Moody’s Investors Service was with us again this week busy taking a
closer look at some of our main macroeconomic and financial indicators before
making a final decision on whether or not to downgrade us in their rating. On 8
August 2007, Moody’s Investors Service put the Baa1 for a local currency
(stable outlook) issue and Baa2 (negative outlook) for a foreign currency loan
on review for a possible downgrade because of the increased risk to the size
and maturity structure of the government debt as a result of rising domestic
interest rates. “The change in outlook
reflects the ongoing increase in the cost of servicing the domestic debt due to
the increasing debt stock over the last decade and currently high interest
rates,” said Moody's Vice President Sara Bertin. “Mauritius' high debt
levels have been exacerbated by the government's low revenue-to-GDP ratio.”
In their view, the budget deficit is still high as efforts at fiscal
consolidation have only reduced income and corporate tax rates and weakened the
revenue base while expenditure is still to be reined in. Moreover, the new
dependence of the budget on substantial EU grants money, in compensation for
sugar reform and the slow progress with
respect to pension or civil service reform were highlighted in the IMF 2007
Article IV Consultation. In their proposals on budgetary savings, they they had
explicitly recommended that Government “stop reducing corporate income tax
rates” “Of particular concern is the increasing cost of servicing the domestic
debt, which hampers the fiscal consolidation process despite better growth
prospects and rising fiscal revenues,” stated Bertin. “Over the
medium-term, we don't expect to see declines in the fiscal deficit, the debt
level, or inflationary pressures sufficient to alleviate marginally higher
credit risk, hence the downward pressure on the ratings.”
She added that the review would concentrate on medium-term fiscal
prospects, as well as how the fiscal balance might affect the external sector,
especially in the context of ongoing current accounts deficits. She believes
that economic issues in Mauritius are more sectoral than macroeconomic, and
unless sector reforms are undertaken to generate productivity improvements --
in agriculture, industry, public utilities, health, education, etc., -- the
long run growth potential will be insufficient to absorb the unemployed. Even
on the macroeconomic front, the strategic balance towards improving export
competitiveness has been excessive, and the cost of inflation is socially
explosive. And the opposition has been harping on the loss of purchasing power
drastically reduced by inflation. They also claim that poverty, crime and
insecurity are increasing and that government has become unpopular and it may
not risk advancing further on reforms. Some in government are even asserting
that making haste slowly is generally a better approach than shock therapy.
Credit ratings
are an important component of modern capital markets. With the dramatic growth
and sophistication of international financial markets, credit rating agencies
have become an unavoidable part of the financial landscape. The three major
rating agencies, also defined as information intermediaries, are Moody’s,
Standard & Poor’s (S&P), Fitch-IBCA, all originating in the United
States. They provide investors with information on the credit-worthiness of
borrowers and convey to markets high-quality information on borrowers in both
developed and emerging economies. Credit ratings help the market to effectively
and efficiently evaluate and assess credit risk, price debt securities,
benchmark issues and create a robust secondary market for those issues. Their
assessments on sovereign and corporate entities are increasingly being used as
benchmarks by regulators and investors.
Critical to a
credit rating agency's ability to serve this key market role is its meeting the
highest standards of integrity, independence, objectivity, transparency,
credibility and quality. Credit rating agencies have built a solid reputation
of providing high-quality, objective, value-added analytical information to the
marketplace though lately this has been tarnished to some extent by their
pro-cyclical rating behaviours that were not tough enough on subprime mortgages
that fanned investor appetite.
Sovereign
credit ratings play an important part in determining countries’ access to
international capital markets and the terms of that access. In understanding
the role of credit rating agencies in the securities markets, it is important
to understand what a sovereign credit rating is. The rating system for Moody’s
is as follows (from highest to lowest): Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1,
Baa2, Baa3, Ba1, Ba2, Ba3. AAA ratings have the highest ratings assigned by
rating agencies. They carry the smallest degree of investment risk. Issuer’s
capacity to pay interest and principal is extremely strong. AA (Aa) are judged
to be of high quality by all standards. They differ from the highest (AAA) ratings
only in a small degree. Issuer’s capacity to pay interest and principal. is
very strong rated.A ratings have strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than those in higher rated
categories.(BBB) are considered medium grade obligations. They are neither
highly protected nor poorly secured. Interest payments and principal security
appear adequate for the present but certain protective elements may be lacking
or unreliable over any length of time. They lack outstanding important
characteristics and have speculative characteristics as well, + / - / 1, 2, 3
is the relative standing within a rating category.
