Friday, 24 April 2009

The inter-generational dimension to a AAA rating

A rather interesting rivalry is emerging between two of London's financial journals regarding the possibility that the UK might lose its AAA rating.

The Daily Telegraph carries a , story which carries the headline Borrowing puts UK's AAA rating in danger after Budget 2009

The article goes on to quote Arnaud Mares, who according to the article is lead analyst at Moody's for the UK:
Treasury projections that public sector net borrowing will remain above 5pc of GDP five years from now... are a cause for concern. This suggests that fiscal policy will have to be tightened much further than currently envisaged. The alternative would be that the Government chooses to live with a permanently higher debt burden which would likely have rating implications over time.
From this and other comments the Telegraph article gives the distinct impression that the AAA rating is looking vulnerable.

Meanwhile an article at FT Alphaville decides to upstage the Telegraph reporter by going to the previously quoted Moody's analyst's boss . Here is what the FT reporter Sam Jones claims Moody's really thinks about the possible downgrade
And as Pierre Cailleteau, Team MD of Moody’s sovereign risk group, and Mares’ boss, says, safe havens’ triple-A status, “depends on two potentially unstable notions: continued public trust in government institutions, including the currency, and sustained inter-generational solidarity mechanisms.”It is the latter of these that gives the US, Germany, Japan and the UK such huge room for manoeuvre. Sovereign credit risks are predicated on a whole series of qualitative as well as quantitative judgements about the strength, age, and “institutionalisation” of a country’s financial practices. That we have an age-old central banking system, a set of (mostly) sound checks and balances and a very secure financial infrastructure means that, in the top rating agencies’ views, the UK, like Germany or Japan, is well positioned relative to more politically and economically fragile peers
So it appears from the FT article and the fact that the source quoted is higher up the totem pole than the more modestly positioned Mr Mares that all is relatively safe for the UK's AAA rating.

That should be the end of the matter then. Well perhaps not.

The most intriguing comment as far as the MD of the sovereign risk group at Moody's is the notion that the UK has a "sustained inter-generational solidarity mechanism" and this should enable the UK to avoid even the tiniest risk of sovereign default - which presumably is what a re-affirmation of the AAA rating would imply. I have no idea what a sustained inter-generational solidarity mechanism actually means other than the rather stuffy and complacent notion that just like corporates, some countries are just too established to ever have problems repaying their debts. And as we all know Moody's and S&P have been very good at always getting those calls right in the corporate space.

In addition to the FT and Telegraph trying to decode what Moody's really thinks about all of this there is another amusing dimension to this story from Willem Buiter at his blogsite. Under the headline Darling is doing his best to clean up Brown’s mess Buiter, who is a Professor of Economics at the LSE, provides a good account of the dire state of the public finances in the UK and suggests that it "would behove the UK to apply for an IMF Flexible Credit Line (FCL)."
Alas it seems that the UK would not qualify for one for the following reasons:

Unfortunately, the criteria for qualifying for an FCL arrangement include “ . . . (iv) a reserve position that is relatively comfortable . . . ; (v) sound public finances, including a sustainable public debt position; . . . (vii) the absence of bank solvency problems that pose an immediate threat of a systemic banking crisis; (viii) effective financial sector supervision.” It is questionable whether criteria (iv) and (v) are met. Criteria (vii) and (viii) are obviously not met.

It would appear then that the UK is unable to meet the criteria for the kind of aid from the IMF which is usually made available to emerging and less established economies, and yet, according to the wonderful piece of waffle about "inter-generational solidarity mechanisms", it may still be considered safe enough for a AAA rating from Moody's.

There is certainly an "inter-generational" aspect to the UK's financial position but unfortunately it is the fact that the current malaise is likely to still be with the present generation's grandchildren.

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