Moody's plans ratings revamp

MOODY'S is changing the way it calculates sovereign debt ratings in response to the global financial situation and subsequent sovereign debt crises, which have exposed flaws in the method.

The proposed changes will affect the "scorecard" that underpins ratings by introducing more qualitative economic analysis and discarding factors that have turned out to be less important, such as wealth per person.

Moody's plans to water down the rankings by using 15 potential scores instead of five, giving it more "scope for analytical differentiation". But this will also add more layers of rankings, potentially slowing down ranking upgrades or downgrades.

John Sorrell, the head of credit at the investment firm Tyndall, says several European governments trapped in the debt crises, which lost their AAA ratings in January, have talked about bringing in new rules limiting when ratings agencies can announce downgrades.

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 the more interesting," he said

"Countries that have always considered themselves above the ratings have now found themselves more and more under scrutiny and exposed to them," Mr Sorrell said.

The New York-based ratings agency is asking governments and bond buyers for feedback. The changes will not affect present ratings, but could have an impact on 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.

The changes by Moody's will increase the impact a crisis will have on ratings by no longer taking into account a government's fiscal ability to deal with it. Moody's believes sudden events can "severely strain public finances" and increase the risk of default, whereas previously it would not change ratings unless it came across a gradual deterioration in the 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," it says.

Another change is that gross domestic product per person will be less important in rankings because Moody's views it as 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 in the wake of the global financial crisis.

"Moreover, the recent default by Greece occurred despite the nation's per capita income ranking among the top 30 globally," the discussion paper notes.

Moody's 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 consider credit booms when assessing economic strength, as this can "flatter" the economic indicators that measure growth. It notes that Ireland's credit growth exceeded nominal gross domestic product growth for four years before it went into recession in 2008. Moody's proposes to lower ratings by up to two notches, such as from AAA to AA2, in the event of a credit boom.