"Regardless of what our national credit rating is, people will always want a roof over their heads, food on their tables, fuel for their cars and clothes on their backs."
- Robert Kiyosaki
In December 2016, Standard & Poor's Global Ratings revised the outlook on its long-term rating on the Commonwealth of The Bahamas to BB+ (speculative or "junk" grade) from BBB- (investment grade). S&P stated that this rating downgrade was based on its projection that the Bahamian economy will grow at a much slower rate than was previously anticipated only eight months earlier.
This is the first time that The Bahamas received such a rating ("junk status") from an internationally recognized ratings agency. Therefore, this week, we would like to Consider This... Why was The Bahamas downgraded, and what does it mean for the country and its citizens?
In part one of the series, we will examine the major ratings agencies, how sovereign ratings are calculated, what Standard & Poor's said and what the downgrade means for The Bahamas.
The ratings agencies
Ratings agencies are independent institutions that assess the financial strength of companies and governments, particularly their ability to meet their financial obligations. They carefully study the terms and conditions of each specific debt issue and the fiscal and social developments of independent countries and rate them, reflecting the agency's degree of confidence that the borrower will be able to meet its promised payments of interest and principal as scheduled.
There are three major ratings agencies that rate company and governmental (sovereign) debt: Standard & Poor's, Moody's Investors Service and Fitch Ratings. These companies were established in 1860, 1900 and 1913, respectively. These three major ratings agencies collectively earn 95 percent of the revenue in this sector, which accounts for their enormous clout relative to other agencies. Ratings offered by these agencies affect the response of investors in capital markets and influence decisions about investing in countries with poor ratings.
How sovereign ratings are calculated
Ratings agencies use a variety of quantitative and qualitative methods to calculate sovereign ratings. In a paper entitled "Determinants and Impact of Sovereign Credit Ratings", Richard Cantor and Frank Packer narrowed the process down to six critical factors that explain more than 90 percent of sovereign credit ratings:
o Per capita income is important because a larger tax base increases a government's ability to repay debt, while it can also serve as a proxy for a country's political stability.
o Strong GDP growth makes a country's existing debt easier to service over time, since that growth typically results in higher tax revenues and an improved fiscal balance.
o High inflation can not only signal problems with a country's finances, but also cause political instability over time.
o A country's external debt can be a problem if it becomes unmanageable.
o Countries with a history of defaulting are perceived to have a higher credit risk.
o More economically developed countries are seen less likely to default.
What did Standard & Poor's say in 2016?
In issuing its report last month, S&P asserted that The Bahamas' downgrade resulted from several key factors:
o The country's weaker economic growth, which is now pegged at 0.3 percent is significantly lower than its 1.2 percent estimate earlier in the year. S&P noted: "We believe that this lower growth trend will challenge the government's ability to meet its fiscal projections, likely resulting in rising debt.
"The erosion of The Bahamas' creditworthiness reflects these growing vulnerabilities within a context of a weak external position with growing levels of external debt, double-digit unemployment, high non-performing loans in the banking system and high household indebtedness".
o The slower pace of fiscal consolidation, which is exacerbated by continued fiscal deficits, increased national debt and infinitesimal improvements in government's excessive expenditures. S&P also noted that government spending is outpacing revenues, despite the introduction of value-added taxes, and increased expenditures that will result from the restoration efforts related to Hurricane Matthew;
o A reduction in the nation's gross domestic product (GDP) will further negatively affect the government's tax revenues and fiscal consolidation plans. GDP will also be adversely impacted by the delay in the opening of Baha Mar, which was anticipated to significantly improve the macroeconomy. S&P noted: "We believe that it will take time before the resort is able to operate at full capacity."
o Notwithstanding S&P's downgrade, the rating agency decided to place
a "stable" outlook on The Bahamas and its credit rating, essentially implying that, barring major negative shocks to the economy, no further downgrades are likely over the next two years.
o It should also be noted that Moody's, the other leading rating agency, is keeping The Bahamas at "investment grade", suggesting a more relaxed perspective on Baha Mar and the Christie administration's fiscal consolidation efforts.
What does this mean for The Bahamas?
S&P's downgrade is potentially highly damaging for the nation and its economy because it signals to the international capital markets that the creditworthiness of The Bahamas is slipping into dangerous territory. There are two immediate possible consequences of the downgrade.
First, a ratings downgrade will affect the government's ability to borrow in the international financial markets and the cost of such borrowings will be higher than it presently is. This could seriously impair the government's ability to achieve its legislative and social agendas, because the government will likely have to pay more for current and future debt issues, raising its debt servicing or interest costs, which could divert money from essential public and social services. We should remember that the government has very little discretionary income available to implement its agenda.
In order to defray the essential costs of governance, in light of these developments, the government will likely incur even greater deficits, which could result in even higher levels of borrowing at a higher cost.
Secondly, a ratings downgrade could severely impact foreign direct investment in The Bahamas. Foreign investors often refer to sovereign debt ratings before making investments in a country because it provides a barometer of the stability of their investment. In addition, foreign companies that operate in The Bahamas could face higher interest on their debt if the lenders of those companies perceive that there is greater risk of such companies' capacity to repay their debts to their foreign lenders. Furthermore, if The Bahamas has a favorable sovereign rating, investors will be more inclined to invest. Unfortunately, if that rating is not favorable, investors may go elsewhere. Because of our historical dependence on direct foreign investment to fuel our economy, the downgrade could stifle prospective investments here.
Conclusion
The challenge before us is how the government will address the systemic weaknesses that plague us, and the proactive measures that will be implemented to ameliorate these systemic weaknesses that contributed to the downgrade.
In part two of this series we will address the government's response to the S&P downgrade and what proactive measures can be taken to reverse the factors that got us to this point.
o Philip C. Galanis is the managing partner of HLB Galanis and Co., Chartered Accountants, Forensic & Litigation Support Services. He served 15 years in Parliament. Please send your comments to pgalanis@gmail.com.
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