International property folk-should they care about Sovereign Debt?

February 7, 2012

When I wrote my recent “City Property Guide”, I included Sovereign credit scores for the first time. It made me think, isn’t it odd how we have come to consider a nation’s credit worthiness now as a factor in determining if a country is suitable to invest in?

But it never used to play a role, so why is it important now?

Turkey_VillaWell we tend to consider a range of factors as part of an investment decision and among these are the stability and risk of a given country. Is the country prospering, growing, attracting industry and got a sound balance sheet to increase its wealth on the world stage?

Social and Political stability

We have seen civil unrest in countries in Europe where austerity measures have been implemented most harshly due to sovereign over-indebtedness, adding to the unemployment burden. Greece, Spain, France and Italy, deemed at risk of late, have all suffered. And the UK has seen its fair share of unrest (although it depends whether you consider the 2011 riots to have been as part of the backlash against austerity, or society or the police). McKinsey reckon that 40 million jobs are needed in the developed economies to ease the jobs crisis.

This unrest in itself causes a level of instability, which not many investors actively seek out, as part of their investment criteria. Social unrest coupled with market pressure, led to the political change experienced by the likes of Silvio Berlusconi in Italy and George Papandreou in Greece

Economic stability

A country’s ability to honour its debt and function as a nation is important. The country’s wealth is a contributor on a number of levels, to employment rates, how well maintained the country’s infrastructure is, attractiveness as a base for multi-national corporations which provide employment, boosting parts of the economy.

A nation’s poor ability to pay, or poor prospects of paying, is reflected in the interest rates charged for sovereign debt. The higher that goes the more difficult it is to pay off that debt and a nation can enter a downward vicious spiral of financial uncertainty and domestic unrest.

Domestic Banks

We have seen how sovereign debt is important. When it comes to bank debt, banks have become intertwined with cross-border assets, liabilities and interests. Banks lend to governments as well as businesses and individuals. Likewise when banks have come under pressure, governments have been obliged to offer a financial helping hand, witness RBS’ £425bn government bailout, Lloyds’ merger with HBOS ultimately requiring £17bn taxpayer’s money and the nationalisation of Northern Rock.

Banks, like governments, are being required to rebalance their Balance Sheets. There are 2 ways of doing this, by raising capital or limiting the amount of lending to house buyers, among others. (It turns out some banks might have discovered a 3rd way by recalculating risk-weightings, the likelihood of default of assigned loans, which allows banks to boost capital ratios without cutting lending). The point is that if people can’t get mortgages, or they are in strict supply, that prevents many people buying, impedes the liquidity of the property market, so making it harder to buy or sell a property.

When it comes to property investment, it is not only social, political and economic stability that count, but also access to finance. If banks are in a poor position to lend, property buyers cannot get secured loans easily to fulfil their investment aspirations.

Currency exchange

Fears over sovereign debt not being paid, unsettle financial markets. As financial investors seek to put their money in “safe haven” countries which offer stability and decent returns, this in turn contributes to strengthening that country’s currency. This currency dynamic impacts investors who hold property or other assets across national borders, as well as expatriates drawing UK pensions or savings, not to mention companies and governments.

Sovereign debt is a linked web of connections

Would you want to be investing in a country that can’t pay its debts, which in turn fosters social unrest which might affect your property investment? Some people have a stronger appetite for risk and are willing to take that punt, on the basis that in the long term their investments will have appreciated. Not many though have the stomach for that level of risk. Most people want to minimise the risk of and protect their hard earned cash.

How to mitigate these risks?

  • If you are risk-averse, you might be more comfortable buying closer to home, in countries that have not suffered a severe downturn
  • Have a  number of options for raising finance, so that you are not left high and dry, if you find a property you want to buy, but finance falls through
  • Talk things through with an someone else with experience on overseas property buying to establish how enduring such risks might be

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