Reframing development and accountability: the influence of sovereign credit ratings on policy making in developing countries

Abstract

At a time of increased financial volatility, understanding ‘development’ requires that we trace spheres of accountability in order to detect the consequences of shifts in power structures from the public to the private sectors, especially. By focusing on the business of sovereign credit ratings, I argue that ratings have been particularly influential in this context not only because of their function as a benchmark for private investment, but because they now also enter into the calculations of policy makers in developing countries who are increasingly compelled to implement policies that reduce their countries' sovereign risk at possibly high costs for sustained economic growth. I explain that governments' eagerness to signal their potential as reliable capital recipients allows for credit ratings to become a powerful site of governance. This outcome is not justified by the quality of rating agencies' output, but by the subjective power of the notion of risk in a crisis prone environment that shifts accountability—through this disproportional influence of credit rating agencies—from the public to the private realm. The Argentine crisis of 2001 is presented here as a case study that illustrates these dynamics.

Notes

Giselle Datz is at the Center for Global Change and Governance, Rutgers University, 123 Washington Street, Suite 510, Newark, NJ 07102–1895, USA. Email: [email protected].

The author would like to thank Jo´zsef Bo¨ro¨cz for helpful comments on the first draft of this paper, which was presented at the Annual Meeting of the International Studies Association, Portland, Oregon, February 2003.

James Rosenau & Mary Durfee, Thinking Theory Thoroughly: Coherent Approaches to an Incoherent World, Oxford: Westview, 1995, p 48.

See James Rosenau, Along the Domestic–Foreign Frontier: Exploring Governance in a Turbulent World, Cambridge: Cambridge University Press, 1997.

Saskia Sassen, ‘Embedding the global in the national: implications for the role of the state’, in David Smith, Dorothy J Solinger & Steven C Topik (eds), States and Sovereignty in the Global Economy, London: Routledge, 1999, p 159.

Christian Barry, ‘The concept of accountability’, unpublished manuscript, 2002.

Ibid.

Saski Sassen, Losing Control?, New York: Columbia University Press, 1996.

Ibid.

Lynn Selhat, ‘How private financiers see development: high risk, high return’, oecd Observer, Winter 2000, 223, available online at: www.oecdoboserver.org.

Louis Pauly, Who Elected the Bankers? Surveillance and Control in the World Economy, Ithaca, NY: Cornell University Press, 1997, p 135. In fact, financial liberalisation was unequivocally a strategic move on the part of the USA. Wade explains that, at least since the Reagan administration, the US government has strongly believed that American financial interests would greatly benefit from freedom of capital movements, since it needs to tap into world's savings in order to make up for its limited savings capabilities. See Robert Wade, ‘The coming fight over capital flows’, Foreign Policy, Winter, 1999, pp 41–53.

Robert Gilpin, The Challenge of Global Capitalism: The World Economy in the 21st Century, Princeton: Princeton University Press, 2000.

Paul Krugman, ‘Dutch tulips and emerging markets’, Foreign Affairs, 74 (4), 1995, pp 28–44.

Friedrich Ebert Foundation, ‘Credit ratings and emerging economies: building confidence in the process of globalization’, paper produced for Studies on the International Financial Architecture, 1999, mimeo.

Roberto Chang & Giovanni Majnoni, ‘International contagion: implications for policy’, paper prepared in 1999 for the World Bank conference on ‘Contagion: How can it be stopped?’, held Washington, DC, 3–4 February 2000, p 21.

Friedrich Ebert Foudation, ‘Credit ratings and emerging economies’.

Rowena Olegario, ‘Credit reporting agencies: the historical roots, current status, and role in market development’, unpublished manuscript, University of Michigan Business School, 2000.

Ibid.

Lawrence J White, ‘The credit rating industry: an industrial organization analysis’, unpublished manuscript, 2001.

Moody's was recently made a stand-alone company by parent Dun and Bradstreet, while s&p is a subsidiary of the publishing company, McGraw-Hill. Timothy Sinclair & David King, ‘Grasping at straws: a ratings downgrade for the emerging international architecture’, cscr Working Paper 82/01, November 2001.

