This has been a rough year on the road to recovery for the global economy. Abnormal weather has led to higher food prices, persistent demand has pushed up energy prices, the U.S. economy remains in a jobless malaise, the Arab and Mideast world has been rocked by citizen unrest, and Europe continues to struggle mightily with sovereign debt and fiscal policy issues.

TUTORIAL: Bond Basics

With that backdrop, it is not surprising that there have been a spate of sovereign downgrades so far this year. While no country has yet defaulted, the risk is arguably as high as it can get without an actual default, and that has ramped up investor anxiety and borrowing costs.

For purposes of convenience for this analysis, only Standard & Poor's ratings actions have been included.

1. A Rough Situation Made Worse in Japan
Japan started the year with sufficient problems just from its own economic situation. S&P downgraded Japan's sovereign rating in January (the first time in nine years) largely on the basis of Japan's huge debt, struggling economy, and decided lack of leadership in addressing either problem. While most of Japan's debt is internally-owned, it is nevertheless a significant economic deadweight. (For related reading, see How The Japanese Crisis Affects The U.S.)

Matters got even worse in March in the wake of a massive earthquake and tsunami that devastated the Tohoku region and prompted a nuclear emergency. In the wake of this disaster, S&P lowered its credit outlook to negative in April (not the same as a downgrade).

Not only is Japan going to have to finance a massive rebuilding effort that will measure in the hundreds of billions of dollars, but this is on top of an already huge amount of debt; while much is made of the U.S. debt problem, Japan's ratio of debt to GDP is the highest in the world and double that of Singapore (the next-highest country that could be reasonably viewed as "healthy"). Making matters worse are the long-term problems of weak consumer spending and an aging society that is generally opposed to immigration. (The earthquake and tsunami that struck Japan on March 11 was a terrible tragedy that killed thousands. For more, see Why The Yen Is So Strong.)

2. Ireland Battered by Its Banks
As a charter member of the infamous PIIGS group (Portugal, Italy, Ireland, Greece and Spain) of sovereign debt problem children, Ireland's downgrade in February was not especially surprising. Ireland continues to struggle with unemployment, weaker exports and a broken banking system that the country has struggled to recapitalize. In point of fact, this recapitalization issue has turned into a bone of contention - representatives of the Irish government complained about the S&P downgrade at the time and stated their belief that the S&P's estimates for how much capital the banks would need was too high.

3. Portugal Teeters at the Edge of Junk
With a downgrade in late March, Portugal's sovereign rating now teeters just one notch above junk bond status. Portugal was the third country (after Greece and Ireland) in the Eurozone to get a bailout, and the situation here is a little different. True, Portugal did gorge on cheap debt and fiscal spending got out of hand, but Portugal's growth had been holding up a little better before late 2010 to early 2011. Unfortunately, Portugal's growth has trailed most of the EU in the past decade and these deficiencies have now caught up to the country and its credit rating. Making matters worse, there has been a lot of political and popular pushback against austerity measures and it is unclear whether the country's citizens are willing to commit to the sort of long-term fiscal austerity that may be necessary to fix the company's image in the debt markets. (For related reading, see How Eurozone Debt Benefits Americans.)

4. Greece - the Granddaddy of the Sovereign Debt Crisis
Greece was really the straw that broke the sovereign debt market's back, and conditions have really not improved. The austerity measures already taken by the Greek government have slowed the economy even more and made the situation worse in many respects. On top of that, the Greek people do not seem terribly inclined to suffer a prolonged decline in their standard of living so that bankers in France and Germany can come out ok on their debt holdings.

S&P ratings actions have left Greece with a sovereign rating of CCC and a negative outlook. That is the worst rating in all of the world; below the likes of Ecuador, Pakistan, Senegal and Uganda (Zimbabwe isn't rated). Moreover, the general expectation now seems to be that default in Greece is a "when" and "how much" question as opposed to an "if" question. (For related reading, see Greece: The Worst-Case Scenario.)

