Downgrades and peacocks

The one-notch downgrade of Malta’s do­mestic and foreign bonds by rating agency Moody’s should be kept in perspective, without losing sight of the implicit warnings in the analysis that led to it.

The one-notch downgrade of Malta’s domestic and foreign bonds by rating agency Moody’s should be kept in perspective- Lino Spiteri

Downgrades are affecting a whole range of countries. In addition to the weak ones, like Greece, Ireland and Portugal, one rating agency – Standard and Poor’s – shoved the US off its hallowed AAA top rating. Fitch, yet another rating agency, is considering downgrading Japan and even China.

Rating agencies have become feared bodies. They perform a necessary market role, analysing and assessing the economic and financial strength of countries (hence sovereign debt), state institutions (like Enemalta) and corporate bodies (say the Bank of Valletta). The analyses lead to ratings, with triple A for the soundest – and so issuing the least risky debt instruments – going down in notches according to the particular agency’s rating methodology.

The lower a rating goes the more it approaches the investment grade threshold, where it is just about possible to attract investors with a high risk appetite. Below that ra-ting, one is talking about ‘junk’ bonds. The analysis takes into account the situation of the country or institution rated, and the foreseeable prospects, which are influenced by the regional and global environment.

The most practical effect of the ratings is on the borrowing rate of the rated unit. The higher the rating, the lower the rate the country or company has to pay for its borrowings, which take place all the time, if you exclude the relatively few cash and asset-rich oil producing countries.

In the eurozone the least risky borrowing is made by Germany. Its bunds (bonds) set the basis for the interest rates which have to be paid by other eurozone countries, depending on their rating, which in turn largely depends on the size of their budget deficit and public debt relative to the Gross Domestic Product measured at current market prices.

The interest rate that has to be paid is hugely relevant to the borrower as it translates into an annual servicing burden, which tends to aggravate the budget deficit. For the deficit to be reduced and (hopefully) removed to enable downsizing of the outstanding public debt of a country, it has to achieve reasonable and sustainable annual real growth rates.

Malta floats in these somewhat mysterious but highly practical waters at a respectable rating, around the single A level. There have been various movements in the rating, with accession to the EU in 2004 helping to fortify it as the outlook for the economy became positive.

What has happened this time round is that various factors converged to make Malta’s outlook negative. Forecast growth rates have not been achieved. The public debt has risen more than projected.

Worse, in Moody’s view there is the expectation that even if debt ratios stabilise in the coming years, they are likely to remain above levels commensurate with an A1 rating.

The responsibility for the failure by Malta to meet its expectations is put roundly by Moody’s to the EU and global situation. That has affected Malta, though not unduly, and there is the possibility that further financial instability and fresh economic downturn (hitting our export markets), will produce contagion – meaning it will hit us. That warning was also made less than a year ago by the International Monetary Fund.

It is important to keep the down-rating in the right perspective, since it must spur all our economic agents, all of us, to still better efforts, and not to dishearten us. But perspective has to be realistic, not permanently lit in high colours, as government spokesmen attempt to do.

For example, the reaction by the Ministry of Finance to Moody’s cut in our sovereign bond ratings (and Enemalta’s bonds, which are guaranteed by the state) was to fire salvo after salvo of excuses and to indulge in more preening than a peacock in high heat. The external environment needs to be stressed. But, according to the ministry, practically everything is going swimmingly.

It is not. In the first instance, that emerges too from Moody’s analytical comments. The rating agency, as indicated further up, recalled that the government’s bond ratings were upgraded at the time of accession to the European Monetary Union, based on an expected acceleration of growth and an improvement in the government’s balance sheet.

These benefits have not materialised as a result of the financial crisis, wrote Moody’s; government debt ratios further weakened – “negating convergence with EU peers”.

In other words, we had already been below the economic and financial standings of EU countries in the second-tier category. Our aim was, at least, to reach their standard. We did not. They too were affected by contagion, by financial instability and economic recession, in some cases more so than us. But we did not make up ground with them.

Another observation made by Moody’s relates to one-off factors that helped the budgetary situation. That is a reference to the various tax pardons given by the government in recent years, which cannot be repeated indefinitely.

There are other factors which Moody’s did not take into account. These include the irregular financing of the Parliament and City Gate projects, which are being kept out of the government’s formal expenditure. And also the various outstanding guarantees of other public sector borrowings which are not included in the public debt.

Furthermore, the state of the economy is far from desirable, with the old sector remaining under pressure, reflected in a very hard core among the unemployed and a high youth-unemployment rate, suggesting a worrying skills gap.

The cut in Malta’s rating is not the end of the world, and should not result in the government having to pay higher interest to cover its borrowing requirements. But Malta is far from being the paradise on earth government propagandists foolishly makes it out to be.