Moody’s: there’s method in its madness

Moody’s Investors Service early this week downgraded Pakistan’s local and foreign currency issuer and senior unsecured debt ratings by two notches to Caa3 from Caa1 but improved the outlook to stable from negative.

Moody’s said its decision to downgrade the ratings is driven by an assessment that Pakistan’s increasingly fragile liquidity and external position significantly raises default risks to a level consistent with a Caa3 rating.

In particular, the country’s foreign exchange reserves have fallen to extremely low levels, far lower than necessary to cover its import needs and external debt obligations over the immediate and medium term.

Significant external financing becoming available in the very near term, such as through the disbursement of the next tranches under the current IMF programme and related financing, would reduce default risk potentially to a level consistent with a higher rating.

The rating agency said its downgrade to Caa3 from Caa1 rating also applied to the backed foreign currency senior unsecured ratings for the Pakistan Global Sukuk Programme Co Ltd. The associated payment obligations are, in Moody’s view, direct obligations of the Government of Pakistan.

Pakistan is in the red zone of Moody’s obligation but is still two notches above the very bottom of obligations of “Ca and C” and has a survival chance if timely bailed out by the IMF. Obligations rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery in principal and interest.

Obligations rated C are the lowest-rated class of bonds and are typically in default, with little prospect for recovery of principal and interest.

Moody’s record from 1994 shows that for most of the years to date, Pakistan fared in B+ and B rating, except Caa rating in 2001 and 2012 to 2015, which is reasonable for an emerging market like Pakistan which is perpetually confronted with governance, fiscal and political stability pitfalls, although, many contemporary emerging markets have been consistent in maintaining ‘A’ rating.

It is worthwhile to understand the credentials of Moody’s and its country rating mechanism. Moody’s is one of the top three global rating firms. It was founded by John Moody in 1909 to produce manuals of statistics related to stocks and bonds and bond ratings. In 1975, the company was identified as a Nationally Recognized Statistical Rating Organization (NRSRO) by the US Securities and Exchange Commission.

According to Moody’s, the purpose of its ratings is to “provide investors with a simple system of gradation by which future relative credit worthiness of securities may be gauged”. To each of its ratings from Aa through Caa, Moody’s appends numerical modifiers 1, 2 and 3; the lower the number, the higher-end the rating. Aaa, Ca and C are not modified this way.

As Moody’s explains, its ratings are “not to be construed as recommendations”, nor are they intended to be a sole basis for investment decisions. In addition, its ratings don’t speak to market price, although market conditions may impact credit risk.

The company ranks the credit worthiness of borrowers using a standardized ratings scale which measures expected investor loss in the event of default. Moody’s Investors Service rates debt securities in several bond market segments.

These include government, municipal and corporate bonds; managed investments such as money market funds and fixed-income funds; financial institutions including banks and non-bank finance companies; and asset classes in structured finance. In Moody’s Investors Service’s ratings system, securities are assigned a rating from Aaa to C, with Aaa being the highest quality and C the lowest one.

Moody’s and other rating agencies have been often criticised for creating a possible conflict of interest, suggesting that rating agencies may artificially boost the rating of a given security in order to please the issuer. Also, the government often refutes and challenges the rating.

Pakistan, too, has refuted Moody’s rating. However, considering the ground realities, refuting Moody’s rating has no significance to those who matter, notably, the lenders, investors and businesses. The rating has taken its toll and has shaken the fiscal and investment dynamics of Pakistan’s fragile economy. This may well turn out to be the last wake-up call.

Copyright Business Recorder, 2023