Moody’s analyst Gabriel Torres penned a nice report on the impact of the global financial crisis on the 27 sovereign nations his firm assigns credit ratings to in Latin America and the Caribbean (email me for a copy — [email protected]). He joined two of his colleagues in an informative conference call today to discuss the report and respond to investors’ questions. Moody’s takes a relatively benign view of the impact of the global financial crisis in the region, though the global rating agency believes Mexico, due to its integration with the US economy and its structural weaknesses, remains most vulnerable to deterioration and a possible downgrade.
Torres outlined four channels by which emerging market countries are affected by the global crisis: remittances (cash sent home by nationals working overseas), exports, capital inflows, and commodity prices. While countries in the region have been negatively impacted through all four channels, Mexico has been hit hardest. Most other countries, notably Brazil and Peru, have been in a relatively strong position to sustain the shocks. Ironically, Latin America is best-prepared for the planet’s worse financial crisis in years (with generally high levels of foreign exchange reserves, reaped during the boom in commodity prices earlier this decade). Rising interest rates and recession in the developed world in the eighties and nineties toppled many Latin countries; however, the strides made in improving public finances, floating exchange rates, and cleaning up banks have made America’s partners in the western hemisphere more resilient to handle this crisis. Of note was the point Torres made that, if their benign view is wrong over the next 18 months, it will be because of problems in the banks that are not apparent today.
Moody’s reports that, since the onset of the crisis, Latin American and Caribbean sovereigns sustained negative rating actions in only 5 out of 27 cases, versus 12 out of 21 in Eastern Europe. Similar trends can be found at the other major rating agencies (S&P and Fitch). See Moody’s Sovereign Ratings. This is partly due to the fact that the rating agencies may have over-rated Eastern Europe (brushing aside gaping current account deficits because they were financed by FDI) and under-rated Latin America (over-weighting the region’s poor credit history and discounting its burgeoning fx reserves).
Finally, ratings are notoriously sticky. This has been part of the criticism leveled at the agencies for rating real estate transactions too high (some of them AAA). Because of all the notches in the ratings scale and the inability to take a binary or at least a less “granular” view of risks, agency analysts have a hard time changing a view dramatically on a country (or any other credit) in a short time frame. In short, the rating agencies are not nimble. They are prisoners of their ratings scale. See an Economist article on the agencies and a Reuters article on Goldman’s new product that bypasses credit ratings.
Hence, although Mexico is on a deteriorating trend — it is running out of oil, which represents about a third of government revenue, and politicians won’t liberalize the energy sector or widen the tax base — and Brazil is on an improving trend — it has become a net oil exporter and has very strong fx reserves, the former is rated Baa1, fully three notches above the latter, at Ba1. Rapid downgrades and rapid upgrades are not possible at a rating agency – until, of course, it is too late — because what does that mean? It means the analyst was wrong.
