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Scope Ratings says the legacy of the Covid-19 crisis includes much higher government debt and structurally wider budget deficits reflecting the shift in fiscal orthodoxy as governments have turned their backs on austerity, which was the default policy paradigm to differing degrees after the Global Financial Crisis.

“Structurally weakened government balance sheets are credit negative, but still highly accommodative monetary policy – particularly from the Federal Reserve, ECB, Bank of England and Bank of Japan – has been compensating by ensuring continued low rates,” says Giacomo Barisone, head of sovereign and public sector ratings at Scope. “The G4 central banks have enhanced roles as lenders of last resort.”

In Europe, important institutional reforms with the agreement on the EU Recovery Fund and joint EU debt issuance is another credit positive development brought about in response to the pandemic.

Since the Covid-19 crisis started, Scope has downgraded two sovereign issuers of the 36 credits it rates (Turkey, Belgium), while upgrading two (Lithuania, Ireland). Eight issuers globally are presently on Negative Outlook (three EU member states, five non-EU) with one on Positive Outlook (Greece).

In emerging economies, the crisis has held greater net negative consequences for sovereign risk as governments’ balance sheets have weakened without domestic central banks being able to provide commensurate monetary support.

“The good news is that the global economy has renewed momentum, supported by vaccination programmes, which have accelerated across many countries,” says Barisone. “However, vaccines are not equally available everywhere, so the economic recovery doesn’t look as sustainable in emerging economies as it may in advanced ones.”

“However, full economic normalisation remains vulnerable even in advanced economies to setbacks as segments of populations are yet to be vaccinated, virus variants present latent health-care risks and the withdrawal of extraordinary economic stimulus potentially lays bare higher unemployment and corporate insolvencies,” he says.

“Governments may have to re-introduce some restrictions to deal with possible future increases in coronavirus cases, though we do not expect a repeat of the economic disruption of 2020 as vaccinations continue and countries adapt to new ways of doing business.”

The slight upward revision to Scope’s 2021 global GDP forecast stems mostly from a revised outlook for the US (+2.2pps to 6.2%) compared with six months ago. In contrast, Scope has revised down its forecast for euro area growth by 0.9pps to 4.7% and revised down China’s by 0.6pps to 9.3%, with forecasts for the UK and Japan unchanged at 6.6% and 3.0%. The impact of the pandemic on labour markets remains comparatively benign due to government intervention, with unemployment rates averaging 8.3% in the euro area this year, 5.7% in the US and 4.6% in the UK.

Monetary policy will remain accommodative over the immediate future, even as scale-back of net asset purchases is contemplated. Scope expects policy rates in the US, euro area and Japan to remain on hold at least through 2022. The UK will likely increase its base rate to 0.25% by end-2022, with the People’s Bank of China raising its loan prime rate 10bps in 2021 and in 2022.

A central risk to Scope’s economic baseline is a further tightening of global financial conditions, in the form of higher long-term treasury yields, a significant correction in bubbly global equity markets and/or depreciation of exchange rates. “This could be a result of a more significant "taper tantrum" in which inflation returns more dramatically or for longer than currently foreseen by global central banks, forcing behind-the-curve adjustments of policy setting and signalling,” says Barisone. “This risk is evidenced as central banks start advancing projections for interest rate increases.”

Such an adverse scenario could test economies, particularly in emerging markets, which have accrued debt and are grappling with fragile recoveries.