Fitch Downgrades Bulgaria, Romania Ratings

"The long-term foreign currency Issuer Default Ratings (IDR) of Bulgaria and Kazakhstan are downgraded to 'BBB-' (BBB minus) from 'BBB', with stable and negative outlooks respectively," Fitch said in a statement. "Romania's long-term foreign currency IDR is downgraded to 'BB+' from 'BBB' with negative outlook, as the risk of a severe economic and financial crisis increases."

The downgrade of Bulgaria reflects the increasing risk of a recession in response to a marked decline in external financing flows, which will necessitate a sharp contraction in domestic demand to rein in the current account deficit.

However, given the strong sovereign balance sheet - large fiscal reserves mean that government net financial liabilities are virtually zero - and the broad-based commitment to the currency board arrangement, Fitch believes the risk of recession broadening into a deeper economic and financial crisis over the medium-term is limited and consistent with a stable outlook.

The two-notch downgrade of Romania reflects Fitch's concerns about the macroeconomic policy framework in Romania and its ability to avoid a severe economic and financial crisis.

With a widening current account deficit - expected to exceed 14% of GDP this year - fuelled by excessive credit growth, Fitch believes a much stronger policy adjustment, especially in fiscal policy, is needed to avoid a currency crisis.

"Given private sector foreign currency balance sheet mismatches, such an outcome could require substantial external financial support from the international community to prevent a sovereign credit crisis. The rating outlook is negative."

Emerging Europe is the most vulnerable emerging market region to the deterioration in the global financial and economic environment owing to the presence in many countries of large current account deficits and relatively high levels of short-term external debt, Fitch said in another statement released later on Monday.

This renders them susceptible to reduced capital and financial market flows (including from foreign parent banks). Other factors that increase the region's vulnerability are the presence of significant currency mismatches on balance sheets and their relative trade openness.