There are three major international credit rating agencies providing investors information about bond and debt instruments and sovereign debt - Fitch, Moody’s Investor Services and Standard and Poor - which raises the question of whether they have created an oligopoly with rules that bar others (small or medium sized) from entering the market.
Prior to the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 securities regulations required funds to maintain certain ratings supplied by the rating agencies – an element that critics legitimately pointed out led to conflict of interest whereby a rating may have been intended to please an issuer, in return for higher revenues, rather than present an accurate assessment of credit and default risk.
The financial crisis of 2007-08 led to the passage of the Dodd-Frank bill by the US Congress with the objective of strengthening the regulatory powers of the Securities and Exchange Commission that included the disclosure of credit rating methodologies.
The European Union has yet to produce similar legislation though it has issued several directives for example Capital Requirements Directive 2006 that impact rating agencies, their business practices and disclosure requirements.
The question is whether after the passage of the Dodd-Frank bill any government has challenged the ratings of the big three? In September 2017 Britain’s rating, the sixth largest economy in the world, was downgraded to Aa2 from Aa1 in response to Brexit (with an associated loss of access to the large European market).
The Treasury criticised the downgrade by pointing out that a day earlier the then UK Prime Minister Theresa May had in a major speech, “set out a more ambitious vision for the UK’s future relationship with the EU.” In 2020, after the onset of Covid19, Britain was further downgraded - from Aa2 to Aa3 – placing it at the same level as Belgium and the Czech Republic.
The outcome: bank stocks and the broader market tumbled, Dow Jones Industrial Average index fell 159 points, or by 0.5 percent. The S&P 500 slipped 0.4 percent and the Nasdaq Composite lost 0.8 percent. JPMorgan Chase (JPM) shares lost 0.6 percent, Wells Fargo (WFC) declined 1.3 percent and Goldman Sachs (GS) fell 2.1 percent. There was no reported official statement on this downgrade.
Standard and Poor and then Fitch downgraded triple A rating of the United States this year, citing fiscal deterioration as debt ceiling negotiations threatened the country’s ability to pay its bills. Janet Yellen, the Treasury Secretary angrily responded to Fitch’s downgrade to AA+ from AAA last month: “Fitch’s decision is puzzling in light of economic strengthening we see in the United States.
I strongly disagree with Fitch’s decision and I believe it is entirely unwarranted….at the end of the day Fitch’s decision does not change what we already know: that Treasury securities remain the world’s pre-eminent safe and liquid asset, and that the American economy is fundamentally strong.”
On 5 October 2022, a week after Ishaq Dar took oath as the country’s finance minister, the Moody’s Investors Services downgraded Pakistan’s rating to Caa1 from B3, a rating that also applied to foreign currency unsecured ratings for the Third Pakistan International Sukuk Co Ltd and the Pakistan Global Sukuk Programme Co Ltd - associated obligations that, in Moody’s views (as well as that of other players in the market) are direct obligations of the government of Pakistan. Moody’s made the following observations: “due to the narrow revenue base, the government’s debt as a share of revenue is very high at about 600 percent in fiscal 2022.
Moody’s expects this ratio to rise further to 620-640 percent in fiscal 2023, well above the median of 320 percent for Caa-rated sovereigns, despite a more moderate debt to GDP ratio at 65-70 percent in fiscal 2023….Elevated social and political risks compound the government’s difficulty in implementing reforms, including revenue-raising measures, that would improve the country’s fiscal position and alleviate liquidity stresses…Pakistan faces risks of a balance of payments crisis, which would increase if its external payments needs are higher than currently expected, for instance, because of larger import needs, while access to external financing is more restricted.”
Dar the very next day, as he attended the Accountability Court with a prosecution no longer pursuing the case of assets well beyond means, threatened Moody’s with “befitting reply” if the agency did not reverse the downgrade and said “they have to meet me. I told them if you don’t (reverse the decision) I will give you a befitting response in our meeting next week.”
This bravado not backed by any meaningful (economically sound) counter narrative by Dar, unlike his qualified counterparts in other countries, was his last public statement on the downgrade.
Be that as it may, Moody’s assessment, dire as it certainly was, nonetheless was premised on the assumption that “Pakistan’s Extended Fund Facility (EFF) programme will remain in place and provide an avenue for financing from the IMF and other multilateral and bilateral partners in the near term.” This assumption, proved inaccurate as the ninth EFF review, scheduled for November 2022, remained pending due to Dar’s baffling recalcitrance.
Dar must be held accountable for: (i) violating economically sound seventh/eighth EFF review agreed conditions, particularly in raising current non-development expenditure from what was budgeted for the year by 21 percent in spite of cessation of all external loans due to the pending EFF review.
The rating downgrade led to a degradation of the capacity to tap the equity market by issuing sukuk/Eurobonds and instead he relied on the highly inflationary policy of increasing borrowing from the domestic market which accounts for negative 178.6 percent credit to private sector in 2022-23 compared to the year before and a consequent negative 10.3 percent growth in large scale manufacturing sector with obvious negative fallout on employment opportunities and growth; and (ii) artificially propping up the external rupee value without the necessary reserves to intervene in the market leading to a 4 billion dollar loss in remittance inflows through official channels.
The then Prime Minister, Shehbaz Sharif, was forced to interact directly with the IMF Managing Director which then led to the 29 June 2023 Stand By Arrangement (SBA), and the suspension of the EFF, though the new programme’s prior conditions included not only the reversal of Dar’s violations of EFF policies but also implementation of much harsher upfront conditions (particularly with respect to administrative measures to achieve full cost recovery in the energy sector) due to delays in implementing them till the SBA was agreed.
To conclude, the general public has paid an extremely heavy price for the faith reposed by the party leadership on Dar; his ill placed bravado in dealing with the rating agencies as well as the IMF and refusal to see the writing on the wall (that may partly be due to his lack of academic background) must be taken as a warning for all future administrations not to reappoint favourites who have repeatedly failed to deliver in the past, a list that includes the five revolving finance ministers this country has been subjected to.
Copyright Business Recorder, 2023
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