S&P: Ratings Should Not Weigh On Regulation

MORITZ KRAEMER
Designation: Head, S&P’s European sovereign analyst group, Germany
Education: BA in Economics, Dartmouth College; D.Phil in Economics, University of Oxford; Ph.D. in Economics, University of Göttingen (Germany)

Bond markets ignored S&P’s downgrade of US sovereign debt last year. Bond auctions in Europe indicate a similar nonchalance over your recent downgrade. Why is that?
It’s not unusual for markets and ratings to sometimes speak different languages. But in the very long term, the fundamental strengths and weaknesses of debtors always come to the fore. Our current ratings speak to the fundamentals of sovereigns whereas markets have a tendency to overshoot and undershoot. But even today, despite much being made of the successful auctions, the spreads that prevail in sovereign bond markets still suggest higher probability of default than our ratings would suggest.

How come your outlook is bleaker compared to Moody’s and Fitch, who haven’t downgraded France, for example?
That’s something you need to ask them. Consistent with our published methodology, which is probably the most transparent in the industry, we downgraded France because France is not a triple A credit. There are different opinions and we think variety of opinion is a good thing. That’s what a rating is – a forward-looking opinion about credit risk. It’s not unusual that three different people might come to more than one single answer on complex issues. And the same is true here when you have three rating agencies. This is a competition of opinions, which is a good thing.   

There is concern that your downgrade of Europe’s rescue fund will increase borrowing costs at a critical time. Your thoughts?
Under the current framework, there are not enough triple A guarantees to support the outstanding bonds of EFSF (European Financial Stability Facility). Now EFSF did issue debt earlier this week and I think there is a lot of exaggeration in terms of what’s going on here. You have a downgrade from the highest mark to the second highest mark out of a continuum of over twenty ratings on the ratings scale that has many shades of grey. We’re going from pure white to almost pure white and I think the markets understand that it’s not a sea change. They understand that with the exception of three small countries – Greece, Portugal and Cyprus – all sovereigns in the Eurozone are rated investment grade. Historically that has gone hand-in-hand with very low probabilities of default. That’s why the market reaction has been much less excited, excitable or hysterical compared to what some other observers have been saying.        
 
Policymakers and politicians have come out with strong responses to the downgrade. That’s expected, right?
I think it’s a typical reflex. We’ve seen a similar thing after the US downgrade. Once you have conveyed sort of a negative message, then the first instinct is to try to discredit the message. We don’t agree of course when they say the ratings are wrong because that’s easily said. And they don’t really say by which standard or which benchmark they make this claim. But we’re actually in agreement with many of the policymakers when they say the ratings should not be tied in as directly into regulation because that burdens a rating agency with a quasi-regulatory function. We support the initiatives to try to reduce the weight of ratings in regulation.

The pressure to reduce debt is leading European governments to adopt severe austerity measures. How would this impact growth?
Having a strategy that depends entirely on fiscal austerity has a high chance of being self-defeating. That’s the problem we’re seeing with the European crisis management right now. It’s a one-sided strategy that relies almost entirely on fiscal retrenchment. That’s a flaw because it misdiagnoses the crisis and therefore comes up with the wrong recipes. And that has been the reason for our ratings action. We think that the pan-European policymaking is not properly addressing the causes of the crisis. The strategy needs to have more growth-enhancing elements and it needs to have more elements that restore confidence in the market because we have a lot of government debt that needs to be issued this year. And we’ll only know the crisis is over when we know who’s going to buy all this debt. Right now we don’t know.

Do you expect policymaking to get better and for leaders to speak with one voice?
I think there is one voice and the difference of opinion has fallen among policymakers lately. But at the same time we have zoomed in on strategies that do not address the core issues of the problem. This is a crisis that has to do with diverging economic trends in the Eurozone in the absence of ability of nominal adjustment through exchange rates or interest rates.

What is your outlook for the Eurozone?  
There’s a lot of speculation on the breakup of the Eurozone and that’s not our forecast at all. The cost of leaving are extremely high and would reflect a high degree of desperation politically and economically, which I don’t think we’ve reached anywhere in Europe as yet.