Previous upward rating momentum in the region has stalled. Over the past 18 months there have only been three foreign currency rating upgrades: the Czech Republic ("A+"), Slovakia ("A+") and Armenia ("BB"); and two downgrades: Latvia ("BBB+") and Georgia ("B+"). "The balance of Positive to Negative Outlooks has swung from plus five in August 2007 to minus five in August 2008, highlighting the downward pressure on ratings. Seven countries are now on Negative Outlooks, which is a record number since Fitch started its sovereign coverage on the region in the mid-1990s," says Mr Parker.
Fitch forecasts EE's GDP growth to fall from 6.9% in 2007 to 5.8% in 2008 (the lowest since 2002) and 5.3% in 2009, bolstered by growth in Russia ("BBB+") of 7.5% this year and 6.5% next. But most countries within the region will grow much slower, and Estonia ("A") and Latvia are at risk of recession. Meanwhile, the spike in commodity prices has unleashed a surge in inflation when many countries were starting to run up against capacity constraints and overheat after years of rapid monetary and GDP growth. Inflation has been highest in countries with fixed or managed exchange rates including the Baltic States, Bulgaria ("BBB"), Kazakhstan ("BBB"), Russia and Ukraine ("BB-"); and best contained in the inflation-targeting central European economies. High and volatile inflation increases the risk of exchange rate and banking crises, and reduces debt tolerance.
Substantial CADs are a significant credit concern across much of EE - and one that has been heightened by the credit crunch. This was the primary reason Fitch revised the rating Outlooks to Negative from Stable on Bulgaria, Estonia, Latvia and Romania ("BBB") in January, following Lithuania ("A") in December. In the report, Fitch has constructed an index of relative vulnerability to external financing pressures, based on its projections of CA balance plus FDI, external debt repayments due this year and net external debt stocks. Latvia, Croatia ("BBB-"), Lithuania, Turkey ("BB-"), Estonia, Bulgaria and Romania come out as most vulnerable on this measure.
EE sovereign external bond issuance at USD14bn year-to-date has already surpassed last year's total of USD13bn. However, although private sector external bond issuance picked up in H108 on H207, it is still well below pre-credit crunch volumes. The rapid pace of bank credit growth in the region is slowing, but remains elevated in parts of the CIS and Balkans. Foreign parent banks should continue to support access to funding and confidence in local banks, but there is a tail risk that a worsening of the international credit crunch could trigger a fall in the availability of their financing to EE banks.
The war between Russia and Georgia, and Russia's tense relations with many of its neighbours and the West has added another layer of risk to the region at an inopportune time. Aside from Georgia, which is on a Negative Outlook, Fitch does not currently expect these developments to trigger any rating changes for Russia or other countries. However, this is not impossible should events lead to a marked reduction in FDI and other capital inflows, seriously disrupt trade and economic activity, heighten domestic political instability or heat up other post-Soviet frozen conflicts.
