OREANDA-NEWS. Rating headroom for EMEA corporates will be tight in 2016 as the emerging market slowdown, low commodity prices and an active M&A market limit any improvement in companies' financial flexibility, Fitch Ratings says.

Rating headroom measures how much breathing space companies have before they reach their tightest quantitative downgrade guidelines. The measure improved to 5.1% in 2015 from just 3% in 2014, largely driven by a spate of downgrades in 2015, which increase headroom because the new downgrade guidelines are rebased at the lower rating level. We expect only a gradual rise to 7.5% in 2016 and 10.3% in 2017 as slowly improving economic conditions for developed European economies help to lift companies' cash generation and debt capacity.

While our base case is for modest improvement, risks are weighted to the downside. For example, we expect M&A activity to be brisk, but measured and focussed on strategic assets. However, a sharper-than-expected rise in debt-funded acquisitions could rapidly erode rating headroom.

Looking at individual sectors, oil and gas producers and miners saw their rating headroom and debt capacity eroded by low commodity prices in 2014 and 2015. However, the consumer and health care sector turned a corner and is seeing steady improvements as economic conditions slowly improve.

The relatively cyclical industrials sector is expected to show a sharp improvement of 9.1 percentage points in 2016 rating headroom, led by the automotive industry where rising car sales and cost-saving measures will strengthen key metrics. Aerospace and defence companies should contribute to the sector's improving headroom, but building materials companies will face negative headroom until 2017 as deleveraging has been delayed by frequent M&A activity.