BLACKROCK INVESTMENT INSTITUTE

COMMODITY CRUNCH BLACKROCK SOVEREIGN RISK INDEX UPDATE

JANUARY 2016

[ 2 ] B L A C K R O C K S O V E R E I G N R I S K I N D E X

Commodity crunchOur latest update of the BlackRock Sovereign Risk Index (BSRI) zeroes in on annual movers in our 50-country index and highlights a deterioration in commodities-exporting emerging markets. Try our interactive BSRI to view individual country scores, compare two countries and sort rankings by index components. Our main headlines:

} Emerging market resources exporters took a beating in 2015 as declining energy and commodity prices led to a deterioration in budget and current account balances – and pressured local currencies. Colombia (down nine notches), Brazil, Russia and Peru (all down eight) were the biggest annual decliners in the rankings.

} We have fine-tuned our methodology for scoring the external finance positions of eurozone economies. The lion’s share of eurozone countries’ debt is euro denominated. We have always viewed a portion of this debt as ‘quasi-external’ because individual members do not control the European Central Bank (ECB). We previously assigned these quasi-external debt weights based on the inverse of each nation’s perceived clout in ECB policymaking. We have now simplified this framework to two eurozone tiers: Germany, France, Italy and Spain – and the rest.

} Peripheral nations Ireland (up 13 notches in the rankings over the past year) and Spain (up six) were the major beneficiaries of this tweak to our methodology, which reduced the perceived external debt burden of both countries. See page 3 for further details on Ireland’s advance.

} Japan rose seven notches in 2015 on a narrowing of its expected budget deficit and an improved assessment of its government effectiveness under Prime Minister Shinzo Abe’s leadership. Fiscal health (bottom quintile in our index) remains Japan’s Achilles’ heel. The Abe administration’s ability to deliver structural reforms is key to reviving growth and fiscal sustainability.

Drawing on a pool of financial data, surveys and political insights, the BSRI provides investors with a framework for tracking sovereign credit risk. The index uses more than 30 quantitative measures, complemented by qualitative insights from third-party sources.

The index breaks down the data into four key categories that count toward a country’s final BSRI score and ranking: Fiscal Space (40%), Willingness to Pay (30%), External Finance Position (20%) and Financial Sector Health (10%).

} Fiscal Space includes metrics such as debt to gross domestic product (GDP), the debt’s term structure, tax revenues and dependency ratios.

} Willingness to Pay measures a government’s perceived effectiveness and stability, and factors such as perceived corruption.

} External Finance Position includes exposure to foreign currency debt and the state of the current account balance.

} Financial Sector Health gauges the banking system’s strength.

For full descriptions, see Introducing the BlackRock Sovereign Risk Index of June 2011. The BSRI’s inputs are updated at irregular intervals, meaning some changes may only reflect the timing of data releases. Small changes in scores can spur big changes in rankings, as many issuers are bunched together in the index. The BSRI is not meant to forecast the creditworthiness of countries.

Benjamin BrodskyGlobal Head of BlackRock Fixed Income Asset Allocation

Sami MesrourMember of BlackRock Multi-Asset Strategies Group

Ewen Cameron WattSenior Director, BlackRock Investment Institute

Garth FlanneryMember of BlackRock Factor-Based Strategies Group

The opinions expressed are as of January 2016 and may change as subsequent conditions vary.

F O U R T H Q U A R T E R 2 0 15 U P D AT E [ 3 ]

GREENER PASTURESIreland BSRI breakdown, 2011-2015

-1

-0.75

-0.5

-0.25

0

0.25

Dec 2015Dec 2014Dec 2013Dec 2012Dec 2011

BS

RI S

CO

RE

FinancialSector Health

ExternalFinance

Willingnessto Pay

FiscalSpace

Overall score

Source: BlackRock Investment Institute, January 2016.

MAPPING SOVEREIGN RISKBSRI country rankings by quintile, December 2015

Source: BlackRock Investment Institute, December 2015.

Click for interactive charts

1 Norway2 Singapore3 Switzerland4 Sweden5 Taiwan6 Denmark7 Germany8 New Zealand9 Canada

10 Australia

Top ten

11 Netherlands12 Finland13 United States14 South Korea15 Czech Republic16 Chile17 Austria18 United Kingdom19 Poland20 Malaysia

11-20

21 Philippines22 Israel23 Belgium24 Thailand25 Japan26 China27 Ireland28 Peru29 France30 Russia

21-30

31 Spain32 Slovakia33 Turkey34 Indonesia35 South Africa36 Colombia37 India38 Mexico39 Brazil40 Nigeria

31-40

41 Hungary42 Slovenia43 Croatia44 Italy45 Portugal46 Argentina47 Egypt48 Venezuela49 Ukraine50 Greece

Bottom ten

IRISH IMPROVEMENTIreland was the standout BSRI gainer in 2015. The country – a poster child for eurozone fiscal consolidation –registered improvements in all four key components of our index. Its overall BSRI score has steadily improved over the past four years. See the chart on the right.

