Fitch: Brexit may impact Mideast, Africa Sovereigns via markets, trade, aid

Brexit will have limited effect on the sovereign credit ratings of SA and other countries in the Middle East and Africa (MEA) region, ratings agency Fitch said in a research note released late Monday.

“Short-term effects could come via market volatility, while a slowdown in British and European growth could weigh on MEA economies at a time of already heightened strains,” Fitch’s senior director of sovereign ratings, Jan Friederich, wrote in the note.

Ten of the 29 countries in the MEA region to which Fitch allocates sovereign credit ratings are on negative outlook, indicating the ratings agency may downgrade them within the next two years.

The most immediate channel of contagion from Brexit is via an increase in investor risk aversion, with the impact depending on the degree of integration into the global financial system. South Africa, which tends to experience large investment outflows during periods of ‘risk-off’ sentiment, saw its currency depreciate by eight per cent in the immediate aftermath of the Brexit vote, although the rand subsequently regained some ground. This followed hawkish comments from the South African Reserve Board and was generally in line with a recovery in global market sentiment, partly driven by the prospect of easier monetary policies in major developed economies.

Broad-based risk aversion would make accessing international financial markets more difficult and costly, but movements in MEA sovereign bond yields have been limited and several Sub-Saharan issuers saw their Eurobond yields drop to the lowest levels for the year in late June. Again, this may be in anticipation of central banks in developed markets easing monetary policy (or delaying tightening), which could encourage capital flows into EMs.
The Brexit vote has also triggered an appreciation of the $against most floating emerging market currencies, which will add to the debt and debt service burden of countries with significant $-denominated debt on their balance sheets. For countries with $pegs (including the GCC) or linked/managed exchange rates (including Ethiopia, Egypt and Angola), it will mean some further appreciation of trade-weighted exchange rates and loss of competitiveness, potentially adding to macroeconomic imbalances.

While Saudi Arabia holds most of its reserve assets in $-denominated assets, the smaller rich Gulf states are believed to hold significant amounts of British and EU assets. However, the size of their estimated sovereign net foreign assets (more than 400 per cent of GDP in Kuwait and around 200 per cent of GDP in Abu Dhabi and Qatar), despite ongoing deficits, are sufficient for them to easily absorb any portfolio losses that could result from market volatility.

Of Fitch-rated MEA sovereigns covered by the IMF Direction of Trade statistics, the Seychelles has the largest exposure to the UK, with merchandise exports to the UK accounting for six per cent of GDP (excluding tourism). None of the other MEA sovereigns have a goods exports exposure greater than 1.5 per cent of GDP. Effects via weaker growth in the euro area could also be significant for Tunisia, where exports to the euro area account for 21 per cent of GDP, and Morocco (12 per cent). Morocco, Tunisia and Egypt also have a significant exposure to the UK via tourism, although security incidents have already had a substantial negative effect for Tunisia and Egypt. Many sovereigns in the region are heavily dependent on commodity exports. The Brexit impact on commodity prices has been contained, but a downturn in the UK and Europe could still affect demand and prices. 
In the medium term, an exit from the EU might require MEA countries to negotiate trade agreements with the EU bilaterally to retain access to the UK market, and this would likely be a lengthy process.

A sustained weakness of the UK economy or change in political sentiment could lead to lower donor flows from the UK. This would most affect Rwanda (UK development aid to Rwanda was 1.0 per cent of Rwanda’s GDP in 2014), Ethiopia (0.9 per cent) and Mozambique (0.9 per cent, although flows were suspended in April 2016).

Source: Reuters