GLOBAL SALON
Global Finance sat down with Fergus McCormick, head of sovereign ratings at DBRS, to discuss the rating agency’s outlook for global markets, sovereign ratings and how the firm differs from its competitors.
Global Finance: What makes up a sovereign rating?
Fergus McCormick: With sovereign ratings we are trying to assess a government’s ability and willingness to repay debt that is held by the private sector. We spend hundreds of hours looking at measures such as the average duration of debt, its composition, and talking to treasuries, finance ministries and large investors.
The interesting thing is that about a dozen indicators will give you 90% of what a rating is, while the remaining 10% is extremely difficult to evaluate. That remaining 10% is, for us, linked to an understanding of what is going on in the country at stake. To do this right, we spend hundreds of thousands of dollars going to these countries every year, and get in front of key policymakers to try to understand the thinking behind the policies. This is no small task.
GF: How are your ratings different from those of the other three major rating agencies (Moody’s, S&P and Fitch)?
McCormick: Our global approach to rating sovereign governments is to rate through the economic cycle. We are trying to look beyond the economic cycle, spending more time on the underlying structural criteria, linking the rating to our perception of debt sustainability. You simply cannot upgrade the ratings when GDP goes up and downgrade them when it goes down. Our ratings came down during the euro crisis, but they shifted less in comparison to those of our competitors for countries such as Ireland—(rated A low), Italy (A low) Portugal (BBB low), and Spain (A low). For our ratings it is very important to determine when the debt-to-GDP ratio will stabilize.
These elements of our methodology should help market participants to understand both why we did not downgrade countries as much as the other rating agencies when the euro crisis hit and why we have not upgraded these countries more recently. What we are looking for now is greater clarity on the growth outlook for these countries.
GF: What is the economic outlook for Europe?
McCormick: Growth has returned to Europe, but we do not know how sustainable it is. We have no previous patterns to study because we have never been in a sequential crisis [following right upon the heels of another] such as the euro crisis.
In our ratings universe, Italy, Spain, Portugal and Greece are our main concern. As they are highly indebted and important to the euro area, they pose a risk to the stability of Europe, although this risk is now declining. Since mid-2013 we have seen some economic growth, which has largely been the result of growth in net exports. Exports are now slowing down, while domestic demand is starting to pick up, mainly in the form of rising capacity utilization. However, private consumption is still lagging. Furthermore, now that fiscal deficits are at a more sustainable level, the pace of fiscal adjustment has slowed, and this is causing less of a drag on growth. But all in all, the medium-term perspective is less clear.
GF: What is your current view of the US economy?
McCormick: The United States is currently leading the global recovery. In fact, it is difficult to reconcile the pace of growth with the fiscal adjustment undertaken. Given the draconian fiscal adjustment that the U.S. has implemented, mainly with the automatic spending cuts known as the sequester, no one expected such a strong growth rate as what we are experiencing now. Unemployment is going down, and there is a good net creation of employment. We rated the United States triple A stable until the last debt ceiling debate, when we placed the ratings under review with negative implications. But now it is back to stable. We have held it at AAA all the way through the crisis because we were confident the Treasury would surely have stayed current on its debt payments.
