Creditworthiness: Does the govt warrant its (local) AAA rating?

PACRA and JCR-VIS award highest credit rating to the treasury bills, though the bond market seems less than convinced

Kazim Alam August 26, 2011


Standard & Poor’s, a New York-based credit rating agency, downgraded US government debt from AAA to AA+ when the American political process got too divisive to make key fiscal decisions. Yet despite the complete inability of any government in Pakistani history to manage the country’s finances adequately, the only two credit rating agencies in Karachi have yet to downgrade the government of Pakistan from AAA.

While international rating agencies such as S&P rate Pakistan B-, the two local agencies – Pakistan Credit Rating Agency Limited (Pacra) and JCR-VIS – rate the government’s debt AAA. They also rate the debt of any state-owned company AAA, almost automatically assuming a sovereign backstop.

The difference in the two ratings is striking, but not surprising, at least to the people who create and maintain the ratings.

According to JCR-VIS Chief Rating Officer Sabeen Saleem, local rating companies don’t take the likelihood of currency devaluation and government default into account.

“The government can always be expected to issue cash and maintain liquidity,” she said. Moreover, she said, local agencies don’t take the political situation into account while dealing with sovereign ratings.

Divergences between local and foreign ratings of government debt are not out of the ordinary. For instance, ICRA, India’s leading rating agency, which is affiliated with America’s Moody’s Investors Service, rates the Indian government Aaa, the highest rating. This is despite the fact that Moody’s current rating for India is Baa3, nowhere near the best.

While Pakistan’s fiscal deficit is high and the government relies heavily on inflows from foreign governments and lending institutions, the total debt-to-GDP ratio – a key measure of indebtedness of a government – is at 60%, a ratio that is considered manageable even by as conservative an institution as the European Central Bank.

Yet Pakistan’s revenue collection, as a percentage of the total size of the economy, remains the lowest in Asia at 8.5% of the GDP. The Federal Board of Revenue (FBR) admits that for every Rs100 it collects in taxes, it loses another Rs73 to tax evasion.

The government also has a poor record in paying its own obligations, as proven by the inter-corporate circular debt in the energy sector, which began because the government was unable to pay the subsidies it promised the energy companies.

Despite all of these considerations, however, Pakistan’s credit rating agencies maintain a AAA rating on the government, essentially stating that the government will never default on its financial obligations, even though the government does at times fail to pay what it owes (though not on its bonds, which are paid on time every time). The reason for this, it seems, is commercial.

“Giving your own sovereign a bad rating isn’t good for business,” admitted Saleem. “It is never a good decision to downgrade your own sovereign.” Yet even though the ratings may be somewhat shaky, the financial markets in Pakistan do not seem perturbed, mainly due to a lack of choice.

“There is no corporate debt market in Pakistan. Anyone who wants to take exposure in long-term has no choice but to buy government bonds,” said a senior treasury official at one of the largest banks in the country. “There is no choice for the lender. There is no corporate debt market in our country.”

Yet the banks clearly are not willing to go along without exacting a price. In 2010, the government cancelled treasury auctions because it received bids for interest rates from banks that were too high. And banks are less willing to invest in longer term treasury bills, forcing the government to do most of its borrowing on three-month treasury bills. Both measures seem to suggest that the bond market in Karachi rates the government a lot less than AAA.

The banks, it seems, are worried that while the government may simply print the money and pay them back, doing so would create so much inflation that their assets would be rendered severely devalued. This is not an idle fear: it is exactly what happened between June 2007 and November 2008.

Published in The Express Tribune, August 27th,  2011.

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