THE DECISION by Moody’s, a credit rating agency, to downgrade marginally Ireland’s sovereign debt rating, while unwelcome, is scarcely surprising. It brings Moody’s into line with credit assessments made by one of the other main rating agencies, Standard Poor’s. A Moody’s analyst said yesterday that its rating decision was primarily driven by the weak state of the public finances, where debt levels have spiralled since 2007.
The large budget deficits of recent years have increased the State’s debt burden, and involved higher borrowing costs. Last year the debt interest bill was €2.5 billion, or 8 per cent of total tax revenue – some €1 billion higher than in 2008. Moody’s estimates the general government debt-to-GDP ratio should stabilise by 2013 at close to 100 per cent, having risen from 25 per cent before the onset of the financial crisis.
Yesterday, Irish bond prices fell after the credit rating downgrade, and the spread between Irish and German 10-year debt again widened, reflecting the higher risk premium – almost three 3 percentage points – demanded by investors. A major investor worry is uncertainty surrounding the ultimate cost to the State of restructuring the banking system. An offsetting consolation to Moody’s credit rating cut is the agency’s positive reassessment of the medium-term outlook, from “negative” to “stable”. This reflects the agency’s belief that Ireland has “turned the corner” and is well placed to benefit from a global economic recovery.
Decisions made by credit ratings agencies still have the power to move markets and change investor sentiment. But, as the subprime mortgage crisis in America highlighted, the business model the major rating agencies used there involved them in major conflicts of interests. In recent years in the US, debt issuers – rather than investors – paid the credit rating agencies to rate their products. And banks, having first paid the agencies for consultancy advice on financial products, later paid the agencies to rate those securities. European Commission president José Manuel Barroso has been strongly critical of how credit rating agencies disregarded European support when assessing Greece’s financial health.
From next year, the European Union will regulate the operation of credit rating agencies – including European subsidiaries of the major US companies. That should provide closer supervision of their activities, and perhaps more much-needed clarity on how they evaluate government debt.