Foolish ideological foray
EDITORIAL: The madness of a Brics ‘ratings club’
The decision by the Brics nations — Brazil, Russia, India, China and SA — to establish their own credit rating agency to "better cater" for developing economies is a foolish ideological foray.
The move is premised on the mistaken belief that the three dominant agencies — Moody’s, S&P Global Ratings and Fitch Ratings — favour developed economies because they are part of the world’s Western-based financial architecture.
This week, President Jacob Zuma said the Brics nations wanted to set up the ratings agency to "further strengthen the global governance architecture".
The idea that the Brics nations need their own agency is as self-defeating as the ANC seeking to start its own newspaper. Here’s why: for investors (or readers, in the case of a newspaper) to have any confidence in ratings (or the content) the information has to be accurate. It has to chime with other information.
To determine a country’s credit-worthiness, rating agencies look at a large number of indicators, including fiscal strength (such as public debt and interest cost burdens), economic strength, the monetary regime (exchange rate flexibility, reserve currency status) and so on.
Most ratings can be explained by these factors, according to a study by the Bank for International Settlements.
However, the credibility of a Brics rating agency, founded for ideological reasons to serve political interests, would be torpedoed if it were to assign ratings at odds with readily quantifiable indicators.
Of course, perceptions that Moody’s, S&P and Fitch are biased persist because some smaller, non-US rating agencies do actually offer rankings more favourable to emerging market economies.
But research shows this more "generous view" is not shared by the markets, as measured by Credit Default Swap (CDS) spreads. Nor does it find favour with asset managers, who actually make the large investment decisions. If biases exist, they are evidently widely shared.
Ability and willingness
Last week, former finance minister Trevor Manuel rubbished the idea of a Brics ratings agency, arguing that global investors will still move money based on the ratings of Moody’s, Fitch and S&P.
Now it is true that ratings are not entirely quantitative: since agencies assess both the ability and the willingness of a country to meet its debt obligations, qualitative factors related to institutional strength and the rule of law are also important — as SA is fast discovering.
Since May 1995, when Moody’s took the lead in granting SA an investment grade credit rating, it has tended to give SA’s policymakers the benefit of the doubt. For a long time, this faith was vindicated.
In 2009, however, the tide began to turn. Since then, SA has been downgraded by all three agencies as its economic prospects deteriorated. While it was Moody’s that led the others on the way up, S&P has led on the way down. This time, it is S&P that has been vindicated.
As it stands, S&P and Fitch both have SA’s foreign currency rating pegged on the bottom rung of the investment grade ladder at "BBB-". Moody’s trails, having ranked SA one notch higher.
Now this is where it gets interesting.
The CDS market shows the spread on SA’s five-year foreign currency debt is trading in line with Brazil and Turkey.
Both are ranked "BB", two rungs into junk territory. Intriguingly, this shows that the CDS market is already pricing in a two-notch rating downgrade for SA.
And yet, readily quantifiable factors suggest SA should be trading somewhere between "BBB-" and "BB+", at least one notch higher than the market thinks.
This suggests the market is pricing in a fair degree of economic policy or event risk — like Pravin Gordhan being axed. And it also implies the market doesn’t follow the rating agencies, but leads them.
This isn’t to say the market is always right. CDS spreads are far more volatile than ratings. But it shatters the myth that the three agencies are all-powerful. The market makes up its own mind, operating with a real degree of independence from the agencies.
This is why the rationale for creating a Brics rating agency is extremely weak. It could end up with as much legitimacy as a Gupta-owned newspaper.