As I move around Barbados, I get a lot of questions and queries about credit rating downgrades. What they mean? When will they end? Are there lower grades? Do they mean the Government is doing the wrong things and so on?
I think part of the confusion surrounding credit ratings comes from the fact that as a society we have made credit ratings something they are not. I thought I would write down a few clarifying points, and hope I don’t succeed in confusing people even more.
A sovereign credit rating is an opinion (issued by a rating agency) on the likelihood a country will default on its debt. Banks, insurance companies and other investors who lend money to governments, find these credit ratings useful in deciding whether or not to lend to the government, what interest rate to charge, and so on.
The credit rating focuses on the ability of the government to service its debts when they fall due, as a way to provide guidance to investors in government bonds, not to pronounce on the overall health or well-being of the economy, or act as a sort of referendum on government’s economic policies.
According to S&P Global Ratings, “An obligation rated ‘AAA’ has the highest rating assigned by S&P Global Ratings.
“The obligor’s capacity to meet its financial commitments on the obligation is extremely strong.”
I want to suggest that this rating can be interpreted as the agency saying to investors that they cannot envisage a reasonable scenario, in any reasonable time frame, where the borrower (the government) would be unable to meet its obligations.
Barbados’ current rating is CCC. According to S&P Global Ratings, “An obligation rated ‘CCC’ is currently vulnerable to nonpayment and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitments on the obligation.” “In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitments on the obligation.”
I want to suggest that this rating can be interpreted as the agency saying to investors that there are a number of reasonable scenarios under which the Government of Barbados may be unable to meet its obligations to bond holders.
The last time we had an investment grade credit rating was in 2012. In 2012, the fiscal deficit was 8.5% of GDP and the economy grew by a meagre 0.3%. Today, with the economy projected to grow by around 1.75% and the deficit expected to be 4.0% or less, we have yet another downgrade. How does this make any sense?
I want to suggest that despite these improvements and the aggressive budget, there is still a high level of uncertainty about the Government’s ability to pay its debts because of the lack of financing options for the Government, and especially the issue of “Rollover Risk,” hence the continuing downgrades and negative outlook.
One of the major reasons governments fail to pay their debts is what is called “Rollover Risk.” For most normal humans, if you borrow $500,000 for 30 years, each payment you make will include interest payments and a repayment of part of the principal. Therefore, at the end of the thirty years, the loan is fully paid off and you are fine.
In the case of most government bonds, the scenario is somewhat different. If a government borrows $50 million for 30 years, over the next 29 years the government will only pay interest on the $50 million. However, in year 30, the government has to make the final interest payment and pay the full amount of the principal. In the majority of cases, the government will not repay the $50 million out of its own funds, it will seek to borrow a new $50 million by selling new bonds and use that money to pay off the old loan and restart the loan cycle. That is called “Rolling Over” the bond.
In reality, there are very few governments, if any, that could repay the principal on their bonds when they fall due out of their own funds. If governments are unable to rollover their bonds consistently, they will be unable to make their principal payments.
For example, if the US Congress does not periodically raise the debt ceiling to allow their government to borrow more money, the USA will likely default on its debts. In fact, in August 2011, Standard and Poors lowered the credit rating of the United States from AAA to AA, after it took a last minute deal to raise the debt ceiling.
The major buyers of Government of Barbados bonds are commercial banks, insurance companies and the National Insurance Scheme. For a variety of reasons, over the last few years in Barbados, there is great uncertainty over whether or not commercial banks and insurance companies will roll over their existing Government of Barbados bonds, and even greater uncertainty over whether they will provide any new long term financing to the Government of Barbados through the purchase of Bonds.
The National Insurance Fund’s surpluses are largely reduced, hence, while the NIS will likely rollover existing bonds, the amount of new financing it will be able to provide by buying Government of Barbados Bonds is likely to be very limited.
In Barbados, bonds valuing hundreds of millions dollars likely mature each year. These bonds were issued 1, 5, 10, 15, 20, 25, or 30 years ago by many different administrations. The uncertainty about the rolling over of existing bonds and the ability of the government to borrow new money is at the heart of the credit rating challenge for Barbados, along with the high level of debt and low reserves.
Until the Government of Barbados can again reliably borrow money, either as a result of funding though an IMF program, commercial banks and insurance companies’ again exhibiting a willingness to consistently roll over debt and provide new financing, or there is access to some other reliable consistent source of funds, the financing challenges will remain, and with it a high level of uncertainty about the government’s ability to pay its debts, which is what the credit rating measures.
The Government’s ability to borrow is key to the functioning of a modern economy. At present, that artery is now blocked in Barbados and needs to be unclogged, either through the financing and credibility that comes with an IMF programme (with the bitter conditionalities of course), a policy mix and/or dialogue that brings the commercial banks back on board (the recent attempt to balance the budget does seem to have moved the banks), or through government finding some new source of reliable financing.
In fact, the major cause of the decline in the foreign reserves is the fact that we have not been able to roll over foreign debts when they have matured and we have been unable to attract new foreign financing.
I want to repeat that I think part of the confusion around credit ratings is that we have made them into something they are not. The credit rating is extremely important because it can affect the ability of the government to borrow and the terms and conditions it can borrow under. However, the rating focuses on the issue of the ability of the government to service its debts when they fall due, as a way to provide guidance to investors in government bonds, not to pronounce on the overall health or well-being of the economy, or the nature of government’s economic policies.
(Dr Justin Robinson is Dean of the Faculty of Social Sciences at the University of the West Indies, Cave Hill)