Fitch ibca, or Fitch Ratings, is the culmination of recent mergers among Fitch Investors Services (New York), ibca (London), Euronotation (Paris), Duff & Phelps (Chicago) and Thomson BankWatch (New York). Timothy Sinclair, ‘The infrastructure of global governance: quasi-regulatory mechanisms and the new global finance’, Global Governance, 7 (4), 2001, pp 441–452.

Olegario, ‘Credit reporting agencies’.

Sinclair, ‘The infrastructure of global governance’.

Olegario, ‘Credit reporting agencies’.

White, ‘The credit rating industry’.

Steven Schwarcz, ‘Private ordering of public markets: the rating agency paradox’, University of Illinois Law Review, I, 2002, available online at: http://ssrn.com/abstract=267273.

Even the US Treasury bond yields, a benchmark for the rates of interest paid on other sovereign bonds, have been known to fluctuate when rating agencies voiced concern about fiscal imbalances or the ability of the USA to finance its huge current account deficit. Friedrich Ebert Foundation, ‘Credit ratings and emerging economies’.

A good part of this money goes to the operational activities of these firms, equally not modest. Moody's has 1500 employees, including 700 analysts, s&p operates in more than 86 countries and has offices in 16 of these, and Fitch works with 75 countries, with offices in 16 of these as well. Moreover, Moody's currently has 4000 clients for its publications and estimates that at least 30 000 people read its output regularly. The annual fees this firm charges range from $15 000 to $65 0000 for heavier users, who also have the opportunity to talk to analysts. This is not to mention the fees they charge to bond issuers. Sinclair explains that it has been argued by a number of scholars that charging fees to bond issuers constitutes a conflict of interest. This may be the case for smaller firms. According to Sinclair, with Moody's and s&p this seems not to be a significant concern because both firms have incomes of several hundred million dollars a year, ‘making it difficult for even the largest [corporate] issuer to manipulate them through their revenues’. Sinclair, ‘The infrastructure of global governance’, p 10.

White, ‘The credit rating industry’, p 18.

Ibid, p 22. Rating agencies such as s&p claim that appraisal of each sovereign's overall credit worthiness is both qualitative and quantitative. The quantitative aspects of the analysis incorporate a number of measures of economic and financial performance and contingent liabilities, although judging the integrity of the data is a more qualitative matter. The analysis is also qualitative ‘due to the importance of political and policy developments and because s&p’s ratings indicate future debt service capacity'. In fact, s&p divides the analytical framework for sovereigns into 10 categories. Each sovereign is rated on a scale from 1 (the best) to 6 for each of the 10 analytical categories. There is no exact formula for combining the scores to determine ratings. The analytical variables are interrelated and the weights are not fixed, either across sovereign or over time. Most categories incorporate both economic and political risk, the key determinants of credit risk. ‘Economic risk’ addresses the government's ability to repay its obligations on time and is a function of both quantitative and qualitative factors. ‘Political risk’ addresses the sovereign's willingness to repay debt. David Beers, Marie Cavanaugh & Takahira Ogawa, Sovereign Credit Ratings: A Primer, New York: Standard & Poor's, 2002.

Ibid.

Ibid.

See Olegario, ‘Credit reporting agencies’; and Frank Partnoy, ‘The Siskel and Ebert of financial markets? Two thumbs down for the credit rating agencies’, Washington University Law Quarterly, 77 (3), 1999, pp619–715.

Carmen Reinhart, ‘Default, currency crises, and sovereign credit ratings’, unpublished manuscript, University of Maryland, 2002, p 21.

This pro-cyclical behaviour of credit rating agencies was detected in Reisen and von Maltzan's study and confirmed also by a broader analysis of the behaviour of credit ratings and financial crises conducted by Kraussl. H Reisen & J von Maltzan, ‘Boom and bust and sovereign ratings’, International Finance, 2 (2), 1999 273–293; and Roman Kraussl, ‘Do credit rating agencies add to the dynamics of emerging market crises?’, cfs Working Paper 2003/18.

Sassen, Losing Control?.

