Markets Sense Oil Country Ratings Still Have Further to Fall

 

S&P delivered a double-notch downgrade to Saudi Arabia, stripped Bahrain of its 'investment grade' status and cut Brazil, Kazakhstan and Oman as the tumble in oil prices triggered its second co-ordinated cull in a year.

 

Other rating agencies like Moody's (MCO) and Fitch are expected to play catch-up over the coming months, but credit default swaps (CDS), which can be used insure against or to bet on debt problems, foresee further downgrades even by S&P.

 

A 'Market Derived Signal' model calculated by S&P's Capital IQ unit shows Saudi Arabia, Russia, Brazil, Kazakhstan and Colombia, which also saw its ratings' outlook cut this week, all being chopped again.

 

Oil giant Saudi Arabia is seen dropping from its current A- to BBB- -- just one rung clear of junk -- while Colombia and Kazakhstan are both being priced now as if they were already 'sub-investment grade', as it is termed in rating agency parlance.

 

Falling into 'junk' can set off a wave of capital outflows as it automatically excludes bonds from certain high-profile indexes compiled by the likes of JP Morgan and Barclays (BCS).

 

That means some conservative funds -- active managers as well as passive ones that "track" the index -- are no longer able to buy and sell the bonds, driving up borrowing costs for governments and businesses with potentially destabilising results.

 

"It is textbook reaction that foreign investors will be far more cautious before buying bonds (after a downgrade) and as a result the cost of borrowing for those countries rises," said Rabobank emerging market strategist, Piotr Matys.

 

As an example of what a downgrade to junk can trigger, Russia lost investment estimated to be worth $140 billion when it was ejected from the Barclays Global Aggregate bond index last year.

 

Matys also pointed to last month's example of Poland's surprise S&P downgrade, which saw its bond yields spike to 3.2 percent from just over 2.9 percent. If that translated into its borrowing costs, it would be a roughly 10 percent rise.

 

In Saudi Arabia, officials have indicated they may start tapping international bond markets to fill some of the holes left in its finances.

 

Russia seems to be sounding out a similar move and if Brazil's rating falls as low as BB-, as the S&P Capital IQ models suggests, its borrowing costs are likely to spiral even higher and add to its economic crisis.

 

The CDS markets have correctly predicted almost all of the blizzard of oil and emerging market rating cuts over the last couple of years, including the latest ones on Wednesday.