Moody's proposes more nuanced method for sovereign debt ratings
The ratings agency will introduce more qualitative economic analysis and discard factors that have turned out to be less important, such as wealth per capita.
It plans to extend the number of rankings to 15 instead of five, giving it more "scope for analytical differentiation", though the added layers of rankings may slow down the task of upgrading and downgrading.
Several European governments caught up in the debt crises, and which lost their AAA ratings in January, have talked about bringing in rules to limit when ratings agencies can announce downgrades, according to John Sorrell, the head of credit at investment firm Tyndall.
The sovereign ratings industry has undergone a dramatic change in the past few years, from "being one of the most boring parts of the market to one of the more interesting".
"Countries that have always considered themselves above the ratings now find themselves more and more under scrutiny and exposed to them," Mr Sorrell said.
Moody's is asking governments and bond buyers for feedback. The changes would not affect current ratings, but could affect future revisions. The head of the Australian Office of Financial Management, which issues bonds on behalf of the federal government, declined to comment.
It is unclear how Australia's AAA rating or state government ratings will be affected.
Moody's changes will increase the impact major crises have on ratings by no longer taking into account a government's fiscal ability to deal it.
Moody's now feels sudden events can "severely strain public finances" and increase the risk of default, whereas previously it would not change ratings unless it saw a gradual deterioration in a government's financial position.
"Our analysis of past sovereign defaults indicates that a number of sovereign defaults have occurred in the aftermath of exogenous shocks such as banking crises and foreign-exchange crises."
Another change is that gross domestic product per capita will be less important in rankings because Moody's believes it is a less reliable indicator of economic stability.
"As recent experience has demonstrated, wealthy countries have endured severe credit stress without defaulting on their debt. Iceland and Ireland have suffered considerable credit stress . . . Moreover, the recent default by Greece occurred despite the nation's per capita income ranking among the top 30 globally," Moody's notes.
It will now put more emphasis on growth and economic potential because "a country with strong growth fundamentals is more resilient to shocks and cyclical disruptions than one without".
Ireland's troubles also prompted Moody's to take credit booms into account. It says Ireland's credit growth exceeded nominal GDP growth for four years before the country went into recession in 2008. Moody's proposes to lower ratings by up to two notches if it sees a severe credit boom.
Frequently Asked Questions about this Article…
Moody's proposes a more nuanced approach: adding qualitative economic analysis, reducing the weight on GDP per capita, putting more emphasis on growth and economic potential, factoring in credit booms and sudden exogenous shocks, and expanding the number of rating gradations from five to 15. The agency is also asking governments and bond buyers for feedback on the proposed changes.
For investors, the changes could make ratings more responsive to sudden crises and credit booms — meaning ratings may move sooner in a crisis. The extra gradations (15 versus 5) give more analytical differentiation but could slow the speed of upgrades and downgrades. Moody's says the proposed changes would not alter current ratings but could influence future revisions.
No — Moody's has said the proposals would not affect current ratings. However, the agency's new approach could influence future rating revisions, and the article notes it is unclear how Australia's AAA or state government ratings would be affected. The Australian Office of Financial Management declined to comment.
Moody's says GDP per capita is a less reliable indicator of credit stability because recent history shows wealthy countries can still suffer severe credit stress. The agency points to examples such as Iceland, Ireland and Greece to justify shifting emphasis away from per‑capita wealth toward growth, resilience and economic fundamentals.
Moody's will give greater weight to sudden exogenous shocks — like banking or foreign-exchange crises — because its analysis finds such events can severely strain public finances and raise default risk. Previously the agency tended to change ratings only after gradual financial deterioration; the new approach allows faster reaction to acute shocks.
Moving from five to 15 gradations gives Moody's more scope for analytical differentiation between countries, allowing finer distinctions in creditworthiness. The trade-off is that the added layers may slow how quickly the agency makes upgrades or downgrades, which could matter to bond buyers and portfolio managers.
Yes. Moody's proposes to take credit booms into account — noting Ireland's credit growth outpaced nominal GDP before its recession — and says it could lower ratings by up to two notches if it sees a severe credit boom that raises future default risk.
According to the article, several European governments that lost AAA ratings have discussed rules to limit when agencies can announce downgrades. John Sorrell from investment firm Tyndall also commented that countries which once felt 'above' the ratings are now more exposed and under greater scrutiny.
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