After Emerging Market Default, Sovereign Ratings Follow A Diverse Recovery

The path of sovereign ratings after default is diverse, ranging from serial defaults to recovery to investment grade.

Overall, the five sovereigns that have defaulted in 2020 – Argentina, Ecuador, Lebanon, Suriname, and Zambia – lack the characteristics associated with strong post-default rating recoveries, although governance indicators in Argentina and Suriname are relatively high in the 40th-50th percentile rank of all sovereigns

Fitch Ratings has recorded 26 defaults of rated sovereigns across 16 countries since the mid-1990s. We recently analyzed the subset of 22 defaults that exclude multiple defaults by a sovereign in the same year to inform the potential evolution of recoveries from current defaults.

Each country and default is unique. Nevertheless,  historical patterns provide lessons on the potential speed, magnitude, and circumstances of the recovery in ratings after default.

Rating Recovery Paths: Key Statistics

The median time in default is 39 days, but 20% lasts for at least a year. The median default exit rating is ‘CCC’, with a minimum of ‘CC’ and a maximum of ‘B’.  Thirty-six percent of current ratings remain at either ‘CC’ or ‘CCC’, 27%  are in the ‘B’ range, 9%  in the ‘BB’ range, and 9%  in the ‘BBB’ range;  while  18%  have been either withdrawn or remain in default.

Of the 22 defaults, six subsequently returned to default (Argentina-2001, 2014 and  2019; Ecuador -2008; Jamaica-2010 ;and Republic  of Congo -2016). The median time for this after exiting the prior default was just over three years, with a maximum of more than 10 years. Of default exits of at least five years’ vintage (or returned to default sooner), 42% of sovereigns had returned to default, 8% were in the ‘CCC’ range, 33% in the ‘B’ range, and 17% in the ‘BB’ range.

Only a weak relationship exists between the default exit rating and the post-default rating peak.  However,  the higher the pre-default rating,  the higher the post-default rating peak.  This highlights that if deep credit fundamentals, such as high income and robust governance, survive the default episode then a sovereign has greater rating recovery potential.

Strong Rating Recoveries: The Drivers

Fewer than one in five sovereigns has reached a rating of more than ‘B+’ after defaulting. However, there are two outliers of strong rating recoveries,  which returned to investment grade: Uruguay and Cyprus.

A distinguishing feature was their strong governance and political stability before their crises, which they retained. To some extent, they were ‘innocent victims’ of contagion from external shocks, mainly transmitted through the banking system. Default reflected a lack of ability rather than a lack of willingness to pay;  there was no haircut and constructive relations with creditors were maintained.

Only the Dominican Republic and Greece reached a  ‘BB’  range rating after default. Their current ratings remain at their post-default peaks.

Cyprus, Greece, and  Uruguay had the highest ratings five years before their respective defaults, the highest composite  World  Bank Governance Indicator scores, and the highest post-default ratings.

It is also worth noting that the government debt/GDP  burden of countries defaulting varies significantly,  underlining that causes of default are multi-faceted.  Ecuador and the  Dominican  Republic had the lowest government debt/GDP  ratio at default,  of only 22% (excluding  Venezuela,  for which data are unreliable).

Ed Parker is Head of EMEA Sovereign Ratings, Fitch Ratings