Unrest blow for ratings

Fitch Ratings says that the recent outbreak of unprecedented unrest in a number of Middle Eastern countries has put downward pressure on the region's sovereign ratings and will continue to do so, even as new political arrangements emerge.

Risks have increased, both political and economic, to varying degrees, even though Fitch's ratings in the region already embodied a large amount of political risk.

In a new report entitled 'Middle East Political Risk Erupts: Negative Rating Pressure to Persist ', the agency notes that political risk in various forms has long constrained Fitch's sovereign ratings in the region.

Fitch estimates that narrowly defined political risk - including regime legitimacy, stability and effectiveness, internal tensions and external threats - reduced long-term foreign currency Issuer Default Ratings by an average of four notches for the 11 public ratings in the region, even before recent downgrades.

Fitch has downgraded Tunisia ('BBB-'/Negative), Egypt ('BB'/RWN) and Bahrain ('A-'/Negative) by one notch and Libya ('BB'/RWN) by a cumulative four notches. It says there has been latent political risk in these countries for many years but it has now come to the fore.

There is political risk in other emerging market regions, with some countries experiencing at least as high risk as in the region. However, in general, risks in the Middle East are somewhat higher. Moreover, geopolitical risks, which affect several countries simultaneously, are considerably higher in the Middle East than elsewhere.

Political risk tends to be higher at lower rating levels, although it may also be present at higher rating levels but mitigated by other considerations. When latent risks erupt, there may be some tolerance in the rating, so that negative rating action is not automatic or immediate. However, ratings of more highly rated sovereigns, notably members of the Gulf Co-operation Council (GCC), have less tolerance for political volatility, and improved political risk and governance more generally are more important to their ratings improvement than at lower rating levels.

Relatively high levels of human development (per capita incomes, education and health outcomes) mitigate political risk in the richer countries in the GCC. However, as Bahrain demonstrates, this does not necessarily prevent pressure for political change.

Recent events in the less advanced countries in the region also provide some support to the idea that relatively small setbacks in development, as occurred during the global financial crisis and are now threatened by rising food price inflation, may have a bigger impact where socio-political grievances are high and difficult to channel through the political system.

Another common factor in the region is the demographic challenge of a young and fast-growing workforce, which demands faster GDP growth rates than most countries have achieved over the past decade, and improvements in education in order to equip the work force for employment.

Excluding the richest three GCC countries, which have used fiscal resources to generate rapid growth, Fitch estimates that GDP growth will need to be, on average, 1.5 per cent to two per cent faster in the coming decade than achieved in the past 10 years.

GCC countries have a separate challenge, of creating jobs that their nationals aspire to and are qualified to do, Fitch Ratings says.