From Brazil, Nigeria, and Turkey to some of the riskiest emerging markets such as Egypt and Zambia, there is growing evidence that a decade-long deterioration in sovereign credit ratings is finally beginning to reverse.
Economists closely monitor sovereign credit ratings because they influence a country’s borrowing costs. Many are now highlighting a positive turnaround that contrasts with the usual concerns about rising debt pressures.
According to Bank of America, nearly three-quarters of all sovereign rating moves by S&P, Moody’s, and Fitch this year have been positive. This marks a significant shift from the near-universal downgrades seen during the first year of the COVID-19 pandemic.
With the spike in global interest rates now behind us, more positive news is expected. Moody’s currently has 15 developing economies on a positive outlook—rating firm parlance for an upgrade watch—one of its highest numbers ever. S&P has 17 such economies, while Fitch has seven more positive than negative outlooks, its best ratio since a post-global financial crisis rebound in ratings in 2011.
Fitch’s global head of sovereign research, Ed Parker, attributes the turnaround to a combination of factors. For some countries, it has been a general recovery from COVID-19 and the energy price spikes caused by the Ukraine war. Others are seeing country-specific improvements in policymaking, while a core group of junk-rated “frontier” nations are benefiting from renewed access to debt markets.
Aaron Grehan, head of EM hard currency debt at Aviva Investors, describes the current upgrade wave as a “definitive shift” coinciding with a sharp drop in borrowing premiums for emerging markets almost everywhere.
“Since 2020, well over 60% of all rating actions have been negative. In 2024, 70% have been positive,” Grehan noted, adding that Aviva’s internal scoring models reflect similar trends.
Decade of Downgrades
However, the recent upgrades cannot fully offset the damage of the past 10-15 years. Turkey, South Africa, Brazil, and Russia all lost their investment-grade status during that period. A surge in debt almost everywhere apart from the Gulf has left the average EM credit rating more than a notch lower than it used to be.
While some countries argue that developed economies with rising debt are treated more leniently by rating firms, emerging market finances are far from robust. Eldar Vakitov, a sovereign analyst at M&G Investments, points to the International Monetary Fund’s recent forecast that the average EM fiscal deficit will edge up to 5.5% of GDP this year.
A year ago, the expectation was that the 2023 EM fiscal expansion would be a one-off, fully reversed this year. Now, the deficit is expected to remain above 5% of GDP until at least 2029.
So why all the rating upgrades?
“For some countries, it is all about the starting point,” Vakitov explained, noting that even though government deficits remain wide, they have at least decreased from peak COVID-19 levels. A few governments, such as Zambia, are benefiting from emerging out of debt restructurings, while others are making notable policy improvements.
Turkey, which has seen upgrades for its efforts to tackle inflation, and Egypt, which has overcome default concerns, are both expected to receive multi-notch upgrades based on market pricing. “Rating agencies tend to be slow,” Vakitov said, “so it often takes them a lot of time to give upgrades.”
Continued Challenges
Despite the positive trend, downgrades have not ceased entirely. Moody’s and Fitch have both issued warnings about China over the past six months. Israel’s ongoing conflict has led to its first-ever downgrades, and Panama has been stripped of one of its investment grades.
Three years after COVID-19 spending sprees, the bills are now due. JP Morgan estimates that EM hard currency debt amortizations and coupon payments will reach an all-time high of $134 billion this year, up $32 billion from last year. Consequently, emerging market policymakers are keen to improve their ratings to keep borrowing costs down.
Indonesia’s Finance Minister Sri Mulyani Indrawati recounted in London this month how rating agencies doubted her when she claimed Indonesia would get its deficit back below 3% of GDP within three years during the pandemic. “It ended up that we were able to consolidate the fiscal position in only two years,” she said. “So I always like to say to my rating agency staff, I won the bet, so you have to upgrade my rating!”
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