Making debt ratings count
A QUESTION OF BUSINESS By P. GUNASEGARAN
S&P’s negative outlook on US bonds may help make rating agencies a wee bit more relevant
Reuters: In this Feb. 14 photo, The National Debt Clock hangs from a building near Times Square in New York.
IS it “better late than never” or “too quick to jump the gun?” That depends, of course, on whom you talk to.
US president Barack Obama will say it is the latter but quite a number of people in the finance industry believe that rating agency Standard and Poor’s negative outlook on US long-term sovereign bonds should have been proclaimed at the start of the world financial crisis in 2008/9.
The US, along with a number of developed countries around the world such as the UK, Australia, Japan, Germany and neighbour Singapore hold an AAA rating for their sovereign long-term bonds.
That simply implies that these countries are the least likely to default on their debts in comparison to other countries.
The US has had its highest rating continuously from the forties. Since the US dollar emerged as the dominant reserve currency – one in which other countries keep their surplus assets – it has a major advantage over most other countries. Its (USA) external debts are in its own currency.
That means that there is hardly any likelihood of default because if the US economy and US government finances are in deep trouble, then all the US government has to do is to put in place measures which will increase the supply of US dollars – printing money to repay its debts. That has other undesirable consequences of course but that’s another story.
For developing countries and even developed countries it is often the case that their external debt is denominated in US dollars or some other reserve currency such as yen or euros and they must earn foreign exchange (that is a surplus of exports to imports of goods, services and capital) to eventually repay these debts. They can’t resort to the printing presses.
When they are in danger of default, the standard prescription is bone-crunching austerity and a steep currency depreciation to make exports more competitive and imports prohibitively expensive so that there is a surplus of reserve funds to repay debts.
Currency depreciation increases the amount of debt in terms of the base currency and therefore such a prescription often leads to prolonged hardship for these countries, as we saw during the Asian financial crisis of 1998. This crippled growth in many Asian countries for years afterwards and resulted in a relative drop in living standards.
So, why does S&P put a negative rating outlook on US long-term bonds when there is little or perhaps, no risk that the US government cannot repay its US dollar debt? That’s a question that is difficult to answer.
Using, S&P’s own definition, “a credit rating is Standard & Poor’s opinion on the general creditworthiness of an obligor.” Its hard to see how such a definition alters anything in terms of the US, even if S&P is now tying its rating to how the US solves its budget deficit problems, unless it is expanding “creditworthiness” to include more than just ability to repay.
For those countries who have substantial US dollar assets in the form of US bonds, bills and other assets, the S&P ratings have hardly mattered at all because all of them know that the US will pay its US dollar obligations and they don’t need the rating agencies to tell them that.
For them they have to make a crucial call on returns – essentially, how much earnings the assets bring in and how the US dollar moves relative to their base currencies.
If the US’ financial position is poor, that will eventually be reflected in the value of its currency. If the US dollar falls like how some Asian currencies did in 1998 and the aftermath, the ratings by agencies such as S&P will count for nought.
Perhaps, that is what is persuading S&P to extend the scope of “general creditworthiness” to something beyond the mere ability to repay a debt. That cannot be a bad thing and one hopes more credit rating agencies will follow suit and show the courage of their convictions and thereby make themselves a wee bit more relevant.
● Managing editor P Gunasegaram thinks that the world is far from making the adjustments needed to prevent a recurrence of the ongoing world financial crisis.