Sovereign debt worries cloud "fragile" recovery: Fitch

Fitch Ratings today said in a newly-launched global report that credit ratings are stabilising across most sectors, with the notable exception of high-grade sovereigns and structured finance.

"Fitch's rating outlooks have been stabilising across most asset classes since the third quarter of 2009," says Monica Insoll, managing director in Fitch's Credit Market Research group. "However, the economic recovery supporting the stabilisation of ratings is fragile and has not yet reached a self-sustaining phase."

"High-grade sovereign credit profiles remain under pressure following the extraordinary intervention and support for the financial sector, as well as fiscal stimulus packages," says David Riley, group managing director at Fitch for Sovereign Ratings. "However, the deterioration in public finances primarily reflects the severity of the global recession, which has hit "tax-rich" sectors such as finance and housing especially hard, and driven up welfare spending."

Sovereign issues are overshadowing credit markets in asset classes such as financial institutions and structured finance. In contrast, the direct risk to corporate ratings of a modest sovereign downgrade in high-grade countries is considered limited, as most corporate ratings have no direct linkage to the sovereign. However, corporate credit profiles will be at risk if economic growth is dampened as a result of fiscal tightening by countries needing to avoid a further deterioration of state finances.

The report, Credit Outlook - Sovereign Debt Worries Cloud Fragile Economic Recovery, highlights that across Fitch's rated universe, the developed market base-case assumption is for a slow and anaemic recovery. As such, the single most significant risk to ratings is a "double-dip" recession. This could be triggered by the upcoming fiscal tightening cycle which will be the greatest in history. However, Fitch expects its effect on growth to be delayed due to lags in the economy.

Other important credit risks include refinancing challenges, particularly affecting HY issuers and European CMBS transactions, but also banks and increasingly high-grade sovereigns. Furthermore, banks face significant regulatory challenges, which will potentially impact many aspects of the sector's business as well as individual financial profiles.

Asset quality is also of broad concern with housing and commercial property values remaining weak in many developed markets, while the risk of new asset bubbles is increasing in Asia, especially in China.