Ireland’s Fiscal Space rose further in 2015, partly due to a surge in economic growth on the back of tax cuts, cheaper oil, and a falling euro boosting exports outside of the currency bloc. Projections for per-capita gross domestic product (GDP) in 2016 have risen a whopping 15% from a year ago, according to the International Monetary Fund (IMF). An improved term structure of Ireland’s debt – with a fall in the proportion of the country’s liabilities due in two years or less – also helped.

Ireland’s political and institutional stability were reflected in an improved Willingness to Pay score in 2015. Also, the tweaks to our BSRI scoring methodology for eurozone economies delivered a one-off boost to the country’s External Finance Position. Last, Ireland’s outsized banking sector is slowly returning to health, reflected in an improved Financial Sector Health score. The country’s banking system has shrunk to (a still huge) 452% of GDP from 521% a year earlier as of end-2015, IMF data show.

This lowers the contingent liabilities of the state (taxpayers picked up the tab for recapitalising the country’s banking system in the last crisis), moderating the riskiness of Ireland’s debt profile.

[ 4 ] B L A C K R O C K S O V E R E I G N R I S K I N D E X

SNAKES AND LADDERSBSRI ranking changes, 2014 vs. 2015

Norway

Singapore

Switzerland

Sweden

Taiwan

Denmark

Germany

New Zealand

Canada

Australia

Netherlands

Finland

US

South Korea

Czech Rep.

Chile

Austria

UK

Poland

Malaysia

Philippines

Israel

Belgium

Thailand

Japan

China

Ireland

Peru

France

Russia

Spain

Slovakia

Turkey

Indonesia

South Africa

Colombia

India

Mexico

Brazil

Nigeria

Hungary

Slovenia

Croatia

Italy

Portugal

Argentina

Egypt

Venezuela

Ukraine

Greece

Norway

Singapore

Switzerland

Sweden

Germany

Taiwan

Canada

Finland

Australia

Netherlands

New Zealand

Denmark

South Korea

US

Austria

Chile

Czech Rep.

Malaysia

UK

Peru

Poland

Russia

Philippines

Israel

China

Thailand

Colombia

Belgium

Slovakia

France

Brazil

Japan

Indonesia

Mexico

Turkey

India

Spain

South Africa

Croatia

Ireland

Nigeria

Hungary

Slovenia

Italy

Argentina

Portugal

Egypt

Greece

Venezuela

Ukraine

2014 2015

Developed markets Emerging markets

Source: BlackRock Investment Institute, January 2016.

UNDER PRESSUREBiggest BSRI fallers score breakdown, 2014 vs. 2015

-0.6

-0.4

-0.2

0

0.2

0.4

BS

RI S

CO

RE

Fiscal Space Willingness to Pay External Finance

Financial Sector Health Overall

2014 2015Peru

2014 2015Brazil

2014 2015Colombia

2014 2015Russia

Source: BlackRock Investment Institute, January 2016. Note: the countries displayed are the four largest decliners in BSRI rankings terms over the past 12 months.

LOSERS’ BOARDA collapse in the BSRI rankings of resources-exporting emerging markets was the dominant trend of 2015. See the chart on the left.

Colombia was the biggest loser in rankings terms. The country’s Fiscal Space and External Finance Position deteriorated as the price of its commodity exports shrunk. See the chart below. Petroleum makes up almost half of Colombia’s exports. The country’s 12-month forward budget deficit swelled to an estimated 3.6% of GDP from 2.1%, according to consensus estimates as of January.

Brazil’s economic troubles mounted. The country’s projected budget deficit swelled to 7.6% of GDP as of January from 4.1% a year ago, consensus estimates show, weighing on its Fiscal Space score. Political turmoil delivered a blow to Brazil’s Willingness to Pay score, too, as President Dilma Rousseff battled to fight off impeachment proceedings.

Russia was a notable loser, driven by a big decline in its Fiscal Space score. The collapse in oil prices and economic sanctions have dealt a heavy blow to Russia, which relies on the energy industry for almost half its fiscal revenues, official data show. Russia’s per-capita GDP shrunk 4.1% in 2015, but should grow modestly in 2016, the IMF estimated in January.

Peru completed the losers’ board. The country’s net debt-to-GDP burden rose due to declining foreign exchange reserves. An accompanying deterioration in Peru’s projected budget deficit hit its Fiscal Space score. Downward revisions to Peru’s government effectiveness by the World Bank and other BSRI contributors as well as an uptick in perceived political risk hurt the country’s Willingness To Pay score.

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