Getting ratings wrong

By bne IntelliNews July 23, 2010

bne -

The "global crisis" that governments are struggling to contain is a misnomer. It is not global at all, but regional; specifically, it is a crisis of the developed world.

The traditional economic powerhouses such as the UK and US are in deep trouble, burdened with massive debts they can't pay back because of their huge deficits. Most developed nations have financial problems more typical of those in emerging markets. So why do they still enjoy triple-A credit ratings - the best score on offer from the international ratings agencies? The 'AAA' rating means these government bonds are the safest investments in the world, when they quite clearly are not.

The short answer is that the ratings are wrong. Two recent surveys have challenged the status quo and concluded that if the US and UK and sovereign ratings were judged on macroeconomic merits alone, both would receive massive downgrades: the US' "fair" rating is 'AA' and the UK's 'AA-', according to the new privately owned Chinese rating agency Dagong Global Credit Rating and Austrian bank Raiffeisen International.

On the flip side, the ratings of the fast growing Chinese economy should leapfrog that of the US to a rating of 'AA+', above that currently from Fitch Ratings, Standard & Poor's and Moody's Investors Service, who rate China 'AA-', 'A+' and 'A1' respectively.

Indeed, the Dagong rating makes much more intuitive sense than those of the major western rating agencies; Dagong rates Norway as the best credit risk in the world (thanks to its massive currency reserves from its oil and gas industry), followed by the staples of prudence and stability Denmark, Luxembourg, Switzerland and Singapore - the only countries to score the sought after 'AAA' ratings.

Russia would also receive a two to three-notch promotion to 'A' from its current 'Baa1/BBB/BBB', which it would share with EU members Poland and Spain, and slightly ahead of fellow "Bric" member Brazil.

Not enough credit

The new ratings from Dagong, which was released for the first time in July, follows a similar study in March by Ingo Jungwirth, a fixed-income analyst at Raiffeisen. Jungwirth found that over the last few years a country's sovereign rating has less and less to do with the state of its economy, and since the crisis the link had all but disappeared. "On the basis of our model, the 'AAA' rating for the US and the United Kingdom cannot be explained, as these two countries are rated two to three rating notches better than countries with comparable fundamental data," concluded Jungwirth, adding that both the US and UK should have a rating of 'AA'.

Both Dagong and Raiffeisen conclude that China and Russia aren't being given enough credit for their low debt levels and massive reserves. China is the richest country in the world with over $2.4 trillion in cash, while Russia is the third richest with about $440bn in cash (and Norway is fourth) This compares with the $89bn and $80bn respectively that the US and UK had in reserves at the start of this year. The two emerging market economies also do better in terms of external debt and budget deficits than their developed world peers. This robust fiscal health means neither Russia nor China is likely to default on their debt, while the currency risks associated with the US and UK are clearly increasing from their dodgy fiscal situation.

So how is it that the US and UK continue to enjoy the best possible credit ratings? "Obviously, the agencies take into consideration other factors [than economics], such as the systemic relevance of the US and the status of the US dollar as a reserve currency," says Jungwirth.

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