EKIP– Expert Club for Economics and Politics A Different Opinion
A few days ago, the credit rating agency Fitch maintained the current assessment of Bulgaria's government debt, but adjusted the "outlook" downwards from "positive" to "stable". This means that Fitch does not believe that in the foreseeable future (most likely by the end of the year) there will be conditions for improving the categorization of Bulgaria's government debt. The question arises - is this downgrade of the outlook on Bulgaria's credit rating an important event?
In theory, a country's credit rating should be used as an indication by the market of how solvent the country is. Based on the credit rating assessment by rating agencies, investors assess whether a country's government debt is a reliable investment. The higher the rating, the more likely it is that the country will remain financially stable and meet its obligations. The problem is that this is often just a theory, and in practice the credit rating does not reflect the real financial condition and solvency of the country.
Credit agencies are often wrong
There are a number of examples of this during the Global Financial Crisis that occurred in 2008. For years, all major rating agencies assessed extremely risky and complex financial instruments backed by mortgages as practically risk-free, categorizing them as the highest quality debt. Subsequently, when the positive developments in the real economy reverse and incomes begin to deteriorate, it turns out that these financial instruments are actually extremely risky and lose all value, because the mortgages that form them become completely non-performing debt.
Ultimately, the rating agencies downgraded these types of instruments, but this only happened around 2010. The situation is "after the rain - hood". The job of the rating agencies is not to tell us that a given financial instrument is garbage when everyone already knows about it and no investor would even think of touching it. They should be the ones who first warn us about the risk of these financial instruments. They should be the ones who, years before the financial crisis, could predict that in the event of a reversal of macroeconomic trends, these instruments would only bring loss. But no, instead the rating agencies rate these instruments as if they carried almost no risk.
Alas, the rating agencies are not much better at assessing sovereign debt. In the period 2004-2009, the rating agencies categorized Greece's sovereign debt as level A. This is an upper-middle level, which is considered completely suitable for investment. Alas, in 2007, trusting this rating and investing in Greek debt was like buying a factory on September 8, 1944. Within the next 3 years, Greece became completely insolvent and began to seek financial assistance from the IMF and other eurozone member states. Subsequently, its credit rating was downgraded. But of course, this happened only when the whole world knew that the Greek state could not pay its debts.
After all, what is the point of rating agencies that cannot predict that a country may default within a few years? A credit rating is supposed to be an indicator of the future, of what we can expect to happen if we invest in the relevant debt (credit). But in reality, it turns out that a credit rating is more of a coincident or even lagging indicator, showing us what has already happened, e.g. that a country is already insolvent.
If you want a reliable indicator - follow the markets
Because of this unreliability of credit ratings, especially during economic crises, you should keep one thing in mind when reading news that a "prestigious" rating agency has upgraded or downgraded a country's rating. In recent years, Prime Minister Borisov has been very fond of bragging about Bulgaria having a "good" credit rating, but that in itself doesn't say much. As you can see, we could be insolvent tomorrow and the rating agencies would probably be among the last to know about it.
If you are interested in what investors really think about the quality of a country's debt...just look at what is happening in the financial markets. Bulgaria's real credit rating is expressed in the interest rates on its government debt. By comparing the interest rates on our government debt with that of an extremely financially stable and solvent country like Germany (the so-called "spread", i.e. the difference between the two), we can understand what investors really think about the quality of Bulgarian debt. This is a far more reliable indicator than the ratings of rating agencies, which in fact often adjust in response to the movement of interest rate spreads between bonds of different countries.
According to the latest data, after a significant jump in the middle of the month, the interest rate on 10-year government bonds of Bulgaria is 0.441%. The interest rate on 10-year bonds of Germany is -0.471. This means that the spread between the two is 0.912%. Exactly 3 months ago on 27.01, that is, before the start of the current crisis, the spread was 0.628%. If the difference between the higher interest rate on the Bulgarian debt and the lower interest rate on the German one has increased, this means that now, compared to 3 months ago, the market assesses the government debt of Bulgaria as riskier than that of Germany.
Don't overestimate the opinion of rating agencies
This shows us that even if the rating agencies do not significantly change the categorization of our debt, but only adjust the "outlook" on it, the markets react to the crisis situation that has formed. And they react through an outflow of investments in the debt of peripheral countries like Bulgaria and an influx of investments in the debt of central and more reliable countries like Germany. We are not alone here. If we look at what is happening with the spreads between the interest rates on the government debt of countries like Italy and Greece compared to Germany, we will see that the same thing is happening there, even to a greater extent.
It is for these reasons that the passionate hopes of some economists and politicians that Bulgaria's credit rating will be raised upon eventual accession to ERM-II are quite infantile. First, even if the rating is raised, as you should already be aware, this in itself means nothing. Second, now that we are already in a crisis, the rating agencies are unlikely to intend to raise anyone's rating in the foreseeable future. And third, it is difficult to justify such an increase, given that membership in ERM-II in itself does not bring any financial support, as we have already explained. Judging by history, if we have to bet, at the moment rating agencies like Fitch most likely overestimate the solvency of most European economies, including Bulgaria.
Keep one thing in mind about credit rating agencies, especially now that we are entering a crisis. History has shown that a credit rating is far from a very reliable indicator of a country's solvency and financial stability. In the end, a credit rating very often turns out to be just cosmetics. The real financial condition of a country is reflected in the movements of its public debt.
