Managing credit ratings

The credit ratings of a country are more important than its natural resources; they reflect a country's probability to repay its debt. In today's modern financial system, countries devoid of natural resources can be rich and prosperous if they have good sovereign ratings. Singapore is a case in point. A nation of five million souls has to import water from a neighbouring state. It does not grow even a single plant of any staple food. However, with the highest per capita in the world, its total national wealth is far more than Pakistan's.

In contrast to this, resource-rich countries with worse credit ratings are marked by hunger, poverty and deprivation. Venezuela and Nigeria well explain this scenario. Both are among the world's top oil-producing countries. However, 40 percent of Nigeria does not have an electricity distribution network and the rest of the 60 percent suffers from 18 hours average daily power shortage. Venezuela is even more unfortunate.

A country cannot grow in isolation. Besides other things, it needs technical expertise and financial support. Credit ratings serve as a reference instrument for investment decision and provide a necessary financial cushion. Corporate interests look for the credit ratings of a country to assess its stability and possibility of attractive returns. Similarly, ratings also determine how much and at what rate a government or a company can raise capital in the domestic and international market.

The world's renowned rating agencies happen to be conservative when it comes to sharing rating taxonomy leading to the rating decisions. However, they accept that political, social and economic developments in a country and their interplay with the external environment play a key role in rating grades.

The Big Three – Standards & Poors, Fitch and Moody's – place Pakistan in Category B with stable and negative outlooks. This renders borrowing cost higher and narrows down credit lines. A low score on the rating dashboard is one of the reasons for the extremely underdeveloped capital market in the country. Given the burgeoning debt burden and increasing borrowing cost, the credit landscape becomes more precarious. It goes without saying that we need to improve this plight on a priority basis.

Interestingly, credit ratings are not absolute truths; they are mere intelligent estimations. After the collapse of AAA graded mortgage products in the financial crisis of 2008, the Credit Rating Agencies (CRAs) have been suspected of deceiving people. Despite the fact that there is a margin or possibility of managing ratings, the relevance of credit ratings is on the rise.

Research focusing on emerging economies evince that improvements can be brought in the rating grades without immediate and drastic gains in macro-economic terms. Among economic variables, foreign currency reserves, balance of payments flows, growth prospects and revenue receipts are given preference while compiling the sovereign rating scale. However, non-economic indicators including rule of law, political stability, and freedom of expression also impact the cognitive biases of analysts. For instance, how can a state be expected to tread a smooth economic path if it is mired in a political crisis? How can an economy improve its competitiveness when pro-regime lobbies are maneuvering hefty concessions in daylight?

The justice system is unable to protect the life and property of citizens. Institutional effectiveness is at standstill. Who would dare to risk their investment when government initiatives have the tendency to evolve into conspiracies and controversies? Key political figures from the opposition ranks are behind bars, and the remaining are flexing their muscles to disrupt the political process. The power structure is exhibiting bizarre fluidity. The traditional establishment is explicitly committing to fix the economy.

While the government is doing everything hard and difficult to correct the economic course, it should equally focus on the country’s toxic political landscape. Domestic political risk is a key determiner of sovereign credit ratings because economic activity decelerates in a turbulent and uncertain environment. Ground realities easily make their way to influence the decision-making process of rating agencies. Hence, there is an urgent need to reconsider runaway ‘accountability’, mindless confrontation, witch-hunting and restrictions on the media which are fueling the political temperature and taking a heavy toll on the country’s sovereign ratings.

The writer is a public policy scholar atthe Lee Kuan Yew School of PublicPolicy, Singapore.