Saturday, April 30, 2011

The Murky Business of Sovereign Ratings

Feb 2011 ratings show United States and United Kingdom at Ranks 15 & 16, with India at Rank 56. Norway and Switzerland are at the top of the table (no surprise here). The surprises are Italy (30th) (Its debt is 116% of GDP! Its financial mess is well known), Spain (34th), Ireland (43rd) (which has asked for a bailout package from IMF in Nov 2010), Iceland (46th) (which went bankrupt and has twice refused to bear losses of their private banks in 2008) and Portugal (44th) being ahead of India. Greece is the only one out of the so-called PIIG countries that is below India (65th). One can quarrel with these ratings, but I suspect that won't help much. More ...
Euromoney, in its country risk ratings, says that it takes the following factors in to account:
Political Risk (30%)
Economic Performance/ Projections (30%)
Structural Assessment (10%)
Debt indicators (10%)
Credit Ratings (10%)
Access to Capital markets (10%)
Access to Bank Finance (?)

All this sounds very nice and objective. But the result looks completely wonky, especially in the way India is rated.

Rating Agencies are not clean!
Former Managing Director Jerome Fons, who worked at Moody's until August of 2007, says Moody's was focused on "maxmizing revenues," leading it to make the firm more "issuer friendly."

Moody's was sued by shareholders claiming false ratings. It has been shown with believable internal emails as evidence, that the big 3 ratings agencies - S&P, Moody's and Fitch - kept companies' credit ratings high for years after they should have been slashed due to inadequate capital, overstated assets, over-exposure to derivatives and other risky investments, and other chronic problems.

Mr. Alan Greenspan said in a TV interview, “What we have created in this world is an aura around the credit rating agencies about certification from them is the Good Housekeeping seal of approval ... I will tell you the record of a lot of the forecasters of ratings have not been distinguished. They never were.

In 2009, rather than re-rate the countries involved, Moody's created 3 subcategories of AAA sovereign debt, with the highest subcategory - "resistant" - being reserved for Germany, France, Canada and the four Scandinavian countries. The U.S. and UK were placed a notch down in the "resilient" category. Ireland and Spain were in the worst - "vulnerable" – group. Ireland has in Nov 2010 applied for a ₤77 Bn bailout package – a country whose debt was, till last year, rated AAA albeit in the "vulnerable" category. Barely 5 months later, an ex-IMF Deputy Director has predicted that Ireland will need a second bailout in 2013 by which time the current bailout money will be used up. India's debt is certainly more investment-worthy, yet India languishes in the barely investment-grade. Especially when one understands that Ireland has gone to the IMF, cap in hand, for a bailout while India's economy has robust economic and liquidity parameters; and its economic clout is being recognized all over the world.

It is well-known that the US overspent at home, fuelled by demand for its currency as a reserve currency. In effect, the world subsidised the US overspending by interest-free loans. Another way of looking at the US policy was that it "exported inflation" to the whole world. This is reflected in Dagong, the Chinese rating agency's 2011 report on Global Sovereign Rating Outlook.

Both, the Euro and the Dollar are on the way down, but look reasonably good with reference to each other. It is only when one compares them both with, say, the Swiss franc that the truth is out – both are hurtling downward. Now, slowly, the rating companies are getting confident of overcoming pressure and righting the imbalance – S&P has recently downgraded the long-term outlook for US sovereign debt. Just a week later, Ben Bernanke publicly warned that the US deficit is 'not sustainable'.

Also, Moody's has warned the US Government, along with UK, Germany and France, about their sovereign ratings. The US ratio of interest to revenue has touched 17% - very high for an AAA country, according to Moody's.

What's more, at the recent BRICS summit at Sanya, the 5 nations jointly announced their decision to refuse mutual payments in US dollars. They pledged to henceforth give credits to one another in their national currencies. Moreover, their development banks have signed an agreement to further gradually withdraw from loans in American dollars. This is another ominous sign that the future G-20 summits will become tougher for US and European countries in that Group; besides being bad news for external demand for the US Dollar – these 5 countries hold 40% of the world's currency reserves; and if they are set to wean themselves away from holding US dollar reserves, it cannot be good news for the US Government's ability to finance their deficit by issue of sovereign debt.

The world, in the meanwhile, is not waiting for the Big 3 to recognize the truth and reflect it in their ratings. Dagong, the Chinese rating agency referred to above, quite some time back, downgraded the local and foreign currency long term sovereign credit rating of the United States of America (hereinafter referred to as “United States” ) from “AA” to “A+“, which reflects its deteriorating debt repayment capability and drastic decline of the government’s intention of debt repayment. The report says that "The U.S. credit rating systems lack of institutional guarantees to reveal credit risk cannot provide reliable credit risk information to the public". It also observed in its 2011 Sovereign Credit Rating Outlook that "The basic layout of worldwide system of sovereign credit and debt is mainly comprised of the debt system of the developed countries and the credit system of the emerging countries". It charged the US, the world's largest debtor country, of using the US Dollar to distribute the output of debt, and waging a global credit warfare. It blamed the quantitative easing policy, and the resultant continuous devaluation caused by excess issuance of US dollars eroded the legitimacy of the global monetary system that takes the US dollar as the key reserve currency, bringing the US dollar’s credit-worthiness to a vulnerable position. So, whether they wanted it or not, the yuan has strengthened from about 8.48 to 6.50 to the dollar in the past one year. This means that in yuan terms, China's US Dollar holdings are down nearly 24%. If the US were to repay today all the US debt that China holds, it would effectively get a discount of 24%. And yet, in remarkable instances of doublespeak, US still accuses China of being a currency manipulator!

Complete Data on Country Sovereign Ratings by various agencies is available here and here for download.

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