Eastern European sovereigns are the emerging markets most vulnerable if the global credit squeeze tightens, says Standard & Poor's Ratings Services today in a report Why The Global Credit Squeeze Could Hit European Emerging Market Sovereigns Harder Than Others.

Just how vulnerable each individual sovereign could become relates directly to its degree of dependence on foreign capital inflows to finance external imbalances and avert balance-of payments crises, the report says.

"We believe Eastern European sovereigns are the most exposed, while Asian and Latin American sovereigns, with their trade surpluses and large foreign exchange reserves, are generally better insulated against the dearth of financial flows that may be in store if the global economy declines more sharply," said Standard & Poor's credit analyst Moritz Kraemer.

This broad trend is underlined by Standard & Poor's liquidity vulnerability index (LVI), a measure of vulnerability calculated for 40 sovereigns. This shows that almost all of the most vulnerable countries are European, with only Lebanon and South Africa joining the group from beyond this region.

Iceland, an "honorary" member of the emerging market (EM) sovereigns for its strong correlation with general EM market conditions, tops the list of the most vulnerable, followed by Romania, Lebanon, and Turkey.

Chile is the least vulnerable owing to its robust external and government balance sheet.

Second-best protected is China, followed by oil exporters Venezuela, Trinidad and Tobago, and Nigeria. Fellow oil exporter Russia is the only European emerging sovereign that managed to squeeze into the sheltered group.

Sovereign downgrades and negative outlook actions have been concentrated among these most vulnerable sovereigns, whereas the least affected generally had positive rating actions, the report says. Domestic political issues were the usual cause for the exceptions to this pattern.

"Sovereign rating actions in emerging markets have therefore been timely in indicating the
increasing risks for sovereigns with shaky credit fundamentals as previously benign credit
conditions have evaporated," said Kraemer.

This article will appear in a special issue of Standard & Poor's CreditWeek titled, Beyond BRIC-2008.