CREDIT rating agencies – Fitch this week followed Moody’s and Standard and Poor’s in downgrading the island – may be inclined to issue more favourable ratings than the actual fundamentals justify as they are caught up in a moral dilemma, economists say.
The success of a share or bond issue by an organisation depends, to some extent, on the grades these securities have, economist Bernard Musyck, who teaches economics at Frederick University, told the Sunday Mail.
The credit rating is an assessment of the credit worthiness of the issuer, a government or a corporation. For example, an investment grade of BBB+ or above (according to Standard & Poor’s and Fitch Ratings) or Baa3 (according to Moody’s) given to a security, tells an investor that the issuing body has a strong capacity to meet its financial commitments, while a lower rating implies higher default risks. All three give Cyprus higher ratings.
When rating agencies are hired and paid by organisations, such states, banks or other companies to have their bonds or shares rated, investors cannot be sure “whether there is an underlying conflict of interest,” Musyck said.
The collapse of Lehman Brothers which saw its credit rating fall only days before September 15, 2008, the day it went bankrupt triggering an unprecedented global financial crisis, is one example that highlights that rating agencies are not necessarily credible, Marinos Yialelis, general manager of the Hotel Employees’ Provident Fund said.
“This may apply both for the rating of corporations and governments,” while this risk may be lower in the case of how Cyprus is rated compared to that of the United States, Yialelis, who manages more than a quarter of a billion euros in funds, said.
Cyprus’ credit rating was placed on credit watch for possible downgrade by Moody’s on January 13 and Fitch Ratings four days later. On November 16, Standard & Poor’s cut Cyprus’ credit rating by one notch. The rating agencies cited mainly concerns over Cyprus’ fiscal situation and the exposure of its large banking sector to Greece.
While markets should not attribute “that much” credibility to rating agencies, Cyprus should not ignore their conclusions, according to Nobel Prize Laureate Christophoros Pissarides.
“We should study these warnings and look why they were issued,” Pissarides, who last week started teaching economics at the University of Cyprus, told reporters on Wednesday.
While not much may be done in the case of financial ties between Cyprus and Greece, “we can do something on the fiscal deficit,” Pissarides said.
As investors require some “tangible” information when taking decisions, there are not many available alternative sources of information on the credit risk related to a security, he said.
“Everyone should carry out his own investigation,” Pissarides added, or request an opinion about a bond from a major bank. “They could explain what they believe and why”.
According to Yialelis, the European Union should have its own independent rating agency which should operate on a “not-for-profit basis” and complete the three US based rating agencies, while other major economies such as Japan should also create their own.
“When everything is about money, it is not easy to have something completely reliable,” he said.
In June, president of the European Commission, José Manuel Barroso announced that the EU was planning the creation of a European rating agency and the introduction of a relevant supervisory framework which could impose fines. The decision came in reaction to the downgrading of Greece’s credit rating, which is meanwhile below investment grade.
Alone the placement of a security on credit watch for possible downgrade may result in a “self fulfilling prophecy” according to Pissarides. It will be perceived as “bad news” by the market, which will think that “something is wrong”. “Then it becomes bad news”.
