The Next to Notch an Upgrade?

Getting moved up -- or down -- in the sovereign-rating hierarchy can have a profound impact on stock and bond markets in developing countries. These days, there is a distinct divide within emerging markets. Some are winning kudos for their economic policies and seem ready to leap up the ladder of credit quality. Others appear increasingly vulnerable to the effects of the credit crunch and may be poised for a slide. Last month, Brazil vaulted into the ranks of countries whose external debt is considered "investment grade," a momentous occasion for a country that less than a decade ago was gripped by financial crisis. Although the move was anticipated, it sent Brazilian shares to an all time-high. The next country in line to receive an upgrade on its sovereign rating could be Peru. "That's the one that everybody is focused on," says Joyce Chang, global head of emerging-markets strategy at J.P. Morgan Chase. Fitch Ratings has already judged Peru's external debt to be investment grade, but its larger counterparts, Standard & Poor's and Moody's Investors Service, have yet to follow suit. An S&P analyst said in April it may upgrade Peru to investment-grade status later this year. Clinching that status carries a host of benefits, because some institutional investors have restrictions on how much they can allocate to places that aren't considered investment grade. Propelled by exports of raw materials, Peru's economy is expected to grow 7% this year, according to the International Monetary Fund, compared with a little over 4% for Latin America as a whole. In recent years Peru has greatly reduced its overall level of debt and now depends only modestly on financing from overseas. "It's a little country that's working like a clock," says Guillermo Mondino, head of emerging-markets research at Lehman Brothers. Russia is another country that could merit a positive change in status, say some investors. "Their fundamentals are so strong, and they've been so prudent with fiscal policy, that economically they should be upgraded," says Thomas Cooper, who helps manage $6 billion in emerging-market debt at GMO LLC. Russia's external debt is already investment grade, but ratings agencies are reviewing the possibility of moving it a notch higher, potentially to a coveted A rating. By contrast, as the credit crunch has intensified this year, ratings agencies have alerted a host of countries that their sovereign-credit quality is at risk of slipping. In the past two months, S&P has added Kazakhstan, Turkey, Hungary and Romania to the list. All four are affected in varying degrees by tighter borrowing conditions worldwide, because their governments or banks depend on overseas financing. "The global credit squeeze is more severe, and likely to prove more prolonged, than anticipated," S&P noted late last month in its warning on Kazakhstan's rating. Another country that risks a downgrade: Argentina. It is struggling with accelerating inflation and recently faced a series of protests by farmers. The resignation of the country's economy minister after just five months on the job is part of an ongoing struggle over economic policy. The minister's departure prompted S&P to change its outlook on the country's sovereign rating to negative from stable. "The instability there has picked up quite significantly," says Mr. Mondino of