Global Sovereigns: 2016 A Record Year for Downgrades. James McCormack, Managing Director, Sovereigns

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1 Global Sovereigns: 216 A Record Year for Downgrades James McCormack, Managing Director, Sovereigns

2 Global Sovereigns Global Macro and Policy Outlook US, UK, Eurozone, China Emerging Markets Rating Trends and Outlooks

3 Global Macro Forecast Slow Growth and USD Appreciation Big UK Downward Adjustment Global Forecast Summary UK growth revised lower by 1% in 217 No UK recession, but investment falls US growth revised marginally lower, again But we still expect the Fed to raise rates China expected to reach 6.5% growth target Stimulus still effective, at least in short term Brazil and Russia show signs of stabilisation Central banks show signs of caution GDP Growth World US Eurozone China Interest Rates (end period) US Eurozone.5.. China (1-year lending) Assumptions Oil (USD/barrel) USDEUR (end period) USDCNY (end period) Source: Fitch 2

4 Global Macro Policy Framework More Fiscal Easing to Come Monetary Easing Not Working Investment spending not responding to lower interest rates Corporate borrowing for M&A, strengthening balance sheet Financial economy benefits greater than real economy benefits Unintended Consequences of Negative Rates Banks smaller net interest margin can affect lending Confidence unconventional policies send message that something seriously wrong Upcoming elections France, Germany, Netherlands, Spain Politics Anti-EU sentiment often equivalent to anti-austerity Austerity fatigue Benefits of economic recovery not reaching average person 3

5 United States New Administration, but Familiar Issues AAA/Stable US Public Finance Issues Unresolved Federal government fiscal deterioration Mandatory spending (social security + Medicare) to increase Discretionary spending in decline Sequestration in 211 Budget Control Act caps discretionary spending Federal debt 77% of GDP and rising Federal Budget Projections Mandatory Discretionary Interest Revenue (%GDP) Debt limit suspended until March 15, Source: Congressional Budget Office 4

6 United Kingdom Brexit: More Questions than Answers AA/Negative Brexit Sovereign Considerations Weaker growth outlook amid possibly prolonged legal and regulatory uncertainty PSNB Treasury target revisions: GBP1bn surplus for abandoned immediately after the referendum Fitch General government debt forecast 89.8% of GDP end-216, and rising in 217 and 218 Only US (1%), Belgium (17%), France (97%) higher in AAA/AA categories; Canada similar to UK (GBPbn) Public Sector Net Borrowing (12-month rolling) 2.3% GDP 1% GDP % GDP Source: Datastream 5

Eurozone Politics Takes Centre Stage Trending Issues and Views Austerity fatigue Euroscepticism/nationalisation Migration/security/integration Political Implications Political fragmentation and

December Republican candidate decided November National Front calling for EU referendum Germany (August-October: Parliament) CDU/CSU (Merkel) leads polls, but slipping Greens (left) and AfD (right)

(November: Constitutional Referendum) Reduces role of upper house, electoral reform for greater lower house stability PM Renzi may resign if referendum fails Elections due by 218; polls even for PD

7 Eurozone Politics Takes Centre Stage Trending Issues and Views Austerity fatigue Euroscepticism/nationalisation Migration/security/integration Political Implications Political fragmentation and polarisation Anti-establishment politics National debates on EU/eurozone membership 217 Elections Other Issues to Monitor France (April/May: President, June: Assembly) Socialist candidate decided December Republican candidate decided November National Front calling for EU referendum Germany (August-October: Parliament) CDU/CSU (Merkel) leads polls, but slipping Greens (left) and AfD (right) gaining ground AfD calling for EU referendum Netherlands (by mid-march: Parliament) Polls led by VVD (leads current coalition) and PVV (right-wing, nationalist) PVV calling for EU referendum Italy (November: Constitutional Referendum) Reduces role of upper house, electoral reform for greater lower house stability PM Renzi may resign if referendum fails Elections due by 218; polls even for PD (Renzi s party) and 5-Star Movement 5-Star calling for eurozone referendum Spain (Third Elections December 216?) 215 election: fragmentation of politics, inability to form coalition 216 election: similar to 215 outcome Third elections possible later this year 6

8 Eurozone Lower Funding Costs, But Higher Debt (%) 1-yr Government Bond Yields France Germany Italy Portugal Spain General Government Debt France Germany Italy Portugal Spain (%GDP) Source: Datastream Source: Fitch 7

9 China Pace of Debt Expansion Not Sustainable A+/Stable Sovereign Credit Considerations Adjustment without a hard landing, financial and/or social stability risks Dealing with high domestic debt debt/equity swaps / NPL securitisation / shutting down excess capacity Banks size and asset quality but balance sheets are in CNY and liabilities are mostly deposits watch non-deposit funding (USDtn) Corporate Debt China US Eurozone Japan China Sovereign Rating History FC LC April 213 A+ A+ November 27 A+ AA October 25 A A+ December 1997 A- - Source: BIS, Datastream 8

