15th June 2012
The Spanish downgrade had been widely flagged. Moody's cut Spain's rating three steps to Baa3, one level above junk, from A3, citing the nation's increased debt burden, weakening economy and limited access to capital markets.
Spain's problems are well-known, but the Wall Street Journal considered the move 'aggressive' nonetheless: "…especially taking account the negative rating watch, which will be reviewed in the next three months. The Spanish 10 yield at 6.80% is already priced in for sub-investment grade rating," noted rates strategist Alessandro Giansanti at ING."
The secondary debt markets are well ahead of the rating agencies in pricing Eurozone debt as 'junk' and the primary markets are not far behind. Nick Stamenkovic, strategist, Ria Capital Markets: "Italy manages to reach the 4.5 billion euro target for its latest bond auction with reasonable demand but yields significantly higher than previous month.
"Clearly investors are demanding ever higher premium to buy Italian sovereign paper. With overseas investors shifting out of BTPs domestic investors are stepping up to the plate but for how long?"
If, at any point, the rating agencies agree, this will present another problem for Eurozone policymakers. Giansanti points out: "The risk of Spain falling out of the main benchmarks is increasing and this event will further reduce the market appetite for Spanish government bonds." The problem is that if these countries fall into 'junk' or 'emerging market' status, there are a whole raft of buyers who will no longer be able to buy.
Another issue is that it may change the nature of 'emerging markets'. The Spanish Prime Minister has been quoted as saying 'Spain is not Uganda' and yet, as a number of commentators have pointed out, the association may now offend Uganda more than it should Spain. On the Forbes site Laurie Kauffman points out: "Uganda's public debt to GDP ratio was around 30% in 2011. Spain's was more than twice as high. It bears repeating: Spain is not Uganda."
There was a similar reaction on Zerohedge: "Recall that it was two weeks ago that Nigeria decided to cut its European exposure. Last we checked, it still held on to Ugandan risk."
The BBC went as far as to draw a direct comparison between the two countries, demonstrating that Uganda had a number of economic indicators in its favour.
It raises the point that, until relatively recently the 'emerging economy' tag has been associated with countries that are on an upward trajectory. This has made them a more attractive, if risky, place to invest. Relatively few countries have moved in the opposite direction. Argentina being the notable exception. If emerging market indices were full of Greek, Spanish and Portuguese companies or government debt, would they be as attractive?
That many developed markets are clinging on to their developed market status has bemused some emerging market observers. James Weir, Asian investment specialist at Guinness Asset Managers, says: "One of China's big bug-bears has been its rating on international bond markets. It cannot understand why the UK, for example, is AAA-rated and not China. Domestic rating agencies have written papers on this very subject. The trouble is that many of these countries have capital controls in place and it is therefore difficult to look at them in the same way."
Weir points to a number of Asian countries where their status looks increasingly anachronistic: "Indonesia, for example, has an economy of 230m people. It is growing well. It has fantastic natural resources such as palm oil and nickel. It has a real need to build infrastructure. There is a question over which is more risky."
The continued downgrades may remove important natural buyers for the debt of Eurozone economies and present another problem for Eurozone policymakers. However, it may also change the nature of emerging markets. In future they may no longer be associated with exciting growth economies, but with yesterday's fallen angels.
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