Fitch Ratings says in its latest Sovereign Review and Outlook report that the outlook for the global economy and sovereign credit is at a critical and uncertain juncture. Economic data show the global recovery is strengthening, but concerns over sovereign debt sustainability in some euro area countries and renewed market volatility raise the risk of a double-dip recession.

The global recovery has strong momentum, and Fitch's base case is that global GDP will grow 3.1% in 2010, after contracting 2.5% in 2009, helped by a rebound in world trade, a turn in the inventory cycle and accommodative fiscal and monetary policies. Emerging market (EM) economies are providing the main impetus to growth, helped by a gradual recovery in US consumption and a strong rebound in Japan. However, activity in the euro area remains sluggish. The extension of loose monetary policy should support continued expansion in 2011 - albeit at a weak pace relative to previous recoveries - despite the fiscal consolidation plans currently mapped out by major advanced countries. However, the high degree of macroeconomic uncertainty is highlighted by the presence of inflation and deflation risks, and the scope for policy misjudgements is high.

"Financial market fears about the solvency of some European governments and the future of the euro zone cast a shadow over the outlook," says Brian Coulton, Head of Global Economics at Fitch. "While not our central case, the elevation of Euro area sovereign debt fears and renewed financial market volatility has increased the risk of a double-dip recession, a scenario that would feed back adversely on bank asset quality and public debt dynamics." However, while abrupt fiscal tightening before private sector demand has gained traction may reduce growth in some economies, the announcement of credible strategies to ensure medium term public debt sustainability should help underpin confidence and set the scene for private sector-led expansion to emerge in the advanced economies from 2011.

The crisis of confidence in the euro area reflects the severity of macroeconomic imbalances within the region, scepticism over the ability of economies to adjust in the absence of exchange rate flexibility, and doubts over the strength of political commitment to the euro zone, given the initially hesitant and reluctant support given to Greece. Nonetheless, Fitch believes the risk of a break-up of the euro zone in the medium term is low.

Most emerging market economies remained resilient during the crisis, containing the impact on their sovereign balance sheets and preserving favourable growth prospects. Nevertheless, although they have outperformed advanced countries and prior expectations, emerging market growth prospects are still heavily influenced by developments in the advanced economies.

Fitch forecasts emerging market GDP growth will rebound strongly to 5.8% in 2010 and 5.6% in 2011, up from 0.9% in 2009, driven by the recovery in global trade, supportive global and domestic fiscal and monetary policy stimulus, higher commodity prices and favourable base effects. Asia is expected to set the pace, while growth will be weaker in emerging Europe, where pre-crisis imbalances were greater and trade and banking sector exposure to the euro area is material. Monetary policy that is looser for longer in developed economies will add to risks of inflation and overheating in emerging markets, unless they are willing to tolerate greater exchange rate appreciation.

Emerging market and advanced country sovereign ratings are continuing to converge. In H110, four EM countries were upgraded, including Indonesia and Lebanon, plus both Azerbaijan and Panama to investment grade, while only Jamaica was downgraded. In contrast, Greece, Portugal and Spain were downgraded.