V. Conference Findings & Recommen-dations

V. Conference Findings & Recommen-dations

Credit ratings are only one of many factors determining how much capital emerging economies are able to obtain, but they are certainly one of the key factors and beyond doubt the most high-profile determinants of how institutional investors controlling the deepest pools of capital perceive developing countries. The agencies themselves see their role in development as essentially a neutral one; on the one hand their first duty is to investors, but by providing information they make it possible countries doing the right thing to attract more capital.

The discussions during the two-day conference, from which the arguments above are extracted, left no question that the agencies take their mission seriously, that they recognize the limits and limitations of their brief and are earnestly looking for ways to improve their methods to more accurately and fairly assess risk. But, the deliberations also demonstrated the profound interest in the credit process in the developing world and the substance of the critiques raised from that quarter.

The conference succeeded in providing a forum that gave these stakeholders a rare opportunity to engage in a constructive dialogue. More such dialogue will be needed, in order to facilitate the cooperation between civil society in developing countries and rating agencies. An expanded dialogue between rating agencies and developing countries is needed to foster an atmosphere of trust, which is the essence of credit, after all. The participants of the conference identified a number of concrete steps and recommendations to help create such an atmosphere:

1. Rating agencies should take a broader approach and place a greater emphasis on accountability to all financial system participants as well as investors.

Rating agency representatives generally acknowledge that more attention must be paid to systemic issues, particularly liquidity risks and banking system vulnerability to shocks, as well as traditional quantitative aspects like debt-to-GDP ratios and reserves. Development advocates urge the rating agencies to widen and deepen the range of qualitative indicators they use to generate overall ratings, to improve not only measures of political risk, but better integrating aspects of human capital and the environment. As the role of the leading agencies could expand if their ratings are used as a basis for calculating bank capital requirements, they are bound to come under scrutiny and should reconsider their rights and responsibilities in the world system.

2. Countries should be more proactive throughout the credit rating process.

Developing country officials have more opportunity than they generally realize to shape the rating process to obtain the best outcome given the economic realities and constraints. Providing comprehensive and precise economic data in a timely fashion is more likely to have a positive than a negative impact on credit standing, as transparency is as much of a factor in building confidence as specific economic data.

The ratings due diligence process can be rationalized. Rating agencies and countries can marshal resources more efficiently and ensure information is distributed more widely and transparently by using the Internet to a greater degree, for instance. The governments could schedule regular group briefings for ratings professionals, rather than receiving them one at a time to present the same material. But analysts still need one-on-one access to senior financial officials to fine-tune their assessments.

More tools are needed to help developing countries manage this relationship. Follow-up discussions with agencies could focus more explicitly on what changes the country might consider to improve its rating and lower borrowing costs. Reference materials should be developed and circulated to developing country leaders to enable them to turn the process to the advantage of their people. Multilateral agencies should be more involved, as their actions and oversight frequently bear upon the outcome.

3. Rating scales should be refined to serve different types of investors in different markets with different investment horizons.

Though the agencies advise those using their research to look beyond the alpha-numeric ratings into the details of rating reports, investors and even institutions often tend to focus on a country's position on the ratings ladder, while giving short shrift to more substantive dimensions. The existing ratings scales might be more useful if the major agencies agreed on a uniform system while expanding and refining it for different instruments and classes of investors. Ratings might be targeted at specific categories of investors – i.e. long-term vs. short-term, institutions vs. speculators – to condition expectations and behaviors, incorporating proactive more signals. Agencies at least should be more explicit about what rating actions signify to avoid stampeding investors into herd responses as witnessed in Asia after the 1997-98 downgrades.

4. More research is needed on qualitative credit issues and systemic effects.

The Asian crisis demonstrated that systemic factors, particularly liquidity and bank credit exposures, can overwhelm economic fundamentals in periods of high stress. Developing countries and rating agencies must pay more attention to such risks in assessing potential vulnerabilities. Greater attention must also be paid to global capital flows cycles as well as business cycles in assigning ratings; a high level of volatility seems likely to remain a feature of global markets. A better understanding is needed of the relationship between development and emerging markets credit quality.

More study is needed of correlations between credit ratings and development metrics such as the Wealth of Nations Triangle Index (a measure of the economic, social and information development of 41 emerging market economies based on 63 variables. More use could be made of existing but lesser-known metrics such as the World Bank’s annual Country Policy and Institutional Assessment, which surveys staff on the policy and institutional framework of Bank client countries to measure success in poverty reduction, sustainable growth and the effective use of development assistance.

5. Countries must develop local capital markets to improve domestic liquidity and dampen the volatility created by abrupt outflows of offshore capital.

Countries with deep domestic capital markets are less likely to experience liquidity problems; the relatively rapid stabilization of South Korea and other Asian markets with high savings rates underscores the value of onshore financial resources in withstanding regional or global contagion effects. Governments of developing countries should encourage the growth and maturation of liquid and properly regulated domestic markets to provide such a buffer in periods of international volatility. This should strengthen a country’s case for higher ratings and lower borrowing costs.

6. Credit rating agencies based in the developing countries must continue to build expertise and assert their independence from local authorities.

The proliferation of newly rated countries has strained the resources of rating agencies. One response to this is the trend among global agencies of establishing partnerships with or acquiring equity stakes in developing country-based rating agencies to draw on local expertise. But local analysts must continue to build their capacities and their agencies must assert their independence to resist pressure from or influence by the political authorities of the country or its largest institutions.

7. Developing countries should explore means to enhance single-country credit by grouping regionally or seeking enhancements from multilateral institutions.

Supranational associations hold promise. The Corporacion Andina de Fomento (CAF), has obtained a higher rating than its sovereign members by compiling a record in markets then convincing agencies its should rise through sovereign caps. Some innovative programs could be expanded, such as the World Bank's provision in 1999 of a rolling guarantee for an Argentine debt issue. But credit enhancement has limits: it does not eliminate risk but merely transfers it. Over the longer term, this process could merely increase the risk of default to the international lenders of last resort.

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The Author: Brendan Murphy is a New York-based freelance journalist specialised on financial and economic questions. He writes on a regular basis for major international and U.S. publications.