Moody’s considers 4 factors in determining a country rating:
2. Institutions and Governance Strength
3. Fiscal Strength
4. Susceptibility to Event risk
Moody’s assessment is that factor 2 has weakened, which has led to an overall downgrading.
Factor 2 is based on the following 4 components:
(i) Quality of Legislative and Executive Functions
(ii) Strength of civil society and the Judiciary
(iii) Fiscal Policy effectiveness
(iv) Monetary policy effectiveness
Factor 2 evaluates whether the country’s institutional features are conducive to supporting a country’s willingness to repay its debt. A related aspect is the govt’s capacity to conduct sound economic policies that foster economic growth and prosperity, which depends on the quality and effectiveness of institutions and policy making.
The downgrading is thus driven by a weakening of the quality and effectiveness of institutions and policy making, i.e., to a growing lack of fiscal and monetary policy effectiveness, or to (iii) and (iv) above.
Fiscal policy effectiveness
Govt’s reliance on transfers from SOEs and asset sales are one-off measures that do not reduce public debt in a sustained manner. Additional unspecified measures for fiscal consolidation will be required to meet additional pension spending as from fiscal year 2024. Fiscal policy is not being applied to ensure a better balance between revenue and spending and protect the economy against future shocks.. Instead Govt is having recourse to SOE transfers and asset sales that are not sustainable.
The Moody’s credit committee met on 26 July, i.e., after the last budget. The lack of revenue and spending measures to control the budget deficit and the dependence on asset sales to finance expenditures are seen negatively. The sale of Air Mtius Holdings to MIC in 21/22 is probably considered as an artificial transaction to disguise the use of central bank money. The projected
sale of assets for Rs22 bn in 22/23 is also viewed by Moody’s as uncertain.
Moodys acknowledges that Govt recourse to SOE balances and central money is contributing to reduce the debt ratio to 70% of GDP (moodys focuses on the debt of the central Govt, not public sector debt, which is higher by about 10% points of GDP). But, contrary to fiscal adjustment, such financing leaves the country vulnerable to future shocks. The current stance of fiscal policy is therefore assessed as irresponsible.
Monetary policy effectiveness
The large BoM grant of Rs55 bn to Govt has made monetary policy less effective, by adding significantly to liquidity. To combat higher inflation, BoM will have to mop up this huge liquidity with great difficulty and at a heavy cost. MIC, the BoM’s subsidiary, is also engaged in financing activities that imply credit risk for the BOM, leading to an eventual need for BoM recapitalization by Govt. The BoM is not playing its role as an institution responsible for sound monetary policy, and to effectively fight inflation.
Consequences
As a consequence of the sovereign credit downgrading, all financial and other institutions will be automatically downgraded to less than Baa3, or less than investment grade, i.s., to junk status. There exists a small probability that some institutions can retain a rating at the level of the sovereign rating. But it is most unlikely.
A downgrading of MCB, currently at Baa3, to non investment grade will have an adverse impact of the conduct of its business in Africa, especially in trade finance. The rest of the banking system will also be affected as foreigners may withdraw their deposits at local banks. This may impart a significant shock to the stability of the banking system.
Govt is boasting that Mtius is still investment grade. This is a totally myopic and stupid argument, because the downgrading is endangering the stability of the financial sector and the economy as a whole.
Govt is also arguing that the outlook rating has improved from negative to stable. Yes, Moody's agrees that govt debt is being reduced, which improves the near term outlook, but the financing of this debt reduction is not in accordance with responsible and sustainable economic policies. The country is becoming more exposed and vulnerable to future economic shocks. Hence the downgrading!
