Crisis-hit Europe dominates rating losers

Credit rating downgrades have menaced western industrial economies since the global financial crisis first erupted almost six years ago. Across much of the rest of the world, the trend is in the opposite direction.

Countries in Latin America and fast-developing regions of Asia top the list of rating upgrades since the start of 2007 compiled by the Financial Times. At the bottom is crisis-hit southern Europe, including Greece, whose creditors last year faced steep losses under the country’s debt restructuring.

The shifts in the global credit ratings map shown by the FT’s analysis highlight how – unlike previous financial crises since the second world war – much of the damage wrought by volatile banking or financial systems and weak public finances has been focused on advanced western economies, especially in Europe.

Although emerging markets are still far from breaking into the exclusive – but shrinking – club of “triple A” rated nations, the changes are creating alternative opportunities for investors looking for higher returns without necessarily increased risk. They are also raising questions about what exactly is a “safe” asset in an uncertain world.

Triple A trouble

Pool of outstanding debt rated triple A by all three agencies

The role played by the big three credit rating agencies – Fitch Ratings, Moody’s and Standard & Poor’s – during the crisis years is controversial.

They are blamed for misjudging the safety of financial products which ultimately proved toxic for banks and investors. But their gauges of sovereign default risks remain closely watched benchmarks, and the agencies are adapting to the new global world economic order.

“In the past, we had advanced industrial country analysts and emerging market analysts – it was almost a different set of skills. All that has gone out of the window,” says Bart Oosterveld, head of sovereign ratings at Moody’s.

“In 2008 our methodology was based on 15-20 years of default experience – but all of the defaults had been in emerging markets. Clearly we have had to let go of the assumption that it was simply impossible for an advanced country to default on its own currency – as Greece did.”

Emerging market debt emerged as a distinct, standardised asset class in the 1990s after the “Brady plan”, named after Nicholas Brady, former US Treasury secretary, rescued Latin America from its debt crises. Since January 2007, Latin American countries have shown the biggest improvements in their credit rating – led by Uruguay, followed by Bolivia and Brazil.

Emerging market upgrades “are happening because of good policies pursued persistently over time”, says John Chambers, chairman of S&P’s sovereign ratings committee.

Mr Oosterveld adds: “It is fiscal positions, growth prospects and, particularly in Latin America, it is the reduction in the vulnerabilities that led to defaults in the past.”

Another factor has been the trend towards free-floating currencies, argues Jonathan Kelly, emerging market portfolio manager with Fidelity Investments in Boston. “The move from fixed to flexible exchange rates has eliminated some of the big currency blow-ups that we used to see in the emerging market world.”

Credit re-ratings are altering investment patterns, especially as central bank action in the western world continues to keep down yields on sovereign debt, which move inversely with prices. “One of the problems for Spain, Italy and other eurozone periphery countries has been that so much money has been flowing into emerging markets that would previously have flowed into Spain and Italy,” says Mr Kelly. “The more there has been a move to safety, the more money has come into emerging markets.”

But while emerging markets have improved their standing significantly, the credit hierarchy remains dominated by the advanced world. “The numbers breaking into the double A and triple A categories have been few and far between,” points out David Riley, global head of sovereign ratings at Fitch. Agencies are wary about upgrading countries overdependent on a single source of growth, commodity markets or footloose capital inflows.

Mr Riley says: “Our criteria give a lot of weight to higher income, mature, diversified economies and less to economic dynamism and growth. If these kinds of weights remain the same, then the new triple A nations are more likely to be countries that have lost their triple A status but win it back – and historically that has taken quite some time.”

Even where countries have broken into the higher ranks – Saudi Arabia and Qatar now have better credit ratings than Italy or Spain – established European debt markets will remain more attractive to many investors because of their depth, liquidity and legal systems.

Also striking has been China’s credit rating upgrades – it now ranks among double A minus-rated nations – which, as the country challenges the US for economic supremacy, could led to a debate about whether the country might obtain triple A status. The rating agencies deny any deliberate bias towards western democracies, but point out that political and legal systems are taken into account.

To secure a triple A, says Mr Riley: “You don’t have to have a western liberal democracy to get triple A but the current level of economic development and transparency in China for example would be a constraint.”