Turkey India Brazil Mexico Poland S Arabia Russia Malaysia Indonesia Bahrain S Africa Russia, South Africa, Turkey Rating Pressure Points BBB-/Negative BBB-/Stable BBB-/Negative International

Revenue Expenditure 1,4 1,2 1, 8 6 4 Gross External Financing Requirement* (%GDP) GXFR ST Debt 2 15 1 5 Reserve Assets 387 - Net IIP 326-2 26 28 21 212 214 216 External balance sheet robust Fiscal

10 Turkey India Brazil Mexico Poland S Arabia Russia Malaysia Indonesia Bahrain S Africa Russia, South Africa, Turkey Rating Pressure Points BBB-/Negative BBB-/Stable BBB-/Negative International Investment Position (June 216) (USDbn) Assets Liabilities Total 1, Direct Investment Portfolio Investment Other Investment Derivatives 1 8 Government Finances (ZARbn) Revenue Expenditure 1,4 1,2 1, Gross External Financing Requirement* (%GDP) GXFR ST Debt Reserve Assets Net IIP External balance sheet robust Fiscal position deteriorating and poor growth outlook Source: Central Bank of Russia, Datastream, Fitch Twin deficits fiscal and current account Political risk rising policy implications Very large external funding needs Institutional implications of post-coup purge are still unclear * Current account + external amortisation 9

11 Emerging Market Sovereigns Strong Dollar, Low Commodities, Lower Ratings Commodities and the Dollar Global Commodities (25=1) US Dollar and EM Sovereign Ratings USD Index (RHS Jan'97=1) Fitch EMSCI USD Index (RHS Jan'97=1) Stronger USD Lower EM ratings Source: Datastream Source: Datastream, Fitch 1

12 Emerging Market Sovereigns No Evidence of Deleveraging Private Non-financial Sector Debt US Eurozone (%GDP) China 22 (%GDP) 7 Corporate Debt Brazil Mexico Turkey Saudi Russia China (RHS) (%GDP) Source: Datastream Source: Datastream 11

13 Sovereign Rating Trends & Outlooks 216 To Be Record Year for Downgrades Sovereign Upgrades by Category AAA AA A BBB BB B C/D Sovereign Downgrades by Category AAA AA A BBB BB B C/D Source: Fitch Source: Fitch 12

14 Sovereign Rating Trends & Outlooks Movements Toward the Bottom of IG and SG 35 Sovereign Ratings by Category AAA AA A BBB BB B/C/D 1 9 Sovereign Rating Category Shares (%) AAA 3 8 AA A BBB Investment Grade BB B/C/D Speculative Grade Source: Fitch Source: Fitch 13

15 Sovereign Rating Trends & Outlooks Negative Outlooks Continue to Dominate Developed Markets Emerging Asia Emerging Europe Latin America Middle East & Africa Negative Outlook Positive Outlook Belgium AA Cyprus B+ Taiwan A+ Japan A San Marino BBB UK AA Sri Lanka B+ Azerbaijan BB+ Croatia BB Macedonia BB+ Russia BBB- Turkey BBB- Israel A Malta A Slovenia BBB+ Philippines BBB- Brazil BB Suriname B+ Dom Rep B+ Colombia BBB Costa Rica BB+ Ecuador B Angola B+ Kenya B+ Namibia BBB- Gabon B+ Ghana B Iraq B- S Arabia AA- Tunisia BB- Zambia B Average Ratings by Region DM EM-Asia EM-Europe EM-Latam EM-MEA AA+ AA+ AA AA AA- AA- A+ A+ A A A- A- BBB+ BBB+ BBB BBB BBB- BBB- BB+ BB+ BB BB BB- BB- B+ B Source: Fitch 14

16 Fitch Ratings credit ratings rely on factual information received from issuers and other sources. Fitch Ratings cannot ensure that all such information will be accurate and complete. Further, ratings are inherently forward-looking, embody assumptions and predictions that by their nature cannot be verified as facts, and can be affected by future events or conditions that were not anticipated at the time a rating was issued or affirmed. The information in this presentation is provided as is without any representation or warranty. A Fitch Ratings credit rating is an opinion as to the creditworthiness of a security and does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. A Fitch Ratings report is not a substitute for information provided to investors by the issuer and its agents in connection with a sale of securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch Ratings. The agency does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS AND THE TERMS OF USE OF SUCH RATINGS AT 15

17 New York 33 Whitehall Street New York, NY 14 London 3 North Colonnade Canary Wharf London E14 5GN

New York 11 June 2015

New York 11 June 2015 New York 11 June 215 Sovereign Update: Divergent Trends More Pronounced Charles Seville, Senior Director Sovereign Group Agenda Growth Outlook & Ratings Trends Developed Markets: US & Eurozone Emerging