Markets beat rating agencies on downgrade

The downgrade of Slovakia's rating by Moody's Investors Service was only a reflection of the current opinion of Slovakia on world markets, according to economic analysts.
On those markets, Slovak bond yields had risen to a speculative level long before the Moody's downgrade on March 30. Therefore, even the possible downgrade indicated by another renowned rating agency, Standard & Poor's, should not substantially affect the interest rate that the Slovak government and corporations must pay when borrowing abroad.

The downgrade of Slovakia's rating by Moody's Investors Service was only a reflection of the current opinion of Slovakia on world markets, according to economic analysts.

On those markets, Slovak bond yields had risen to a speculative level long before the Moody's downgrade on March 30. Therefore, even the possible downgrade indicated by another renowned rating agency, Standard & Poor's, should not substantially affect the interest rate that the Slovak government and corporations must pay when borrowing abroad.

"The current benchmark government-guaranteed Slovak bond, issued by the dam-builder Vodohospodárska výstavba (VV), sold approximately 3.8 percent above the interest rate offered on United States T-bills even before the [Moody's] announcement," said Dušan Mészáros, an analyst with ING Barings. "When demanding this rate, investors had already taken into account not only Moody's previous announcements, but also the expected change of Standard & Poor's outlook."

The question therefore is why agencies are reacting only now? "I see this as part of an internal clean-up at the rating agencies following the Asian crisis," said one government analyst who requested anonymity. "They did not react there until it was too late, and were criticized for it. Now they are trying to stay ahead of things."

Moody's downgraded Slovakia's rating for sovereign lending from Baa3, the lowest possible investment grade, to Ba1, the highest non-investment, or speculative grade. Although expected to follow suit, Standard & Poor's has as yet only changed Slovakia's rating outlook from stable to negative. This means that although the purchase of debt issued by the Slovak government is still considered to be an investment instead of a speculation, the agency is warning investors that it might soon decide to take Slovakia down a peg, from the lowest investment grade of BBB- to a risky BB+.

The downgrading of Slovakia's creditworthiness came as no surprise. Before the change, both the government and VSŽ Holding had wanted to issue large bond issues abroad, but both had balked, citing turmoil on financial markets following the crisis in Southeast Asia. The Financial Times claimed that Slovak officials had hoped to pay only 1.1 percent on top of the interest rate the US government accepts for its T-bills, but soon discovered there were no takers at this price.

VSŽ Holding postponed an issue worth $200 million until June or July. But the Slovak government, which is hoping to raise $500 million to 1 billion, can hardly afford to delay the issue substantially or call it off. "The failure of the issue would mean a further exacerbation of the government's liquidity problem, and would cause an increase in domestic interest rates," said Ivan Mikloš, an economic expert for the opposition SDK party, noting that Standard & Poor's had already called the current domestic interest rates "prohibitive".

"There is no success or failure in this case," Mészáros countered. "Everything depends on price. If the government wants to sell its bonds, it will have to offer an interest rate equivalent to what the benchmark bond indicates - 3.8 percent above U.S. T-bills, perhaps a little below that since it is a government bond and not just a government-guaranteed one."

Corporate debt will also suffer from the downgrade. The interest rates on bonds issued by companies whose rating is tied to that of the government (Slovenské elektrárne, Slovenská sporiteľňa, Všeobecná úverová banka) are particularly vulnerable, as these rates are tied to changes in the country's overall creditworthiness. Peter Staněk, State Secretary at the Finance Ministry, estimated that foreign financial sources will now be "about one third more expensive than they used to be."

If the government changes

There are two schools of thought on whether the ratings will quickly return to their previous levels if governmental changes follow September's parliamentary elections.

"Since the principal reasons for the downgrade were political, and the reasons that economic problems in this country remain unsolved are also political, elections offer an opportunity to solve political and, consequently, economic problems," Mikloš claimed, adding that if the opposition came to power, it could achieve a swift upgrade. His opinion was supported by James Droop, chief analyst of another rating agency, Fitch IBCA, who told the SITA press agency that the principal problem of the Slovak economy is the unfavorable influence of political uncertainty.

Mészáros was much more sceptical about how quickly Slovakia could join the ranks of investment-worthy countries. "To achieve an upgrade, the new government would not only have to clearly explain how it wants to solve the problems of the Slovak economy, but also show that it is able to solve them and accomplish some genuine successes," he said. "And this will take some time."

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