Egalitarian: Federalism and the threat of a credit rating downgrade

Last month, Moody’s, one of the biggest credit rating agencies, warned that the possible shift to federalism could drag the country down. This is sending fears to economic managers.

Where are these fears coming from? Our dependence on global factors shows the nation’s susceptibility to global factors. Second, a credit rating downgrade will mean more expensive loans for the country.
A sovereign rating is given by credit rating agencies like S&P, Moody’s and Fitch. These credit agencies provide services of providing information on issuer’s ability (government) to meet debt obligations, and these agencies monitor the policies of the issuer (government) according to their expectations of political and regulatory risks which will affect the country’s loan default, and they will set the alarm to the international bond market by issuing a threat of downgrade.

Very recently, Moody’s issued threat of downgrade as it looks at federalism disrupting the fiscal stability and requirement of larger public expenditure. However, economists reveal that the ratings given by credit rating agencies aren’t the one-way lens, downgrades are not due to domestic politics alone.

Economists Rozada and Yeyati studied in 2006 the global factors that affect the emerging markets, which included the Philippines. Contrary to usual claim, even with improving macro fundamentals such as the prudent monetary response of Bangko Sentral amidst inflation and the improving debt-payments standing, the country needs “to account the exposure to global factors and devise mechanisms to reduce that exposure.”

To my mind, the unitary setup is an open claim that the country is wholly exposed to global factors which endanger our credit ratings all year round. Federalizing the country is a mechanism that reduces exposures to global factors. The rule of law and corruption are also used as barometers of a country’s credit worthiness. Look, the rule of law is never premium in unitary government, and corruption is widespread in this setup. So federalism, which is the exact opposite of unitary government addresses the rule of law and corruption.

In another 2014 study by Ruud Meeuwissen of Tilburg University in the Netherlands, he showed the impact of the sovereign credit rating on domestic loan supply in emerging markets like the Philippines.

The study found that banks generally won’t cut loans after a country receives a downgrade, although all of the banks will receive a credit downgrade after the sovereign rating downgrade. The banks usually won’t share the opinion of the credit rating agencies; banks keep on supplying loans though at a reduced amount. The banks know better the country than the credit raters.

A downgrade affects all banks rating but not the banks’ financial health. During these times also, banks will receive more money due to increasing demand for time deposits due to increasing interest rates.

With a lot of money available for loans, banks will be forced to be more prudent by improving their non-performing bank loans. Eventually, banks will shift supplying loans to consumers to Small and Medium Enterprises (SMEs) to reduce if not avoid loan defaults. The former is the common source of bad loans in developing countries. So, don’t worry much of the credit rating downgrade, there is always a better story of it, and those stories are dispassionate and also empirical.

Posted in Opinion