James Rosenau, ‘Governance, order and change in world politics’, in James Rosenau & Ernst-Otto Czempiel (eds), Governance without Government: Order and Change in World Politics, Cambridge: Cambridge University Press, 1992.

Sinclair & King, ‘Grasping at straws’, p 4.

Ibid.

Ibid.

Arturo Escobar, Encountering Development: The Making and Unmaking of the Third World, Princeton, NJ: Princeton University Press, 1995.

Colin Powell, Remarks at the Sovereign Credit Rating Conference, US Department of State, 23 April 2002, at www.state.gov/secretary/rm/2002/9634.htm, emphasis added.

Dani Rodrik, ‘Promises, promises: credible policy reform via signalling’, The Economic Journal, 99, 1989, p 158, emphasis as in the original. In his article, Rodrik focuses on trade reform particularly. However, it is credible that the argument should hold for other components of neoliberal reform—among them, of interest here, the element of financial and monetary reform towards deregulation, and market-based approaches to monetary policy.

Illene Grabel, ‘The political economy of policy credibility: the new–classical macroeconomics and the remaking of emerging economies’, Working Paper Series 269, Kellogg Institute for International Studies, University of Notre Dame, 1999.

Ibid, p 6.

Ibid, p 7.

Michael Mussa, Argentina and the Fund: From Triumph to Tragedy, Washington, DC: Institute for International Economics, 2002; and Anne Krueger, ‘Crisis prevention and resolution: lessons from Argentina’, NBER conference on the ‘Argentine Crisis’, July 2002, available online at: www.imf.org/ external/np/speeches/2002/071702.htm.

Alan B Cibilis, Mark Weisbrot & Debayani Kar, ‘Argentina since default’, Briefing Paper, Center for Economic and Policy Research, Washington, DC, 3 September 2002, at http://www.cepr.net/argentina_since_default.htm.

Paul Krugman, ‘Argentina’s crisis is a US failure', New York Times, 2 January 2002.

Dani Rodrik, ‘Reform in Argentina, take two: trade rout’, New Republic, 14 January 2002.

See Miguel Kiguel, ‘The Argentine currency board’, CEMA Working Papers 152, 1999.

Rodrik, ‘Reform in Argentina, take two’.

For an account of the experience of Argentina during the spill-over of the Mexican crisis, see Eduardo J Ganapolsky & Sergio L Schmukler, ‘Crisis management in capital markets: the impact of Argentine policy during the Tequila effect’, unpublished manuscript, World Bank, 1995. Eight days after the Mexican devaluation on 20 December 1994, the Argentine central bank lost $353 million in reserves (the largest amount since the currency board was established). Three months later the loss of reserves amounted to more than one-third of the total before the Mexican crisis. A series of prompt and effective policies was carried out to counteract the massive outflows of capital, including the relaxing of stipulations of reserve requirement on US dollar deposits; the dollarisation of central bank deposits; the establishment of a fund by the central bank to help institutions by purchasing their non-performing loans; the announcement of a new agreement with the imf allowing the Argentine government to gain access to roughly $7 billion, among other technically effective measures. Ganapolsky & Schmukler, ‘Crisis management in capital markets’.

Ricardo Hausmann & Andres Velasco, ‘The Argentine collapse: hard money’s soft underbelly', paper prepared for the Brookings Trade Forum, July 2002, p 4.

Whereas in 1992 Argentine debt amounted to $62 billion, in 1998 it was a staggering $142 billion. Hausmann & Velasco, ‘The Argentine collapse’.

Michael Mussa, Argentina and the Fund; and Paul Krugman, ‘Argentina’s crisis is a US failure'.

Krueger, ‘Crisis prevention and resolution: lessons from Argentina’, 2002c.

‘Now, Argentina’s default looks inevitable', Business Week, 21 October 2001.

Krueger, ‘Crisis prevention and resolution: lessons from Argentina’, 2002c.

Ibid.

Andres Gaudin, ‘Thirteen days that shook Argentina—and now what?’, nacla Report on the Americas, XXXV (5), 2002.

Rodrik, ‘Can integration into the world economy substitute for a development strategy?’ Cambridge: Harvard University.