The future of sovereign ratings

Ahead of the October 8-10 annual meetings of the World Bank and the International Monetary Fund, David Beers, Standard & Poor's global head of sovereign and international public finance ratings, answers questions about the future of sovereign credit ratings.

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Standard & Poor's now has credit ratings on 126 sovereign governments. Why do governments seek ratings from Standard & Poor's these days, and in what ways have their reasons changed from the past?
Until relatively recently, the rationale for seeking a sovereign rating was simple: credit ratings helped unlock funding in the cross-border bond markets. Nevertheless, it took quite some time for governments to become comfortable about accepting ratings across the entire credit spectrum. But once they did, our ratings expanded rapidly to the point where today Standard & Poor's rates virtually all cross-border bonds in the sovereign sector.

Over the past decade, we've also observed that governments have begun to see broader benefits from requesting credit ratings. For example, rated bonds denominated in both local and foreign currencies are now commonplace in the sovereign sector. Our ratings have also become an important element in the debt exchanges that many governments employ to emerge from default. But governments often seek sovereign ratings in pursuit of broader objectives such as fostering deeper local capital markets, attracting foreign direct investment, and supporting private-sector access to the global capital markets. Ratings, and the published research that underpins them, also play an important role in supporting greater public-sector financial transparency. As a result, even sovereigns that rarely issue cross-border debt are seeking credit ratings from Standard & Poor's. Indeed, this group of governments is now driving much of the growth in ratings in the sovereign sector.

Can you give examples of sovereigns that have been rated for reasons other than issuing cross-border debt?
The government of Chile was an early case. When the authorities requested ratings from Standard & Poor's in 1992, they told us that they were not planning any cross-border bond issuance. Indeed, Chile did not issue its first rated global bond until 10 years later, in 2002. In the meantime, the government wanted to demonstrate that its own credit standing had recovered from the Latin American financial crisis in the 1980s, when most governments in the region had restructured their cross-border bank debt. Equally important, Chile saw the sovereign rating as a benchmark that could enhance the private sector's access to capital markets and help attract foreign direct investment. Similar considerations appear to have been behind the government of Libya's request for a credit rating in 2009. Increasingly, too, the desire of governments to demonstrate financial transparency is a motivating factor, as is the case with the sovereigns we are rating in sub-Saharan Africa.

You mentioned sovereign defaults and the debt exchanges used by many sovereigns to come out of default. Have any ratings been withdrawn after a government default?
Just one (the Seychelles) thus far, and that is quite significant because in addition to the Seychelles,14 sovereigns -- Argentina, Belize, Cameroon, the Dominican Republic, Ecuador, Grenada, Indonesia, Jamaica, Pakistan, Paraguay, Russia, Suriname, Uruguay and Venezuela -- have either restructured bonds or bank loans, or did not make debt service payments on them when due, since their ratings were initially assigned. We used to think that many issuers would drop the ratings in a default situation. But we have found that most governments in financial distress realise that their credit story does not end abruptly when a default occurs.

All sovereign defaults are resolved eventually, although the process can take far longer than in a corporate bankruptcy. When sovereigns emerge from default their ratings improve, and that is something in which rated governments, as well as investors, have an interest. So, starting with Pakistan in 1999, Standard & Poor's became involved in rating the distressed debt exchanges that often resolve sovereign defaults. And we expect to be rating more governments emerging from default, from now on. About a quarter of rated sovereigns are currently rated in the 'B' category or lower, which, based on historical trends, indicates that a significant number could default in the coming years.

Standard & Poor's, along with other rating agencies, has been criticised for its sovereign rating actions during the Asian financial crisis and other periods of financial stress, and most recently because of its rating actions affecting some sovereigns in the eurozone. Has the criticism had any impact on the growth in sovereign ratings?
No, and this may come as a surprise to some people. I think the main reason is that most users of ratings, including the governments we rate, have a more nuanced understanding of the role that ratings play than do many of our critics. Market participants understand that credit risk exists because the future is uncertain, and that analysts cannot have perfect foresight. If we all knew for certain what the future holds, there would be no credit risk. As a result, occasionally there are big events with a credit impact that takes almost everyone by surprise, and the Asian financial crisis was one such event. While the story in the eurozone is still playing out, it's worth noting that we first lowered the ratings on sovereigns such as Greece and Portugal well before the market confidence crisis in the eurozone began to intensify last year.

At Standard & Poor's, we certainly learn from these episodes, and we incorporate what we learn into our credit analysis. Still, the fact is that our ratings methodology, which continues to evolve with experience, works: sovereign ratings are robust predictors of default risk. The ratings behave similarly to our corporate ratings across all rating categories, which is impressive given that we are comparing just 126 sovereigns with many thousands of rated companies. The historical rating transition and default rates are also similar. Therefore, while we cannot have perfect foresight, it is clear that sovereign ratings perform in the same way that Standard & Poor's ratings do generally, and I expect they will go on doing so even if tensions in credit markets persist. This track record, combined with our impartiality and independence, is why we believe that Standard & Poor's sovereign credit ratings and research add value in the global financial marketplace.

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