Mauritius’
rating is quite high for the developing world and is with Botswana, South
Africa, Tunisia amongst the four countries in Africa with investment grade
ratings. Sovereign credit ratings are taken as summary measures of the
likelihood that a country will default. Hence it is hardly surprising that the
countries with the lowest ratings are those that are unable to borrow from
international capital markets and are dependent upon official loans from
multilateral institutions or governments. In a cross-sectional setting,
sovereign credit ratings do well in distinguishing across borrowers.
Credit rating
criteria often encompass a set of both qualitative and quantitative indicators.
The quantitative information includes a set of financial indicators that are
likely to determine the ability of the issuer to generate future income to
fulfil its timely debt repayment obligations. The sovereign rating not only
takes into account the country’s tangible ability to pay back its debt
obligations, but offers also an implicit evaluation of its institutional
quality, such as rule of law, political stability, and general commitment to
carry out rule-based capital market transactions.
In empirical
applications, a host of macroeconomic and institutional variables have thus
been used. Whether a sovereign is insolvent or not depends on its stock of debt
relative to its ability to pay, measured, for example, by GDP, exports, or
government revenues. Other factors are exchange rate misalignment (an
overvaluation can cause an external imbalance that leads to debt accumulation
-- a currency crisis triggered by overvaluation can lead to severe balance
sheet effects if part of the debt is in foreign currency). Openness,
macroeconomic stability, such as low inflation or low money growth, policy
credibility and predictability (which influence investors’ risk attitudes
toward a country), liquidity measures, such as short-term debt to reserves or M2
( Broad money defined as narrow money plus savings deposits ,time deposits and
foreign currency deposits?) to reserves and institutional and political factors
which affect policy credibility, as well as government’s willingness to pursue
policies consistent with a sustainable debt path are other indicators that are
used to assess the risks of sovereign default and debt crises.
For external
debt sustainability, for example, an assessment is made whether the level of
external debt will remain constant, grow, or fall over time relative to the
sources of external income. (The external debt is “sustainable” if borrowers --
private and public -- are expected to service such debt without realistically
large future corrections of their balance of income and expenditure.) A country
may be able to refinance growing levels of external debt (relative to income)
for some time. However, the external debt (relative to income) cannot grow
without bound: an adjustment is eventually called for. There are threes steps
in carrying out the external debt sustainability: a Baseline (or central)
Scenario -- project the flow of revenues and expenditures to get a view of how
external liabilities will evolve over time; Stress Testing -- examine how the external debt outlook
changes under different shocks; and Sustainability Implications -- assess if
the country could fall into an unsustainable situation.
The stress
tests carried out by the 2007 IMF Article IV team reveal that “the risks to the
baseline outlook are balanced. A further decline in oil prices and sustained
growth in the service sector could restore external balance faster than
projected and lead to higher growth. Higher-than-expected fiscal deficits or a
renewed surge in oil prices could increase external vulnerability of external
imbalances.”
Where does the
country stand now?
The total public sector debt, i.e. central government debt including domestic
and external debt of parastatals and excluding the Consolidated Sinking Fund,
declined from almost 70% of GDP in June 2005 to around 63% in June 2007. The
maturity structure of the domestic debt portfolio has been lengthened, that is
the ratio short maturity Treasury Bills to total debt has decreased. Government
has reduced its reliance on short-term instruments to meet its financing needs.
The weighted average life of the domestic debt portfolio has increased from 1.7
years in 2002 to 2.8 years at June 30, 2007. The inflation rate is expected to
decline from a high of 10.7% at end June 2007 to around 9% at end December
2007. Inflationary expectations seem to be under control and the currency has
stabilised. As the yield on 91-day Treasury Bills is on the downward trend,
interest payments earmarked in the Recurrent Budget will be revised downwards.
Foreign direct investment maintains its upward trend on account of sustained
direct investment in hotels and IRS projects. Though a whole range of the economic
fundamentals may not be significantly correlated with credit ratings, Moody’s
assessment of our present credit rating will be based on some of these main macroeconomic parameters
.
As an aside , I still believe that the delicate issue of the huge figure
of Rs 10 billion in errors and omissions
from our Balance of Payments could have been tackled with greater finesse. (Carry
out your survey, but for the moment tais toi) Nor is now the moment to be hesitant in our resolve to tackle inflation
(be it imported or local) or about the effectiveness of the Repo Rate as a
policy instrument to control inflation. (But for this regime to work, the Central
Bank has to be involved in daily transactions and adjust the market liquidity
so that the Repo Rate reflects banks’ demand for funds.) It’s high time the ‘the
authorities… analyze more closely the link between a broad set of indicators
and inflation, inflation expectations, as well as real economic developments.
International experience suggests that useful indicators may include the growth
of various monetary and credit aggregates, the yield curve, or more narrowly
the yield gap between short-term and long-term interest rates.” ( 2007 IMF Article IV Consultation)
We will then be “fully fit” for an upgrade.
