LONDON (Reuters) - The global trade war kicking off between the United States and China will not trigger a spate of credit rating downgrades, Fitch’s top sovereign analyst says, but the dollar’s growing strength could.
The recent imposition of tariffs between the world’s two largest economies and the threat they could reach $200 billion means a trade war has gone from “a risk to a reality”, Fitch’s head of government ratings James McCormack told Reuters.
It has changed the firm’s overall view of the world. Fitch had hoped the trade tension might blow over, but now believes it could wipe as much as 0.5 percentage points off U.S. economic growth and probably the same off Chinese growth too.
While that certainly isn’t healthy, the developments on their own however shouldn’t cause a mass wave of downgrades.
“I wouldn’t anticipate it to be honest on a trade war alone,” McCormack said.
“The U.S. is on the strong side of triple A,” he said, adding that U.S. debt as a proportion of its GDP would have to rise somewhere between 20-35 percent before Fitch’s in-house model started flashing downgrade warnings.
China’s A+ rating should also be able to handle it, although there are some caveats.
“Weaker growth in itself wouldn’t bring the (China) rating lower, it would be a policy response to weaker growth to try to prevent that.”
“In other words, another run up in credit growth such that the corporate debt stock got larger and concerns about the imbalances got larger - that would be a rating issue.”
Some signs of that old reflex are starting to emerge. But even zooming out to the global list of countries that could see tariff increases, there are hardly any obvious rating cuts in store.
Mexico is one that could see one, but it faces the specific threat of the NAFTA trade pact being unravelled. Its new government could also potentially roll back energy reforms which have helped its finances since being introduced.
Could that move the rating outlook to ‘negative’ on its own? “Potentially yes.” McCormack said. “It depends on the magnitude of the changes and what the government wants to do.”
Scrapping NAFTA, meanwhile, would certainly be damaging. One example cited was that 9 percent of Mexico’s exports to the United States are “light” trucks. Under NAFTA there are no tariffs, without it they would be an eye-watering 25 percent.
To view a graphic on Fitch's sovereign ratings on the turn again, click: reut.rs/2L8NKhe
More broadly the bigger risk for emerging market ratings in particular is the ongoing rise of the dollar.
The greenback hit its highest level in a year on Thursday, having surged 7 percent since April and for four months in a row, a run not seen for over 3 years.
There is a 20-year pattern of downgrades for poorer countries whenever the U.S. currency strengthens and their FX reserves drop. EM ratings fell 1-1.5 notches on average between 2013 and 2017 when the greenback surged 30 percent.
It could mean a turnaround for emerging market ratings which had only just started to creep higher again. Fitch’s overall balance between positive and negative rating ‘outlooks’ has just gone back into negative territory again.
“We think what might happen to the dollar is a more important question (than the trade war one),” McCormack said.
“When EM dollar income is growing faster than local currency income, in that environment we are tending to upgrade sovereigns when it is the other way round we are tending to downgrade sovereigns. That is the relationship that has always held.”
There are plenty of other country by country issues to judge, too. Turkey, which remains on a downgrade warning, needs to refinance over $200 billion of debt between its government and companies this year. That is more than all other emerging markets.
Mexico has its NAFTA issues, while on the plus side Brazil’s economy looks to “have turned a corner”, and South Africa’s rating “has stabilized” thanks to a potentially “meaningful” change in policy direction by the government.
With the dollar so dominant though it is the broader EM strains that McCormack was wary of.
“The rhetorical question is whether we have seen the peak (of rating upgrade cycle) for emerging markets,” he said.
To view a graphic on Dollar gain equals emerging market credit rating pain, click: reut.rs/2LvSHNc
Reporting by Marc Jones; Editing by Hugh Lawson