Ratings agency verdicts ‘help new members to reform’

Date: 25/11/04

By Pete Sweeney

THE opinion of the private risk-assessment industry, which grades economic performance and predicts risk for those investing in sovereign currencies, can apply economic and political pressure to the new member states.

Moody's, one of the largest ratings firms, believes that the agencies have a positive role to play yet admits that “reforms and restructuring also require painful changes that entail unpleasant social costs, such as temporary increases in unemployment”.

The economic consequences of a downgrade in the accession states may be over-amplified by investor nervousness and drastic capital flight.

In Do Credit Rating Agencies Add to the Dynamics of Emerging Market Crises? Roman Kräussl, of the Centre for Financial Studies in Frankfurt, claims that bad news has more market impact than good news. “The empirical results are significantly stronger in the case of government's downgrades than positive adjustments,” he writes.

Moritz Kraemer, Standard & Poor's (S&P) director for European sovereign credits, is bullish on the accession process. “It constrains governments,” he says, “which you may think is bad.”

But he adds that it diminishes the risk that a given government will go “walking off in the completely wrong direction”. Accession, he says, strengthens institutions and makes them more predictable.

Despite expressed concerns about “weakened fiscal discipline” in the accession countries, S&P is nevertheless upbeat on their prospects. The agency recently upgraded Slovenia and Estonia's ratings, and revised Poland's outlook from negative to stable.

A report by Moody's likewise argues that accession economies can be rated higher, simply because of accession. “Economic and social institutions should be strengthened through harmonization with those of the EU,” claims the report, allowing them to fend off destabilizing capital flows and consequently allowing Moody's to rate them “at a level that could be up to several notches higher than that indicated by

their fundamentals”.

But the influence of rating agencies raises concerns. When he was a Greek MEP, Giorgos Katiforis called the industry a “duopolistic” split between Moody's and S&P and, in a report to the European Commission, expressed concerns

about the “predominantly American character” of the two firms .

Katiforis also questioned the agencies' competence to assess European conditions and called for them to be regulated by the EU.

Article suggests that the opinion of the private risk-assessment industry, which grades economic performance and predicts risk for those investing in sovereign currencies, could apply economic and political pressure to the new Member States.

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