Tougher euro debt ratings stoke downward spiral - study

ZURICH (Reuters) - Credit rating agencies have fuelled rising euro zone indebtedness by issuing more severe downgrades since the sovereign debt crisis unfolded in 2009, a study by economists at St Gallen university said.

Manfred Gaertner and Bjorn Griesbach examined evidence from the debt crisis from 2009 to 2011, looking at the effect of interest rates and other economic variables on debt ratings, and at how ratings cuts in turn affect countries’ borrowing costs.

They concluded that rating agencies were not consistent in their judgments, becoming more critical as the crisis built, grading countries one notch lower on average for given interest rates and other variables than prior to 2009.

Portugal, Ireland and Greece, which were eventually forced to seek international aid, were rated 2.3 notches lower than under pre-crisis standards on average -- as was Spain, which is increasingly seen at risk of requiring a sovereign bailout.

“For a lot of euro zone countries ... they were treated in a way that differs from how they were treated before the financial crisis and it differs from how other countries are still being treated,” Gaertner, a professor of economics, told Reuters.

Gaertner cited the example of Ireland, which he said by pre-crisis standards would have been downgraded by 1.5 notches due to its deficit and debt problems. “In reality, they were downgraded by seven notches and a downgrade like this would bring any country into deep trouble,” he said.

Ratings agencies Standard & Poor’s and Moody’s rejected the study while a Fitch spokesman said: “We are entirely confident in the quality, transparency and rigour of the methodology and procedures underpinning our ratings and analytical research.”

S&P said the study was “fundamentally flawed” in both its methodology and conclusions, adding its ratings had an excellent track record as indicators of future defaults.

“As we have seen throughout the history of the euro, ratings are only one factor among many impacting market behaviour,” S&P said in an emailed statement.

A Moody’s spokesman said: “Sovereign ratings have not contributed to the crisis: the structural and economic issues which are its ultimate cause are well-documented. Moody’s ratings have, throughout the crisis, proven more stable than bond and equity market-based credit measures.”


The economists said they were aiming to fill a gap in research on the topic as there had been little empirical evidence until now to support widespread speculation that ratings downgrades are in effect self-fulfilling prophecies.

Gaertner said they had published the research now because of the topicality of the subject, as it could take years to come out in a peer-reviewed journal. For a link to the paper, click on: here

Their empirical analysis used annual data for 25 countries from the Organisation for Economic Cooperation and Development from 1999 to 2011, including real gross domestic product data and budget figures, and long-term debt ratings from Fitch.

The economists used Fitch ratings as they were the only ones for which a full data set was publicly available, but said there was a high correlation between its ratings and those of rivals Moody’s and S&P.

The research showed that a rating downgrade by one notch raises sovereign borrowing costs by 0.3 percentage points on average when ratings are in the range between ‘AAA’ -- the highest possible rating -- and ‘A-‘. That rises to 3.12 percentage points once the rating has fallen into the ‘B’ segment or below, denoting a much higher degree of investment risk.

“Once a country is being pushed into the ‘B’ segment, it is drifting further and further towards insolvency and it cannot really rescue itself, it needs outside help,” Gaertner said.

“The rating agencies have succeeded in shifting the perceived problem away from the financial markets and make governments appear like the culprits.”

Austerity programmes adopted by indebted governments to preserve their credit ratings and retain access to bond markets have been blamed for exacerbating the crisis in Europe, by stifling growth needed to reduce debt.

Gaertner and Griesbach said their findings suggested governments should look closely at sovereign bond markets and “the motivations, dependencies and conflicts of interest of key players in these markets”.

Critics have accused rating agencies -- on whose opinions many big investors rely when deciding where to put their money, and which are used to calculate banks’ mandatory capital buffers -- of exacerbating market volatility and hampering efforts to resolve the euro zone crisis.

Regulators in the European Union and elsewhere have sought to weaken their influence since they were blamed for helping to sow the seeds of the financial crisis that broke in 2008 by giving top ratings to securities that proved almost worthless.

Fitch Ratings affirmed Italy’s long-term sovereign debt rating at ‘A-’ last week, averting for now the threat of aggressive forced selling by bond traders if the country had lost its only remaining single-A grade.

Last month, Moody’s cut its rating on Spanish government debt by three notches to Baa3 from A3, helping to push its borrowing costs up sharply and raising the prospect that the country will need a full-scale bailout.

Moody’s revised its outlook for Germany to ‘negative’ this week. With S&P already assigning Finland a negative outlook, no euro zone country has a stable outlook on its triple-A rating from all three credit agencies.

Reporting by Emma Thomasson; editing by Stephen Nisbet