By Arjoon Harripaul
Senior Rating Analyst
In the earlier articles, we looked at the capital markets
and bond markets, the evolution of credit ratings, the rating
symbols used by the global agencies and the role of a rating
agency in the development of local bond markets.
In this article and the ones to follow, we will be discussing
the rating methodologies adopted by CariCRIS in assigning
ratings. The publication of these methodologies is an important
part of CariCRIS effort to be transparent and to bring
about investor confidence in the analytical robustness and
the objectivity of its credit ratings. We begin with CariCRIS
approach in assigning ratings to national governments, also
known as sovereign ratings.
The CariCRIS sovereign rating gives investors an insight into
the relative risks associated with lending to various Caribbean
governments. In other words, it is an objective assessment
of a particular sovereigns creditworthiness relative
to other debt issuing governments in the region, for instance
between the Government of Jamaica and the Government of Barbados.
It is important to note that sovereign ratings assess the
credit risk of national governments and are not to be seen
as a country rating.
The CariCRIS framework for assigning a sovereign credit rating
is based on internationally established best practices, involving
a fair amount of qualitative judgment as well as quantitative
parameters such as debt/GDP, fiscal deficit/GDP, etc. Sovereign
risk is usually assessed by analysing five key risk categories
viz income and economic structure, fiscal policy/indebtedness,
monetary and exchange rate policy, balance of payments and
external liquidity and finally, the political environment.
The analysis focuses on the question of how these risk parameters
affect the sovereigns ability to repay its debt. Sovereign
ratings also have another dimension viz the currency of debt.
The ratings explicitly indicate this by adding a suffix foreign
currency or local currency.
Typically, local currency ratings are one or two notches higher
than the foreign currency ratings, reflecting the ability
of the government to print local currency or raise taxes to
meet its debt obligations. Exception to this includes countries
that have an official currency peg (such as Panama) or which
are part of a larger monetary union and have a common currency
(such as the OECS countries), where printing money
is not an easy option available to the sovereign.
A natural question arises here. If a government has the ability
to print money or raise taxes, why is it not rated AAA,
at least for its local currency? The answer lies in the fact
that no government has unlimited ability to print money or
raise taxes as this may have other serious repercussions,
such as high inflation, sharp depreciation against hard currency,
Weighing these costs, the government might choose to default
on its local currency, rather than print money to meet debt
obligations. Thus, unless the fundamental credit quality of
the sovereign is strong, the ability to print money cannot
take the local currency ratings significantly higher and hence
the strong linkage with its foreign currency rating.
We now take a closer look at some of the risk parameters under
each risk category.
Income and economic structure
This parameter assesses the state of the economy, its performance,
composition, size and diversity, quality of income distribution
and quality of private sector participation in the economy.
A partial list of factors assessed under this risk category
Size of the economy;
Past growth rates;
CariCRIS assessment of future growth rates;
Key drivers of growth;
Degree of private sector participation and their global
Human development index, and its trend-line.
Under this parameter, CariCRIS assesses the fiscal policy
and performance of the sovereign and compares the same with
other sovereigns in the region. The extent of indebtedness
of the sovereign, the nature of such debts and extent of the
sovereigns fiscal flexibility in meeting its debt repayments
are assessed in this parameter. A partial list of factors
Government revenues, growth in revenues and quality/diversity
of these revenues;
Government expenditure levels, past growth and composition
(discretionary vs committed);
Coherence and consistency of government policy, methods
of deficit financing;
Effectiveness and equitable nature of tax regimes and government
flexibility to increase tax revenues;
Debt/GDP and Interest/Govt revenues, their trend in the
past and CariCRIS expectation of future indebtedness;
Off-budget and contingent liabilities, size and health of
the non-financial public sector enterprises.
and exchange rate policy
In this risk category, CariCRIS assesses the governments
monetary policy and track record in maintaining stable monetary
conditions including past inflation rates, interest rates
and exchange rates. The independence of central bank to pursue
sustainable exchange rate and monetary policies and extent
of development of domestic equity, bond and foreign exchange
markets to facilitate the achievement of monetary policy objectives
are also assessed in this risk category.
Balance of payments and external liquidity
The governments policy on external liquidity and ability
to meets its balance of payments are assessed in this risk
category. A partial list of factors assessed in this risk
Current and capital account position;
Extent of net international reserves and its trend in the
Comparison of immediate foreign exchange needs (imports,
debt repayments) and external indebtedness vis-à-vis
Extent of government control on private sector foreign exchange
Foreign investment inflows in the past, quality and stability
of this source of foreign exchange.
The political environment has a profound impact on every aspect
of a sovereigns operations and consequently its credit
quality. The factors assessed in this risk category are predominantly
qualitative and the assessments are made in relation to other
countries in the Caribbean region. A partial list of factors
Stability, predictability and transparency of a countrys
Continuity of economic policies;
Consensus (or lack of it) on the direction of economic policies
across major political parties;
Degree of social cohesiveness and acceptability of key economic
decisions by the populace;
Any national/cross-border security concerns and their impact
on potential investment inflows.
Based on these five broad parameters, CariCRIS assigns sovereign
ratings in local currency and foreign currency to about 19
countries in the Caribbean region. No sovereign analysis can
be considered comprehensive in this region, without an analysis
of the impact of natural disasters.
While assigning sovereign ratings, CariCRIS will perform a
comprehensive catastrophe risk analysis on each sovereign,
including the probability of occurrence based on past history,
preparedness of the government to handle natural disasters,
extent of damage witnessed in the past, impact analysis at
various levels of damage, extent of insurance penetration,
financial strength of the insurance companies, etc. and factor
in this assessment in its sovereign risk analysis.
Comments/suggestions on this methodology can be forwarded
to [email protected]