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Worrying about Global Sovereign Risk
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Worrying about Global Sovereign Risk
  • By matthew
  • March 15, 2010, 17:53
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In 2009, the global financial market environment showed speedy improvement following efforts to overcome the global financial crisis and the recovery of the global economy. However, misgivings still remain regarding global financial markets as seen by Dubai World's debt moratorium and Greece's fiscal crisis.

A tsunami of sovereign risk is imminent, with Moody's and Standard & Poor's downgrading the sovereign ratings of Greece and Spain in late 2009 and that of Portugal earlier this year. In addition, several countries in East Europe and Latin America, including Venezuela, Ukraine, Argentina, Latvia are being mentioned as risky countries that may go bankrupt within the next five years. Furthermore, the condition of more industrialized countries does not look good either, with their five-year CDS premiums have risen by 25-45bp since last October. For example, in January this year, Japan's sovereign rating was adjusted downward from AA stable to AA negative by Standard & Poor's. More recently, Moody's has also warned of the possible downgrading of Japan's sovereign rating, worrying about its serious fiscal deficit. In short, the shadow of sovereign risk is being cast not only over emerging countries but also developed ones.

Such global sovereign risk has been being triggered by the worsened fiscal conditions of major countries. For Japan, its ratio of public debt to GDP soared over 220% as of the end of 2009, ranking top among G20 countries. One reason why major countries' fiscal condition has worsened is because of their expansionary policy to boost the economy. If a country holds out its expansionary policy in order to boost its economy, its fiscal condition will subsequently weaken and inflation will occur. Consequently, it is very likely that its sovereign rating will be downgraded, which in turn will lower the value of its stocks, bonds, and currencies, and thereby causing an exodus of foreign investors. As the result of such a chain reaction, the chance of a country experiencing default increases.

As such, those countries that have fiscal difficulties or large-scale external debts are more likely to face a serious sovereign risk. Furthermore, if their neighbor countries tries to avoid taking such risk-something very likely to happen-a severe financial crunch may well swoop down on the global markets again.

As a matter of course, the global community will cooperate to prevent such sovereign risks from attacking the globe and avoid the worst-case scenario. However, these sovereign risk-related issues are fully expected to sweep the world at some time this year. For example, although EU countries have taken action to rescue Greece and Portugal, it is quite within the realms of possibility that foreign investments will begin to move away from these countries.

In addition to the sovereign risk, global financial markets are facing diverse risks related to exit strategy, global regulation, dollar-carry trade, global asset bubble, unstable mortgage market, and so on. As mentioned above, if the expansionary policy continues, the fiscal condition of each country will get worse, while inflation and asset bubbles will intensify. However, a hasty exit policy may trigger a double-dip downturn as well as another asset bubble burst.

Global regulation, the possible liquidation of the dollar-carry trade and an unstable mortgage market are also expected to cause related risks. However, I think the sovereign risk is the biggest of all and most likely to hit the global financial market hardest this year. As a result, the global community should speed up more sophisticated global financial cooperation so as to avoid a tsunami of sovereign risk.