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Outlook for Sovereign Ratings in the Wake of COVID-19

Governments and monetary authorities reacted quickly to the coronavirus disease (COVID-19) health crisis with massive fiscal and monetary support. As economies re-open, DBRS Morningstar expects some credit challenges to emerge from the corporate and household sectors - potentially leading to noisy data and market volatility - but ultimately the world economy will make a full recovery. In this environment, some fiscal rebalancing will occur, but public debt will in many cases remain well above pre-crisis levels through this decade. We expect continued divergence between some economies that have developed strong reputations for fiscal prudence, and several other major economies that will likely prioritize higher public spending.

In this commentary we explore factors that could affect our sovereign ratings outlook, which remains mixed. Some sovereigns are in an advanced stage of economic recovery and are already beginning the process of balance sheet repair. In such cases, upward pressures on ratings are likely. In other cases, policy responses have exacerbated existing fiscal challenges, and could ultimately weigh on credit ratings. In less developed economies, a more tepid policy response combined with limited access to vaccines may delay recoveries. Countries with unaddressed macroeconomic or fiscal imbalances may see additional downward pressures on ratings.

Key highlights:
(1) The global recovery faces some headwinds, including continued supply and demand disruptions from COVID-19 and emerging price pressures. While sustained and high inflation would clearly be detrimental, a short-lived burst of somewhat higher inflation could benefit the more indebted advanced economies.
(2) Adverse geopolitical developments, changing energy policies, or shifting attitudes toward globalization could complicate the outlook for growth and inflation.
(3) Advanced economy debt burdens are likely to remain highly affordable as more expensive debt is refinanced, but in several cases medium-term fiscal adjustments are likely to be needed.

“The quality of public spending matters, and running fiscal deficits to fund infrastructure improvements would likely bring considerable benefits over the medium-term,” comments Nichola James, Co-Head of Sovereign Ratings at DBRS Morningstar. “Nonetheless, slower fiscal adjusters may ultimately face some ratings pressures - whether due to a subsequent crisis or downturn, or due to a more gradual deterioration in public financial strength”.

“The financial flexibility of advanced economies has allowed them to engage in a massive fiscal response while lowering debt service costs,” adds Thomas Torgerson, Co-Head of Sovereign Ratings at DBRS Morningstar. “In contrast, emerging markets undertook more limited fiscal responses, yet most are expected to see debt service costs rise further in the next few years,” says Thomas Torgerson, Co-head of Global Sovereign Ratings.