2015. Moreover, in 2016 there was one case in which the rating was downgraded from investment level to speculative level (the local and foreign currency ratings of Algeria from BBB- to BB+), and one case in which the rating was upgraded from speculative level to investment level (the domestic currency level of Romania from BB+ to BBB-). Countries with mother ratings of A and B tended to have a higher transition rate downwards.
From 2010 to 2016, Dagong ran 365 credit ratings on 100 countries. Among these, there were 70 local currency rating transitions and 74 foreign currency transitions (including multiple changes in a single year), which accounted for 19.1% and 20.2% of all ratings. As for local currency transitions, there were 15 upward adjustments, with a 4.1% transition rate, equal to that from 2010-2015; and 55 downward adjustments, with a 15.0% transition rate, up by 0.1 percentage points compared with the period from 2010 to 2015. As for foreign currency transitions, there were 16 upward adjustments, with a 4.4% transition rate, equal to that from 2010 to 2015; 58 downward adjustments, with a transition rate of 15.8%, down by 0.1 percentage points compared with the period from 2010 to 2015.
According to the distribution of countries that had their credit ratings adjusted from 2010 to 2016, a trend of moving from high-debt advanced countries to emerging market economies was observed. The downward trend of advanced countries beginning to slow down was observed, as no advanced country was downgraded in 2016, and Ireland even saw itself upgraded. This was because Dagong had already adjusted their ratings when they were over-issuing currencies in order to roll-over their debt, and therefore their risks had been properly identified. The downgraded zone moved from advanced countries to emerging market economies. This phenomenon could be seen in the 10 emerging market economies which had their credit ratings downgraded with downward expansion in 2016. For instance, Venezuela, Bahrain, and Brazil were downgraded by two ratings. This showed the impact of falling commodity prices, changes in the Federal Reserve’s monetary policy, and the deep level adjustment of the Chinese economy, as well as other factors. These risks in emerging market economies accumulated before bursting out, threatening sovereign credit security.
III. Default Rate Statistics
Since 2010, when Dagong began to carry out sovereign credit rating, two sovereign debt defaults have occurred in countries and regions which Dagong has assessed. These are Greece’s sovereign debt default in 2012 and Argentina’s foreign currency debt default in 2014. Because sovereign ratings are objectively limited in terms of quantity, coupled with the complexity and particularity of sovereign debt, sovereign debt defaults rarely happen. As a result, there have been no debt defaults since Argentina’s foreign currency debt default in 2014. As can be seen from table 7 and table 8, the default rate of each level increases with the decrease of the ratings. This reflects Dagong’s scientific approach to sovereign credit rating. In addition, it can be seen that when comparing the default rate of local currency to foreign currency, the foreign currency average cumulative default rate in each period is significantly higher than the local currency.
Dagong’s calculation method for the default rate of sovereign credit ratings is as follows:
The calculation of the default rate is based on credit rating subjects. The calculation of the annual default rate is based on static groups, where each static group is composed of the initial sovereign credit rating subject in each rating cycle. The default cases at each level through the static group of each rating cycle are surveyed, then the default rate at the level is calculated. The annual default rate is the total number of rating subjects in a static group found in the initial stage of the rating cycle, divided by the number of subjects defaulted in the same rating cycle. The average marginal default rate and average cumulative default rate are further derived from the annual default rate.
(1) Annual Default Rate:
(2) Average Marginal Default Rate: The average marginal default rate in year t indicates the average default rate of the credit rating subject in year t with no default in the previous t-1 years. The formula is as follows:
(3) Average Cumulative Default Rate: The average cumulative default rate is calculated by the average marginal default rate. The average cumulative default rate during T years can be expressed as follows:
——The group comprised of rating R, founding at the beginning of year y;
——The annual default rate of subject whose rating is R in the year y ;
——During the year and Y, the average marginal default rate in the year t of the subject whose rating is R;
——The average cumulative default rate during T years;
——The number of subjects in group defaulted at year y+t-1;
——The number of rating subjects in group that are still alive(not be withdrawn or default) at the beginning of year y+t-1.