5. The Arab Spring Comes At a Cost
Political turbulence is one of the biggest fears of foreign bond investors, and the Arab/Mideast world has provided that in spades. While it is hard to argue that the toppling of governments in Egypt and Tunisia was not morally right, the ongoing problems around the region have impacted the economies and the outlook for prompt repayment of debt. As a consequence, countries including Bahrain, Tunisia and Libya have all seen S&P cut their ratings from A- all the way down to BB (junk territory) for Libya and close to junk for Bahrain and Tunisia.

The Bottom Line
Downgrades are not unusual and it is not surprising to some economies face these ratings actions in any given year. What is more unusual, though, is the regional concentration of these moves and the extent of the downgrades. All in all, it has made the sovereign debt world a riskier place and has led to real concerns about the durability of the global economy. With riots and squabbling still distressingly common in many countries, investors should expect a summer of volatility to continue on into the fall and beyond. (For related reading, see The Risk Of Sovereign Bonds.)

Related Articles
  1. Stock Analysis

    The Biggest Risks of Investing in Berkshire Hathaway Stock

    Learn about the risks of investing in Berkshire Hathaway. Understand how issues of succession, credit downgrade risk and increased regulation could hurt it.
  2. Stock Analysis

    Who Are Delta Airlines’ Main Competitors?

    Compare the top competitors of Delta Air Lines, Inc. Take a deeper look into the key drivers of competition in the airline industry.
  3. Investing

    Impact Investing Funds: What are the Risks?

    Impact investing funds can carry risks unique to this asset class, including political risk, currency risk and exit risk.
  4. Mutual Funds & ETFs

    Top 3 German Bonds ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and private bonds issued by Germany with different duration yields.
  5. Investing

    China's Top Trading Partners

    A slowdown in China, the largest trading nation in the world, will have significant impacts on major trading partners: the U.S., Hong Kong, and Japan.
  6. Economics

    A Long Road to Full Diplomatic Relations with Cuba

    Over the past 50 years, the U.S. and Cuba have remained at odds, only recently to restore diplomatic ties. What does this mean?
  7. Economics

    Looking to Invest In Ukraine? Here is How

    We examine a number of ways to invest in Ukraine, including ETFs, managed funds, corporate investments, and Eurobonds.
  8. Economics

    The 5 Countries That Produce the Most Solar Energy

    Discover which countries are taking advantage of solar power and how they are implementing systems to use solar as a viable source of energy.
  9. Markets

    Is Another Bear Market Ahead?

    With market volatility recently reaching its highest level, investors are questioning what the outlook is for U.S. stocks in 2015 and beyond.
  10. Economics

    How US Interest Rates Move the World Economy

    Because the US has the world's largest economy, fluctuations in America's interest rates affect much more than domestic growth
  1. Are high yield bonds a good investment?

    Bonds are rated according to their risk of default by independent credit rating agencies such as Moody's, Standard & ... Read Full Answer >>
  2. Is Japan an emerging market economy?

    Japan is not an emerging market economy. Emerging market economies are characterized by low per capita incomes, poor infrastructure ... Read Full Answer >>
  3. How can I use the funds from operations to total debt ratio to assess risk?

    The funds from operations (FFO) to total debt ratio is used in fundamental analysis to determine a company's financial risk. ... Read Full Answer >>
  4. What is the difference between a greenfield investment and a regular investment?

    A greenfield investment is a particular type of investment where an international company begins a new operation in a foreign ... Read Full Answer >>
  5. How stable are municipal bonds?

    Stability is relative in the municipal bond market. Municipal bonds tend to be safer than many other types of investments, ... Read Full Answer >>
  6. What are the benefits for a company investing in a greenfield investment?

    Advantages of greenfield investments include increased control, the ability to form marketing partnerships and the avoidance ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  2. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  3. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  4. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  5. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
  6. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!